Understanding the Concepts - Assignment Example

? Understanding the Concepts Understanding the Concepts Financial ratios are mathematical comparisons of financial entries that are made from an organizations financial statement. These ratios helps an organization to make financial, management and investment decisions, since they present information based on the time value of money, where the present value differs from the future money value (Bangs, 1992). Financial ratios serve to help a business monitor its progress, noticing all the trends and the factors inhibiting its desired performance. There are various financial ratios that are key to the running of a small business. These ratios include the current ratios, which are applied to measure the liquidity of a business, thus determining how well the business is placed to undertake business activities, such as investments, which may call for immediate liquid cash (Horcher, 2005). Quick ratios are the other important ratios for the small business, where the current assets of a business entity, with an exception of the inventories, are compared to the current liabilities to determine how best the business is placed in meeting its current cash payment obligations. Profitability ratios are also vital for a small business, since they help the business determine how much profits it has generated within a specified period of business operation (Bangs, 1992). In so doing, the business understands its performance, ranging from the effectiveness of its operations to how well the business is placed to compete with other businesses of its nature, serving the same market segment. Through the creation of such insights, developed from the analysis of financial ratios, a business makes suitable, tactical and strategic decisions that help it thrive in the market while improving on its operations effectiveness; customer needs satisfaction and profitability (Horcher, 2005). These ratios compares with those applied by large corporations in that, the same ratios are applied by the large corporations for the same reasons, as are for the small businesses. Thus, such ratios are equally important to the managers of large corporations, as they are to the owner managers of small businesses. However, some financial ratios are more appropriate to aid the process of making decisions in large corporations. Such ratios, which are more useful to the managers of large business entities include the debt to asset ratios, which compares the debts that an organization has, to the assets owned by the organization, thus determining how well the organization is placed to meet its debt obligations (Bangs, 1992). Return on asset ratios are the other important ratios for the large corporations. These ratios analyses how the assets of the organization has been generating returns. Such ratios, which are more appropriate for the large corporations, differs from those most suitable for small businesses in that, the financial ratios for larger organizations mostly deals with the assets and the debts owed by the entity, as most of the large organizations owns many assets as well as debt obligations. This is in contrast to the small businesses, which owns fewer assets, and which are mostly financed from the pockets of the owners, making such ratios not very vital for such businesses (Horcher, 2005). Debt financing is mostly applied by business owners who do not have sufficient finances to establish or to finance the operations of their business, yet they prefer to have total control of their business, at the expense of inviting investors into their business, who will take some control. There are various advantages associated with this type of business financing. First, the owner of the business retains the full control of the business, while obtaining the required financing to run the operations of the business (Bangs, 1992). Therefore, the owner of the business reserves the whole privilege of making the business decisions to himself. The other advantage associated with debt financing is the fact that the interest paid by the owner of the business on loans obtained through debt financing is tax deductible (Horcher, 2005). This serves to ensure that the tax burden for the business is reduced. Considering that debt financing involves obtaining finances to run a business from the lenders, then, they do not share in the profits of the business, as would be the case of investors. This allows the business owners to reserve all the profits to himself. However, the disadvantages associated with debt financing are the fact that any failure of the business owner to meet their debt obligations can strain their relations with the friend or the family members from whom they obtained the finances (Bangs, 1992). Additionally, any default in repayments damages the credit ratings of the business owner, making it difficult for him to obtain subsequent financing, when such a need arises in the future. A business may opt to issue bonds a t the expense of selling stocks, in order to finance its operations. This decision may be because; the business may wish to avoid increasing the stake of the already existing shareholders in the company (Horcher, 2005). This effectively avoids diluting the shareholding of the business, through splitting of the existing shares to create more others. There is a strong relationship between risks and returns. The nature of this relationship is direct proportionate, whereby the nature of the risks to which an investment is exposed to, determines the nature of the returns obtainable. Thus, the higher the risk factors involved in an investment, the higher the expected returns (Bangs, 1992). The investors who are willing to take up risky investments are entitled to higher returns, as reward for their high-risk taking propensity. Considering that the investment, which appears more safe and certain, will attract more investors, as they are assured of the safety of their investment, the competition in such investments is higher making the returns earned less. On the other hand, the investments that seem more uncertain are mostly avoided by investors; in that, they may fear to commit their resources to an investment that is not assured to grant them returns or even safeguard their investment. This way, such areas are left to individuals with a higher risk taking propensity, effectively eliminating high competition, and thus making the returns obtainable higher (Horcher, 2005). The concept of Beta refers to the most dependable measure of risk in stocks risks (Bangs, 1992). This concept provides insights into how the stocks are moving, in relation to the movement of the stock in the market. This concept analyses the risk associated with an individual stock in the market, relative to all the stocks (Horcher, 2005). This concept is applied through the calculation of the price movements of the single stock, which is then, compare to the price movement value of the entire stock movements in the market. When there are higher movement values for the single stock, compared to the movement of the entire stocks in the market, then, the stock is associated with a higher risk, and thus expected to earn higher returns (Bangs, 1992). The unsystematic risks refer to the diversifiable risks, which occurs as a result of random cause, and can be eliminate through diversification (Horcher, 2005). On the other hand, systematic risks refers to the risks that affects the entire market that a business is operating in, and which are beyond the control of the investor (Bangs, 1992). While the unsystematic risks can be reduced through portfolio diversification, the systematic risks cannot. With 41 million at hand to invest, and in consideration of the risk factors, both systematic and unsystematic, then diversification becomes the best option. In investing this funds, venturing into different markets, with diversified products and services ensures that the risks associated with the investment is spread over various areas, ensuring that if one of the area invested in fails, there are chances of the other areas succeeding (Horcher, 2005). This is better, as opposed to investing in a single market with limited products and services, where if the area invested in fails, the whole 41 million is lost. References Bangs, H. (1992). Managing by the Numbers: Financial Essentials for the Growing Business. Upstart Publishing. Horcher, A. (2005). Essentials of financial risk management. John Wiley and Sons. Read More