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Financial Management: Ratios, Risk and Diversification
Financial Ratios Relevant to Small Businesses and Large Corporations
In an attempt to determine the performance of his or her business, a small business owner can utilize ratios such as the current ratio and the profit margin ratio. The profit margin in the words of Needles and Powers (2010) "shows the percentage of each sales dollar that results in net income." For a small business owner, this ratio would be an appropriate measure of the profitability of his or her business. The current ratio as Stickney et al. (2009) point out helps in the measurement of a firm's ability to settle its short-term debts/obligations. A small business owner interested in determining the ability of the business to settle its everyday bills and other obligations would find this ratio useful. On the other hand, a manager of a large corporation would be interested in ratios such as return on equity (ROE) and debt-to-equity ratio. The debt to equity ratio in the opinion of Needles and Powers (2010) "shows the proportion of a company's assets that are financed by creditors and the proportion financed...
ROE is regarded one of the most important ratios for not only existing stockholders but also potential investors. Both potential and existing stockholders would desire to sink their dollars in a company with a high ROE.
Debt Financing: Advantages and Disadvantages
One of the key advantages of debt financing has got to do with the prevention of ownership dilution as providers of debt in this case do not become part-owners of the business. In that regard, their say in decisions concerning the business is limited. However, debt financing puts the borrower at a greater risk of bankruptcy should such a borrower be unable to service the said debt. Further, interest payments can in some instances strain an entity's cash flows. With that in mind, some businesses may opt for equity financing i.e. stock issuance. As Shim and Siegel (2008) point out, an entity's credit rating can be improved by the issuance of common stock as opposed to a bond issue. Issuing stocks does not commit the business to periodic payments…
References
Graham, J. & Smart, S.B. (2011). Introduction to Corporate Finance (3rd ed.). Mason, OH: Cengage Learning.
Needles, B.E. & Powers, M. (2010). Financial Accounting (11th ed.). Mason, OH: Cengage Learning.
Stickney, C.P., Weil, R.L., Schipper, K. & Francis, J. (2009). Financial Accounting: An Introduction to Concepts, Methods, and Uses (13th ed.). Mason, OH: Cengage Learning.
Shim, J.K. & Siegel, J.G. (2008). Financial Management (3rd ed.). Hauppauge, New York: Barron's Educational Series.
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