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
Financial Concepts
Total Return Swaps (TRS)
Total Return Swaps (TRS), sometimes known as a total rate of return swaps or TR swaps, are an on off-balance sheet transaction for the party who pays total returns composed of capital gains or losses plus the ordinary coupon or dividend, and receives LIBOR plus spread related to the counterparty’s credit riskiness on a given notional principal. The bank paying total returns is effectively warehousing, renting out its balance sheet while transferring economic value and risk to preferably an uncorrelated counterparty to the referenced assets. A TRS is similar to a plain vanilla swap except the deal is structured such that the total return (cash flows plus capital appreciation/depreciation) is exchanged, rather than just the cash flows. It is one of the principal instruments used by banks and other financial instruments to manage their credit risk exposure, and as such is a credit derivative. They are used as credit risk Continue reading
Effects of Price Level Changes on ROI and RI
The price level changes are a common phenomenon and will introduce entirely new distortions into ROI and RI measures. The principal distortions occur because revenues and cash costs are measured at current prices, while the investment cost and depreciation charge are measured at historical prices used to acquire the assets. Depreciation based on historical cost underestimates what the depreciation charge would be based on the current cost. This results in overstating the firm’s income. At the same time, the firm’s investment is understated, because most of firm’s assets were acquired in precious years at lower price levels than those currently prevailing. The combination of overstated net income and understated investment causes the ROI or RI measures to be much higher than if inflation had not occurred. The increased ROI or RI is not a signal of higher profitability and it is mainly due to a Continue reading
Relationship Between Agency Theory and the Existing Accountancy Practices
The agency theory is a mixture of the relationships between principals and agents, it occurs when the principal and the agents create a delegation. The agency theory argues that in modern corporations, where share ownership is widely held, managerial actions depart from those required to maximize the shareholder’s return. In Agency theory terms, the owners are principals and the managers are agents and there is an Agency loss which is the extent to which returns to the residual claimants, the owners, fall below what they would be if the principals, and the owners, exercised direct control of the corporation. The long-term strategies for agency theory include the principle of the company, business, franchise, etc. providing incentives such as increasing commission, continuing to provide advertising, training, and motivation to increase outlet operations. Regarding the exogenous factor, outlet managers have an incentive to shirk and misrepresent their abilities because the firm is Continue reading
The Advantages and Disadvantages of Budgeting
A budget can be described as a financial plan for a business that has been prepared well in advance to demonstrate and dictate the future course of work of a business. A budget may be set in money terms or it can be expressed in terms of units. Budgets can also be put across in the form of income budgets for money received i.e. sales budget, or expenditure budgets for money spent, i.e. a purchases budget. However, a major emphasis has always been on the cash budget which combines both income and expenditure in estimating the business working capital, cash in hand and bank balance during a course of work or a time period. The budgets are usually prepared for the following financial years (budget period), and are usually broken down into shorter time periods in order to emphasize on the figures and their attainment/fulfillment. The periods are usually monthly Continue reading
Audit Quality – Meaning and Factors Affecting It
The major accounting scandals occurred worldwide has brought the focus of public to the audit profession and the audit quality. Enron and WorldCom cases in United States and Parmalat case in Europe are the example of major scandals as a result of the failure of audit services. These examples of corporate and accounting scandals that happened worldwide have indicated that the audit quality of the audit profession is not at an appropriate and acceptable level. Over years, the audit quality issue has been discussed and debated globally. Several actions have been taken by international and domestic authorized agencies to address the audit quality issue. For example, the government of United States has introduced and enacted the Sarbanes-Oxley Act in 2002 as a response to the audit failure in big major corporations, such as Enron and World Com. In addition, the Center for Audit Quality has been established in United States Continue reading