money

Reviewed by Michael J Boyle
Fact checked by Yarilet Perez

What Is the Balance of Payments (BOP)?

The balance of payments (BOP) is the method countries use to monitor all international monetary transactions in a specific period. The BOP is usually calculated every quarter and every calendar year.

All trades conducted by both the private and public sectors are accounted for in the BOP to determine how much money is going in and out of a country. If a country has received money, this is known as a credit, and if a country has paid or given money, the transaction is counted as a debit.

Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance, but in practice, this is rarely the case. Thus, the BOP can tell the observer if a country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.

Key Takeaways

• The balance of payments (BOP) is the record of all international financial transactions made by the residents of a country.
• There are three main categories of the BOP: the current account, the capital account, and the financial account.
• The current account is used to mark the inflow and outflow of goods and services into a country.
• The capital account is where all international capital transfers are recorded.
• In the financial account, international monetary flows related to investment in business, real estate, bonds, and stocks are documented.

How the Balance of Payments (BOP) Is Divided

The BOP is divided into three main categories:

• Current account
• Capital account
• Financial account

Within these three categories are subdivisions that account for a different type of international monetary transaction. As an example, the current account includes a goods and services account, a primary income account, and a secondary income account.

The Current Account

The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account.

Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold, or given away, possibly in the form of aid. Services refer to receipts from tourism, transportation, engineering, business service fees, and royalties from patents and copyrights.

Goods and services together make up a country’s balance of trade (BOT). The BOT is typically the biggest bulk of a country’s balance of payments, as it makes up total imports and exports. If a country has a BOT deficit, it imports more than it exports, and if it has a BOT surplus, it exports more than it imports.

Receipts from income-generating assets such as stocks—in the form of dividends—are also recorded in the current account. The last component of the current account is unilateral transfers. These are credits that are mostly workers’ remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received.

The Capital Account

The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of nonfinancial assets—for example, a physical asset such as land—and non-produced assets, which are needed for production but have not been produced, such as a mine used for the extraction of diamonds.

The capital account is broken down into the monetary flows branching from debt forgiveness, the transfer of goods, and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets, the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies, and, finally, uninsured damage to fixed assets.

The Financial Account

In the financial account, international monetary flows related to investment in business, real estate, bonds, and stocks are documented. Also included are government-owned assets, such as foreign reserves, gold, special drawing rights (SDRs) held with the International Monetary Fund (IMF), private assets held abroad, and direct foreign investment. Assets owned by foreigners, private and official, are also recorded in the financial account.

How the BOP Is Balanced

The current account should be balanced against the combined capital and financial accounts; however, as mentioned above, this rarely happens. We should also note that with fluctuating exchange rates, the change in the value of money can add to BOP discrepancies.

If a country has a fixed asset abroad, this borrowed amount is marked as a capital account outflow. However, the sale of that fixed asset would be considered a current account inflow (earnings from investments). The current account deficit would thus be funded.

When a country has a current account deficit that is financed by the capital account, the country is actually foregoing capital assets for more goods and services. If a country is borrowing money to fund its current account deficit, this would appear as an inflow of foreign capital in the BOP.

Liberalizing the BOP

The rise of global financial transactions and trade in the late 20th century spurred BOP and macroeconomic liberalization in many developing nations. With the advent of the emerging market economic boom, developing countries were urged to lift restrictions on capital- and financial-account transactions to take advantage of these capital inflows.

Important

Some economists believe that the liberalization of BOP restrictions eventually lead to financial crises in emerging market nations, such as the Asian financial crisis.

Many of these countries had restrictive macroeconomic policies, by which regulations prevented foreign ownership of financial and nonfinancial assets. The regulations also limited the transfer of funds abroad.

With capital and financial account liberalization, capital markets began to grow, not only allowing a more transparent and sophisticated market for investors but also giving rise to foreign direct investment (FDI).

For example, investments in the form of a new power station would bring a country greater exposure to new technologies and efficiency, eventually increasing the nation’s overall gross domestic product (GDP) by allowing for greater volumes of production. Liberalization can also facilitate less risk by allowing greater diversification in various markets.

Explain Like I’m Five

The balance of payments measures how money flows across a country’s borders over a specific period of time. It records the value of a country’s exports and imports, as well as the flows of investments and loans, and remittances by workers. Economists use the balance of payments to assess how a country is interacting with the world market.

What Is the Balance of Payments (BOP) Used for?

The BOP looks at an economy’s transactions with the rest of the globe. It is an important indicator of an economy’s health.

What Are the Main Components of the BOP?

There are three main components of the BOP: the financial account, the capital account, and the current account. The combination of the first two should balance with the third, but that doesn’t always happen.

What Is the Most Important Part of the BOP?

The balance of trade (BOT)—which is the total of imports and exports—is the biggest part of the BOP. It makes it clear whether a country has a trade surplus or deficit.

What Does a Trade Deficit Mean?

A trade deficit happens when the value of a country’s imports is greater than the value of its exports—in other words, it has more money going out than coming in. When the value of exports is greater than the value of imports, it is called a trade surplus.

Is a Trade Deficit Bad?

A trade deficit is not inherently bad, but it comes with tradeoffs that can sometimes have negative consequences for a nation’s economy. Countries with large trade deficits typically rely on overseas markets to provide a large share of consumer goods, which can harm domestic industries and lead to unemployment. Conversely, a trade deficit also allows domestic consumers to have access to a wider variety of in-demand goods. For example, the United States typically imports most of its labor-intensive manufactured goods, because these are more affordable in the overseas market.

The Bottom Line

The balance of payments (BOP) is the method by which countries measure all of the international monetary transactions within a certain period. The BOP consists of three main accounts: the current account, the capital account, and the financial account. The current account is meant to balance against the sum of the financial and capital account but rarely does.

Globalization in the late 20th century led to BOP liberalization in many emerging market economies. These countries lifted restrictions on BOP accounts to take advantage of the cash flows arriving from developed foreign nations, which in turn boosted their economies.

Reviewed by Thomas Brock
Fact checked by Suzanne Kvilhaug

Do You Include Working Capital in Net Present Value (NPV)?

The change in a company’s annual net working capital is used when calculating net present value using the unlevered discounted cash flow (DCF) approach. DCF is the present value of a company’s future cash inflow and is used by analysts when estimating a business’s net present value.

Key Takeaways

• Net present value is the forecasted value of a business’s future cash flows brought back to present value.
• Working capital is the difference between a company’s current assets and its current liabilities.
• Change in net working capital is used when calculating a discounted cash flow model to calculate a business’s net present value (NPV).

Net Present Value

Net present value (NPV) is the forecasted value of a business in the future, brought back to the present (called discounting). It is most often calculated using a discounted cash flow model. NPV is based on the assumption that money today is worth more than money in the future. This is due to assumed inflation and lost opportunity cost—the value of potential gains given up when making a choice.

Important

When determining net present value, it is necessary to forecast using the three main financial statements: the balance sheet, statement of cash flows, and income statement. Generally, analysts will not go too far into the future with their assumptions, usually between five and 10 years. An analyst makes assumptions about the line items on future statements of cash flows and income statements, which are reflected on the future balance sheets under current assets and current liabilities. In turn, changes in net working capital occur.

A positive NPV indicates a profitable investment, while a negative NPV indicates a loss-producing investment. To account for the time value of money, analysts often apply a discount rate when calculating the value of money in the future.

Using NPV to value investments has its advantages, but there are drawbacks as well. NPV calculation relies heavily on assumptions and estimates. Several factors could affect the future value of an investment that is not predicted by the model. For example, the longer the time frame of the investment, the more risk there is.

Net Working Capital

Working capital is the difference between a company’s current assets and its current liabilities. Current assets can include things like cash, accounts receivable, and inventories. Current liabilities can include items like accounts payable or other debts. Working capital is calculated by simply subtracting current liabilities from current assets.

Changes in net working capital (NWC) are used when calculating NPV using the DCF model. There are several formula variations an analyst can use, depending on their preferences:

• NWC = Current Assets – Current Liabilities
• NWC = Current Assets (less cash) – Current Liabilities (less debt)
• NWC = Accounts Receivable + Inventory – Accounts Payable

The analyst then determines the changes in estimated NWC over the periods being forecast.

NWC Effect on NPV

If net working capital increases, the company has more cash outflow. If net working capital decreases, the company has more cash inflow.

Accordingly, cash flow decreases as accounts receivable increase or accounts payable decrease. Therefore, as working capital changes from period to period, it has an effect on a business’s net working capital, which in turn affects NPV.

Is CapEx Included in NPV Calculation?

Capital expenditures are included in a net present value calculation because they are deducted from free cash flow, which is used when using the discounted cash flow model.

What Should Not be Included in the NPV Calculation?

Some items that should not be included in NPV are financing costs, sunk costs, and depreciation expenses.

Does NPV Include Cost of Capital?

NPV can be calculated using a company’s weighted average cost of capital as the discount rate.

The Bottom Line

Net present value is not an easy thing to calculate because there is a laundry list of assumptions that must be made. Analysts must forecast line items for future financial statements and estimate changes in forecasted annual net working capital to calculate a business’s net present value.

Reviewed by Brandon Renfro
Fact checked by Vikki Velasquez

Retirement can evoke images of a relaxing, debt-free life with no monthly mortgage payment, assuming you have already paid it off. However, some financial planners suggest retirees continue to carry a mortgage into and throughout retirement.

Reinvesting the proceeds from your home equity to generate a stream of income might make your golden years more golden.

Carrying a mortgage in retirement has benefits in certain situations but can come with drawbacks since no one-size-fits-all solution exists for increasing retirement income.

Key Takeaways

• Carrying a mortgage into retirement may help you increase your income by reinvesting the equity from a home.
• Carrying a mortgage into retirement also allows you to benefit from the mortgage interest tax deduction.
• On the downside, investment returns can fluctuate while your mortgage payment remains fixed. 
• A diversified portfolio may provide greater returns than your mortgage rate, but you could experience investment losses and still need to repay your loan.

You Can’t Eat Your Home

The basic concept behind taking out a home equity loan is “you can’t eat your home.” Your home equity generates no income unless you borrow against it and invest the funds. Since home equity typically makes up a substantial portion of a retiree’s net worth, it may serve as a drag on income, net worth growth, and overall quality of life in retirement.

Important

Carrying a mortgage during retirement may prove troublesome if investment returns fluctuate, leading to an inability to repay the mortgage or uneasiness related to carrying so much debt during a market downturn. 

As a homeowner, you could shift your assets from your home by taking out a mortgage loan and investing the money in securities. The theory is that the investment return should outperform the after-tax cost of the mortgage, enhancing your net worth and cash flow. Additionally, you can readily liquidate investments like some mutual funds and exchange-traded funds (ETFs) to meet your spending needs. 

This strategy sounds attractive, but it’s not simple since you’re introducing more leverage into your finances. Before considering taking out a mortgage or equity loan on your house to invest or spend the funds, consider the pros and cons of carrying a mortgage in retirement.

Pros of Carrying a Mortgage into Retirement

A properly diversified investment portfolio may outperform residential real estate returns over the long term. For example, if residential real estate generates single-digit annual rates of return while your diversified portfolio performs much better, some homeowners might prefer to carry a mortgage in retirement.

Having a mortgage loan in retirement also has tax benefits since the interest is tax-deductible, which can serve to minimize the cost of borrowing. A tax break can also increase the overall return on investment for your securities.

Finally, from an investment point of view, you could consider a single property as undiversified, which is bad news if it comprises a substantial portion of your net worth. Diversification can help you maintain financial stability and peace of mind.

Cons of Carrying a Mortgage into Retirement

Despite the potential benefits, having a mortgage in retirement strategy can cause some unpleasant side effects. Using this strategy can increase your total asset exposure to include your house and investments.

However, taking out a mortgage is another form of leverage, which can increase your total risk exposure and complicate your financial life. Also, the income earned from your investments will fluctuate, and you could lose all or a portion of your invested funds. Prolonged market downturns can negatively impact your retirement portfolio and be challenging to manage. 

Furthermore, the Tax Cuts and Jobs Act of 2017 mitigated the deductibility advantage. Taxpayers can deduct interest on $750,000 of qualified residence mortgage (down from $1 million). The act also suspended the deduction for interest paid on home equity loans and lines of credit unless they are used to buy, build or substantially improve the home, securing the financing.

Pros

• Investment returns can exceed the mortgage rate

• Mortgage interest tax deduction

• More diversified with both a home and investments

Cons

• Increases your leverage or debt

• Risk of investment loss

• Fewer tax deductions on home equity loans

Investment Returns vs. Mortgages

Keep in mind that investment returns can fluctuate significantly in the short term, while mortgages tend to remain fixed. It is reasonable to expect periods of time when your portfolio substantially underperforms the mortgage cost.

The Psychology of Leverage

Periods of market underperformance can erode your financial base and potentially jeopardize your ability to keep up with payments. This volatility could also compromise your peace of mind, make you nervous during a market downturn and lead you to sell your portfolio to pay off your mortgage.

As a result, you would miss out on the benefits of a recovery in your investments, potentially decreasing your net worth instead of increasing it. It’s important not to underestimate the unsettling psychological influence of leverage.

Hurdle Rate

There are many objective financial factors you need to take into consideration to determine the merit of this strategy in your given financial situation. While some financial planners may issue the same advice across the board, this strategy is not appropriate for everyone.

An important consideration includes determining your total mortgage interest cost since this represents the hurdle rate your investment portfolio must overcome to achieve a net positive gain. The factors that affect your mortgage rate include your creditworthiness and prevailing mortgage interest rates.

Of course, the better your credit, the lower your total interest cost. Furthermore, the higher your tax bracket, the more tax benefit you receive from the interest write-off. 

Tapping Your Home Equity During Retirement 

First, speak with your loan officer and accountant to determine your mortgage interest cost—net of the tax benefit—which will tell you how much your investment portfolio needs to earn to pay the mortgage interest rate charges. Next, consult an investment advisor to discuss outperforming this investment hurdle.

Risk Tolerance and Rate of Return

Knowing your desired rate of return is simple enough, but whether you can reasonably achieve that rate of return or tolerate the necessary risk is another story. Generally speaking, beating your mortgage cost may require a larger allocation to equities, which can lead to portfolio volatility.

Most retirees are unlikely to accept such levels of volatility, especially since they have less time to ride out the market’s ups and downs. Another factor to consider is that most financial advisors rely on historical averages to estimate a portfolio’s future return. In other words, do not totally rely on return expectations. 

Determine Your Net Worth

Finally, the last major consideration is determining the percentage of your total net worth your home represents. The larger the percentage of your net worth your home represents, the more important this decision becomes.

For example, if you have a $2 million net worth and your home only represents $200,000 of it, the net marginal gain from this strategy will probably have a minimal effect on your net worth.

However, if you have a $400,000 net worth with $200,000 from your home, investing your home equity may have a profound meaning in your financial planning.

Warning

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report, either to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).

Should I Include My House in My Retirement Plan?

Your home equity can help you in retirement since it often represents a large portion of your net worth. By using your home equity, you can pay for medical bills and generate income.

Does It Make Sense to Have a Mortgage in Retirement?

It can help you to have a mortgage in retirement since you can invest the funds and perhaps earn a rate of return that exceeds the interest rate on the mortgage. However, be aware that investing comes with the risk of loss.

Does Net Worth Include My Home?

Yes. Your net worth includes the value of your home minus any outstanding mortgage or home equity loans.

The Bottom Line

It’s never a good idea to blindly accept a piece of advice, even if it comes from a financial planner. The safety of carrying a mortgage into retirement depends on several factors. This strategy is not guaranteed to succeed and can substantially complicate your financial life. Most importantly, leverage is a double-edged sword, meaning you could experience investment losses, leading to dire financial consequences for a retiree.

Martha Stewart is a businesswoman and media personality

Reviewed by David Kindness
Fact checked by Michael Rosenston

Known to millions for her cooking and decorating products, books, shows, and more Martha Stewart is a successful entrepreneur who built a media empire from scratch out of the old adage “there is no place like home.” During her pinnacle as a prominent media mogul, she found her name among the world’s wealthiest and most powerful business leaders on the Forbes billionaires list.

Martha Stewart first became a self-made billionaire when her company, Martha Stewart Living Omnimedia, went public in 1999. The initial public offering raised $1.9 billion and the stock climbed to an all-time high of $39.75 per share the following day. Her net worth did significantly drop in the early 2000s but has since slightly recuperated. Her fortune in 2025 is estimated to be somewhere around $400 million.

Key Takeaways:

• Down from over a billion, Martha Stewart’s net worth is estimated to be in the vicinity of $400 million as of 2025.
• Martha Stewart first became a billionaire when her company, Martha Stewart Living Omnimedia, went public in 1999.
• Due to obstruction of justice, making false statements to federal investigators, and conspiracy to lie, Stewart served five months in jail in 2004.
• In 2015, Martha Stewart Living Omnimedia was sold to Sequential Brands Group for $350 million.
• Sequential Brands Group sold Martha Stewart Living Omnimedia in 2019 to Marquee Brands for $175 million.

Early Life and Education

Martha Stewart was born on August 3, 1941, in Jersey City, New Jersey. Even when she was just a child, Martha was making money. When she was 10 years old she often found herself babysitting for extra change.

At 13, she modeled on the side and regularly appeared in television commercials. One of her clients was the luxury fashion company, Chanel.

Following her graduation from Barnard College, she made an impressive income and learned about business as a stockbroker in New York.

Stewart’s billion-dollar empire actually started out as a small home-based catering business that she founded with a friend as her partner. The business began to see success. However, the pair split due to disagreements.

Notable Accomplishments

Publishing Powerhouse

In 1980, Martha had been hired to cater for a book release event. At the party, she met Alan Mirken, who was the head of Crown Publishing Group.

Following that night, the two began having discussions regarding the possibility of publishing a cookbook based on the recipes that Martha used for her catering events. That idea bore fruit when Martha’s first book, “Entertaining,” was published in 1982 by Crown imprint Clarkson Potter. The book went on to sell more than 625,000 copies.

From 1983 to 1989, Martha published a number of other cookbooks for Clarkson Potter. During that time she was slowly becoming a household name throughout the United States.

In addition to contributing columns on home-keeping to newspapers and magazines, Martha began to regularly appear on a handful of well-watched television programs such as “Larry King Tonight” and “The Oprah Winfrey Show.”

Martha Stewart Living Magazine

By the early 90s, Martha Stewart had achieved a great deal of fame and success. However, she was not completely satisfied. In an attempt to further extend her reach and expand her brand, she signed a magazine deal with Time Publishing Ventures, Inc.

With a quarter of a million subscribers signed up for the initial issue, Martha released Martha Stewart Living magazine in late 1990. Subscriptions for the magazine quickly grew to over two million.

Note

Martha Stewart’s career history includes being a stockbroker, starting her empire through a catering business, publishing successful cookbooks, and founding her own magazine.

Originally started as a quarterly magazine, it soon grew into a monthly publication. Each issue featured a variety of cooking recipes, decoration instructions, craft ideas, and homemaking guides.

Billionaire Status

Martha may have been the face behind her magazine and other merchandise, but she did not completely own all the rights to them. Time Warner, for example, owned and published the Martha Stewart Living magazine.

This all changed in 1997 when Stewart raised the money to purchase the rights to all of her related brands. Martha borrowed $85 million to finance the acquisition of the magazine alone.

She formed Martha Stewart Living Omnimedia in 1996, which became the holding company that housed all of her projects, publishing, and merchandise.

Three years following the formation of Martha Stewart Living Omnimedia, Stewart listed the company on the New York Stock Exchange. This allowed her many fans and followers across the country to actually own a piece of Martha’s media powerhouse.

On the day the company went public in 1999, Martha Stewart Living Omnimedia’s stock opened at $18 per share. The price soared from day one, and that growth made Martha’s 96% stake in the company worth more than a billion dollars.

Important

Martha Stewart Living Omnimedia, once valued at $2 billion, was sold for $350 million in 2015 and then again for $175 million in 2019.

Criminal Conviction

Stewart’s life and her media empire were both interrupted when Stewart was convicted of obstruction of justice, making false statements, and conspiracy for lying to investigators about her sale of shares of ImClone Systems in 2001.

She sold shares a day before the company announced a negative Food and Drug Administration ruling about one of its cancer drugs that prompted a massive sell-off in the stock. She served five months in a federal correctional facility following her conviction in 2004.

On May 31, 2018, former President Trump indicated that he might grant Stewart a presidential pardon. However, he left office without doing so. While Stewart never faced insider trading charges for the sale, she paid $195,000 to settle civil charges with the Securities and Exchange Commission.

Post-Prision Successes

Since her release from prison in March 2005, Martha Stewart has embarked on a remarkable journey of rebuilding and expanding her brand. She quickly returned to television with The Martha Stewart Show, which aired from 2005 to 2012, and also appeared in The Apprentice: Martha Stewart, although the latter was not renewed for a second season.

In addition to her television ventures, Stewart has been prolific in publishing. She released several books, including The Martha Rules in 2005, Martha Stewart Baking Handbook later that year, and Martha Stewart’s Homekeeping Handbook in 2006. Her books have been generally well-received, contributing to her enduring popularity and influence in the lifestyle industry post-scandal.

Stewart’s post-prison career has also been marked by innovative partnerships and ventures. She has collaborated with numerous brands, launching collections ranging from home decor and kitchenware to frozen foods and beauty products. Notably, she has partnered with rapper Snoop Dogg on various projects, including a line of handbags called “Best Buds Bags” and several television shows, such as Martha & Snoop’s Dinner Party and Martha & Snoop’s Potluck Party Challenge.

How Did Martha Stewart Get Famous?

Martha Stewart was a model as a child, then became a stockbroker after college, then a caterer, a cookbook author, a publisher, and a media icon.

What’s Martha Stewart’s Net Worth?

As of 2025, Martha Stewart’s net worth is estimated to be around $400 million.

How Long Was Martha Stewart in Prison?

In 2004, Martha Stewart was convicted of obstruction of justice, making false statements, and conspiracy. She served five months in a federal correctional facility.

What’s the Relationship Between Martha Stewart and Snoop Dogg?

Martha Stewart and Snoop Dogg met on Martha’s television show in 2008. Since then, they have appeared together many times on talk shows, game shows, and other events.

The Bottom Line

Stewart has made an indelible mark in the media industry as well as the lives of countless Americans looking to brighten their lives in the household.

She continues to be an entrepreneur, having launched her own podcast, becoming involved in the cannabis business, having her own TV shows, selling new products on her website, and more. A successful entrepreneur, Martha Stewart shows no signs of slowing down.

Reviewed by Andy Smith
Fact checked by Michael Rosenston

Accrual Accounting vs. Cash Basis Accounting: An Overview

The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method provides an immediate recognition of revenue and expenses, while the accrual method focuses on anticipated revenue and expenses.

Key Takeaways

• Accrual accounting records revenue and expenses when transactions occur but before money is received or dispensed.
• Cash basis accounting records revenue and expenses when cash related to those transactions is actually received or dispensed.
• Accrual accounting provides a more accurate view of a company’s health by including accounts payable and accounts receivable.
• The accrual method is the more commonly used method by large companies, especially by publicly traded companies, as it smooths out earnings over time.
• The cash basis method is generally used by sole proprietors and smaller businesses.

Accrual Accounting

Accrual accounting is a method that records revenue when it is earned, meaning when a product or service has been delivered to a customer and there is a reasonable expectation of payment. This approach follows the principle that financial events should be recognized in the period in which they occur, regardless of when payment is received.

In this system, revenue is not dependent on the timing of cash transactions. Instead, it is recorded once the earning process is complete and the business has fulfilled its obligations to the customer. This method is especially important for companies that provide goods or services on credit or have long-term contracts, as it ensures that income is matched with the time period in which it was actually earned.

Likewise, expenses are recorded when they are incurred, not when they are paid. If a business receives goods or services in a given period, the associated expense is recognized during that same period, even if the company doesn’t make the payment right away. This matching of expenses with the revenues is at the heart of accrual accounting.

Cash Basis Accounting

In cash basis accounting, revenue is recorded only when cash is actually received. A business recognizes income at the moment payment is collected, regardless of when the product or service was delivered. This approach is an easier way to track money coming into the business and provides no discrepancies between the amount of revenue earned and the amount of cash received.

Expenses are recorded only when they are paid, not when they are incurred. This means a bill does not show in financial records until payment has been made. For example, if a company receives an invoice for services in January but doesn’t pay the bill until February, the expense would show up in February.

This method is often favored for its simplicity and ease of use, especially by small businesses and individuals managing personal finances. It requires minimal tracking of accounts receivable or payable and focuses solely on transactions that affect the actual cash balance. It also follows the logic that revenue isn’t truly “earned” until you’ve received the actual cash from the sale, regardless of what a customer actually owes you.

Note

Advanced accounting software platforms can reconcile between the two methods. As you enter transactions, you can then pull cash-basis or accrual-basis financial reports depending on your needs.

Key Differences

Timing of Revenue/Expense Recognition

In cash basis accounting, revenue is recognized only when cash is physically received. Accrual accounting recognizes revenue at the point it is earned—typically when a product is delivered or a service is performed—regardless of when payment is made. Similarly, expenses under the cash method are recorded only when the payment is actually made whereas accrual accounting records them when they’ve been incurred.

Complexity

Cash basis accounting is simpler and easier to implement. It does not require complex accounting systems or extensive record-keeping. Accrual accounting is more intricate, requiring more robust systems to track items owed to others or owed to you.

Adherance to the Matching Principle

Accrual accounting adheres to the matching principle, which requires that expenses be matched with the revenues they help generate in the same reporting period. This produces a more accurate depiction of financial performance. Cash accounting does not follow this principle.

Use of Accounts Payable and Accounts Receivable

Accounts receivable and accounts payable are integral to accrual accounting. These accounts help track money owed by customers and money owed to suppliers. These are not used in cash accounting, as transactions are recorded only when cash is exchanged so there’s never any outstanding payments or receivables.

Implications for Long-Term Contracts

For businesses that engage in long-term projects, such as construction or software development, accrual accounting offers superior financial insight. It allows them to recognize portions of revenue and associated expenses as the project progresses. Instead of potentially having to wait years until revenue is collected under cash basis accounting, incremental revenue can be recognized over the life of the long-term contract.

Regulatory Compliance

Regulatory bodies, such as the IRS in the U.S. or the SEC for public companies, often mandate the use of accrual accounting for companies above a certain size or revenue threshold. This requirement stems from the method’s ability to provide a more consistent and transparent financial picture. Cash accounting may be permissible for smaller entities but is typically not accepted for audited financial statements or filings under GAAP or IFRS.

Tax Implications

The method of accounting can significantly affect tax liabilities. Under cash accounting, income is not taxable until it is received, and expenses are not deductible until they are paid. This allows for some flexibility in managing taxable income, as businessowners could theoretically delay when they deposit a check to defer that revenue into the following period.

Recognition of Unearned Revenue

When customers pay in advance for goods or services, accrual accounting records this payment as unearned revenue—a liability—until the service is performed or the product delivered. Under cash accounting, such payments are recorded as revenue immediately. In this case, cash accounting fails to consider that the company still has an obligation to satisfy (i.e. provide the good or service that customer has prepaid for).

Use of Accruals and Deferrals

Accrual accounting incorporates both accruals and deferrals to ensure that revenues and expenses are recorded in the appropriate periods. Accruals include items like unpaid wages or earned interest, while deferrals refer to prepaid expenses and unearned income. Both types of entries are used to record revenues and expenses before the cash transaction has occurred.

Use of Depreciation and Amortization

In accrual accounting, the cost of long-term assets is allocated over their useful lives through depreciation or amortization. This aligns expenses with the periods that benefit from the asset, as the cost of a capital asset is spread over its life as it gets used. Cash accounting typically expenses the entire asset cost at the time of purchase. This can severely distort earnings, as a company may have a gigantic expense one year followed by little to no expense the next.

Note

The Tax Cuts and Jobs Act increased the number of small business taxpayers entitled to use the cash basis accounting method. As of 2024, small business taxpayers with average annual gross receipts of $30 million or less in the prior three-year period can use it.

Special Considerations

The accrual method is the more commonly used method, particularly by publicly traded companies. One reason for the accrual method’s popularity is that it smooths out earnings over time since it accounts for all revenues and expenses as they’re generated.

The cash basis method records these only when cash changes hands and can present more frequently changing views of profitability.

For example, under the cash basis method, retailers would look extremely profitable in Q4 as consumers buy for the holiday season. However, they would look unprofitable in the next year’s Q1 as consumer spending declines following the holiday rush.

Both methods have their advantages and disadvantages. Each provides different views of the financial health of a company. For investors, it’s important to understand the impact of both methods when making investment decisions.

The vast majority of companies that people would potentially invest in will be using accrual-based accounting. However, should you come across a small company using cash-based accounting, it’s definitely something to watch out for.

Accrual Accounting vs. Cash Basis Accounting: Example

Let’s say you own a business that sells machinery. If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check.

Under the accrual method, the $5,000 is recorded as revenue as of the day the sale was made, though you may receive the money a few days, weeks, or even months later.

The same principle applies to expenses. If the company receives an electric bill for $1,700, under the cash method, the amount is not recorded until the company actually pays the bill. However, under the accrual method, the $1,700 is recorded as an expense the day the company receives the bill.

What Is Accrual Accounting?

Accrual accounting is an accounting method that records revenues and expenses before payments are received or issued. In other words, it records revenue when a sales transaction occurs. It records expenses when a transaction for the purchase of goods or services occurs.

What Is the Difference Between Cash Basis and Accrual Accounting?

Cash basis accounting records revenue and expenses when actual payments are received or disbursed. It doesn’t account for either when the transactions that create them occur. On the other hand, accrual accounting records revenue and expenses when those transactions occur and before any money is received or paid out.

Companies might also use modified accrual accounting and modified cash basis accounting.

When Does a Company Account for Revenue If It Uses Cash Basis Accounting?

Under the cash basis accounting method, a company accounts for revenue only when it receives payment for the products or services it provides a customer.

The Bottom Line

Accrual accounting and cash basis accounting are two ways to record financial transactions. They differ in when a transaction is recorded: accrual accounting when money is earned or an expense is incurred, and cash basis accounting when money is received or an expense is paid. Accrual accounting is required by law; however, there are exceptions where cash basis accounting can be used.

Fact checked by Timothy Li
Reviewed by Michael J Boyle

Historically, countries have used tariffs to protect domestic products from foreign competition. While many countries have reduced tariffs through trade agreements, that trend is being undone fast, given the broad tariff regime announced by U.S. President Trump in 2025.

The Trump tariffs are the most sweeping in the U.S. since before World War I, ending what had been a long liberalization of trade barriers through decades of international agreements and the build-up of institutions meant to increase trade worldwide. The tariffs, including a baseline 10% on nearly all U.S. imports and additional tariffs the administration is dubbing “reciprocal” for many specific countries, are far higher for nations that have long been competitors of the U.S., and many that until 2025 weren’t. Vietnam (56%), Cambodia (59%), and Sri Lanka (54%) were among the hardest hit, but, so, too, were some of the world’s most valuable trade partnerships: tariffs were increased significantly on goods from China (44%), the EU (30%), and Japan (34%).

Key Takeaways

• Tariffs are taxes on imports imposed by a government to help direct domestic consumers toward goods made within the country.
• Less industrialized countries, such as those in Africa and the Caribbean, traditionally have had the highest tariff rates.
• In April 2025, the U.S. introduced significant new tariffs that put tariff rates well above historic rates. They are, for now, the world’s highest.
• Many economists view tariffs as liable to increase consumer prices and lead to higher inflation.
• Tariffs are not the only trade barrier: others include exchange controls, subsidies, fair trade laws, local-content requirements, and quotas on imports and exports.

While slapped on goods from specific countries, tariffs are taxes paid by consumers within the country that applies them. Those who support them argue they redirect domestic consumer demand toward goods made within the country. The 2025 Trump administration tariffs far outstrip previous highs worldwide for a country’s average tariff rate, according to data from the World Trade Organization. In 2024, those at the high end of the list included Algeria (18.9%), Cameroon (18.1%), and Tunisia (19.5%). Below, we review these figures further and explore their economic implications.

World’s Highest Tariffs

The landscape of global tariffs shifted dramatically following the U.S. administration’s April 2025 tariff rollout. Those tariffs include a baseline 10% on virtually all imports, with additional tariffs (the Trump administration labels them “reciprocal”) depending on the country. Below are the combined figures, which stand as the world’s highest as of April 2025.

These rates represent a consequential shift from historical patterns. While traditionally less-developed African and Caribbean countries maintained the highest tariffs, the U.S.’s moves are likely the beginning of a worldwide ratcheting up of tariffs on U.S. goods in response. The administration imposed particularly high tariffs on goods from many Southeast Asian manufacturing hubs. Major longstanding trading partners had substantial increases in duties placed on their goods, including China (44%), the European Union (30%), and Japan (34%).

Economists and international organizations have expressed concern about these dramatic increases, with the World Trade Organization warning they could cause global trade volumes to contract by 1% in 2025. “No one wins a trade war,” Justin Wolfers, professor of public policy and economics at the University of Michigan, told Investopedia, noting that economists are “very” concerned about a recession coming out of the significant increases in duties.

Warning

In the map below, we use a weighted average of tariffs calculated by the World Trade Organization for each country. However, countries often impose tariffs on specific goods that can be far higher than the average. For example, India has a 70% tariff on imported passenger vehicles, and many nations, including the U.S., had, before 2025, carved out specific areas of their economies to protect via import duties.

Lowest Tariffs

In contrast to the countries with high tariff rates, some nations have maintained very low or even zero tariffs. Despite the threats in recent years of protectionism led by the U.S., these countries had continued, at least until 2024, to maintain open trade policies. On the map below, those with the lowest or no tariffs in 2024 are in blue. They include Hong Kong, Singapore, Georgia, and Australia.

Tariffs vs. Free Trade

When Adam Smith published “The Wealth of Nations” in 1776, international trade was primarily defined by extremely restrictive import tariffs and quotas. Following Smith, David Ricardo in early 19th-century works developed the case for free trade in the early 19th century through his theory of comparative advantage.

Ricardo argued that countries benefit from specializing in producing goods where they have a relative efficiency advantage and trading for other goods, even if one country is more efficient at producing everything. Suppose you’re the manager of a baseball team. You could have Shohei Ohtani pitch and hit—he’s an elite talent at both—but you might produce more wins by having him focus on being a position player to maximize his effectiveness and prevent injury. You certainly, too, wouldn’t have Ohtani handing out water to other players when not up at bat or mowing the grass. That’s why economists argue that nations should specialize in areas where they have comparative advantages and freely trade with others for the rest (get someone else to handle the other role on the team). This way, total economic output increases, with each participating country benefiting over time. For this reason, economists have long argued for bringing down trade barriers—you want to make it easier for your country to get the goods that aren’t to its advantage to make.

Note

The average tariff rate for the U.S. in 2024 was 0.9% and was estimated to increase to between 22.5% and 24% from the April 2025 changes made by the Trump administration.

Ricardo’s ideas formed the foundation of modern trade theory and contributed to the consensus among economists that lowering trade barriers encourages economic growth—a view particularly strong among European and American economists in the second half of the 20th century, leading to a general decline in tariffs worldwide.

What Happens When There Are High Tariffs on Imported Goods?

High tariffs on imported goods increase the prices of these goods. As a result, consumers end up paying higher prices for the goods. Alternatively, consumers can opt to purchase substitute goods that are domestically made, which are most likely to be cheaper.

Do Any Countries Have No Tariffs?

Yes, a few countries do not have any tariffs, and several have very low tariffs. The World Bank reports tariffs on a weighted mean. Hong Kong (China), Macau (China), and Sudan have no tariffs.

Which Country Has the Highest Import Duty?

As of April 2025, that would be the U.S., with tariffs well above historic highs in recent decades.

The Bottom Line

Until 2025, many countries had abolished tariffs or lowered them significantly after signing free trade agreements to pursue foreign markets for their goods. Changes begun by the U.S. are likely to spark rounds of negotiations and reciprocal tariffs implemented by trading partners to match the Trump administration’s moves.

Fact checked by Suzanne Kvilhaug
Reviewed by Margaret James

If your business is new, there are several factors to consider before developing a sense of your ideal profit margin. In this article, we look at some of the basics of what you should consider when you’re measuring profitability and studying your profit margins.

Key Takeaways

• Profit margins are financial metrics that are used to measure a company’s profitability.
• A gross profit margin can be used to determine a particular item’s profitability, but net profit margins are a better measure of overall profitability.
• The net profit margin is key as it measures total sales, less any business expenses, and then divides that number by total revenue.
• The best net profit margin for your business depends on what industry your business is in, which means you shouldn’t compare your margins to companies in other industries.
• Newer companies may have better profit margins than older ones because when sales increase, so do manufacturing costs.

What Is a Profit Margin?

The profit margin is the total percentage of sales that results in profit. You have to subtract all of the expenses that go into running the business in order to get the resulting profit. A company’s profit margin tells interested parties (e.g. investors, creditors, and others) how well it handles its money.

There are several types of profit margins. We’ll look at two of the most common: the net profit margin and the gross profit margin.

Net Profit Margin

A company’s net profit margin, or net margin, measures profit (or net income) as a total percentage of revenue.

It’s typically expressed as a percentage, but in some cases, you may see it reported as a decimal.

Here’s how you figure out the net margin for a business. Take the company’s total sales and subtract the total business expenses incurred. Divide the result by the company’s total revenue. So if your new business brought in $300,000 last year and had expenses of $250,000, your net profit margin is 17%.

Net margins allow companies (and others) to see how well their business models are working and to measure their overall profitability. They are also used to help devise profit forecasts, which is especially useful for individuals who invest in public companies.

Gross Profit Margin

The gross profit margin, or the gross margin, is calculated by subtracting the cost of goods sold (COGS) from a company’s net sales. The result is then divided by its net sales.

It’s usually expressed as a percentage.

Major shifts in the gross margin may indicate that the company needs to make changes to the way it’s being managed. Or it may signal that the company’s products and services may need to be reviewed.

Small business owners use the gross profit margin to measure the profitability of a single product. If you sell a product for $50 and it costs you $35 to make, your gross profit margin is 30% ($15 divided by $50).

Note

Operating profit margin is the amount of profit a company makes per dollar after factoring in certain variable costs, such as labor and materials. But this metric doesn’t factor in taxes or interest. To calculate it, you divide the total operating income by the company’s net sales.

The Industry Makes a Difference

Profit margins are very dependent on the industry that a business operates in. Business owners make a higher margin in some sectors compared to others because of the economic factors of each industry. That’s why it’s important to keep the industry in mind (in addition to the business size) when you’re comparing the profit margins of any company with others. You have to make sure that you’re making an apples-to-apples comparison.

Let’s say you own a bakery. You kept really good records and, after doing the math, came up with a net profit margin of 21%. But your friend owns an IT company that installs complicated computer networks for businesses and has a net profit margin of 16%. Does this mean you’re a better business owner because your profit margin is five percentage points better? No. It doesn’t work that way, as the profit margin is industry-specific.

Similarly, you may expect margins of 19.8% as an accountant. If you’re in the food service business, you might only see net margins of 3.8%. Does this mean you should sell your bakery and become an accountant? No. Profit margin doesn’t measure how much money you will make or could make, only how much is actually made on each dollar of sales.

If you’re a consultant, your margins are likely quite high since you have very little overhead. You can’t compare yourself to a manufacturer who rents space and equipment and who must invest in raw materials.

Profit Margins of New vs. Established Companies

Many new business owners generally expect a lower profit margin in the early years of their operations. It’s not that they want to rake in lower profits. Rather, they believe that it takes time, effort, and a lot of money to start a business so making a profit may take some time.

In some cases, there’s an inverse relationship between profit margins and sales. For instance, profit margins in the service and manufacturing industries decrease as sales increase. Businesses in these sectors may see a 40% margin until they hit around $300,000 in annual sales. That’s about when the business has to start hiring more people. Each employee in a small business drives the margins lower.

Explain Like I’m Five

It’s hard to say what a good profit margin is, because it depends on your business and your industry. Some types of businesses, like software companies, will naturally have a higher profit margin than others, like restaurants. That’s because some businesses (like restaurants) have to spend more money to make money than other businesses (like software companies) do. This means you should only compare your business to businesses like it. So if you own a restaurant, don’t compare your profit margin to a software company. Compare it to other restaurants.

What Is a Good Gross Profit Margin Ratio?

A company’s gross profit margin ratio compares the company’s gross profit margin to its total revenue. It is expressed as a percentage. So if the ratio is 25%, that means that the company’s gross profit margin is 25 cents for every dollar in sales.

A higher gross profit margin ratio generally means that the business manages its sales costs well. But there’s no good way to determine what constitutes a good gross profit margin ratio. That’s because some sectors tend to have higher ratios than others. It’s not a one-size-fits-all approach.

What Are Good Gross Profit Margins for Various Major Industries?

NYU’s Stern Business School releases sector-related data on a regular basis. According to the school’s margin report from January 2025, the average gross profit margin for education companies was 41.15%. Machinery companies saw gross margins of 37.08%, while real estate developers saw margins of 35.13%. Oilfield services and equipment companies saw gross margins of 10.71%, and grocery stores raked in gross margins of 26.09%. Software had some of the highest margins.

What Is a Good Profit Margin for a Small Business?

The profit margin for small businesses depend on the size and nature of the business. Keep in mind, though, that certain businesses may see lower margins, such as retail or food-related companies. That’s because they tend to have higher overhead costs.

The Bottom Line

In the beginning, when your company is small and simple, margins could be quite high. You don’t have a large workforce and other substantial overhead expenses. As your sales increase and your business grows, more money comes in. But your margins will likely shrink because you’re probably hiring more people, investing in bigger facilities, and expanding your product line. Simply bringing in more cash doesn’t mean you’re making a bigger profit.

Remember, as your business expands, tend to its margins. Larger sales figures are great, but make sure you’re earning maximum money on those sales.

Reviewed by Erika Rasure
Fact checked by Betsy Petrick

Target Corporation’s RedCard program is a leading loyalty program among retailers in the United States. The program is accessible to everyone and is integrated seamlessly into customers’ payment methods.

With lower barriers to entry than other loyalty programs, Target tries to build a relationship with its customers and can personalize the promotions and advertising offered to the consumer with this card.

Target’s RedCard comes in three forms: a Mastercard (open loop card), an in-store-only credit card, or a debit card. The debit card is linked to customers’ existing checking accounts, and for the in-store card, users can charge in-store purchases or buy online with the credit card at Target.com.

The Target-branded Mastercard can be used anywhere that accepts Mastercard. In this article, we are primarily discussing the Target RedCard debit card and in-store credit card, not the Mastercard.

Key Takeaways

• All Target cards can be used at Target stores (brick-and-mortar and online).
• The Target RedCard comes with 5% off purchases and free two-day shipping.
• The Target debit card is linked to your checking account.
• If you regularly shop at Target, the perks of a RedCard may be worth the high rates.

Features of the Target RedCard

All Target cards offer 5% off purchases every day at in-store and online locations and free two-day shipping on most items. Users also have an extended return facility giving them 30 extra days to return products to Target or Target.com. However, RedCard extended returns do not apply to the following:

• Target Optical purchases
• Non-returnable items
• Contract mobile phones
• Online purchases of Supplemental Nutrition Assistance Program (SNAP) eligible
  items using both Electronic Benefits Transfer (EBT) and a RedCard for
  payment.

The Target RedCard has a late payment fee of up to $41 and a return payment fee of up to $30. Customers looking to combine the benefits of the RedCard with a more traditional credit card can sign up for a Mastercard Incorporated RedCard through TD Bank, USA.

What’s in It for Target?

Most companies use loyalty programs to collect customer data in addition to building loyalty among patrons. Target’s data collection system is thorough.

Every purchase, email, or phone call is tracked, and data is applied to algorithms for marketing and planning purposes. By collecting data, the company can personalize deals and discounts for its shoppers.

Important

You should pay off your credit card balance every month to avoid high interest charges.

How Can I Get a Target RedCard?

You can get a Target RedCard by applying online for one. The RedCard credit application is on the Target.com website. You must verify your employment and income and review the terms.

You may be approved to shop online instantly, or you may have to wait for seven to 10 days to get your card, depending on whether Target approves you automatically.

The website isn’t 100% clear on how long it may take to be approved for either RedCard if you are not automatically approved. If you are not approved it may be due to red flags on your credit report or a low credit score.

Like any credit card, you have to meet certain requirements to be approved for a new credit card. If you apply and are not instantly approved, you may get a notice that your file is “in review.”

Is the Target RedCard a Credit Card?

Yes. Target offers a RedCard credit card issued by TD Bank USA. The RedCard brand also has two other options: an in-store credit card and a debit card.

Where Can I Use My Target RedCard?

You can use a Target RedCard Mastercard credit card anywhere that takes Mastercard, and you can use your Target RedCard charge card or Target debit card at Target stores or on Target.com.

How Do I Pay My Target RedCard?

You can pay your Target RedCard charge card online. In the case of the Target RedCard debit card, the money comes immediately out of your checking account when you use it.

How Long Does It Take for the Target RedCard to Post to My Account?

Your Target RedCard may be added immediately to your account at Target if you are automatically approved.

How Do I Close My Target RedCard?

You can call Target’s toll-free number or close it via mail.

The Bottom Line

Target’s RedCard can be used for both in-store and online ordering for user convenience. Once a customer is signed up, Target begins to collect data from that individual’s profile. The program is appealing to shoppers because it provides generous discounts and community donations.

However, users should be aware of the high interest rate and the late payment fees, which could cause debt to mount if the balance is not paid off each month.

Reviewed by Somer Anderson
Fact checked by Ryan Eichler

What Is Business Forecasting?

Business forecasting involves making informed guesses about certain business metrics, regardless of whether they reflect the specifics of a business, such as sales growth, or predictions for the economy as a whole. Financial and operational decisions are made based on economic conditions and how the future looks, albeit uncertain.

Key Takeaways:

• Forecasting is valuable to businesses so that they can make informed business decisions.
• Financial forecasts are fundamentally informed guesses, and there are risks involved in relying on past data and methods that cannot include certain variables.
• Forecasting approaches include qualitative models and quantitative models.

Understanding Business Forecasting

Companies use forecasting to help them develop business strategies. Past data is collected and analyzed so that patterns can be found. Today, big data and artificial intelligence have transformed business forecasting methods. There are several different methods by which a business forecast is made. All the methods fall into one of two overarching approaches: qualitative and quantitative.

While there might be large variations on a practical level when it comes to business forecasting, on a conceptual level, most forecasts follow the same process:

1. A problem or data point is chosen. This can be something like “will people buy a high-end coffee maker?” or “what will our sales be in March next year?”
2. Theoretical variables and an ideal data set are chosen. This is where the forecaster identifies the relevant variables that need to be considered and decides how to collect the data.
3. Assumption time. To cut down the time and data needed to make a forecast, the forecaster makes some explicit assumptions to simplify the process.
4. A model is chosen. The forecaster picks the model that fits the dataset, selected variables, and assumptions.
5. Analysis. Using the model, the data is analyzed, and a forecast is made from the analysis.
6. Verification. The forecast is compared to what actually happens to identify problems, tweak some variables, or, in the rare case of an accurate forecast, pat themselves on the back.

Once the analysis has been verified, it must be condensed into an appropriate format to easily convey the results to stakeholders or decision-makers. Data visualization and presentation skills are helpful here.

Types of Business Forecasting

There are two key types of models used in business forecasting—qualitative and quantitative models.

Qualitative Models

Qualitative models have typically been successful with short-term predictions, where the scope of the forecast was limited. Qualitative forecasts can be thought of as expert-driven, in that they depend on market mavens or the market as a whole to weigh in with an informed consensus.

Qualitative models can be useful in predicting the short-term success of companies, products, and services, but they have limitations due to their reliance on opinion over measurable data. Qualitative models include:

1. Market research: Polling a large number of people on a specific product or service to predict how many people will buy or use it once launched.
2. Delphi method: Asking field experts for general opinions and then compiling them into a forecast.

Quantitative Models

Quantitative models discount the expert factor and try to remove the human element from the analysis. These approaches are concerned solely with data and avoid the fickleness of the people underlying the numbers. These approaches also try to predict where variables such as sales, gross domestic product, housing prices, and so on, will be in the long term, measured in months or years. Quantitative models include:

1. The indicator approach: The indicator approach depends on the relationship between certain indicators, for example, GDP and the unemployment rate remaining relatively unchanged over time. By following the relationships and then following leading indicators, you can estimate the performance of the lagging indicators by using the leading indicator data.
2. Econometric modeling: This is a more mathematically rigorous version of the indicator approach. Instead of assuming that relationships stay the same, econometric modeling tests the internal consistency of datasets over time and the significance or strength of the relationship between datasets. Econometric modeling is applied to create custom indicators for a more targeted approach. However, econometric models are more often used in academic fields to evaluate economic policies.
3. Time series methods: Time series use past data to predict future events. The difference between the time series methodologies lies in the fine details, for example, giving more recent data more weight or discounting certain outlier points. By tracking what happened in the past, the forecaster hopes to get at least a better-than-average view of the future. This is one of the most common types of business forecasting because it is inexpensive and no better or worse than other methods.

Criticisms of Forecasting

Forecasting can be dangerous. Forecasts become a focus for companies and governments mentally limiting their range of actions by presenting the short to long-term future as pre-determined. Moreover, forecasts can easily break down due to random elements that cannot be incorporated into a model, or they can be just plain wrong from the start.

However, business forecasting is vital for businesses because it allows them to plan production, financing, and other strategies. However, there are three problems with relying on forecasts:

1. The data is always going to be old. Historical data is all we have to go on, and there is no guarantee that the conditions in the past will continue in the future.
2. It is impossible to factor in unique or unexpected events or externalities. Assumptions are dangerous, such as the assumption that banks were properly screening borrowers prior to the subprime meltdown. Black swan events have become more common as our reliance on forecasts has grown.
3. Forecasts cannot integrate their own impact. By having forecasts, accurate or inaccurate, the actions of businesses are influenced by a factor that cannot be included as a variable. This is a conceptual knot. In a worst-case scenario, management becomes a slave to historical data and trends rather than worrying about what the business is doing now.

Negatives aside, business forecasting is here to stay. Appropriately used, forecasting allows businesses to plan ahead for their needs, raising their chances of staying competitive in the markets. That’s one function of business forecasting that all investors can appreciate.

What Are the Main Steps of Forecasting?

Forecasting should (1) start with identifying the problem. It should then (2) gather all the information necessary to solve the problem. After gathering data, (3) a business should run a preliminary analysis, (4) choose an appropriate forecasting model, (5) and once the forecasting is complete, analyze the results.

Is Forecasting a Business Strategy?

Forecasting is more of a business technique or tool than a business strategy. It seeks to take historical data and apply it to current data to predict the future business environment. From there, a business will make decisions to adapt to this predicted environment to ensure success.

What Do Business Forecasting Models Answer?

Business forecasting models seek to answer a variety of questions for a business, such as demand for a product or service, the ability to compete in an environment, predicting future sales, and estimating growth and expansion.

The Bottom Line

Businesses use forecasting to help make decisions about the direction of the company. Forecasting aims to predict the future to a degree and by doing so can help companies allocate resources, and make decisions on capital allocation, staffing, advertising, and more. Without forecasting, a business operates in the dark and may not be able to adjust itself to the right path for earnings success.

Fact checked by Betsy Petrick

A home equity loan is a type of second mortgage that allows you to borrow against the equity you have in your home, using your home as collateral. They typically have lower interest rates than other personal loans and provide fixed interest rates and regular monthly payments. To take out a home equity loan, determine how much money you want to borrow, shop around for lenders, complete an application, and work with the lender. We’ll walk you through each of these steps in detail.

Key Takeaways

• A home equity loan is often called a second mortgage because you borrow against the equity you have in your home and make regular monthly payments on the loan.
• Lenders will check your home equity, debt-to-income ratio, credit history, income, and assets to determine whether or not to approve your application.
• Homeowners with great credit will qualify for better interest rates and loan terms.

Step 1: Make Sure You Meet the Requirements

Applying for a home equity loan can be quite a process, so check to see if you meet the requirements before you spend time filling out paperwork. Specifically, you should find out your credit score to see if it’s at least in the mid-600s. If it’s lower, work on building your credit before starting a home equity loan application. While this can take time, having a better credit score can greatly improve your chance of getting approved.

While you’re looking into your credit score, check your credit report for errors. If you spot any, reach out to the credit monitoring bureaus and submit a dispute. Potential lenders will read your credit report to see how many credit accounts you have and if you’ve been late on any payments.

Tip

Access your credit reports for free through AnnualCreditReport.com, a government-sponsored site that provides free weekly access to reports from Equifax, Experian, and TransUnion, the three major credit bureaus.

Lenders will also consider your debt-to-income (DTI) ratio. This is the percentage of your income that goes towards monthly debts. Generally, lenders want borrowers with DTIs below 36%, but some may work with you if your DTI is up to 43%. To improve your odds of getting approved, work on paying down debt (like student loans, medical bills, and credit card debt) or earning more income.

Lastly, it’s important to learn how much equity you have since lenders will only consider your application if you have at least 20% equity in your home. For example, if you have a $400,000 home and have $320,000 left on the mortgage, you have the necessary 20% equity. Most lenders allow you to borrow up to 85% of your current equity.

Step 2: Determine How Much You Want to Borrow

You should already know how much equity you have in your home, so you also have an idea of the maximum you can borrow. Using our previous example, if you have a $300,000 home and no mortgage, a lender might offer you a maximum of $240,000, which is 80% of your equity. But, if you still owe $150,000 on the home, you’d subtract this from the potential loan amount, so you’d only be eligible to get $90,000.

Before you accept the maximum offered, consider how much you truly need to borrow. After all, by taking out a second mortgage, you’re reducing your equity and adding a hefty monthly payment to your budget. If you fail to make payments, you risk losing your home.

Think carefully about how much you want your loan to be, keeping in mind that you will be reducing the equity in your home and increasing your monthly debt obligation. You’ll also be paying closing costs, which will reduce the lump sum amount you get. Your goal should be to borrow just enough rather than taking more than you need.

Step 3: Compare Interest Rates and Lenders

Once you have an idea of how big of a loan you want to get, you can begin shopping for home equity lenders. Resist the urge to skip this step and use the first lender you come across.

The terms and interest rates offered by lenders can vary widely, which can cost or save you hundreds or thousands of dollars. Look for legitimate lenders from banks, credit unions, and mortgage brokers. Then, request quotes and compare them based on:

• Interest rates
• Loan term options (like term length and repayment options)
• Closing costs
• Fees (like prepayment penalties)

Step 4: Complete a Home Equity Loan Application 

Once you’ve chosen a lender and home equity loan product, you can complete an application. Some lenders allow you to submit an application online or over the phone, while others require you to apply in person.

You’ll usually need to provide the following information on your application:

• Contact information and proof of identity
• Details about your home (like the title and property tax statements)
• Loan needs—how much you’re applying for
• Income documentation (like paystubs, W2s, and federal tax returns)
• Permission for a credit check

Note

You might assume that if you have the best credit score possible (850), you’ll get the best interest rates on the home equity loan. However, meeting the lender’s minimum requirements, having other accounts at the institution, and signing up for automatic payments also can help qualify you for the same top rate even if your credit score falls well short of being perfect.

Step 5: Wait for Approval

Some might say this is the hardest step: waiting. During this time, the lender will closely look over your application and the company’s underwriting team will research and verify the information. You might be asked additional questions or asked to provide more documentation. For instance, the lender may ask you to set up and pay for a home appraisal.

If your application checks out and you meet the lender’s requirements, you’ll be approved. Be aware that you do have the right to cancel a home equity loan within three days if you change your mind or for any reason.

Step 6: Close and Receive Funds

If approved, your lender will tell you the closing date. This is when you’ll sign the loan documents and the funds will be transferred. Since this is a big financial obligation, be sure to read through the paperwork closely before signing.

When all is said and done, it can take anywhere from a few weeks to months between applying for a home equity loan and receiving the funds.

The Bottom Line

In many ways, getting a home equity loan is easier than getting a mortgage, assuming you meet the lender’s requirements. To make the loan application process go more smoothly, research qualifications, check out your credit factors, and consider how big of a loan you need. If you’re unsure whether or not a home equity loan is right for you, talk with a financial advisor about your best options.