Glossary · Finance
Circularity
A loop in which a calculation depends, directly or indirectly, on its own result — commonly interest calculated on average debt that the interest itself affects. It is resolved by controlled iteration or by an opening-balance convention.
- Field
- Finance
- Examined in
- CBA-FMA
- Learning objectives
- 1
Where the CBA Standards examine it
In the specimen paper
Ledbury Chemicals is reviewing its model for sources of circularity before handover. Which of the following drivers creates a circular reference?
Answer
Interest income calculated on average cash balances
Why that is the answer
A circular reference exists when a calculation depends, through a chain of links, on its own result. Tracing that chain is the skill: interest income on average cash runs from income to profit to cash to the closing balance and back into the average, whereas every other driver here starts from a figure the current period cannot change. This is why the standard conventions charge interest on opening balances, since they deliberately keep the chain one-way. If you do choose average balances, you are accepting iteration, and you then need a switch that can zero the loop so trapped errors can be flushed out.
Related terms
- Financial modelFinance
A structured calculation, usually in a spreadsheet, that represents a business or decision in numbers so that the effect of assumptions on outcomes can be examined.