Financial Impact Of The Sarbanes-Oxley Act Essay

Length: 5 pages Sources: 4 Subject: Business Type: Essay Paper: #12745236 Related Topics: Expansion, Stocks And Bonds, Stock Valuation, Public Vs Private
Excerpt from Essay :

¶ … Sarbanes-Oxley Act on a Medium Sized Company

The following paper begins with a discussion of the benefits of going public. The paper then gives a comparison between a public and private company. It focuses on the fund raising procedures of the private companies as well. The paper also discusses the ratios that are evaluated at the time of and IPO and determines the impact of these ratios on the decisions of the company. The paper then discusses the positive and negative impacts of the Sarbanes-Oxley act and finishes with a recommendation about whether to continue as a private company or go public.

Benefits of Going Public

Going public refers to an initial public offering of a private company. An initial public offering is the first time a company offers its shares to public. Different companies have different reasons for going public. One of the reasons is to obtain capital. Privately, a company will have a limited amount of capital and they will have to make strict choices about investment options. If, however, the company decides to go public, the company will have an option to increase capital by offering stock. This is the primary goal of the company if it goes public as it needs cash for several projects. (Jong, Huijgen, Marra & Roosenboom, 2012)

In addition to that, firms also decide to go public to improve their position in the market by capturing the market of their private competitors. This is because the stock offering makes the reputation of a firm better by improving its liquidity position. Therefore, the firm obtains better investors, workers and therefore, market share. (Jong, Huijgen, Marra & Roosenboom, 2012)

There are several benefits that a firm reaps by going public. Three of them are listed below: (PricewaterhouseCoopers, 2010)

Increased cash and capital

Increased market value

Attraction of key personnel (PricewaterhouseCoopers, 2010)

As mentioned earlier, a public firm has more funds. This is because it opens up a way to increase its capital by going public. This helps the company in issuing equity and gaining capital without paying interest. In addition to that, the public companies also get lenient borrowing terms than private firms. This makes the acquisition of loans easier and further increases the probability of getting easy funds. (PricewaterhouseCoopers, 2010)

Apart from that, the company improves its market value by going public. One of the main reasons is the increase in funds. The increase in funds improve the liquidity of the company. As a result, the liquidity ratios of the company get better which are then published. The investors and public becomes aware that the company has the ability to pay off its debts. Therefore, the investments increase in number and the overall value of the company improves. (PricewaterhouseCoopers, 2010)

A public company can also attract and retain skilled key personnel. This is because the public companies give its employees stocks and stock options as a part of their fringe benefits. Stock options are preferred by many workers as there is a chance that the value of the stock will go higher. Moreover, the company will have a better reputation, as mentioned earlier, and hence, it will automatically attract efficient personnel. (PricewaterhouseCoopers, 2010)

Remaining Private and Fulfilling the Goals

The primary goal of the company, if it goes public, is to get funds to initiate its expansion projects. In addition to that, the market value and obtaining skilled personnel are two other goals. These goals can be achieved by a company even if it remains private. The company can raise capital in order to invest in the expansion projects by issuing shares to company members. The company can also issue debentures to its debenture holders as well. In addition to that, a private company can also get a short-term or long-term loan from a bank as well. The terms will not be as flexible as a public limited company but the goal will be achieved. (Wallace & Wallace, 2001)

An increase in funds will similarly increase the market valuation of the company. Although the ratios and statistics of this company will not be published but still the good finance, it also transfers the controls to the ordinary shareholders. Moreover, a private company does not have to disclose its information to the public and therefore, its rivals remain unaware of its strengths and weaknesses. The public company, on the other hand, informs the public and its rivals about its plans and projects. This gives a chance to its competitors to adjust their strategy accordingly. (Wallace & Wallace, 2001)

Evaluation of Ratios

The companies normally check their performance using ratios. The information from these ratios are then used to make decisions. As an IPO is a company's big decision, the ratios are considered here as well. The verdict of an IPO is based on four financial ratios. These are: (Troy, 2008)

Current Ratio

Return on Investment

Debt to equity ratio

EBITDA margin (Troy, 2008)

The current ratio determines the short-term debt payment ability of the company. It is calculated by dividing the current assets by current liabilities. If the company wants to improve its current debt payment ability, the inflow of funds via an IPO will certainly help the company in its purpose. Therefore, the company will be helped by the IPO as its current ratio will improve. (Troy, 2008)

Return on investment ratio shows how profitable the investment of a shareholder will be. It is calculated by dividing net income by Average total shareholders' equity. This ratio is evaluated by an investors before investing in a certain company. If the ratio shows good performance, the IPO will be a success. If the ratio is not that handsome, the company will delay its IPO until it is improved. This is because the IPO will not bring in sufficient funds required and expected by the company. (Troy, 2008)

Debt to equity ratio shows the proportion of debts and equity the firm is using to finance its assets. It is calculated by dividing total debt by total shareholders' equity. First of all, the ratio shows how well the company is covering its cost of finance. If the debts are high, the company will be incurring a high financing cost and therefore, it will not be as profitable. Secondly, it also shows the control of shareholders on the decisions of the company. Both the ratios should be in good shape at the time of an IPO. If not, the success of the IPO will be affected. (Troy, 2008)

EBITDA margin shows the profitability of the company. It is calculated by dividing earnings before interest, tax, depreciation and amortization by total revenue. The ratio shows the operating efficiency of a firm. If the EBITDA is high, the operating expenses would be low and the company will be rendered as profitable. In addition, the growth in EBITDA margin is also measured. If the company shows healthy growth, then it will be a profitable option to invest in. If the ratio is not up to the standards, the company will not get much investors in its IPO. (Troy, 2008)

Sarbanes-Oxley Act -- Impacts

The Sarbanes-Oxley act will have a negative financial impact on the company. The act requires the company to take extra care of its internal controls and matters. The act also makes it necessary for the companies to include an internal control report in the financial reports. This leads to extra time and money being spent on internal controls. In addition, the act also requires the company to get the report reviewed by an external auditor which will then charge his fees as well. Moreover, the act also requires the change of the chief auditor in some years which again incurs expenditure. (Primack, 2012)

In addition to that, the effect of this act is exacerbated when the company is medium sized. This is because the revenue and income of the company are not as huge as a large company. This puts the concerned company at a disadvantage. However, the company will be able to tackle this advantage if they are efficiently managed. The company will not have many accounts and finance. Therefore, the fees of the auditor will also be reduced. (Primack, 2012)

In addition to the financial disadvantages, the company is also required to give huge amounts of information which will put it to a disadvantages as its competitors will get information about its strengths and weaknesses. (Primack, 2012)

On the other…

Sources Used in Documents:

References

Jong, A., Huijgen, C., Marra, T., & Roosenboom, P. (2012). Why Do Firms Go Public? The Role of the Product Market. Journal Of Business Finance & Accounting, 39(1-2), 165 -- 192.

PricewaterhouseCoopers,. (2010). Roadmap for an IPO A guide to going public (pp. 4-13). London: PricewaterhouseCoopers.

Primack, S. (2012). The Financial Impact of the Sarbanes-Oxley Act on Small vs. Large U.S. Public Companies (1st ed., pp. 1-5). Berkeley: University of California. Retrieved from http://live.econ.berkeley.edu/sites/default/files/Primack.pdf

Troy, L. (2008). Almanac of business and industrial financial ratios (1st ed., pp. 9-22). Chicago, IL: CCH.


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