Finance concepts and applications

Finance

Necessity never made a good bargain

The idiom is attributed to Benjamin Franklin and it stands the most truth. What it virtually means is that a company or an individual in a desperate situation does not hold any ability to negotiate a higher position. Basically, he is obliged to accept whatever terms imposed by the other party. Consequently, it is more likely for him to give up part of his demands or desires, as requested by the other party. He is under no circumstances able to impose new conditions or stand by his initial requests. He is so desperate to close the deal that he will gradually agree to most, if not all, of the conditions imposed by the other negotiator. All these point out to the fact that, when in dire need for an agreement to be reached, the individual or organization will not be able to make a good bargain.

Cash in the bank

There are numerous ways in which the cash owned in bank accounts helps increase company performance. On the one hand, there is the example revealed by Urban Outfitters, in which the cash they held in banks helped increase their levels of liquidities, which then allowed the company to honor its short-term commitments -- namely the payment of the short-term debt. This reduces the pressures imposed by the internationalized financial crisis, but also supports organizational performance in other states of economy. Therefore, on the other hand, the increased levels of liquidity allow the organization to pay the counter value of the services and commodities received from their purveyors, meaning that no shortages will be encountered here and negatively impact production. The money could also be used to ensure the payment of the personnel salaries, and even other financial incentives such as premiums and bonuses, which further increase employee satisfaction, commitment to the organization and performances.

3. Risky finance

As the economic crisis has shown, too many organizations became involved in risky financial operations and as a result had to declare bankruptcy, or at least put on a great struggle to survive. A first example is offered by the International American Group, or AIG, a leading insurance company. Their mistake revolved around the blind implementation of credit derivatives. Similar to other players in the financial sector, the AIG executives believed that these instruments would help protect against risks. They were introduced by the London offices, a subsidiary of the U.S. organization, handling financial services. Basically, what the offices did was to sell credit default swaps (a financial tool of credit protection) on collateralized debt obligations. However, the value of the assets held as guarantees gradually declined. The organization's credit rating was demised, and all these materialized in an impending necessity to upfront $15 billion as collateral with its business partners. This threw AIG into a liquidity crisis (Morgenson, 2008).

The second example is revealed by Lehman Brothers. Their situation is simpler to describe as the company's financial fallout has been due to their decision to grant sub-prime mortgages -- the main generator of the internationalized economic crisis. In short, the financial institution offered loans to virtually all customers, regardless of their ability to reimburse the loan. As the clients defaulted on their payments, the company found itself in an impossibility to recuperate its investments. Gradually, the value of its share decreased, the investors lost interest and confidence, their assets devalued and they were eventually forced to declare bankruptcy. The same situation was present and Merrill Lynch.

4. Using debt to expand the business

The scenario presented in the article, as well as the entire crisis as a whole, has had the general impact of making economic agents more prudential in terms of financial operations. This could also translate in the desire to use lower levels of debt when financing a business endeavor. Rather, one could be inclined to use more equity than debt. A first reason to explain this stand is given by the fact that shareholders are only entitled to a part of the company's profits, their capitals remaining within the company's capital structure; otherwise put, if the company does not register profits, they will not pay dividends. Secondly, the debt is pegged to collaterals; in times of asset devaluation, the cost of debt will as such increase. Equity on the other hand does not require any collateral. Finally, funding through debt does not restrict the company from pursuing any development endeavors, whereas debt could force it to stick to the core business processes which ensure revenue sustainability (Schwartz, 2009).

5. Update on the case