Capital is the money needed to produce goods and services. In plain terms, it is money. All businesses must have capital in order to purchase assets such as land, buildings, machinery, raw materials and maintain their operations. Business capital comes in two main forms: debt and equity. Debt refers to loans and other types of credit that must be repaid in the future, usually with interest. Equity, on the other hand, generally does not involve a direct obligation to repay the funds. Instead, equity investors receive an ownership position in the company which usually takes the form of stock, and thus the term “stock equity.” One of the factors of capital is the factor of production, debt capital; the cost is the interest rate that the company must pay in order to borrow funds. For equity capital, the cost is the returns that must be paid to investors in the Continue reading
Financial Management Concepts
Agency Theory in Financial Management
Agency theory is often described in terms of the relationships between the various interested parties in the firm. The agency theory examines the duties and conflicts that occur between parties who have an agency relationship. Agency relationships occur when one party, the principal, employs another party, called the agent, to perform a task on their behalf. Agency theory is helpful in explaining the actions of the various interest groups in the corporate governance debate. For example, managers can be seen as the agents of shareholders, employees as the agents of managers, managers and shareholders as the agents of long and short-term creditors, etc. In most of these principal-agent relationships conflicts of interest is seen to exist. It has been widely observed that the conflicts between shareholders and managers and in a similar way the objectives of employees and managers may be in conflict. Although the actions of all the parties Continue reading
Optimum Level of Working Capital
A firm has to maintain an adequate level of working capital to run its operations smoothly and effectively. It should be adequate in the sense that it shall not be more than the requirements nor it shall be less than the requirements. Both the excessive as well as inadequate working capital positions are dangerous from the firm’s point view. We know that the current liabilities are met out of the current assets. So the level of current assets shall be sufficient enough to meet the current liabilities. Excessive working capital refers to the position where when the level of current assets is much higher to meet current liabilities. The excessive capital has opportunity cost for the firm, as this excessive capital remains idle in the firm, which earns no profit for the firm. If these funds shall be invested in some profitable project, it adds the profitability of the Company. Continue reading
Importance of Financial Statements to External Users
In the presence of globalization, financial statements have become the standard measurement in judging a company’s performance. Financial statements are an overall impression of the company which shows profitability, efficient utilization of assets, settlement of outstanding debts, management of equity, and liquidity position to make economic and business decisions by both internal and external users. The analysis of financial statements is the application of financial activities and additional facts of the business, the examination of historical, present, and possible results and monetary situation to make investing, financing, and commercial decisions. External decision makers of an organization are defined as potential shareholders, clients, creditors (banks), and tax authorities who need a financial record to give decisions about investment, approval of loan application, acquisition of products, and compliance with applicable tax laws and regulations. This article will assess the importance of financial statements to external users in addition to a qualitative factor. Continue reading
Definition of Budgetary Control
Budgetary control is the process of determining various budgeted figures for the enterprise for the future period and then comparing the budgeted figures with the actual performance for calculating variances, if any. It is a continuous process, which helps in planning and coordination. It provides a method of control too. The Institute of Cost and Management Accountants, England defines budgetary control as “the establishment of budgets relating to the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy or to provide a basis for its revision”. According to J.A.Scott, “it is the system of management control and accounting in which all operations are forecast and so far as possible planned ahead and the actual results compared with the forecast and planned ones”. Thus, budgetary control involves the following: Establishment of Continue reading
Capital Gearing and It’s Significance
Definition of Capital Gearing The most important factor which must be taken into account by the promoters while drafting the financial plan of a company is capital gearing. Gearing means the ration of different types of securities to total capitalization. The term, when applied to the capital of a company, means the ratio of equity share capital to the total capital and is known as capital gear ratio or capital gearing. J. Batty defines the term ‘capital gearing’ as “The relation of ordinary shares (equity shares) to preference share capital and loan capital is described as the capital gearing.” Thus the term capital gearing is used to indicate the relative proportion of fixed cost bearing securities such as preference shares and debentures to the ordinary share capital in the capital structure. Interest of equity share holders is represented by the amount of share capital plus retained earnings and undistributed profits. Continue reading