In practice it is difficult to specify an optional capital structure-indeed, managers even feels uncomfortable about specifying an optional capital structure range. Thus, financial managers worry primarily about whether their firms are using too little or too much debt, not about the precise optimal amount of debt. Even if a firm’s actual capital structure varies widely from the theoretical optimum, this capital structure decisions are secondary in importance to operating decisions, especially those relating to capital budgeting and the strategic direction of the firm. Different kinds of theories have been propounded by different authors to explain the relationship between capital structures. The four important theories of capital structure are: 1. Net Income Approach: According to this approach, a firm can minimize the weighted average cost of capital and increase the value of the firm as well as market price of equity shares by using debt financing to the maximum possible Continue reading
Financial Management
Financial management entails planning for the future of a person or a business enterprise to ensure a positive cash flow, including the administration and maintenance of financial assets. The primary concern of financial management is the assessment rather than the techniques of financial quantification. Some experts refer to financial management as the science of money management. The five basic components of the Financial Management Framework are: Planning and Analysis, Asset and Liability Management, Reporting, Transaction Processing and Control.
Altman Z-Score Formula – Corporate Bankruptcy Prediction Model
The financial failure of a company can have a devastating effect on the all seven users of financial statements e.g. present and potential investors, customers, creditors, employees, lenders, general public etc. As a result, users of financial statements as indicated previously are interested in predicting not only whether a company will fail, but also when it will fail e.g. to avoid high profile corporate failures at Enron, Arthur Anderson, and WorldCom etc. Business failure is defined as the unfortunate circumstance of a firm’s inability to stay in the business. Business failure occurs when the total liabilities exceeds the total assets of a company, as total assets is consider a measure of productivity of a company assets. The main reasons for business failure are high interest rates, recession squeezed profits, heavy debt burdens, government regulations and the nature of operations can contribute to a firm’s financial distress. The traditional analysis of Continue reading
The Objective of Financial Reporting
The main objective of financial reporting is to provide financial information to current capital provides to make decisions. This information might also be useful to users who are not capital providers. The general purpose financial reporting develops superior reporting standards to help in the efficient functioning of economies and the efficient allocation of resources in capital markets. General purpose financial reporting focuses on an extensive range of users’ needs that lack the ability to obtain financial information needed from the entity. It should be broad enough to comprehend information for the various users. Therefore, the financial report is where they depend on to acquire information. Diverse users may require different information which might go beyond the scope of general purpose financial reporting. The financial reports are prepared from the entity’s perspective (deemed to have substance on its own, spate from that of its owners), instead of the entity’s capital providers. Continue reading
Motives for Holding Cash – Cash Management Concepts
Cash is the medium of exchange on the common purchasing power and which is the most important component of working capital. It includes coins, currency, cheques held by the firm and the balances in its bank accounts. Sometimes near-cash items also are included.’ Cash is the basic input required to keep the firm running on a continuous basis. At the same time it is the ultimate output expected to be realized by selling goods and services. A firm should hold sufficient cash, neither more, not less. An excessive cash remains idle which simply increases the cost without contributing anything towards the profitability of the firm and in the opposite case, trading and/ or manufacturing operation will be disrupted. Not only that, it largely upholds, under given condition, the quantum of other ingredients of working capital, viz., inventories and debtors, that may be needed for a given scale and type of Continue reading
Importance of Capital Investment Decisions
Investment decision otherwise known as capital budgeting decision is perhaps the most important decision taken by a Finance Manager. Whatever is the objective of the firm, whether profit maximization or wealth maximization, capital budgeting decision affects performance of the firm decisively. These investment decisions have the following implications for the firm. They define the strategic focus and direction of the business. The capital expenditure made in new investments may result in entry into new products, services or new markets. Capital budgeting decisions require large funds and generally have long repayment periods. The results of capital budgeting continue to impact the finances of the firm for many years. Due to long project life, assessment involves number of years of future events leading to difficulty and uncertainty regarding the accuracy of assessment. Capital budgeting decisions are mostly irreversible. They involve investment in plant and machinery or new soft wares or technology etc. Continue reading
The Fundamental and Enhancing Qualitative Characteristics of Financial Information
The purpose of financial statements is to give financial statements information about the change in financial position, financial performance and financial position of the organization. These can provide data use in decision making such as investment, credit and economic decision making which are useful for various users. There are seven main groups of users which are public, investors, lenders, employees, customers, supplies, government and other agencies and the needs of information is different for each group, for instance, employee will interest on the profitability, retirement benefits and employment opportunities and so on. The qualitative characteristics can be categorized as fundamental (relevance and faithful representation) or enhancing (comparability, verifiability, timeliness and understandability) based on how they influence the usefulness of financial information. However, it can limited by two pervasive constraints which is cost and materiality in providing useful financial information. Fundamental Qualitative Characteristics of Financial Information Relevance: Relevant financial reporting information Continue reading