Re: Havells 1:1 Bonus
Agilent said:
JDM
That statement is conceptually flawed, my friend, and can mislead learners.
Expansion, capex, acquisitions (all examples of fresh asset buildups) are NOT 'financed' through deployment of reserves (liabilities in the B/Sheet), but by redeployment of other assets OR by raising of fresh liabilities.
Think about it : if what u say (red above) is true, then u imply that a co's reserves get depleted (i.e. liabs get reduced) when it embarks on expansion (i.e. assets enlarge). If that is so, how will the balance sheet balance ?
Don't even attempt to solve this riddle ? Pl try understand that Reserves. in accounting parlance, is totally different from Reserves in common usage. The latter connotates 'cash' or assets, whereas Resreves in the B/Sheet appear in the networth section and are liabilities, and have no cash connotation whatsoever.
This concept is not at all conceptually flawed neither it's mis-leading. It can be mis-leading only to a person who is not seeing it from a 360 degree angle but it won't be mis-leading to a person who knows the matter or who does not know it at all.
Please try to co-relate profit & loss account with Cash Flow Statement. What happens when a profit arises in the books?? Except to some minor adjustments which are wrikled out in the long term, some assets are created which most probably will be Cash & Debtors. If the company has same Debtor Turnover as was in the previous financial year there will be an increase in Cash Balance due to Profit made by the company. Similarly, if the debtor turnover is same as compared with that for the peer companies, a company earning more profit will certainly have more cash.
Now how that cash is to be utilized?? That cash can be distributed among the shareholders as dividend, can be used in generating fixed assets,i.e., enhancing capacity or simply may be used as war-chest for inorganic growth via mergers and acquisitions.
So, its not conceptually flawed to say that reserves are used for expansion, etc. Bonus issue is one way of utilization of reserves without touching the cash as it's a simple book entry. At the other hand, there are use of cash which does not touch the reserves at all. For example, purchase of Fixed Assets like Plant & Machinery etc. Finally, there are some transaction which cause chage in both cash and reserves, e.g., amalgamation in the nature of purchase in which case identity of the reserves except statutory reserves is not preserved.
Thus, while a huge reserve in itself will not translate into huge cash reserves as the reserves of previous years might have been used in expansion and thus might have resulted into depletion of cash balance, an increase in reserves during a certain period will most certainly translate into an increase in cash balance unless & until there have been huge debtors outstanding (usually not a case in sound businesses) or the cash had been used into expansion.
Also : 'bonus' issues as they are termed in India convey a false image of a 'gift' to shareholders , somewhat akin to a Diwali 'bonus' or a salary 'bonus'. In USA it is termed a stock split. While it is true that bonus issues are generally bullish for the share price, remember they are totally neutral to shareholder value since the the enlargement in floating stock (and in individual shareholding) is arithmetically neutralised by the proportionate fall in stock price (ex-B).
Suggest u read this for a better understanding
http://www.investopedia.com/articles/01/072501.asp
Also, its interesting to read the US SEC's definition of stock split
http://www.sec.gov/answers/stocksplit.htm
Happy to clarify further
AGILENT
PS By the way, what we call a 1:1 bonus in India will be called a 2 for 1 split in US
Well, Bonus are different from Split so far as face value is concerned. In a 2:1split, the face value of a Rs. 10 share quoting into market at Rs. 100 will be changed as a share with face value of Rs. 5 quoting into market at Rs. 50. At the other end, in case of a bonus issue of 1:1, the same share with Rs. 10 face value quoting into market at Rs. 100 will be changed to a Rs. 10 share quoting into the market @ Rs. 50.
Further, a stock split does not affect the Balance Sheet of a company while a Bonus issue affects the balance sheet as the reserves diminish while share capital increases.
Bonus issues are also known as "Scrip issue" or "Capitalization Issue" and are different from Stock Split. There is no need to be confused on this matter.
While Bonus issue is a mean of distributing historic reserves to the shareholdres and are really akin to diwali bonus, stock split does not involve distribution of reserves to the shareholders.
Also, what we call bonus issue in India is not called a stock split anywhere in the world. The confusion arises due to some mis-informations available on the net. Sites like mootley fool (a respected site anyway) say that bonus issue is known as stock split in the USA. But the appropriate word for Bonus Issue in the USA is "Stock Dividend" and not "Stock Split"
As can be seen from the discussion above, there are inherent differences between Bonus Issue & Stock Split. It also has impact in future. As the Book value of a shares is increased permanently due to bonus issue, the management needs to work hard to generate more profit in future so as to provide the same rate of return to the shareholders as it was doing pre-bonus issue. In simple words, to maintain the same rate of dividend, they need to generate more profits while same is not the case with stock split. Stock split are the way to generate liquidity while the bonus issue's objective is to reward shareholders which serves the purpose of stock split as well.
Agilent,
From the same source only:
http://www.investopedia.com/terms/s/stocksplit.asp
http://www.investopedia.com/terms/b/bonusissue.asp
I don't like referring to web-sites for such basic matters but your assertion made me do so.
Best Regards,
--Ashish
