The use of fixed-charges sources of funds, such as debt and preference capital along with owner’s equity in the capital structure described as financial leverage gearing or trading on equity. The use of the term trading on equity is derived from the fact that is the owner’s equity that is used to raise debt; that is, the equity that is traded upon. Financial leverage is defined as the ability of a firm to use fixed financial charges to magnify the effect of change in E.B.I.T on the firm’s earning per share. The financial leverage occurs when a firm’s Capital Structure contain obligation of fixed financial charges. For instance, interest on debentures, dividend on preference share etc., along with owner’s equity to enhance earning of equity shareholder’s. The fixed financial charges do not vary with the operating profit. They are fixed and are to be paid irrespective of level of operating Continue reading
Financial Management Tools
Exit Value Accounting
Exit value accounting is a form of current cost accounting which is based on valuing assets at their net selling prices (exit prices) at the balance sheet date and on the basis of orderly sales. An exit value is the maximum price a currently held asset could be sold for in the market less the transactions costs of the sale (the net realizable value for the asset). This normative accounting theory was developed by Raymond Chambers and labeled as Continuously Contemporary Accounting (CoCoA). The theory relies on assessments of the exit or selling price of an entity’s liabilities and assets. The exit value accounting theory was developed under the following key assumptions. Firstly, firms exist to increase the owners’ wealth. Secondly, the organization’s ability to adapt to changing circumstances is the basis of successful operations and Finally, the capacity to adapt will be best reflected by the monetary value of Continue reading
Differences Between Value Chain Analysis and Traditional Management Accounting
The Limitations of Traditional Management Accounting There exist five major limitation for traditional management accounting. The first one is the traditional management accounting may treat the firm as a single part. It only provided information for a single enterprise management decision and control, ignoring the external environment and other relevant information also can reflect the firm’s position in the market. Second, the traditional management accounting limited to the collection and analysis of internal financial information, the information break away from the requirements of corporate strategic management and weakened the role of management accounting. Third, the concept of traditional management accounting just focus on solving the relevant and individual internal issues. It can not form a sound management system with the market and long-term interests, so that the composition of the budget system just only concentrate on the enterprise’s internal planning and operations. The forth is the traditional management accounting adopted Continue reading
Financial Accounting vs Management Accounting
Financial Accounting and Management Accounting are two interrelated facets of the accounting system. They are not exclusive of each other; they are supplementary in nature. Financial accounting provides the basic structure for collecting data. The data collection structure is suitably modified or adjusted for accumulating information for management accounting purposes. In a broader sense, management accounting includes financial accounting. They differ in their emphasis and approaches. They are as follows: Financial accounting serves the interest of external users (i.e. investors etc.) while management accounting caters to the needs of internal users (i.e. management). Financial accounting is governed by the generally accepted accounting principles while management accounting has no set principles. Financial accounting presents historical information while management accounting represents predetermined as well as past information. Financial accounting is statutory while management accounting is optional. Financial accounting presents annual reports while management accounting reports are of both Continue reading
Marakon Model of Shareholder Value Creation
The Marakon model was developed by Marakon Associates, a management consulting firm known for its work in the field of value-based management. According to Marakon model, a firm’s value is measured by the ratio of its market value to the book value. An increase in this ratio depicts an increase in the value of the firm, and a reduction reflects a reduction in the firm’s value. The model further states that a firm can maximize its value by following these four steps: Understand the financial factors that determine the firm’s value Understand the strategic forces that affect the value of the firm Formulate strategies that lead to a higher value for the firm Create internal structures to counter the divergence between the shareholders goals and the management’s goals. 1. Financial Factors The first step in this model is to identify the financial factors that affect the value of the firm. Continue reading
Financial Statements – Definition and Meaning
Past events and performances serve as background for making projections if they are to be realistic. The financial statements provide important information concerning past financial transactions and their effects om the profitability and the financial position of the business. Various users of financial statements such as owners, investors, creditors, management etc. must make an analysis of financial statements to make right decision. Therefore financial statements are the means of conveying to owners, management or to interested outsiders a concise picture of profitability and financial position of the business. Financial statements are the end products of the accounting process which give a concise accounting information of the period after the accounting period is over. Financial statements are the summary reports of a company’s financial transactions during a given period of time. A firm communicates to the users through financial statements and reports. The financial statements contain summarized information of the firm’s Continue reading