When you enter the financial world, you encounter such concepts as money, currency, and fiat money. And you might wonder while hearing these words whether they differ. Are money, currency, and fiat money interchangeable synonyms or are there conceptual differences between these notions? In what follows, we are shedding some light on these concepts, dwelling longer on the concept of fiat money.
How Do Money and Currency Differ?
The two concepts of money and currency seem interchangeable, but they are fundamentally different. These are several points at which these two concepts diverge:
- Money is not tangible. They cannot be touched or smelled. Money is seen only as numbers. Currency is, by contrast, tangible. It is the promissory note or coin that can be touched, smelled, cast up or down, or kept in your wallet.
- Money takes the form of numbers. Currency is shaped like coins, banknotes, or hard plastic.
- Money can be transferred online, whereas currency must be transferred physically. You hand currencies out to another person.
What Is Fiat Money?
The concept of fiat money is not difficult to understand. The etymology of the word fiat might be helpful. This word comes from the Latin word facio – facere meaning “to do” and in Latin means “let it be done.” It, therefore, presupposes some authority behind it. When we hear the words fiat money, we hear the authoritative voice giving it permission to exist. And indeed, fiat money is currency backed by the government that issued it. Imagine the government minting fiat money and confirming its existence by its authority and you will understand the concept of fiat money.
How Does Fiat Money Differ from Commodity Money?
Another type of money – commodity money – is backed by precious commodities – gold or silver. The value of fiat money is not derived from the value of gold or silver but from the relationship between supply and demand. Its value also depends on the stability of the government that issued it rather than on the stability and worth of commodities backing it, as is the case with commodity money. Note that the majority of our paper money, be it the US dollar, the euro, or the British pound, are fiat currencies.
It is worth emphasizing that fiat money has value only because the government decides to maintain its value. Two parties in a transaction can agree on its value, too. Fiat money is inconvertible and cannot be redeemed. Because fiat money is not backed by physical reserves, such as gold or silver, it can lose value due to inflation or hyperinflation. If people stop believing in their country’s currency, it will stop having any value. Herein lies the major difference between fiat money and commodity money. Currency backed by gold or silver does have intrinsic value, absent in fiat money, because of the demand for gold in jewelry, decoration, electronic devices, or aerospace vehicles.
The credit theory of money maintains that money should not be backed by commodities or any other valuables. This theory views all money as a credit-debit relation, which in itself is binding. Therefore, to be valuable, money does not need to be backed by anything at all.
Is the US Dollar Fiat Money?
Like the majority of the major currencies, the US dollar is fiat currency. But this was not always the case. Earlier in US history, the greenback was backed by gold and sometimes silver. In 1933, however, the federal government signed the Emergency Banking Act that disallowed citizens to exchange currency for government gold. The gold standard, which backed US currency with federal gold, ended completely in 1971. That year, the government also stopped issuing gold to foreign governments in exchange for US currency.
Since 1971, the US dollars have been backed by the “full faith and credit” of the US government, “legal tender for all debts, public and private” but not “redeemable in lawful money at the United States Treasury or at any Federal Reserve Bank,” according to the words formerly written on the American banknotes. These days, US dollars are “legal tender,” rather than “lawful money,” exchanged for gold or silver.
Advantages of Fiat Money
At TRADERPROFX, you will be able to understand that fiat money plays the role of a country’s money by storing value, providing a numerical account, and facilitating exchange but it shouldn’t be like that, boring, you can make some money from it. Fiat currencies became particularly popular in the twentieth century because governments and central banks wanted to protect their economies from the worst effects of the natural blossoming and crush of the business cycles. Because fiat money is not as rare as gold, central banks have more control over its supply. Having this control over money gives them the power to manage economic variables – interest rates, liquidity, credit supply, and money velocity. Fiat money gives governments the flexibility to manage their currency, set monetary policy, and even stabilize global markets. Commercial banks can also increase the amount of money in circulation when they need to meet particular demands from borrowers.
What Are the Alternatives to Fiat Money?
Gold and silver coins were used to participate in monetary exchanges. These days, you can definitely buy or sell gold or gold coins but you cannot use them in exchange for everyday purchases. Gold and gold coins have turned into speculative assets.
Many people view Bitcoin and other altcoins as a new alternative to fiat money since they challenge their inflationary nature. And yet, even though the popularity of digital coins has been growing, they have not become money in our traditional understanding of the concept.
In what follows, we are explaining why and how earnings per share (EPS) are calculated. As EPS is a widely used metric for estimating corporate value, understanding this concept is useful and important. In investors’ eyes, a higher EPS indicates a larger value: they will pay more for a company’s shares if they think the company has higher profits relative to its share price.
What Is Earnings Per Share (EPS)?
Earnings per share (EPS) is calculated as follows: a company’s profit gets divided by the outstanding shares of its common stock. The number that you get by these calculations shows how profitable a company is. The higher a company’s EPS, the more profitable it is thought to be.
How Is EPS Calculated?
Earnings per share value are calculated as net income, i.e. profits or earnings, divided by available shares. If you want to make a more refined calculation, adjust the numerator and denominator for shares that could be created through options, convertible debt, or warrants. Note also that the numerator of the equation is also more relevant if it is adjusted for continuing operations.
When you want to calculate a company’s EPS, you need to obtain its balance sheet and income statement. Use them to find the period-end number of common shares, dividends paid on preferred stocks, if they exist, and the net income or earnings. But note that your calculations will be more precise if you use a weighted average number of common shares over the reporting term because the number of shares can change over time.
Remember to include in the calculation of the weighted average number of shares outstanding any stock dividends or splits. You may also simplify the calculation by using the number of shares outstanding at the end of a period.
How Is EPS Used?
You cannot determine a company’s profitability on an absolute basis without EPS. It is one of the most important metrics employed in determining how much the company is worth. EPS is also an important component of calculating the price-to-earnings (P/E) valuation ratio. “E” in “P/E” is EPS. When you divide a firm’s share price by its earnings per share, you will see how much the market is willing to pay for each dollar of its earnings.
EPS is also useful if you are looking to choose stocks in which to invest. Interactive Traders can help you choose stocks with high EPS and explain how to invest in them. We will show you how to compare EPS with the share price of the stock so that you can determine the value of earnings with precision and gauge how investors feel about your chosen stock’s future growth.
What Is the Difference between Diluted EPS and Basic EPS?
Basic EPS is the company’s net income divided by its outstanding shares. When you read about companies’ profits, this is the figure you usually see in reports about them. As its name suggests, basic EPS is the simplest definition of EPS. Diluted EPS, by contrast, includes a more complex definition of the company’s shares outstanding. Diluted EPS is, therefore, is lower than or equal to the basic EPS. Diluted EPS includes shares that are not presently outstanding but can be so if stock options and other convertible securities are exercised.
What Is the Difference between EPS and adjusted EPS?
As its name suggests, adjusted EPS is a type of EPS calculation in which the analyst makes some adjustments to the numerator. Usually, analysts would add or remove components of net income considered non-recurring. Suppose a company’s net income grew because of one single successful sale. In this case, analysts, seeing that the sale was not recurring, might deduct the proceeds from this sale and, in doing so, make the company’s net income smaller. If this happens, adjusted EPS would be lower than basic EPS.
Some Limitations of EPS
There is a caveat when you look at EPS to make an investment: this measure has drawbacks. There are certain ways to play with EPS: companies buy back stocks, reduce the number of shares outstanding, and even increase the EPS number, even though the level of earnings remains the same. Also, note that EPS does not take into account the price of the share. Hence, by looking at EPS, you cannot understand whether a company’s stock is overvalued or undervalued.