money

Fact checked by Giselle Cancio

Failing to file your tax returns can lead to serious consequences. Worst case scenario, you can face jail time for intentionally evading taxes. In other cases, the Internal Revenue Service (IRS) can file a lien on your property in order to get money that is owed, which can include freezing your bank account and garnishing your wages.

While jail time is typically reserved for criminal offenses of tax evasion and fraud, there can be other severe financial consequences for nonfilers.

Key Takeaways

• If you don’t file your taxes or pay your tax returns, it will not result in jail time—unless the IRS considers it was done through criminal tax evasion or fraud, in other words, the willful intent to avoid tax payments illegally.
•  The IRS can file a lien on your property if you don’t pay your taxes, including garnishing wages, freezing your bank account, and taking from your 401(k).
• Failing to file by April 15th will result in a “Failure to File” penalty, which adds significant costs to your tax bill.

Penalties for Nonfilers

The IRS is a very powerful creditor in America. In fiscal year 2024, it collected $5.1 trillion in payments and processed over 160 million individual tax returns. Overall, these payments funded 96% of the federal government’s operations.

Among the worst outcomes for not filing a tax return or paying taxes are listed as follows:

Prison Time

Taxpayers found guilty of tax evasion or tax fraud may face jail time for up to five years. Tax evasion includes willfully attempting to evade taxes while tax fraud includes hiding income from different sources or destroying bank account information if requested by an IRS auditor. In some cases, if you delay filing a tax return, the IRS may impose criminal penalties if it considers this a willful attempt in evading taxes.

Federal Tax Lien

Often, the IRS will file a federal tax lien on your property if you owe $10,000 or more in taxes and have not set up an arrangement to pay it back in six years. If more than $50,000 is owed in taxes, the IRS will almost certainly file a lien on your property even if a payment arrangement has been made. This grants the federal government a legal claim to your property, such as freezing your bank account, garnishing wages, or taking from your 401(k) or IRA. If you sell your home or other assets, proceeds will go toward paying off tax debt first.

Penalties and Fees

Nonfilers face stiff penalties, the two most common being failure to file a return and failure to pay taxes due.

For example, if you owed $1,000 in taxes for 2024 and didn’t file on time, you would face a $435 failure to file penalty and a $60 failure to pay penalty. Interest begins to accrue immediately on April 15th at an annual rate of 8%, compounded daily.

Warning

The Failure to File penalty is 5% of unpaid taxes for each month, or portion of a month, that it is late up to a maximum of 25% of taxes that are owed.

What Solutions Are Available?

If you can’t file your taxes on time, or make the payment in full, there are a number of options available at IRS.gov.

• File for an extension: It is possible to get a three-month filing extension if you file the IRS Form 4868 by April 15th. This will help you avoid the costly failure to file penalty if you file your return by July 15th. Keep in mind, interest on taxes that you owe starts accruing on April 15th even if you don’t know the taxes that you owe. If you don’t file an extension by April 15th, or pay the balance in full, be sure to file as soon as possible.
• Payment plans: The IRS also has payment agreements available for people who owe under $100,000 in taxes that are fairly straightforward. Payment is owed within 180 days under short-term plans at no cost to set up online.
• Installment agreements: There are installment agreements that have longer payment schedules available to taxpayers that owe under $50,000. These typically cost $22 to set up for direct monthly withdrawals, with the fee waived for low income individuals.

The Bottom Line

There are several penalties if you don’t file your taxes—from expensive fees and federal tax liens to jail time in the most extreme cases. The good news is the IRS provides taxpayers a number of options, such as tax filing extensions and payment plans to help pay back taxes that are owed. If you file your taxes past the due date or owe Uncle Sam, it may be worth seeking out a tax relief company to help you navigate the complexities of the tax system with more confidence.

Home décor, window coverings, power equipment, online directory, distribution

Reviewed by Charles Potters
Fact checked by Vikki Velasquez

Throughout its history, Home Depot (HD) has focused on catering to professional contractors and do-it-yourself consumers with customized service. That service includes a knowledgeable staff who can guide customers on how to do everything from operating a power tool, to changing a valve, to laying tile. Home Depot’s acquisitions reflect that approach. The company has focused on deals that strengthen its core business: by adding both more product offerings and highly trained experts in specific home improvement niches. While Home Depot’s core business is brick-and-mortar stores, it also has expanded by purchasing online companies with a track record of strong customer focus.

Below, we look at six of Home Depot’s key acquisitions.

Key Takeaways

• The Home Depot Inc. (HD), a leading home improvement retailer, was founded in 1978 by Bernie Marcus and Arthur Blank, two avid do-it-yourselfers.
• The company went public in 1981 and has since grown into the world’s leading home improvement retailer, with nearly 2,300 stores throughout the United States, Canada, and Mexico. It also offers more than 1 million products online.
• Home Depot has expanded beyond its brick-and-mortar stores by acquiring other companies, including online retailers, equipment rental services, and other home improvement businesses.

Compact Power Equipment Inc.

• Type of business: Equipment rental and maintenance services
• Acquisition price: $265 million
• Acquisition date: July 6, 2017 (announced date)

Compact Power Equipment, founded by entrepreneur Roger Braswell, provides equipment rental services, including rentals of cranes, excavators, tractors, and trenchers. Compact Power Equipment first formed a long-term commercial partnership with Home Depot in 2009 that began rentals at 115 Home Depots in six states.

In 2017, Home Depot acquired the company, which then was providing equipment rentals at more than 1,000 Home Depot stores throughout the United States and Canada. The acquisition strengthens Home Depot’s offerings and services to professional business customers.

The Company Store

• Type of business: Online retailer of textiles and home décor products
• Acquisition price: Terms of the deal undisclosed
• Acquisition date: Dec. 19, 2017

The Company Store, founded in 1911, sells sheets, quilts, bath towels, select clothing, and other home décor products online. Home Depot acquired The Company Store, excluding its five retail locations, in 2017 from Hanover Direct.

In addition to immediately bolstering Home Depot’s online footprint, the deal also enabled the company to expand into broader areas of the online décor business by providing strong product development and sourcing capabilities.

Interline Brands Inc.

• Type of business: Distributor and direct marketer of building products
• Acquisition price: $1.6 billion
• Acquisition date: Aug. 24, 2015

Interline Brands was founded in 1978 under the name Wilmar Industries Inc. The company provides maintenance, repair, and operations products to professional contractors, facilities maintenance professionals, hardware stores, and other customers throughout the United States and Canada.

Home Depot acquired Interline Brands in 2015 for just over $1.6 billion. The acquisition expanded Home Depot’s sales and services primarily to professional contractors and maintenance repair businesses by adding an experienced account sales force, fulfillment capabilities, and an extensive distribution network.

Blinds.com

• Type of business: Online window coverings retailer
• Acquisition price: Terms of the deal undisclosed
• Acquisition date: Jan. 23, 2014

Blinds.com traces its roots to a website named NoBrainerBlinds.com, which first began selling blinds and shades in June 1996. The company specializes in selling window coverings online, which includes live chat and face2face video consultation services.

Home Depot acquired Blinds.com in 2014, when the online window coverings market was growing rapidly. The acquisition has bolstered Home Depot’s online presence.

Redbeacon

• Type of business: Online home improvement services
• Acquisition price: Terms of the deal undisclosed
• Acquisition date: Jan. 20, 2012 (announced date)

Redbeacon, which won the 2009 TechCrunch 50 award, was founded in 2008 by former Google employees Aaron Lee, Ethan Anderson, and Yaron Binur. The company provides an online search directory of local business listings with ratings and reviews of screened and approved home contractors. Customers using the site can get multiple price quotes and schedule appointments with local business professionals.

In 2012, Home Depot acquired Redbeacon, which the parent now calls Pro Referral. The acquisition is another example of how Home Depot has expanded and strengthened its suite of online services.

HD Supply

• Type of business: Wholesale distributor of maintenance, repair and operations (MRO) products
• Acquisition price: Approximately $8 billion
• Acquisition date: Dec. 24, 2020

HD Supply Holdings Inc. was founded in 1974 as Maintenance Warehouse. The Home Depot originally acquired Maintenance Warehouse in 1997 and later renamed it Home Depot Supply, and then HD Supply. In 2007, Home Depot sold HD Supply to a group of private equity firms.

By the time Home Depot reacquired HD Supply in late 2020, the company had grown to encompass 44 distribution centers across the United States and Canada and had become a top distributor of maintenance, repair and operations (MRO) products. The acquisition bolsters Home Depot’s MRO presence in the hospitality and multifamily end markets. The deal also will help Home Depot to increase business with larger contractors and other professional customers, who tend to get business from specialty suppliers.

Home Depot Diversity & Inclusiveness Transparency

As part of our effort to improve the awareness of the importance of diversity in companies, we have highlighted the transparency of Home Depot’s commitment to diversity, inclusiveness, and social responsibility. The chart below illustrates how Home Depot reports the diversity of its management and workforce. This shows if Home Depot discloses data about the diversity of its board of directors, C-Suite, general management, and employees overall across a variety of markers. We have indicated that transparency with a ✔.

Home Depot & Inclusiveness Reporting
	Race	Gender	Ability	Veteran Status	Sexual Orientation
Board of Directors	✔ (U.S. Only)	✔ (U.S. Only)
C-Suite	✔ (U.S. Only)	✔ (U.S. Only)
General Management	✔ (U.S. Only)	✔ (U.S. Only)
Employees	✔ (U.S. Only)	✔ (U.S. Only)	✔ (U.S. Only)	✔ (U.S. Only)	✔ (U.S. Only)

How Many Stores Does Home Depot Have?

As of 2024, Home Depot has more than 2,347 stores across the United States, Mexico, and Canada, through which it employs over 470,000 associates.

How Are Home Depot’s Financials?

Home Depot reported $159.5 billion in revenue in 2024. As of March 2025, it has a market capitalization of $347.25 billion.

Who is Home Depot’s Main Competitor?

Lowe’s is Home Depot’s primary competitor. As the second-largest home improvement retailer worldwide, Lowe’s is a direct competitor that challenges Home Depot for market share and customers.

The Bottom Line

The Home Depot is the world’s largest home improvement retailer and one of the biggest employers in the United States. Since its founding in 1978, it has expanded beyond brick-and-mortar stores into online retail and purchased several other companies and well-known home improvement brands. It has several wholly owned subsidiaries, including Blinds.com, Interline Brands, Compact Power Equipment Inc., The Company Store, Redbeacon, and HD Supply, as well as exclusive brands like Chem-Dry, Behr, Ryobi, and American Woodmark cabinetry.

Reviewed by Eric Estevez

Microfinance is a growing sector. According to the 2023 Microfinance Social Performance Report by BNP Paribas, 156.1 million borrowers worldwide benefited from these services in 2022. Learn how microfinance helps people access financial services and potentially climb out of poverty and how you can get involved as an individual, investor, or finance professional.

Key Takeaways

• Microfinance is a range of banking products and services (microloans, microsavings accounts, micro-insurance) provided to low-income individuals or groups who don’t otherwise have access to financial services. 
• Like regular lenders, microfinance lenders set specific repayment plans and charge interest on their loans.
• Microfinance lenders comply with ethical lending practices, allowing borrowers to take on small business loans in a safe manner.
• Microfinance practices try to demonstrate that low-income people can pull themselves out of poverty.
• Investors and finance professionals can benefit from the rapid growth of the microfinance market.

What Is Microfinance?

The term microfinance describes the range of financial products (such as microloans, microsavings, and micro-insurance products) that microfinance institutions (MFIs) offer to their clients.

Microfinance began in the 1970s when social entrepreneurs began lending money on a large scale to people with low incomes and no access to credit. One individual who gained worldwide recognition for his work in microfinance is Professor Muhammad Yunus who, with Grameen Bank, won the 2006 Nobel Peace Prize.

Yunas demonstrated that people with low incomes have the ability to pull themselves out of poverty. He also demonstrated that loans made to this demographic, if properly structured, had very high repayment rates. His work caught the attention of both social engineers and profit-seeking investors.

Note

The global microfinance market is expected to triple in value by 2033.

Microfinance Products and Services

The following products and services are currently being offered by microfinance institutions :

Microloans

Microloans (also known as microcredit) are loans that have a small value. These loans are generally issued to finance entrepreneurs who run micro-enterprises in developing countries. Examples of micro-enterprises include basket-making, sewing, street vending, and raising poultry.

Interest rates are typically high, due in part to higher default risks and the higher costs associated with processing the labor-intensive micro-loan transactions, and can vary considerably, depending on the borrower and country as well as the size and length of the loan. Interest rates, worldwide, are said to average about 36.6%.

In some cases, interest rates have been reported to even be as high as 100%, although many countries have caps in place to prevent such extortionate borrowing costs. Microloans funded by the U.S. Small Business Administration are available in amounts up to $50,000, with repayment terms up to seven years and interest rates that range from 8% to 13%.

Microsavings

Microsavings accounts allow individuals to store small amounts of money for future use without minimum balance requirements. Like traditional savings accounts in developed nations, micro-savings accounts are tapped by the saver for life needs such as weddings, funerals and old-age supplementary income.

Micro-Insurance

Individuals living in developing nations face more risks and uncertainties in their lives. For example, there is more direct exposure to natural disasters, such as mudslides, and more health-related risks, such as communicable diseases.

Micro-insurance, like its non-micro counterpart, pools risks and helps provide risk management. But unlike its traditional counterpart, micro-insurance allows for insurance policies that have very small premiums and policy amounts. Examples of micro-insurance policies include crop insurance and policies that cover outstanding balances of micro-loans in the event a borrower dies.

Due to the high administrative expense ratios, micro-insurance is most efficient for MFIs when premiums are collected together with microloan repayments.

Important

Microfinance has been credited with helping to eradicate poverty and making it worse through expensive borrowing costs and generally unfavorable terms.

Investing in Microfinance

It’s possible to get involved in microfinancing and potentially make money from it.

Ways include:

• Investing directly in a MFI
• Investing in a fund that invests in microenterprises and MFIs
• Microfinance bonds
• Peer-to-peer lending services

Microfinance has been pitched as a way to make decent money while doing good. Default rates are said to be lower than maybe expected and as borrowing costs can be high this can result in attractive returns.

However, it’s important to remember that microfinance investments have different risk profiles. Some may be less volatile and offer low prospective returns and vice versa.

It’s also possible to lend micro-entrepreneurs money without demanding a return through non-profit online services such as Kiva.

Institutions generally make high returns on their microfinance investments.

Microfinance Career Opportunities

Microfinance requires highly specialized financial knowledge as well as a unique combination of skills, such as knowledge of social science, local languages, and customs. Finance professionals with these skills shouldn’t have trouble finding work.

Moreover, traditional career roles are blurring as microfinance brings together professionals with varied backgrounds to work in collaborative teams. For example, development professionals (such as people who have worked for the Asian Development Bank or other development agencies) can now be found working side by side with venture capitalists.

A wide range of microfinance career opportunities can be found online, including at FinDev Gateway.

In What Countries Is Microfinance Most Popular?

The majority of microfinance services take place in developing countries like Bangladesh, Cambodia, India, Afghanistan, the Democratic Republic of Congo, Indonesia, and Ecuador.

What Is the Main Criticism of Microfinance?

The greatest criticism of microfinance is the idea that the financial world is making money instead of providing a service and essentially offering unfavorable financial terms to people in financial difficulty. In other words, microfinance lenders can become a profitable business at the cost of borrowers. Contributing factors that shed a negative light on microfinance are the alleged lack of policies to protect borrowers’ rights, the high interest rates on microfinance loans, and the high pressure to repay loans.

Who Provides Microfinance Services?

Microfinance products and services are provided by a variety of institutions such as non-profit organizations, some traditional banks, credit and savings cooperatives, and other non-bank financial institutions.

The Bottom Line

Capital and expertise are increasingly flowing into microfinance, a type of banking service provided to low-income individuals or groups who otherwise wouldn’t have access to financial services. Microfinance is potentially helping to eradicate poverty and provide equal opportunities. It’s also emerging as a new type of asset class for investors.

Reviewed by Charlene Rhinehart
Fact checked by Ryan Eichler

Market Capitalization vs. Equity: An Overview

Two of the most common ways of assessing a company’s value are market capitalization and equity (also known as shareholder equity). Each term describes a different way of looking at a company’s value. It is helpful to consider both to get the most accurate picture of a company’s worth.

Market Capitalization

Market capitalization is the total dollar value of all outstanding shares of a company. It is calculated by multiplying the current share price by the number of outstanding shares.

Market analysts commonly use this figure to designate a company’s size, as many stock market indexes are weighted by market capitalization. Because market capitalization is dependent on share price, it can fluctuate greatly from month to month, or even from day-to-day.

Key Takeaways

• Market capitalization is the total dollar value of all outstanding shares of a company.
• Equity is a simple statement of a company’s assets minus its liabilities.
• It is helpful to consider both equity and market capitalization to get the most accurate picture of a company’s worth.

Market capitalization does not measure the equity value of a company. Only a thorough analysis of a company’s fundamentals can do that. Shares are often overvalued or undervalued by the market, meaning the market price determines only how much the market is willing to pay for its shares. 

Although it measures the cost of buying all of a company’s shares, the market cap does not determine the amount the company would cost to acquire in a merger transaction. A better method of calculating the price of acquiring a business outright is the enterprise value. 

Equity

Shareholder equity is considered a more accurate estimate of a company’s actual net worth. Equity is a simple statement of a company’s assets minus its liabilities; it could also be seen as the net profit that would remain if the company was sold or liquidated at fair value. Unlike market capitalization, equity does not fluctuate day to day based on the stock price.

Equity represents the true value of one’s stake in an investment. Investors who hold stock in a company, for example, are usually interested in their personal equity in the company, represented by their shares. Yet, this kind of personal equity is directly tied to the company’s total equity, thus a stockholder will also have a concern for the company’s earnings.

Owning stock in a company over time ideally yields capital gains for the shareholder and potentially dividends. A shareholder may also get the right to vote in the board of directors’ elections. These benefits further promote a shareholder’s ongoing interest in the company.

Key Differences

Market capitalization value is nearly always greater than equity value since investors figure in factors such as a company’s expected future earnings from growth and expansion. It can be helpful to make a historical comparison between market capitalization value and equity value to see if there is a trend one way or the other.

Important

If market capitalization has grown steadily higher and further above equity value, this indicates increased confidence on the part of investors.

Both market capitalization and equity can be found by looking at a company’s annual report. The report shows the number of outstanding shares at the time of the report, which can then be multiplied by the current share price to obtain the market capitalization figure. Equity appears on the company’s balance sheet.

Fact checked by Ariel Courage
Reviewed by Erika Rasure

A recession is a significant, persistent, and widespread contraction in economic activity. Since the Great Depression, the United States has suffered 14 official recessions. Here, we break down each one.

Key Takeaways

• A recession is an economic downturn that typically lasts for more than a few months.
• Recessions in the United States have become shorter and less frequent in recent decades.
• The COVID-19 recession was the shortest on record, while the Great Recession of 2007-2009 was the deepest since the downturn in 1937-1938.

What’s a Recession?

Recessions are sometimes defined as two consecutive quarters of decline in real gross domestic product (GDP), which measures the combined value of all the goods and services produced in an economy.

In the U.S., the National Bureau of Economic Research (NBER) dates recessions based on indicators including GDP, payroll employment, personal income and spending, industrial production, and retail sales.

Important

Recessions have grown increasingly infrequent over the past four decades.

Surveying Past U.S. Recessions

Let’s take a look at all of the official U.S. recessions since the Great Depression, focusing on common measurements of their severity as well as causes.

• Duration: How long did the recession last, according to NBER?
• GDP Decline: How much did economic activity contract from its prior peak?
• Peak Unemployment Rate: What was the maximum proportion of the workforce left jobless?
• Reasons and Causes: What unique circumstances contributed to the recession?

The Own Goal Recession: May 1937–June 1938

• Duration: 13 months
• GDP Decline: 10%
• Peak Unemployment Rate: 20%
• Reasons and Causes: Expansionary monetary and fiscal policies had secured a recovery from the Great Depression after 1933, albeit an uneven and incomplete one. In 1936-1937 policymakers changed course, more preoccupied with cutting budget deficits and heading off inflation than with the dangers of a depressive relapse. Following a tax increase in 1935 and Social Security payroll deductions starting in 1937, the budget deficit shrank from 5.4% of GDP in 1936 to 0.1% of GDP by 1938. Meanwhile, the Federal Reserve in 1936 doubled the reserve requirement ratios for banks, thus curbing lending with the stated aim of preventing “an injurious credit expansion.” Perhaps most damaging of all, the U.S. Treasury began the same year to sterilize gold inflows, ending brisk money supply growth that had supported the expansion. Industrial production began falling in September. It would decline 32% in the course of the recession. The stock market crashed in October. The recession ended after policymakers rolled back the increase in reserve requirements and gold sterilization as well as fiscal austerity.

The V-Day Recession: February 1945–October 1945

• Duration: Eight months
• GDP Decline: 10.9%
• Peak Unemployment Rate: 3.8%
• Reasons and Causes: The 1945 recession reflected massive cuts in U.S. government spending and employment toward the end and immediately after World War II. Federal spending fell 40% in 1946 and 38% in 1947 while the private sector’s output grew rapidly. The severity of the downturn remains open to question because much of the eliminated spending represented wartime production that did not serve to increase living standards. The elimination of price controls in 1946 artificially depressed output as adjusted for inflation, while the unemployment rate remained low in part because women left the workforce in large numbers.

The Post-War Brakes Tap Recession: November 1948–October 1949

• Duration: 11 months
• GDP Decline: 1.7%
• Peak Unemployment Rate: 7.9%
• Reasons and Causes: The first phase of the post-war boom was in some ways comparable to the economic recovery from the COVID-19 pandemic. Amid a backlog of consumer demand suppressed during the war and a shortage of production capacity, the collapse of wartime price controls fueled an abrupt surge of inflation by mid-1946. The annualized inflation rate rose from 3.3% in June 1946 to 11.6% two months later and 19% at its peak in April 1947. Policymakers only responded in the second half of 1947, and when they did their efforts to tighten credit ultimately led to a relatively mild recession as consumers and producers retrenched.

The Post-Korean War Recession: July 1953–May 1954

• Duration: 10 months
• GDP Decline: 2.7%
• Peak Unemployment Rate: 5.9%
• Reasons and Causes: The wind-down of the Korean War caused government spending to decline dramatically, lowering the federal budget deficit from 1.7% of GDP in fiscal 1953 to 0.3% a year later. Meanwhile, the Federal Reserve tightened monetary policy in 1953.

The Investment Bust Recession: August 1957–April 1958

• Duration: Eight months
• GDP Decline: 3.7%
• Peak Unemployment Rate: 7.4%
• Reasons and Causes: The end of the Korean War unleashed a global investment boom marked by a surge in exports of U.S. capital goods. The Fed responded by tightening monetary policy as the inflation rate rose from 0.4% in March 1956 to 3.7% a year later. Fiscal policy focused on limiting budget deficits produced a surplus of 0.7% of GDP in 1957. The 1957 Asian Flu pandemic killed 70,000 to 100,000 Americans in 1957, and industrial production slumped late that year and early in 1958. The dramatic drop in domestic demand and evolving consumer expectations led to the failure of the Ford Edsel, the beginning of the end for Detroit’s auto industry dominance. The sharp worldwide recession contributed to a foreign trade deficit. The recession ended after policymakers eased fiscal and monetary constraints on growth.

The ‘Rolling Adjustment’ Recession: April 1960–February 1961

• Duration: 10 months
• GDP Decline: 1.6%
• Peak Unemployment Rate: 6.9%
• Reasons and Causes: This relatively mild recession was named for the so-called “rolling adjustment” in U.S. industrial sectors tied to consumers’ diminished demand for domestic autos amid growing competition from inexpensive imports. Like most other recessions, it was preceded by higher interest rates, with the Fed increasing the federal funds rate from 1.75% in mid-1958 to 4% by the end of 1959. Fiscal policy also tightened at the end of President Dwight Eisenhower’s second term, from a deficit of 2.6% of GDP in 1959 to a surplus of 0.1% a year later.

The Guns and Butter Recession: December 1969–November 1970

• Duration: 11 months
• GDP Decline: 0.6%
• Peak Unemployment Rate: 5.9%
• Reasons and Causes: Military spending increased in the late 1960s amid growing U.S. involvement in the Vietnam War and alongside high expenditures on domestic policy initiatives. As a result, the federal budget deficit rose from 1.1% of GDP in 1967 to 2.9% in 1968, while inflation increased from 3.1% in 1967 to 4.3% a year later and 5.3% by 1970. The Federal Reserve increased the federal funds rate from 5% in March 1968 to more than 9% by August 1969. By early 1971, the Fed had lowered the federal funds rate back below 4%, aiding the recovery.

The Oil Embargo Recession: November 1973–March 1975

• Duration: 16 months
• GDP decline: 3%
• Peak Unemployment Rate: 8.6%
• Reasons and causes: This long, deep recession began following the start of the Arab Oil Embargo, which would quadruple crude prices. That tipped the balance for an economy struggling with the devaluation of the dollar amid high U.S. trade and budget deficits and slipping domestic crude output. The collapse of the Bretton Woods Agreement fixing currency exchange rates contributed to a rise in U.S. inflation from 2.4% in August 1972 to 7.4% a year later, causing the Fed to double the federal funds rate to 10% between late 1972 and mid-1973. After increasing the federal funds rate to 13% in the first half of 1974, the Fed cut it to 5.25% in under a year. Inflation and unemployment remained elevated after the recession ended, ushering in stagflation. Unemployment reached 9% in May of 1975, after the declared end of the recession.

The Iran and Volcker Recession, Part 1: January 1980–July 1980

• Duration: Six months
• GDP Decline: 2.2%
• Peak Unemployment Rate: 7.8%
• Reasons and Causes: Accommodative monetary policy aimed at alleviating rising unemployment pushed U.S. inflation to 7% by early 1979, just before the Iranian Revolution caused oil prices to double. The Federal Reserve was already raising rates when Paul Volcker was named Fed chair in August 1979, and the rate went from 10.5% at the time of his appointment to 17.5% by April 1980. This short recession formally ended as the Fed dropped the fed funds rate back down to 9.5% by August of 1980, but inflation stayed high and the Volcker Fed wasn’t done.

Part 2 of Double-Dip Recession: July 1981–November 1982

• Duration: 16 months
• GDP Decline: 2.9%
• Peak Unemployment Rate: 10.8%
• Reasons and Causes: By the fourth quarter of 1980 inflation was up to 11.1%, prompting the Federal Reserve to raise the fed funds rate to 19% by July 1981. As the downturn worsened and joblessness climbed, Volcker resisted repeated demands in Congress to change course. By October 1982 inflation had declined to 5%, while unemployment would remain above 10% until mid-1983. Most economists today accept Volcker’s arguments at the time that failure to control inflation and restore the Fed’s credibility would have led to continued economic underperformance.

The Gulf War Recession: July 1990–March 1991

• Duration: Eight months
• GDP Decline: 1.5%
• Peak Unemployment Rate: 6.8%
• Reasons and Causes: This relatively mild recession began a month before Iraq invaded Kuwait, and the resulting oil price shock may have contributed to a frustratingly lackluster recovery. The Fed had raised the federal funds rate from 6.5% in February 1988 to 9.75% in May 1989 in an effort to contain inflation, which rose from 2.2% in 1986 to 3.9% for 1990.

The Dot-Bomb Recession: March 2001–November 2001

• Duration: Eight months
• GDP Decline: 0.3%
• Peak Unemployment Rate: 5.5%
• Reasons and Causes: The collapse of the dot-com bubble contributed to one of the mildest recessions on record following what was then the longest economic expansion in U.S. history. The Fed raised the fed funds rate from 4.75% in early 1999 to 6.5% by July 2000. The September 11 attacks and the associated economic disruptions may have hastened the recession’s end by encouraging the Fed to keep cutting the fed funds rate. The benchmark rate reached a low of 1% by mid-2003.

The Great Recession: December 2007–June 2009

• Duration: Eighteen months
• GDP Decline: 4.3%
• Peak Unemployment Rate: 9.5%
• Reasons and Causes: The nationwide downturn in U.S. housing prices triggered a global financial crisis, a bear market in stocks that had the S&P 500 down 57% at the lows, and the worst economic downturn since the recession of 1937-38. Global investment flows into the U.S. had kept market rates low, likely encouraging unscrupulous mortgage underwriting and mortgage-backed securities marketing practices. Oil prices spiked to record highs by mid-2008 and then crashed, depressing the U.S. oil industry. Dropping oil and commodity prices led to deflation and strained the U.S. economy.

The COVID-19 Recession: February 2020–April 2020

• Duration: Two months
• Peak Unemployment Rate: 14.7%
• Reasons and Causes: The COVID-19 pandemic spread to the U.S. in early 2020, and the resulting travel and work restrictions caused employment to plummet, triggering an unusually short but sharp recession. The unemployment rate climbed from 3.5% in February 2020 to 14.7% in April 2020 but was back below 4% by the end of 2021, capped by $5 trillion in pandemic relief spending. In addition, quantitative easing by the Federal Reserve expanded its balance sheet from $4.1 trillion in February 2020 to nearly $9 trillion by the end of 2021, complementing a federal funds rate that remained near zero until March 2022.

What Is the Average Length of a Recession?

The U.S. has experienced 34 recessions since 1857 according to the NBER, varying in length from two months (February to April 2020) to more than five years (October 1873 to March 1879). The average recession has lasted 17 months, while the six recessions since 1980 have lasted less than 10 months on average.

Which Stocks Tend Fare Better During a Recession?

Companies in the consumer staples, health care, and utilities sectors, which see relatively small fluctuations in demand for economic reasons, tend to fare best during recessions, and their stocks have outperformed during past downturns as a result.

Do Recessions Always Coincide with Bear Markets?

A bear market is commonly defined as a sustained drop of 20% or more from a market peak. Of the 25 bear markets since 1928, 14 have overlapped with recessions.

The Bottom Line

As the history of recessions over the past century or so suggests, they’re almost always preceded by monetary policy tightening in the form of rising interest rates. Fiscal contractions, whether they involve lower government spending, higher taxes, or both, have also played a role.

This is not to automatically deprecate such policies when they lead to a recession. In some cases, as during the 1970s, the long-run alternative to immediate economic pain may be even less palatable. In others, as with the end of World War II and the Korean War, there may be no easy way or no will to find immediate alternatives to high military spending.

That doesn’t change the fact that most modern recessions have occurred in response to some combination of rising interest rates, lower budget deficits, and higher energy prices.

Fact checked by Patrice Williams
Reviewed by David Kindness

Working capital represents a company’s ability to pay its current liabilities with its current assets. This figure gives investors an indication of the company’s short-term financial health, its capacity to clear its debts within a year, and its operational efficiency.

Working Capital Formula

Subtract a company’s current liabilities from its current assets.

Key Takeaways

• Working capital is the amount of available capital that a company can readily use for day-to-day operations.
• It represents a company’s liquidity, operational efficiency, and short-term financial health.
• Subtract a company’s current liabilities from its current assets to calculate working capital.
• A positive amount of working capital means that a company can meet its short-term liabilities and continue its day-to-day operations.
• Current assets divided by current liabilities, called the current ratio, is a liquidity ratio often used to gauge short-term financial well-being. It’s also known as the working capital ratio.

Components of Working Capital

Current Assets

Current assets are assets that a company can easily turn into cash within one year or one business cycle, whichever is less. They don’t include long-term or illiquid investments such as certain hedge funds, real estate, or collectibles.

Examples of current assets include:

• Checking and savings accounts
• Highly liquid marketable securities such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs)
• Money market accounts
• Cash and cash equivalents
• Accounts receivable
• Inventory and other shorter-term prepaid expenses
• Current assets of discontinued operations and interest payable

Current Liabilities

Current liabilities are all the debts and expenses that the company expects to pay within a year or one business cycle, whichever is less. They typically include:

• Normal costs of running the business, such as rent, utilities, materials, and supplies
• Interest or principal payments on debt
• Accounts payable
• Accrued liabilities
• Accrued income taxes
• Dividends payable
• Capital leases that are due within a year
• Long-term debt that’s coming due

How to Calculate Working Capital

Working capital is calculated by subtracting current liabilities from current assets. Calculating the metric known as the current ratio can also be useful. The current ratio, also known as the working capital ratio, provides a quick view of a company’s financial health.

You can calculate the current ratio by taking current assets and dividing that figure by current liabilities. A ratio above one means that current assets exceed liabilities. Generally, the higher the ratio, the better an indicator of a company’s ability to pay short-term liabilities.

But a very high current ratio means a large amount of available current assets and may indicate that a company isn’t utilizing its excess cash as effectively as it could to generate growth.

Working Capital Example: Coca-Cola

The Coca-Cola Co. (KO) had current assets valued at $36.54 billion for the fiscal year ending Dec. 31, 2017. They included cash and cash equivalents, short-term investments, marketable securities, accounts receivable, inventories, prepaid expenses, and assets held for sale.

Coca-Cola also registered current liabilities of $27.19 billion for that fiscal year. The company’s current liabilities consisted of accounts payable, accrued expenses, loans and notes payable, current maturities of long-term debt, accrued income taxes, and liabilities held for sale.

Coca-Cola’s current ratio was 1.34 based on this information:

$36.54 billion ÷ $27.19 billion = 1.34

Does Working Capital Change?

The amount of working capital does change over time because a company’s current liabilities and current assets are based on a rolling 12-month period, and they change over time.

Working Capital Can Change Daily

The exact working capital figure can change every day depending on the nature of a company’s debt. What was once a long-term liability, such as a 10-year loan, becomes a current liability in the ninth year, when the repayment deadline is less than a year away.

What was once a long-term asset, such as real estate or equipment, can suddenly become a current asset when a buyer is lined up.

Current Assets Can Be Written Off

Working capital can’t be depreciated as a current asset the way long-term, fixed assets are. Certain working capital such as inventory can lose value or even be written off, but that isn’t recorded as depreciation.

Note

Working capital can only be expensed immediately as one-time costs to match the revenue they help generate in the period.

Assets Can Be Devalued

Working capital can’t lose its value to depreciation over time, but it may be devalued when some assets have to be marked to market. This can happen when an asset’s price is below its original cost and others aren’t salvageable. Two common examples involve inventory and accounts receivable.

Inventory obsolescence can be a real issue in operations. The market for the inventory has priced it lower than the inventory’s initial purchase value as recorded in a company’s books. A company marks the inventory down to reflect current market conditions and uses the lower of cost or market method, resulting in a loss of value in working capital.

Accounts Receivable May Be Written Off

Some accounts receivable may become uncollectible at some point and have to be totally written off, representing another loss of value in working capital. It may take longer-term funds or assets to replenish the current asset shortfall because such losses in current assets reduce working capital below its desired level. This is a costly way to finance additional working capital.

Unearned revenue from payments received before the product is provided will also reduce working capital. This revenue is considered a liability until the products are shipped to the client.

Important

Working capital should be assessed periodically over time to ensure that no devaluation occurs and that there’s enough left to fund continuous operations.

What Does the Current Ratio Indicate?

A healthy business has working capital and the ability to pay its short-term bills. A current ratio of more than one indicates that a company has enough current assets to cover bills that are coming due within a year. The higher the ratio, the greater a company’s short-term liquidity and its ability to pay its short-term liabilities and debt commitments.

A higher ratio also means that the company can continue to fund its day-to-day operations. The more working capital a company has, the less likely it is to take on debt to fund the growth of its business.

A company with a ratio of less than one is considered risky by investors and creditors because it demonstrates that the company might not be able to cover its debts if needed. A current ratio of less than one is known as negative working capital. 

We can see in the chart below that Coca-Cola’s working capital, as shown by the current ratio, has improved steadily over a few years. This indicates improving short-term financial health.

Special Considerations

A more stringent liquidity ratio is the quick ratio. This measures the proportion of short-term liquidity compared to current liabilities. The difference between this and the current ratio is in the numerator where the asset side includes only cash, marketable securities, and receivables. The quick ratio excludes inventory because it can be more difficult to turn into cash on a short-term basis.

What Is Working Capital?

Working capital is the amount of money that a company can quickly access to pay bills due within a year and to use for its day-to-day operations. It can represent the short-term financial health of a company.

How Does a Company Calculate Working Capital?

You can calculate working capital by taking the company’s total amount of current assets and subtracting its total amount of current liabilities from that figure. The result is the amount of working capital that the company has at that time. Working capital amounts can change.

What Does Working Capital Indicate?

Working capital is the amount of current assets left over after subtracting current liabilities. It’s what can quickly be converted to cash to pay short-term debts. Working capital can be a barometer for a company’s short-term liquidity. A positive amount of working capital indicates good short-term health. A negative amount indicates that a company may face liquidity challenges and may have to incur debt to pay its bills.

The Bottom Line

Working capital is the difference between a company’s current assets and current liabilities. The challenge here is determining the proper category for the vast array of assets and liabilities on a corporate balance sheet to decipher the overall health of a company and its ability to meet its short-term commitments.

Fact checked by Betsy Petrick

Banks may have more advertising dollars to spend on promoting personal loans, but the loans they offer are not necessarily better than those offered by credit unions. Many credit unions offer more favorable borrowing terms like lower interest rates and fewer fees. However, you do have to qualify for credit union membership in order to apply.

Key Takeaways

• You have options when it comes to taking out a personal loan—you’ll find them from banks, credit unions, and online lenders.
• Banks offer more branches and in-person customer service, while credit unions have fewer locations and are limited to specific regions.
• Credit unions typically require you to be a member in order to get a personal loan.
• Credit unions may offer lower rates and fees, while banks may offer more convenience.

Banks vs. Credit Union Loans

A bank is a financial institution authorized to offer services and accounts like checking and savings or loans like personal loans, auto loans, and mortgages. Banks operate in order to generate a profit and they are regulated by the federal government.

Although credit unions operate similarly to banks and have many of the same credit products and financial accounts, they do not operate to generate revenue. Credit unions are usually established as a network of nonprofit financial institutions that operate within a geographic region or a community. Because of this, they usually have membership requirements and might charge a small fee to join.

In order to get a personal loan from a bank, one simply has to submit an application. The bank will review the application, pull your credit score, and issue a decision. Getting a personal loan from a credit union follows the same process, but the credit union will also usually check that you’re a member. If you aren’t and you meet membership requirements, you can apply, pay the membership dues, and become a member. The process may only take a few minutes.

Tip

Many credit unions extend membership eligibility to anyone who is a member of an affiliate group, and you can typically join those affiliate groups for a small fee to gain access to credit unions. One such organization is the American Consumer Council, which partners with many credit unions nationwide. Check with your local credit union to see which organizations it partners with.

Personal Loans From Banks

Almost all major banks offer a variety of loans like mortgages, auto loans, student loans, and personal loans. If you already have a home bank, you may have received pre-approval offers for loans for which you’re already qualified.

Pros of Personal Loans From Banks

• Convenient to work with your current bank: If you already have a bank that you have a checking or savings account with, you might be more comfortable working with them. After all, you already have a relationship with the bank and know your way around the website and app.
• Wide access to a number of locations: Banks are known for their established brick-and-mortar branches, in case you need to visit a location in person.
• More customer service availability: The larger the bank, the better the chances it has customer service available via phone, web chat, or mobile app for more hours per week. Some banks operate 24/7 customer service lines.

Cons of Personal Loans From Banks

• More challenging qualification requirements: Lending money is risky for any type of financial institution. Since banks lend larger sums of money, it’s in their interest to ensure the debt will be repaid. To manage that risk, banks may require borrowers to have a higher credit score.
• Higher interest rates and fees: Again, banks try to manage risk when it comes to lending, and they usually have higher interest rates and more fees compared to credit unions, especially if you don’t have other banking products (like checking or savings accounts) with the bank.

Best Banks for Personal Loans

Lender	Best For	Loan Amounts	Repayment Terms	APRs
Citibank	Overall	$2,000 to $30,000	12 to 60 months	11.49% to 20.49%
Discover	Debt consolidation	$2,500 to $40,000	36 to 84 months	7.99% to 24.99%
Santander	Fast funding	$5,000 to $50,000	36 to 84 months	7.99% to 24.99%
Wells Fargo	Large loan amounts	$3,000 to $100,000	12 to 84 months	6.99% to 24.49%
U.S. Bank	Repayment terms	$1,000 to $50,000	12 to 84 months	7.99% to 24.99%
American Express	Amex cardholders	$3,500 to $40,000	12 to 60 months	6.90% to 19.97%

Learn more about the best banks for personal loans to find the right lender for your financial situation.

Personal Loans From Credit Unions

Credit unions have many of the same banking products as banks, but they don’t operate for profit. Instead, the credit union is made up of members who pay small fees to access financial services.

Pros of Personal Loans From Credit Unions

• Less rigorous lending requirements: Credit unions often pride themselves on working with all members, including those with poor or average credit. If you don’t qualify for a loan at a bank, you might be able to get one through a credit union.
• Lower interest rates and fees: Because credit unions operate to assist their members, they can offer competitive interest rates and might not charge fees like those imposed by big banks (like origination fees). Even though differences may be minor percentage points, this can add up to hundreds or thousands of dollars in savings for a personal loan.

Cons of Personal Loans From Credit Unions

• Membership is usually required: Unlike a bank where anyone can apply for a loan, you usually must be a credit union member before opening an account with one. You usually can join the credit union and apply for a personal loan at the same time, but you’ll have to submit an application and possibly pay a fee.
• It might take longer to get the funds: Large banks can quickly transfer the personal loan funds to you, but credit unions might take longer to issue them. Credit unions also might place more restrictive limits on how much you can borrow, although most people probably won’t run into the upper limit. But if you need a very large sum of money fast, this could be a deal breaker.
• Not as many credit union branches: Credit unions can’t compete with the number of physical branches that big banks have. For this reason, you may have to go out of your way to find a credit union in your area.

Best Credit Unions for Personal Loans

Lender	Best For	Loan Amounts	Repayment Terms	APRs
Patelco Credit Union	Overall	$300 to $100,000	6 to 84 months	9.30% to 17.90%
NASA Federal Credit Union	Debt consolidation	$1,000 to $30,000	1 to 84 months	9.84% to 18.00%
PenFed Credit Union	Low interest rates	$300 to $50,000	12 to 60 months	8.99% to 17.99%
Blue Federal Credit Union	Bad credit	$500 to $30,000	12 to 72 months	10.99% to 17.99%
First Tech Federal Credit Union	Secured loans	$500 to $50,000	6 to 84 months	8.49% to 18.00%
Lake Michigan Credit Union	Credit building	$250 to $25,000	1 to 60 months	9.99% to 18.00%
Navy Federal Credit Union	Military members	$250 to $50,000	6 to 180 months	8.99% to 18.00%

Learn more about our picks for the best personal loans from credit unions.

How to Choose a Personal Loan Lender

Before you start requesting quotes for a personal loan, check your credit and determine how big of a loan you’d like to take out. This can help you narrow down your options, since some credit unions might not offer large personal loans. And although your credit score and history are significant factors in your creditworthiness, there are a few instances when a bank or credit union makes more sense.

In general, it’s a good idea to shop around with several lenders to see what rates you can get. In general, banks may offer more convience, while credit unions may offer better rates and lower fees.

Here are a few basic examples:

• Bank: You want to take out a $100,000 loan to complete a home renovation project, but your credit union only lets you borrow up to $50,000.
• Credit union: Your credit score is below average and you can’t qualify with a bank, or you pre-qualify for a loan with a lower rate when rate shopping.
• Bank or credit union: You want a small loan that’s easy to take out, so you choose the bank or credit union you already have a relationship with.

How Do People Use Personal Loans?

To give you an idea of how personal loans can be used, take a look at this national survey commissioned by Investopedia in 2023. The survey revealed that debt consolidation was the primary reason people took out personal loans, followed by home improvement and other large purchases.

Are Credit Unions Better Than Banks for Personal Loans?

Whether credit unions or banks are better depends on your needs and personal finances. For instance, a bank might be a better option if you need to borrow a large amount of money and you have good credit. On the other hand, you might pay less in interest and fees if you take out a loan from your local credit union. That’s why it pays to check your potential rates with a few lenders.

Is It Easier to Get a Personal Loan From a Bank or a Credit Union?

Banks may have more rigorous lending standards, which means they might require higher credit scores. If your credit score needs work, consider applying for a personal loan at a credit union.

Are Interest Rates on Loans Higher at Credit Unions or Banks?

Because banks are looking to generate a profit, they may charge higher interest rates (and often more fees) than credit unions, which are owned by the credit union members and aren’t trying to make a profit.

What’s Best for a Debt Consolidation Loan—a Bank or a Credit Union?

Credit unions tend to offer more competitive interest rates for loans, including debt consolidation loans, but that’s not always the case. Every circumstance is different and rates change regularly, so it’s important to shop around.

The Bottom Line

The best thing you can do before taking out a personal loan is to shop around and check your rates with a handful of lenders. By requesting quotes from banks and credit unions, you can compare interest rates, terms, and fees. Pay attention to added fees and potential discounts before you submit your application to find the best possible offer for your credit and financial situation.

Fact checked by Suzanne Kvilhaug

If you are having trouble with your taxes, tap one of these five free resources for help.

The Internal Revenue Service (IRS) offers two programs to help you do your taxes, the Defense Department backs one, the AARP Foundation runs one, and one is a federal grant program that provides help with tax disputes. All have answers to the tax questions you may be struggling with alone.

Key Takeaways

• Volunteer Income Tax Assistance helps people with incomes up to $67,000, limited English, or disabilities.
• Tax Counseling for the Elderly offers free tax assistance for people 60 and older.
• MilTax offers free one-on-one counseling sessions and free tax software to military members and their families.
• AARP Foundation Tax Aide aims to help people 50 and older with low and moderate incomes, but this free program is open to everyone.
• Low Income Taxpayer Clinics help taxpayers who are having disputes with the IRS. The service is provided for free or for a slight fee.

1. Volunteer Income Tax Assistance (VITA)

This IRS program has been helping taxpayers for more than 50 years. To qualify for this free tax help, you’ll need an income of $67,000 or lower. People with disabilities and people who speak limited English also qualify.

VITA sites are run by IRS partners, and the volunteers who fill out tax returns must pass tax law training that meets the IRS’s standards.

“The volunteer preparers I’ve worked with took the service very seriously, many coming back year after year to help elderly and lower-income taxpayers,” says Mark Rosinski, a certified financial planner with Dunes Financial. “Also, every VITA volunteer is required to pass IRS training before every tax season. And lastly, every return is reviewed by another preparer for a second set of eyes before filing,”

The VITA locator tool allows you to find a Volunteer Income Tax Assistance site near you by searching by zip code.

“If it’s difficult for someone to sit and wait for their return to be completed, many VITA programs now offer a drop-off program. This allows a taxpayer to drop off their documents and come back when completed, saving them time and money.” Rosinski says.

2. Tax Counseling for the Elderly (TCE)

This IRS program provides free tax help for people 60 and up. Questions about pensions and other retirement-related questions are all answered in this free program. The VITA locator tool can be used to find Tax Counseling for the Elderly sites. Like VITA, this program is managed by the IRS, and the program sites are run by IRS partners and volunteers who must pass tax law training that is up to the standards set by the IRS.

3. MilTax Free Tax Services

MilTax provides free tax software and free tax assistance for military members. Military tax experts offer one-on-one help, and the free tax software is designed for the specific tax issues of military life. MilTax helps military members file a federal tax return and up to three state returns. The service is available to military members and their families. For in-person assistance, check the VITA locator for programs on military installations.

4. AARP Foundation Tax Aide

While AARP Foundation Tax Aide offers help to everyone who reaches out, the focus of the program is helping people 50 and up with moderate to low income. Started in 1968, AARP Tax Aide is available in more than 3,600 locations across the United States. Volunteers are certified by the IRS. To find a location near you, use this locator tool.

5. Low Income Taxpayer Clinics (LITC)

These clinics offer tax help for people with low incomes who have tax disputes with the IRS. Tax services are free or for a small fee. The disputed tax amount is typically below $50,000. A clinic locator is found on the program’s website. Low Income Taxpayer Clinics also provide outreach to people who speak English as a second language.

The Bottom Line

With April 15 around the corner, it is not too late to reach out for some free tax help in filing your return. Which free service is right for you? Volunteer Income Tax Assistance is for people with disabilities, limited English, and those who make up to $67,000 a year. Tax Counseling for the Elderly offers tax assistance for people 60 and up.

AARP Foundation Tax Aide is free and open to everyone, but it aims to help taxpayers 50 and older with low and moderate incomes. MilTax offers free tax help, including free tax software, to military members and their families. If you have a dispute with the IRS, contact Low-Income Taxpayer Clinics. You’ll get tax assistance for free or a modest fee.

Reviewed by Lea D. Uradu
Fact checked by Suzanne Kvilhaug

If you are a financial professional and wish to work as an investment adviser to help individual investors manage assets their assets, or provide financial counsel, you generally need to become an investment adviser representative (IAR) under a registered investment adviser (RIA) firm.

An RIA is a firm registered with the Securities and Exchange Commission (SEC) or a state securities regulator to offer advisory services for a fee. An IAR is an individual who works for a RIA firm and has passed the necessary licensing requirements to offer investment advice. So, while the two terms and their acronym may look similar, there are important distinctions between them.

RIAs and IARs have a fiduciary duty to act in the best interest of the client and disclose any conflicts of interest. They also have specific requirements and regulations that can differ from some other types of financial advisors.

Key Takeaways

• Registered investment advisors (RIAs) are financial firms
• To form an RIA, investment advisors must pass the Series 65 exam (or equivalent).
• RIAs must register with the SEC or state authorities, depending on the amount of money they manage.
• Applying to become an RIA includes filing a Form ADV, which includes a disclosure document that is also distributed to all clients.
• Usually compensated by a percentage of assets under management, RIAs are legally required to act in a fiduciary capacity for their clients at all times.

Licensing and Qualifications

The first step to starting an RIA is for you to pass the Series 65 or Uniform Investment Advisor Law exam so that you can become an IAR. The Series 65 test is given by the Financial Industry Regulatory Authority (FINRA). The test itself covers federal securities laws and other topics related to investment advice. It has 140 multiple-choice questions, of which 10 are pretest questions that will not count toward final grade. Of the 130 scored questions, a candidate must correctly answer 92 to pass the three-hour exam.

While no other designations are required to become an IAR, most advisors will find it rather difficult to bring in business without additional qualifications. These can include other FINRA exams, such as the Series 6 or Series 7, and credentials, such as the certified financial planner (CFP) or certified financial advisor (CFA). In fact, many states allow advisors who carry the following designations in good standing to waive the Series 65. These designations include the following:

• CFP
• CFA
• Chartered investment counselor
• Chartered financial consultant
• Personal financial specialist

Here’s a list of the major terms for securities professionals:

Securities Professionals and Their Firms
Attributes	Registered Representative (RR)	Broker-Dealer (BD)	Investment Adviser Representative (IAR)	Registered Investment Adviser (RIA)
Also known as	Stockbroker	Securities dealer	Financial adviser	Financial advisory, wealth manager
Primary Regulating Bodies	FINRA	FINRA, SEC	SEC, state regulators	SEC, state regulators
Primary Services	Buying and selling securities on behalf of clients	Facilitating trading of securities	Providing financial advice and planning services	Managing investment portfolios and providing financial advice
Compensation	Commissions	Fee-based or Commission-based	Fee-based	Fee-based
Examples	Employees of major brokerages like Morgan Stanley	Morgan Stanley, Merrill Lynch, Edward Jones, UBS, Wells Fargo, as well as independent broker-dealers (IBDs)	Employees for firms like Merrill Lynch, JPMorgan, and independent RIAs.	Merrill Lynch, JPMorgan, and independent RIAs.

Federal and State Registration for RIAs

If providing investment advice or asset management services is vital to your services, the next step to becoming an RIA is to register your firm with either the SEC or the state(s) where you’ll be doing business.

Series 65 test-takers are not required to be sponsored by a broker-dealer, as they are for most other securities-related exams administered by FINRA.

However, you will not have to do this if providing investment services or advice is purely incidental to your practice. Professionals who are often exempt under this exception include the following:

• Accountants
• Attorneys
• Engineers
• Teachers
• Bankers
• Broker-dealers
• Publishers
• Advisors who work only with U.S. government securities
• Advisors who are registered with the Commodity Futures Trading Commission and for whom providing investment advice is not a primary line of business
• Employees of charitable organizations

SEC Registration Eligibility

Here are the SEC requirements on the type of registration an RIA needs, which depend on how much in assets you manage:

• Under $25 million of assets under management (AUM): A small adviser with less than $25 million in AUM is prohibited from SEC registration if its principal office and place of business are in a state that regulates advisers (all states except Wyoming).
• Between $25 million and $100 million of AUM:
• Required to register with the SEC if its principal office and place of business is in New York or Wyoming unless otherwise exempted.
• Prohibited from SEC registration if its principal office and place of business are in any state except New York or Wyoming, and the midsized adviser is required to be registered in that state. If the midsized adviser is not required to be registered in that state, then the adviser must register with the SEC, unless a registration exemption is available.
• Between $90 million and $110 million of AUM:
• May register with the SEC when it reaches $100 million of AUM.
• Must register with the SEC once it reaches $110 million of AUM, unless otherwise exempted.
• Once registered with the SEC, is not required to withdraw from SEC registration and register with the states until the adviser goes lower than $90 million of AUM.
• Over $110 million in AUM: A large adviser with at least $110 million of AUM is required to register with the SEC, unless otherwise exempted.

Any firm or individual who acts as an investment advisor on behalf of an investment company is also required to file with the SEC, no matter the amount of AUM.

Firms that register with the SEC are not required to file with states, but they must file a notice of SEC registration with each state where they do business. Most states don’t require registration or filing of notice if the advisor has less than five clients in the state and does not have a place of business there.

Most firms register with these entities as corporations, with each advisor acting as an investment advisor representative (IAR).

RIAs and Form ADV

The next step in registering is to create an account with the Investment Adviser Registration Depository (IARD), which FINRA manages on behalf of the SEC and states. (A few states do not require this, so advisors who only do business in those do not have to go through this process.) Once the account is open, FINRA will supply the advisor or firm with a CRD number and account ID information. Then, the RIA can file Form ADV and the U4 forms with either the SEC or states.

Form ADV is the official application document for applying to become an RIA. It has several sections, and all must be completed, although only the first section is electronically submitted to the SEC or state government for approval. Part II of the form serves as a disclosure document that is distributed to all clients. It must clearly list all services supplied to clients, as well as a breakdown of compensation and fees, possible conflicts of interest, the firm’s code of ethics, the advisor’s financial condition, educational background and credentials, and any affiliated parties.

Important

Form ADV must also be uploaded electronically into the IARD and made available to all new and prospective clients. Preparing and submitting these forms typically takes most firms a few weeks, and the SEC must respond to the application within 45 days.

Some states may respond as soon as 30 days, but requests for additional information often delay the process. All firms that register with the SEC must also create a comprehensive compliance program that covers all aspects of their practice, from trading and account administration to sales and marketing and internal disciplinary procedures.

Once the SEC approves an application, the firm can start work as an RIA, filing annual amendments to Schedule 1 of the ADV and updating all of the firm’s relevant information (such as the AUM). In addition, while the SEC has no specific financial or bonding requirements for advisors, such as a minimum net worth or cash flow, it does examine the advisor’s financial condition during the application process.

Most states require RIAs to have a net worth of at least $35,000 if they have custody of client funds and $10,000 if they do not. RIAs who fail to meet this requirement must post a surety bond. (The rules for this requirement and several other aspects of registration vary from state to state.)

IARs vs. RRs

Financial professionals become IARs and establish RIAs because it allows them greater freedom to structure their practices—more so than for RRs who also advise and buy and sell securities for individual investors, usually as employees of brokerage firms.

RRs who work for broker-dealers—aka stockbrokers—pay a percentage of their earnings as compensation for their back-office support and compliance oversight.

Brokers also usually work on commission, while most RIAs charge their customers either a percentage of assets under management or a flat or hourly fee for their services. Many RIAs also use another firm, a custodian like Schwab or Fidelity, to house their clients’ assets instead of holding the accounts in-house. This simplifies recordkeeping and administration.

Important

Despite the similar-sounding names, registered representatives (RRs) are not the same as investment advisor representatives (IARs). RRs work for a brokerage firm, serving as its representative for clients trading investments. Brokers are RRs.

Fiduciary Standard

Although the SEC and the states have the responsibility of overseeing RIAs, FINRA has tried at various points to get Congress to let it take on the task. Advisors see FINRA substantially lowering the protection given to RIA clients, as RIAs are legally required to act in a fiduciary capacity for their clients at all times. Brokers and securities licensed reps only have to meet the suitability standard, which only requires that a given transaction performed by a broker must be “suitable” for the client at that time.

What Are the Primary Steps To Becoming an RIA?

Establishing an RIA involves several key steps. First, you need to pass the Series 65 exam or have a valid Series 7 and Series 66, as this is required by most states. Second, draft your firm’s compliance documents, including Form ADV Parts 1 and 2, which describe the nature of your business, types of clients, fees, and potential conflicts of interest. Then, register with the SEC or state regulator by filing the Form ADV along with other required forms. Finally, carry out an ongoing compliance program to follow SEC regulations.

How Much Does It Cost To Start an RIA?

Costs to start an RIA can vary widely depending on a number of factors, including state registration fees, legal and compliance consulting fees, technology costs, and operational expenses. Generally, the startup cost can range from $10,000 to $50,000. However, ongoing costs such as compliance, technology, and staffing should also be considered in the budget.

Can I Operate My Ria in More Than One State?

Yes. Nevertheless, each state will have its own registration requirements, so you’ll need to ensure you follow the regulations in each state where you do business. If your RIA manages $100 million or more in client assets, you can register with the SEC at the federal level instead of with state securities authorities, which will allow you to offer services in multiple states more easily.

What Is the Fiduciary Duty of an RIA and Why Is It Important?

The fiduciary duty of an RIA is a legal obligation to act in the best interests of its clients. This means an RIA must provide investment advice that best meets the client’s needs, even if it’s not in the RIA’s own best interest. This is important as it ensures that the advice provided to clients is based only on their needs, goals, and risk tolerance, which helps to build trust and confidence in the relationship.

The Bottom Line

Registered Investment advisors enjoy greater freedom than their counterparts in the industry who work on commission. They are also required to adhere to a much higher standard of conduct, and most advisors feel strongly that this should not change.

Of course, those who register to become RIAs must also contend with the normal startup issues that most new business owners face, such as marketing, branding, and location, in addition to the registration process.

Reviewed by Amy Drury
Fact checked by Suzanne Kvilhaug

A company needs financial capital to operate its business. For most companies, financial capital is raised by issuing debt securities and by selling common stock. The amount of debt and equity that makes up a company’s capital structure has many risk and return implications. Therefore, corporate management must use a thorough and prudent process for establishing a company’s target capital structure. The capital structure is how a firm finances its operations and growth by using different sources of funds.

What You Need to Know

• A company’s capital structure is the mix of debt and equity that are used to finance its spending.
• A company’s financial leverage is the amount of debt and preferred stock in its capital structure, as opposed to common equity.
• A high degree of financial leverage can be a good thing, if it is used to purchase productive assets.
• However, an over-leveraged company can also increase its financial risk.

Use of Financial Leverage

Financial leverage is the extent to which fixed-income securities and preferred stock are used in a company’s capital structure. Financial leverage has value due to the interest tax shield that is afforded by the U.S. corporate income tax law. The use of financial leverage also has value when the assets that are purchased with the debt capital earn more than the cost of the debt that was used to finance them.

Under both of these circumstances, the use of financial leverage increases the company’s profits. With that said, if the company does not have sufficient taxable income to shield, or if its operating profits are below a critical value, financial leverage will reduce equity value and thus reduce the value of the company. 

Given the importance of a company’s capital structure, the first step in the capital decision-making process is for the management of a company to decide how much external capital it will need to raise to operate its business. Once this amount is determined, management needs to examine the financial markets to determine the terms in which the company can raise capital. This step is crucial to the process because the market environment may curtail the ability of the company to issue debt securities or common stock at an attractive level or cost.

With that said, once these questions have been answered, the management of a company can design the appropriate capital structure policy and construct a package of financial instruments that need to be sold to investors. By following this systematic process, management’s financing decision should be implemented according to its long-run strategic plan, and how it wants to grow the company over time.

The use of financial leverage varies greatly by industry and by the business sector. There are many industry sectors in which companies operate with a high degree of financial leverage. Retail stores, airlines, grocery stores, utility companies, and banking institutions are classic examples. Unfortunately, the excessive use of financial leverage by many companies in these sectors has played a paramount role in forcing a lot of them to file for Chapter 11 bankruptcy.

Examples include R.H. Macy (1992), Trans World Airlines (2001), Great Atlantic & Pacific Tea Co. (A&P) (2010), and Midwest Generation (2012). Moreover, excessive use of financial leverage was the primary culprit that led to the U.S. financial crisis between 2007 and 2009. The demise of Lehman Brothers (2008) and a host of other highly levered financial institutions are prime examples of the negative ramifications that are associated with the use of highly levered capital structures.

The Modigliani and Miller Theorem on Corporate Capital Structure

The study of a company’s optimal capital structure dates back to 1958 when Franco Modigliani and Merton Miller published their Nobel Prize-winning work “The Cost of Capital, Corporation Finance, and the Theory of Investment.” As an important premise of their work, Modigliani and Miller illustrated that under conditions where corporate income taxes and distress costs are not present in the business environment, the use of financial leverage does not affect the value of the company. This view, known as the Irrelevance Proposition theorem, is one of the most important pieces of academic theory ever published. 

Unfortunately, the Irrelevance Theorem, like most Nobel Prize-winning works in economics, requires some impractical assumptions that need to be accepted to apply the theory in a real-world environment. In recognition of this problem, Modigliani and Miller expanded their Irrelevance Proposition theorem to include the impact of corporate income taxes, and the potential impact of distress cost, for purposes of determining the optimal capital structure for a company.

Their revised work, universally known as the Trade-off Theory of capital structure, makes the case that a company’s optimal capital structure should be the prudent balance between the tax benefits that are associated with the use of debt capital, and the costs associated with the potential for bankruptcy for the company. Today, the premise of the Trade-off Theory is the foundation that corporate management should use to determine the optimal capital structure for a company.

Impact of Financial Leverage on Performance

Perhaps the best way to illustrate the positive impact of financial leverage on a company’s financial performance is by providing a simple example. The Return on Equity (ROE) is a popular fundamental used in measuring the profitability of a business as it compares the profit that a company generates in a fiscal year with the money shareholders have invested. After all, the goal of every business is to maximize shareholder wealth, and the ROE is the metric of return on shareholder’s investment.

In the table below, an income statement for Company ABC has been generated assuming a capital structure that consists of 100% equity capital. The capital raised was $50 million. Since only equity was issued to raise this amount, the total value of equity is also $50 million. Under this type of structure, the company’s ROE is projected to fall between the range of 15.6% and 23.4%, depending on the level of the company’s pre-tax earnings.

In comparison, when Company ABC’s capital structure is re-engineered to consist of 50% debt capital and 50% equity capital, the company’s ROE increases dramatically to a range that falls between 27.3% and 42.9%.

As you can see from the table below, financial leverage can be used to make the performance of a company look dramatically better than what can be achieved by solely relying on the use of equity capital financing.

Since the management of most companies relies heavily on ROE to measure performance, it is vital to understand the components of ROE to better understand what the metric conveys.

A popular methodology for calculating ROE is the utilization of the DuPont Model. In its most simplistic form, the DuPont Model establishes a quantitative relationship between net income and equity, where a higher multiple reflects stronger performance. However, the DuPont Model also expands upon the general ROE calculation to include three of its parts. These parts include the company’s profit margin, asset turnover, and equity multiplier. Accordingly, this expanded DuPont formula for ROE is as follows:

$begin{aligned} text{Return on equity} &= frac{text{Net Income}}{text{Equity}}\ &=frac{text{Net Income}}{text{Sales}} times frac{text{Sales}}{text{Assets}} times frac{text{Assets}}{text{Equity}}\ end{aligned}$Return on equity​=EquityNet Income​=SalesNet Income​×AssetsSales​×EquityAssets​​

Based on this equation, the DuPont Model illustrates that a company’s ROE can only be improved by increasing the company’s profitability, by increasing its operating efficiency or by increasing its financial leverage.

Measuring Financial Leverage Risk

Corporate management tends to measure financial leverage by using short-term liquidity ratios and long-term capitalization, or solvency ratios. As the name implies, these ratios are used to measure the ability of the company to meet its short-term obligations. Two of the most utilized short-term liquidity ratios are the current ratio and acid-test ratio. Both of these ratios compare the company’s current assets to its current liabilities.

However, while the current ratio provides an aggregated risk metric, the acid-test ratio provides a better assessment of the composition of the company’s current assets for purposes of meeting its current liability obligations since it excludes inventory from current assets. 

Capitalization ratios are also used to measure financial leverage. While many capitalization ratios are used in the industry, two of the most popular metrics are the long-term-debt-to-capitalization ratio and the total-debt-to-capitalization ratio. The use of these ratios is also very important for measuring financial leverage. However, it’s easy to distort these ratios if management leases the company’s assets without capitalizing on the assets’ value on the company’s balance sheet. Moreover, in a market environment where short-term lending rates are low, management may elect to use short-term debt to fund both its short- and long-term capital needs. Therefore, short-term capitalization metrics also need to be used to conduct a thorough risk analysis.

Coverage ratios are also used to measure financial leverage. The interest coverage ratio, also known as the times-interest-earned ratio, is perhaps the most well-known risk metric. The interest coverage ratio is very important because it indicates a company’s ability to have enough pre-tax operating income to cover the cost of its financial burden.

The funds-from-operations-to-total-debt ratio and the free-operating-cash-flow-to-total-debt ratio are also important risk metrics that are used by corporate management. 

Factors in the Capital Structure Decision-Making Process

Many quantitative and qualitative factors need to be taken into account when establishing a company’s capital structure. First, from the standpoint of sales, a company that exhibits high and relatively stable sales activity is in a better position to utilize financial leverage, as compared to a company that has lower and more volatile sales.

Second, in terms of business risk, a company with less operating leverage tends to be able to take on more financial leverage than a company with a high degree of operating leverage.

Third, in terms of growth, faster-growing companies are likely to rely more heavily on the use of financial leverage because these types of companies tend to need more capital at their disposal than their slow growth counterparts.

Fourth, from the standpoint of taxes, a company that is in a higher tax bracket tends to utilize more debt to take advantage of the interest tax shield benefits.

Fifth, a less profitable company tends to use more financial leverage, because a less profitable company is typically not in a strong enough position to finance its business operations from internally generated funds.  

The capital structure decision can also be addressed by looking at a host of internal and external factors. First, from the standpoint of management, companies that are run by aggressive leaders tend to use more financial leverage. In this respect, their purpose for using financial leverage is not only to increase the performance of the company but also to help ensure their control of the company.

Second, when times are good, capital can be raised by issuing either stocks or bonds. However, when times are bad, suppliers of capital typically prefer a secured position, which, in turn, puts more emphasis on the use of debt capital. With this in mind, management tends to structure the capital makeup of the company in a manner that will provide flexibility in raising future capital in an ever-changing market environment.

Why Is Financial Leverage Bad?

Financial leverage refers to the amount of debt or debt-like instruments that a company uses to raise capital, as opposed to selling common stock. Since these costs must be repaid, a high degree of leverage increases the burden on a company’s finances and increases the likelihood that it will default on its obligations.

How Do You Calculate a Company’s Leverage Ratio?

There are several metrics to measure a company’s financial leverage, depending on whether the focus is on the company’s equity, assets, or earnings. Perhaps the most frequently-used one is the debt-to-equity ratio, which measures a company’s debt relative to its shareholder’s equity.

What Is the Optimal Financial Leverage Ratio?

There’s no hard rule about what make’s a “good” financial leverage level for a company’s capital structure, and different industries have different sources of capital. The easiest way to tell if a company is over-leveraged is to compare it with other companies in the same industry and see if they use a similar mix of debt and equity financing.

The Bottom Line

In essence, corporate management utilizes financial leverage primarily to increase the company’s earnings per share and to increase its return-on-equity. However, with these advantages come increased earnings variability and the potential for an increase in the cost of financial distress, perhaps even bankruptcy.

With this in mind, the management of a company should take into account the business risk of the company, the company’s tax position, the financial flexibility of the company’s capital structure, and the company’s degree of managerial aggressiveness when determining the optimal capital structure.