Commercial and Financial Management - Essay Example

09 November 2006 Finance Discuss the relationship between business finance and accounting. Financialmanagement is very much essential in ensuring the health and well being of a business organization. Business finance, in the simplest sense, is concerned with the goal of a firm to maximize shareholder value (Keown, et. al. 2004). It should be noted that finance is all about managing the financial resources of a business entity into those opportunities which will yield maximum value for stockholder's wealth. This involves generating cash in order to support the operations of the company and choosing among competing ends of investment opportunities present in the market. Horngren, et al. (2002, pp. 6) defines accounting as the "information system that measures business activities, processes that information into reports, and communicates the results to decision makers." Accounting is generally classified into fields according to the intended users of financial data. Financial accounting focuses on providing information for people outside the firm like creditors and outside investors. Management accounting on the other hand focuses on giving internal decision makers information which aids them in making financial and operational strategies (Horngren, et al. 2002). Accounting and business finance are closely interrelated. The business arena often refers to accounting as "the language of business" implying that a better understanding of the accounting language will aid making better financial decisions (Horngren et al. 2002). Thus, in general, accounting is a prerequisite in understanding the important concepts used in financial accounting. Basic knowledge in accounting is imperative in understanding finance. As stated earlier, concepts which are commonly used in accounting appears in financial management. For instance, a company which needs to determine the profitability of an investment needs to be acquainted with the effects of different transactions on the income statement of the business organization. With this, knowledge in accounting becomes imperative for financial managers. Accounting acquaints individuals with the necessary knowledge in business and financial terminologies. It also becomes a foundation of financial skill. Thus, decision makers need to be adept in speaking the language of business in order to be able to come up with financially efficient business decisions geared to help in attaining the financial goals of a firm. In the early part of this paper, the classification of accounting according to users has been discussed. It should be noted that these two different fields of accounting has different relationships with business finance. Financial accounting which is more concerned with the reporting of historical financial information becomes a reflection of the how the financial aspect of business is managed, while managerial accounting is almost identical in function with business finance as it directed toward the future of the firm (Finance 2006). The company's financial statements are the product of financial accounting. These documents clearly show how the business organization is performing in terms of income, capital structure, asset growth and other numerical information (Horngren et al. 2002). It should be noted that the company's financial performance is a direct result of how business finance is conducted by decision makers. The profit or loss in the financial statement, the growth in total assets, and how they resources are financed becomes an indication of how well a business organization is attaining its financial goals. Financial accounting is a yardstick revealing how business finance is achieving its goal of maximizing shareholder value. With this, financial accounting is very important in ascertaining the efficiency of financial decisions in a company. Business finance can be further modified or improved by looking at a firm's various financial statements. Management accounting takes a step further by having a future orientation (Horngren et al. 2002). This filed of accounting has quite similar function with business finance. It should be noted that both management accounting and business finance are geared in making business decisions which will enhance the financial situation of a business organization. However, it should also be noted that management accounting focuses on the cost efficiency of a firm's operations while business finance is concern is investing not only in enhancing production but maximizing the financial resource of the organization. Business finance takes a step further because it also takes into account associated risks, time value of money, and ethical considerations. Even though classified as two different fields, business finance and accounting are closely intertwined. 2. Describe the theoretical correct approaches to assessing investment opportunities and their application. Evaluate how theses are used in an organisation with which you are familiar. What are the practical problems of these theories The payback method is one of the most popular tools in conducting capital budgeting decision. The payback period tells the company the length of time required to recoup the original investment through investment cash flows. The payback period is computed as the follows: Payback = Initial Investment Annual Cash Flow (equation 1) Other things being equal, the investment with a low payback period is chosen as it implies less risk for the company. As the investment is recouped in a shorter period of time, it also indicates that the investment is less likely to fail. There are essentially three reasons why the payback method is popular among business circles. First of all, the payback method is simple. The computation is less complicated and is easily grasped by managers. Secondly, the payback method is gives some indication of risk. As this technique indicates the length of time that the investment can be recouped, it gives the company an opportunity to separate long-term projects to short-term ones. Lastly, this tool helps the company gain a more accurate and reliable assessment of a project by taking into account taxes and depreciation (Lightfoot 2003). However, the use of the pay back period in assessing the profitability of an investment also suffers limitation. The payback method is not a reliable method of profitability because it stresses the return of investment and not on the return on investment. Instead of taking into account how much profit an investment can generate for a business entity, the payback method only tells the length of the time the investment is "returned." (Lightfoot 2003). Secondly, the payback method also falls short in measuring profitability as it ignores the cash flow after the payback period. Failure in including these cash flows will lead to understatement of profits. Lastly, the payback method ignores a very important principle-the time value of money. It is very important to include the time value of money in assessing the profitability of investments as the value of money today is relatively higher than its value say, a year or two years from now. Thus, managers who want to really know if the proposed project is really good for the company should discount cash flows. With this, economists favor the use of another capital budgeting method known as NPV. The net present value (NPV) of a project represents the present value of the total cash inflows and outflows. The NPV can be calculated by discounting the cash flows according to the required rate of return. the NPV can be mathematically represented as: (equation 2) where Ct is the cash flow in time t, Co is the cash flow during the first year, and r is the required rate of return (Keown, et. al. 2004). It should be noted that in the assessment of the profitability of an investment, it is also important to consider the timing of cash inflows. The rationale behind this is expressed in the concept of the time value of money which is widely recognized as one of the single most important concept in financial analysis. This tells us that a dollar to be paid today has a higher value than any dollar to be paid tomorrow. Holding a dollar has an opportunity cost in terms of interest. Thus, a dollar invested today can be turned into $1.10 next year when lent at 10% interest. In the same way, a dollar collected today will be used by a company to be invested in its profitable undertakings which can yield more dollars in the future. Thus, it can be deduced that investments which generates more cash earlier in their lives are more profitable. This might sound consistent with the payback period. However, it should be noted that NPV takes into account the total cash flow generated by the investment and does not stop when the total investment is recouped. NPV, unlike the payback period recognizes the importance of a company's preset return on investment. It should be noted that when the company calculates the return on investment using NPV, it measures the cash flow based on cost of capital. The payback period, on the other hand, only looks at the earliest possible time the investment is recouped and not at the investments meeting the standard of the company. 3. 'It is nave to expect businesses to act ethically. Whenever there is a choice between acting ethically and making greater profitsfirms will choose the latter'(I. Chambers, Business Studies, Causeway Press). Discuss this statement. As stated above, the main goal of business organizations is the maximization of shareholder value. This is often interpreted as being able to generate profits to cover the company's expenses with some residual being added to the value of its common stock. However, this goal is sometimes in the expense of ethics. The prevalence of lack of ethics in finance is very prevalent in the current world's economy. Keown et. al notes: "During the late 1980s and early 1980s, the fall of Ivan Doesky and Drexel Burnham Lambert, and the near collapse of Salomon Brothers seemed to make continuous headline. Meanwhile, the movie Wall Street was at the hit box office and the book Liar's Poker, by Michael Lewis, chronicling unethical behavior in the bond markets, became a best seller (pp 17)." Accounting fiascos has been very prevalent in the past decade and it has tainted the credibility of firms in reporting their true financial positions. What became apparent is their desires to create portray good financial conditions amidst their predicaments. Business organizations have been choosing to act unethically than to admit their losses. However, looking deeper at the situation, lack of ethical consideration runs in contrast with the goal of a business organization to maximize shareholder value. It should be noted that trying to hide the losses of a business organization does not contribute to the real value of the company's common stock. It only masks problems which will adversely affect the shareholder value. It is the responsibility of a business organization to act morally in order to preserve their equity and profitability. The business community has already felt and seen how the public negatively reacts to fiascos. Unethical behavior is often left unforgiven and unforgotten by stakeholders. Business organizations who failed to comply with the preset moral and ethical standards often suffer from downslide and never manage to recover. It should be seen that the adverse consequences of unethical behavior now prompts companies to act morally. It can be seen that the business arena increasingly recognizes the importance of paying attention not only to making profits but making contributions in the environment where they operate. This is in response to the global clamor for more socially responsible and more sustainable business practices. Companies are now becoming more involved in their corporate social responsibility programs. These programs generally lower the profits of companies but nonetheless, business organization strives to create image in their environment. An example of this is the worldwide recall of Dell, Inc. batteries. It can be recalled that Dell's laptop exploded in a conference in Japan raising alarm to customers. Notwithstanding the costs of recalling more than 1.4 million batteries, Dell, Inc. opts to announce a worldwide recall of its laptop batteries. In this situation, it can be seen that Dell made its choice between profit and ethics. Surely, the recall will have an adverse impact in the income statement of the computer manufacturer. However, it chooses to act morally and preserve its credibility and reputation in the industry. In developing economies, one of the pressing issues is the degradation of environment. Oil companies like Exxon Mobil are guilty of burning fossil fuels which facilitates the flow of negative environmental spillovers such as air pollution and global warming. In order to offset the hazards that it brings to the environment, Exxon Mobil focuses on pursuing sustainable development. In its 2005 Corporate Citizenship Report, the multinational emphasizes its role in promoting sustainable development by "providing support for scientific research on important environmental issues, encouraging public discussion on environmental policy, and implementing biodiversity conservation through the preservation of endangered species, their habitats, and other biologically diverse ecosystem" (Exxon Mobil 2006). Exxon Mobil recounts granting $5.3 million for worldwide environmental contributions in 2005 with $3.4 million being allocated to support environmental programs outside the United States (Exxon Mobil 2006). In some instances, business organizations act unethically for the prospects of profit. However, the increasing corporate social responsibility pursued by industry players show a transformation. It can be seen that companies are recognizing the costs of unethical behavior. In fact, choosing to act unethically for profit is not profitable at all. References Exxon Mobil. 2006, Retrieved 09 November 2006, from http://www.exxonmobil.com/Corporate/Citizenship/citizenship.asp Finance 2006, Retrieved 09 November 2006, from http://en.wikipedia.org/wiki/Finance#Business_finance Horngren, C et. al. 2002, Accounting, Prentice Hall: New York Keown, A et. al. 2004, Foundations of Finance, Pearson Prentice Hall: Upper Sadle New Jersey Lightfoot, D 2003, Return on Investment in CTP, Retrieved 09 November 2006, from http://www.newsandtech.com/ctp_chicago/presentations/ROI.pdf Read More