Financial Management Fundamental Decisions in Financial Management

Financial Management

Fundamental Decisions in Financial Management

In financial management, there are three fundamental decisions, which are central to capital budgeting, capital structure and working capital management. Capital budgeting refers to the process of planning and managing the company's long-term investments. Capital structure refers to the particular mixture of long-term debt and equity a company utilizes to fund its functions. Working capital management refers to the company's short-term assets, which may include inventory, and its short-term liabilities (Parrino, Kidwell and Bates, 2011).

Pros and Cons of the three forms of business ownership

Sole Proprietorship

Advantages

It is easy to start and end a business

There is no sharing of profits

It does not involve any special taxes

Disadvantages

Available funds are limited to what the owner has

There are management issues

There are limited developments

Partnerships

Advantages

The business experiences more financial resources

There is shared management, which enhances growth of the business

Partnerships are likely to succeed when compared to sole proprietorships

Disadvantages

There is unlimited liability

There is division of profits

There are likelihoods of disagreements among partners

Corporations

Advantages

Corporations can raise substantial funds

It has a perpetual life

There is ease of change in ownership

Disadvantages

Corporations experience double taxations

Corporations involve extensive paperwork

There is difficulty of termination in corporations

Importance of ethics in business

Finance doe not teach people on ways of becoming rich, rather it teaches people how to become rich. On the other hand, ethics teaches people to be morally good in their activities. Therefore, when incorporated in the financial sense, it will teach businesspersons how to become reach, but in morally accepted ways. In business, ethics are important because they will influence how the parties will apply when making business decisions. In addition, business ethics will keep the parties to operate within legitimate approaches, which will result to increased sales because most consumers like dealing with honest businesspeople.

Risks of holding interests so low

Holding of interests so low, is a response from the federal government in an attempt to stabilize the economy and the overall financial system. In addition, keeping the interest rates so low will help households and business finance new spending and support the prices of assets. Moreover, the low interest rates were to assist the government narrow the deficits, by decreasing their borrowing prices. However, keeping the interest rates low has adverse effects. For instance, low rates of interest can result to extreme risk taking and asset bubbles. In addition, this can lead to delays in balance sheet repair and has the capacity to raise credit over the medium period (Parrino, Kidwell and Bates, 2011).

GAAP

Generally, Accepted Accounting Principles (GAAP) refers to a set of rules for financial accounting utilized in any given jurisdiction, commonly known as accounting standards or the standard accounting practice. They include the standards, conventions, and guidelines followed by auditors when recording, summarizing, and preparing financial statements. GAAP is essential because it helps in maintaining the consistency when reporting financial information and reduces the vulnerabilities to errors or frauds. In addition, GAAP helps in setting the standard for a firm and reduce the risk of tax issues and erroneous reporting of transactions.

Information contained on Income Statements and Balance Sheets

An income statement shows the revenue and expenses of a company over some period. In addition, the statement shows the company's net earnings or losses. It also reports the company's earnings per share. On the other hand, balance sheets provide detailed information concerning the company's assets, liabilities and shareholder's equity.

Section 2

Financial ratios

Financial ratio, also known as accounting ratio refers to the measurements of business; it is the relative size of two selected numerical values retrieved from a company's financial statement. In addition, managers, potential shareholders, and creditors can use the financial ratio. Analysts employ financial ratios to compare the SWOT analysis of companies.

Days Sales Outstanding

DOS is a measure of the average of days, which a firm takes to collect revenue after the company has made a sale. When the DSO number is low, it means that the company took few days to collect its accounts (Parrino, Kidwell and Bates, 2011). On the other hand, when the DSO number is high, it means that the company sells products on credit, hence, explaining why it takes long to collect the sales. The DSO is calculated as follows;

Accounts receivable/Total credit sales x Number of days

Current Ratio

The current ratio is a financial ratio, which measures the company's capacity to pay its outstanding debts over the next one year, or 12 months. In addition, the current ratio compares the company's current assets in relation to its current liabilities. The current ratio is calculated as follows;

Current Ratio = Current Assets/Current Liabilities

Inventory Turns

In accounting, inventory turns refers to the measure of the number of time that a company's inventory cycles in a given year. In addition, the equation for inventory turns is equivalent to the cost of sold goods divided by the average inventory. Inventory turns is calculated as follows;

Inventory Turnover = Cost of Goods Sold/Average Inventory

Inventory Turnover = Cost of Material -- Change in Inventories (of 1/2 and 1/1 goods)

Inventories

Average Inventory = Beginning Inventory + Ending Inventory

2

Average days to sell the inventory = 365

Inventory Turnover Ratio

Profitability Ratio

In accounting, the profitability ratio measures the capacity of a company to generate earnings relative to the firm's expenses and costs. In addition, the profitability ratio evaluates the company's capacity to generate earnings, profits and cash flows relative to the invested amount money (Parrino, Kidwell and Bates, 2011). Profitability ratios include the following ratios;