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Currency in Circulation

By: Punam Sharma

Currency in Circulation
 

  • Currency in circulation refers to all bank notes and coins in the economy.
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  • In India, RBI manages currency as part of its role as the central bank of India
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Currency in Circulation snap shot
 
Currency in Circulation snap shot
 

  • Charts below show trend of currency in circulation over the years, value and volume data of banknotes for FY2013.

 
Currency in Circulation
 
Volume of banknotes in circulation
 

  • Currency in circulation FY13 is around 11,909bn of which notes in circulation account for around 99%.FY14 till 10th Jan 2014, currency in circulation is around 12,766bn.
  • FY13, growth in value of banknotes was around 11.6% which outpaced its volume growth of around 6%.
  • Banknotes of denominations of 500 &1000 accounts for around 83% of total value of banknotes in circulation while banknote of denomination of 10 accounts for the highest volume of banknote in circulation at around 34%.
  • Every year, on an average of around 20% of banknotes in circulation is withdrawn as soiled banknotes.
  • FY13, around 14.1bn pieces of soiled banknotes were removed from circulation.

 
What is demonetization of currency?
 

  • Demonetization of currency refers to withdrawal of the currency from circulation and ceasing to be a legal tender.
  • In India, demonetizations of banknotes have taken place twice.
  • 1000 and 10,000 banknotes were demonetized in January 1946 and 1000, 5000 and 10,000 banknotes which were reintroduced in 1954 were demonetized in January 1978.
  • As per the RBI notification on 22nd January 2014, all pre 2005 notes will be withdrawn from circulation and not demonetized as they continue to be a legal tender.

 
Timeline of Indian Banknotes

 

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Types of Leverage
 

  • A company is said to be leveraged1 if it has fixed cost (operating leverage) or debt (financial leverage).
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Operating Leverage
 

  • A company which has fixed costs in its operations is said to have operating leverage.
  • Operating leverage reflects effect of fixed cost on a company’s operating profits.
  • Higher the ratio of fixed cost to variable cost, higher is the operating leverage.
  • For operating leverage companies, a small change in sales will result in large change in its operating profit.
  • These companies tend to make higher profits when sales are increasing and more losses when sales are decreasing.
  • Companies with operating leverage benefit with increase in their sales which can be because of better capacity utilization, product mix, price increase.
  • Chart below graphically shows an example of how a company with better capacity utilization, generates higher profits.
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  • From above chart, we can see that a company starts making profits after it reaches it breakeven point i.e. when sales = costs.
  • Increase in capacity utilization (above 80 units) magnifies profit. With increase in units produced, fixed cost per unit remains same and only variable cost per unit increases thereby generating huge gains.
  • Small incremental change in sale units, from 80 units to producing 110 units multiplies the profit by 2 times and producing 170 units multiply company profit by 8 times.
  • We can see how a company with operating leverage benefits with better capacity utilization as incremental sales tends to absorb fixed costs resulting in higher profits.
  • Similarly, a company can benefit from operating leverage by increasing selling price or adding product mix as with same amount of cost per unit, profits can multiply.

 
Financial Leverage
 

  • Company which has debt in its capital structure is said to have financial leverage.
  • Higher the debt in the capital structure, higher is the financial leverage.
  • Debt does not impact company sales or operating profit but impacts bottom line profits and EPS2 as company has to pay interest.
  • Companies with financial leverage benefit when interest rates fall as with lower interest out go, profits multiply increasing EPS.

 

Operating and Financial Leverage snap shot

 

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Leverage – IDFC MF

By: Punam Sharma

Leverage
 

  • Every company goes through a business cycle which is a reflection of the economy.
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Business Cycle
 

  • Business cycle can be characterized by different phases of economic cycle-expansion, recession recovery.

 

 
Profit = Income (Sales) – Expense (Costs)
 

  • A company’s sale depends on demand and production of its products, which will have a direct impact on its profits.
  • Rate of increase/decrease of profits are not in line with rate of increase/decrease of its sales.
  • Profit a company makes varies from its sales on account of various costs it incurs.
  • Company cost can be classified into variable and fixed cost.
  • Fixed cost are cost which do not vary with sales. Irrespective of sales, these costs are incurred by the company. It includes rent, cost on plant and machinery, depreciation, insurance, salary etc.
  • Variable costs are directly related to sales and include cost on raw materials, utilities etc.
  • The allocation towards various cost by the company has a huge impact on is profitability.
  • Table below shows hypothetical example of two companies having different allocation towards fixed and variable cost and its impact on their profitability during different phases of a business cycle.

 

 

  • We can see that during growth phase, company B with higher fixed cost witnesses 7x increase its profits as compared to company A.
  • Company B has been able to increase its profit as with incremental sales, fixed cost does not increase and with same amount of cost it can produce more.
  • Also, company’s profit can be impacted by amount of debt it has. In a growing economy, companies tend to increase their production capacity leading them to borrow capital as interest rates are generally low.
  • Table below shows hypothetical example of two companies having different amount of debt and its impact on profit during different business cycles1 .

 

 

  • Generally, interest rates tend to be higher in a slowdown phase of the economy and tend to ease as the economy graduates into an expansionary cycle.
  • We can see that during growth phase, company A with higher debt sees 8.8 x increases in its profits as compared to company B.
  • Company A benefits from lower interest rate cycle when economy is growing, thereby increasing it profits.
  • From both the above hypothetical examples, we can see that how a company uses its resources to make higher gains. This concept is known as leverage.
  • Leverage is a technique a company uses to aid profit growth either by addition of fixed costs or raising borrowing limit (debt).
  • The benefit of leverage comes into play when the economy starts recovering.

 

 

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