Differences Between Liquidity and Profitability The liquidity is the ability of a firm to pay its short term obligation for the continuous operation. A firm is considered normally financially solid and low risky which has huge cash in its balance sheet. The liquidity is not only measured by the cash balance but also by all kind of assets which can be converted to cash within one year without losing their value. It has primary importance for the survival of a firm both in short term and long term whereas the profitability has secondary important. The profitability measures the economic success of the firm irrespective to cash flow in the firm. It is often observed that a firm is very profitable in its books but it does not have sufficient cash and cash equivalent to pay its daily bills and due obligations. That is an illustration of classical poor liquidity management. Continue reading
Business Finance Terms
Factoring of Receivables – Meaning and Mechanism
Raising short term and medium term debt by inviting and accepting deposits from the investing public has become an established practice with a large number of companies both in the private and public sectors. This is the outcome of the process of dis-intermediation that is taking place in Indian economy. Similarly, issuance of Commercial Paper by high net-worth Corporates enables them to raise short-term funds directly from investors at cheaper rates as compared to bank credit. In practice, however, commercial banks have been the major investors in Commercial Paper in India, implying thereby that bank credit flows to the corporate sector through the route of CPs. Inter-Corporate loans and investments enable the cash rich corporations to lend their surplus resources to those who need them for their working capital purpose. Factoring of receivables is a relatively recent innovation which enables corporates to convert their receivables into liquidity within a short Continue reading
Capital Asset Pricing Model (CAPM) – Definition, Formula and Calculation
The risk or variation in return of a security is caused by two types of factors. The first type of factors will affect the return of almost all securities in the market. Examples of such sources of risks are changes in the interest rates and inflation of the economy, movement of stock market index and exchange rate movement. The risk caused by such factors is known as systematic risk. Apart from systematic risk, the variation in return of a security is also caused by some other factors which are specific to a security, like a strike in a company or the caliber of the management of a company. The risk caused by such factors is known as unsystematic or specific risk. The unsystematic risk of a security can be diversified away by combining different securities into a portfolio. But systematic risk cannot be diversified away by the construction of a Continue reading
Cash Budget – Definition, Objectives, Features, and Advantages
Meaning and Definition of Cash Budget A cash budget is a budget or plan of expected cash receipts and disbursements during the period. These cash inflows and outflows include revenues collected, expenses paid, and loans receipts and payments. In other words, a cash budget is an estimated projection of the company’s cash position in the future. Management usually develops the cash budget after the sales, purchases, and capital expenditures budgets are already made. These budgets need to be made before the cash budget in order to accurately estimate how cash will be affected during the period. For example, management needs to know a sales estimate before it can predict how much cash will be collected during the period. Management uses the cash budget to manage the cash flows of a company. In other words, management must make sure the company has enough cash to pay its bills when they come Continue reading
Market Value Added (MVA)
Economic Value Added (EVA) is aimed to be a measure of the wealth of shareholders. According to this theory, earning a return greater than the cost of capital increase value of company while earning less than the cost of capital decreases the value. For listed companies, Stewart defined another measure that assesses if the company has created shareholder value or not. If the total market value of a company is more than the amount of capital invested in it, the company has managed to create shareholder value. However, if market value is less than capital invested, the company has destroyed shareholder value. The difference between the company’s market value and book value is called Market Valued Added or MVA. From an investor’s point of view, Market Value Added (MVA) is the best final measure of a Company’s performance. Stewart states that MVA is a cumulative measure of corporate performance and Continue reading
Economic Value Added (EVA) and Shareholders Value Maximization
Almost in all books on financial management, the very first chapter introduces the fact that the goal of financial decisions is to maximize shareholder’s value. But why only shareholder’s value and what about others stakeholders like employees, customers, creditors? If one focuses on the shareholder value creation other stakeholder’s interests will automatically become the sub-goals and achieving these sub goals becomes crucial to the achievement of the overall goal i.e. shareholder value maximization. For example, the firm’s profit depends a lot on how the employees perform and to motivate them the firm needs to satisfy their needs and constantly upgrade their knowledge and skills by proper training. Similarly the firm would be required to pay its creditors on time so that they keep providing them credit whenever needed in the future and the credit availability does not hamper the operations of the firm. So a firm’s goal to maximize wealth Continue reading