The phrase trading on equity is a financial jargon which indicates the utilization of non-equity sources of funds in the capital structure of an enterprise. At a high debt-equity ratio, a firm may not be able to borrow funds at a cheaper rate of interest it may not able to borrow funds at all. This is so because creditors lose confidence in the company which has a high debt-equity ratio. How can creditors have confidence in the company which has only creditors and no equity stockholders? The company will, therefore, have to strive hard to regain a reasonable debt-equity ratio so that the expectations of the market may be satisfied. In fact, equity financing by way of a public sale of stock offers real value of a firm. Traditionally, it has served as a spearhead for expansion of resources and productive capacity involving risk. Merwin Waterman states that the term Continue reading
Financial Management Tools
Earnings Management – Meaning and Mechanism
The relationship between managers and shareholders in the business world cannot be disputable. This relationship is interpreted under Agency Theory. They are very dependent each other, even somehow there exist conflict of interest among these two parties. In example the shareholders put on trust to agency by contributing huge amount of money in terms of paid up capital, so that agency can generate business and obtain profit and increase the firm’s value as principles return. Meanwhile agency (managers) is dependent to the principles for remunerations and bonuses as compensation. Because of the great pressure from principles (shareholders) towards the high performance of firms values, so agency commonly practice earnings management in order to be sustained in market place. Earnings management may involve manipulation of accounting record, intentional omission or intentional misapplication of accounting o accounting principles. Earnings management is defined as the intentional misstatement of earnings leading to bottom line Continue reading
Difference Between Job Costing and Process Costing
The main objective of manufacturing firms is to make profit. The profit on each product sold is the difference between the selling price of the product and the total cost of making the product. Cost therefore plays an important role in the product design process. To calculate the cost that incurred on the product we use different Costing Techniques. Costing is not an easy task because in the process of manufacturing a product many indirect materials and labor are used. To identify these costs we use different costing techniques. Here we are going to discuss two methods of costing; Job Costing and Process Costing. Job Costing Job Costing is to calculate the costs involved of a business in manufacturing goods. These costs are recorded in ledger accounts throughout the year and are then shown in the final trial balance before the preparing of the manufacturing statement. In a job costing Continue reading
Financial Leverage and the Shareholders Risk
It has is seen that financial leverage magnifies the shareholder’s earnings. It has also been observed that the variability of EBIT causes EPS to fluctuate within wider ranges with debt in the capital structure. That is, with more debt, EPS rises and falls faster than the rise and fall of EBIT. Thus, financial leverage not only magnifies EPS but also increases its variability. The variability of EBIT and EPS distinguish between two types of risk- operating risk and financial risk. 1. Operating Risk- Operating risk can be defined as the variability of EBIT (or return on assets). The environment- internal and external- in which a firm operates determines the variability of EBIT. So long as the environment is given to the firm, operating risk is an unavoidable risk. A firm is better placed to face such risk if it can predict it with a fair degree of accuracy. The variability Continue reading
Value Added – Concept, Definition and Uses
Meaning and Definitions of Value Added The traditional basic financial statements are balance sheet and Profit & Loss account. These statements generate and provide data related to financial performance only. They do not provide any information which shows the extent of the value or the wealth created by the company for a particular period. Hence, there arose a need to modify the existing accounting and financial reporting system so that the business unit is able to give importance to judge its performance by indicating the value or wealth created by it. To this direction inclusion of Value Added statement in financial reporting system is useful. The Value Added concept is now a recognized part of the accountant’s repertoire. However, the concept of Value Added (VA) is not new. Value Added is a basic and broad measure of performance of an enterprise. It is a basic measure because it indicates Continue reading
Revenue Management – Meaning, Benefits, Scope and Future
The phenomena of revenue management gained importance in recent years due to variable and discriminatory pricing schemes offered by various companies to their customers. Revenue management applies the orderly analytics that predict the behavior of the consumer at micro level and augment the prices and availability of products to the customers thus enhancing the overall revenue for the company. The aim of devising revenue management techniques is to deliver the fine product or service to the appropriate customer at the precise price. Revenue management system is based on analyzing the customer’s perception of the value that the product would provide and make straight the availability, placement and price according to that perception. This discipline became the need of every business rapidly. There could be many reasons for this. Even a kid whose is out for selling orange juice will have to analyze and predict the appropriate weather and time for Continue reading