Financial ratios for businesses

Disucss about the Business investment activity in financial crisis.

Money related experts work with organizations or people to get ready for their budgetary prospects by offering data and direction on themes that incorporate charges, ventures and protection choices (O’connor, 2017). Frequently called budgetary guides, these advisors work intimately with customers to offer customized monetary exhortation. These experts gives a clear view of where to invest how to invest along with that they also provide information on how a company should raise fund to support their activities.

Before investing in a stock of a certain company the clients, who are the external users of accounting information, should carefully analyze the financial data of the company in which the client want to invest in (Jordà, Schularick & Taylor, 2016). this process is generally based on making a data analysis of the profit and loss account, the balance sheet, and the cash flow statement as well. The Third and the easiest way to examine how a company is performing is to go through all the financial ratios that are present in the annual report of the company (Cassar, Ittner & Cavalluzzo, 2015).

Firstly, the calculation of the gross profit margin which is done by deducting revenue from sales from cost of goods sold and divided by revenue from sales. Say for instances, the sales revenue of a certain company is about $ 75 million and it’s cost of sales is $ 57 million, so the gross profit margin of that company will be 24 percent. This margin, which is calculated, gives a lot of information about financial health of the company (Smallbone & Mitsui, 2016). It gives us information about how much money the company has for going through any further operation for example: expansion of the firm, repayment of debt, distribution of the amount of capital raised from the owner and other shareholders. It also gives us a proper picture of how much financially sound the company is (Wright, 2015).

Secondly, operating margin can be an important source for the client to know about financial stability of a firm. This can be calculated by dividing operating income by net sales of the company (Lee, Sameen & Cowling, 2015). From this the client comes to know how much revenue is left over after being able to pay for the different variable cost that are needed for production namely: wages, raw materials, freight and so on. This operating margin efficiently help in calculating that well is the company operating and what is the amount of profitability. This does not only analyze the profitability of the whole company whereas can also analyze every unit project within the boundaries of a company.

Gross profit margin

Third important ratio that is needed to be analyzed by the client is the return on the capital employed (Saghir & Aston, 2017). It is generally calculated by dividing net operating profit by the difference between total assets and current liabilities. The information that this ratio deliver to the client is the amount of profit to the per unit capital employed. A Higher ratio will estimate to be favorable whereas a lower ratio will not. The client from this can make assumption and take decisions based on the ratio analyzed (Burns, P., 2016).

Along with knowing the profitability of a business a client needs to assess the riskiness of the company. While establishing a relationship with a company a client should know the risk involved with the company as if this is not done then the party involved with the company will also be affected by the risk which the company faced itself (Mason & Harrison, 2015). This is the reason why an effective analysis of the books of accounts should be done by a client to know certain rations which will provide information on the riskiness there by providing a cushion to the consequences to the risk faced. Few ratios that are important on analyzing the riskiness of a company are the gearing ratio, interest coverage ratio and finally the liquidity ratio (Xiang, Worthington & Higgs, 2015).

The gearing ratio helps in measuring the proportional changes of the borrowed fund of a company to the amount of equity raised for funding the company. The ratio helps in the indication of the amount of financial risk that the company is subjected to and keeps the client and the company prepared for the difficulties that may happen while conducting financial activities (Gambetti & Musso, 2017). The leverage of the company can be more when the gearing ratio is high. Which indicates the company is collecting debts for mainly paying off the changes in regular business operation. Such companies having high gearing ratio which is calculated by adding term debts divided by the shareholders equity, may be troubled while meeting the repayments of such debts and can also be prone to the risk of bankruptcy.

Second ratio that will help in assessing the riskiness of a company is the interest coverage ratio of the company. Which is calculated by dividing earning before interests and taxes by interest expenses? This ratio can be at times tricky to be analyzed as it always depends on the risk taking ability of the creditor and the investor. If the ratio is less than one then, it can be said that the company is not making enough profit to pay the interest to the creditors whereas at times pay back the principal amount (Lambrecht, 2017). However, of the ratio is more than one, it proves that the company is more promising in the case of repaying debts.

Operating margin

A client also needs to know the company’s ability to make payment to short term creditors from the total cast that it possess. This can be known by analyzing the liquidity ratio of the company. The liquidity ratio is calculated by dividing the total cash in hand of a company by the short term borrowing of the company. The client will come to know the actual riskiness in case of short term loan repayment.

To start a business the first thing that is needed to be thought about is the fund which is required to set up the business. Raising fund for the business also brings along with it the liability of the principal amount funded of the interest of the fund raised. So to properly finance a projects there are few useful methods such as: Bank Loans, Issuance of bonds, angel investors and lease 8.

Bank loan is the facility provided by a bank which helps in borrowing a certain amount of money for a certain time limit and a promise of repaying within a pre assigned scheduled (Ogechukwu, Akinlo & Goldman, 2017). The amount of money that is to be repaid depends on two constraints that is size and the duration of the loan that is taken. This is used as a suitable content of the financial structure of the various companies as it is available for all type of companies such as: the well-established one, the business which are growing as well as the one which is being started. Unless and until the company breeches the condition of the loan taken, the amount of money that is obtained as loan is guaranteed to the companies for a period of 3 – 10 years. This loan proves to be a good source of finance, as it can be matched to the assets of the company in the balance sheet in the lifetime of the business (Smallbone & Mitsui, 2016). The interest that s to be paid remains un effected by the profitability of the business, as the interest rates are fixed at times, forecast of the company in the coming years of business. With advantages bank loans also have certain disadvantages, it is a security that the bank gets over the assets that the business has. The bank always stays as the secured creditor of the business which is collateral to the assets of the business. Above this the bank loan is lack in flexibility, even if the company is running at loss then to the bank interest is to be paid.

Return on capital employed

When companies are in need of fund they also raise money by issuing of bonds. Bonds are nothing but loans that are issued amid a certain corporation and a person interested in investing. When the investor decides to pay the company a certain sum of money for a specified time by exchanging the promise of getting periodical payments of interest at pre stated rate and finally the loan is repaid when the value reaches its maturity. Bonds are a better source of fund in comparison to bank loans. Though bank loans are the first thought that comes in the people management. It is devoid of the restrictions that are attached to the bank loans. There is no restriction in issuing bonds. A company can continue the process of issuing bonds till it reaches the point where it does not require more funds (Cassar, Ittner & Cavalluzzo, 2015). The earning is not distributed at large increasing the profitability of the company. It attracts the more number of lenders as the deal is same with the same rate of interest without paying attention to the amount of profit earned, which is better for both the company and the lenders. The company generally issue bonds to derive advantage if there is any drop in the rates in future.

Angel investors are good source of funds for start of business. They are generally among the owner’s relatives or friends. The funds they provide are mainly of one time investment type either when the business is starting or when the business is facing some problem in operation. These angel investors are at times called the informal investors, private investors, business investors and angel funders and so on. They generally use the money of their own which is different from venture capitalist (Cassar, Ittner & Cavalluzzo, 2015). They take the risk on behalf of the company without paying any attention to the risk that can come in the life of the business of the company they are investing in. They are at times retired executives or entrepreneurs, who are interested in investing their amount in a startup business environment. They share both the profit and loss of the company.

There are certain other sources of finance which are made for leasing companies. The most important is finance lease. Generally investors buy a certain attest which is a necessity for the business in which he wants to invest in and then provide it on rent to the business. It is when the lessor takes an amount of rent as a reward for taking certain assets on hiring from the lessee. The ownership of the material lies in hands of the lessor and lessor only provides the lessee an authority to use the assets for its business purpose. The lessee makes payment as rental which is the total cost of the assets during the primary time of the lease. The lessee is obliged to pay the regular rental according to the contract between him and the lessor at the end of the lease either the asset is sold off to the third party by the lessee with the consent of the lessor, at times the asset is generally given back to the lessor when the lessee completes using it for the business. If the utility is not met then the lessee can extend the period of lease on consulting the lessor (Wright, 2015). This helps the company who is using leas as a source of finance to be free of any liabilities or depreciations which is incurred on the asset which is being leased making this source of financing quite profitable.

From the above analyzing it can be concluded that to finance a certain company either in the start up or ongoing or a developed industry certain things are to be kept in mind. Choosing bank loans, angle investors, issuing bonds or taking lease from a lessor it is better to know the advantage and the disadvantages as well.  If the above is kept in mind while financing then the vulnerability to the risk of incurring loss will be less.  The financing of a company is the prior decision making challenge to reduce the risk of the loss that can be incur while paying off the dividend.

References

Burns, P., 2016. Entrepreneurship and small business. Palgrave Macmillan Limited.

Cassar, G., Ittner, C. D., & Cavalluzzo, K. S. (2015). Alternative information sources and information asymmetry reduction: Evidence from small business debt. Journal of Accounting and Economics, 59(2-3), 242-263.

Gambetti, L., & Musso, A. (2017). Loan supply shocks and the business cycle. Journal of Applied Econometrics, 32(4), 764-782.

Jordà, Ò., Schularick, M., & Taylor, A. M. (2016). The great mortgaging: housing finance, crises and business cycles. Economic Policy, 31(85), 107-152.

Lambrecht, M. B. (2017). The Basel II rating: ensuring access to finance for your business. Routledge.

Lee, N., Sameen, H., & Cowling, M. (2015). Access to finance for innovative SMEs since the financial crisis. Research policy, 44(2), 370-380.

Mason, C. M., & Harrison, R. T. (2015). Business angel investment activity in the financial crisis: UK evidence and policy implications. Environment and Planning C: Government and Policy, 33(1), 43-60.

O’connor, J. (2017). The fiscal crisis of the state. Routledge.

Ogechukwu, O. L., Akinlo, A. E., & Goldman, G. A. (2017). Financial schemes to boost small and medium sized enterprises. Sources of finance by the Nigerian government: a commentary.

Saghir, M., & Aston, J. (2017). The Impact of Various Economic Factors in accessing Finance within the Business Sector: Cases from UK Financial Services Companies.

Smallbone, D., & Mitsui, I. (2016). An Assessment on the Sources of Finance and Business Support for EU SME’s Seeking to Internationalise in Japan. Fraser, S., Bhaumik, S. K., & Wright, M. (2015). What do we know about entrepreneurial finance and its relationship with growth?. International Small Business Journal, 33(1), 70-88.

Xiang, D., Worthington, A. C., & Higgs, H. (2015). Discouraged finance seekers: An analysis of Australian small and medium-sized enterprises. International Small Business Journal, 33(7), 689-707.