Finance and Accounting
Financial condition is often considered the single best measure of a firm’s competitive position and overall attractiveness to investors. Determining an organization’s financial strengths and weaknesses is essential to effectively formulating strategies. A firm’s liquidity, leverage, working capital, profitability, asset utilization, cash flow, and equity can eliminate some strategies as being feasible alternatives. Financial factors often alter existing strategies and change implementation plans. Especially good websites from which to obtain financial information about firms are provided in Table 6-5.
James Van Horne, the functions of finance/accounting comprise three decisions: the investment decision, the financing decision, and the dividend decision.20 Financial ratio analysis is the most widely used method for determining an organization’s strengths and weaknesses
Financial condition is often considered the single best measure of a firm’s competitive position and overall attractiveness to investors. Determining an organization’s financial strengths and weaknesses is essential to effectively formulating strategies. A firm’s liquidity, leverage, working capital, profitability, asset utilization, cash flow, and equity can eliminate some strategies as being feasible alternatives. Financial factors often alter existing strategies and change implementation plans. Especially good websites from which to obtain financial information about firms are provided in Table 6-5.
James Van Horne, the functions of finance/accounting comprise three decisions: the investment decision, the financing decision, and the dividend decision.20 Financial ratio analysis is the most widely used method for determining an organization’s strengths and weaknesses
in the investment, financing, and dividend areas. Because the functional areas of business are so closely related, financial ratios can signal strengths or weaknesses in management, marketing, production, R&D, and MIS activities. Financial ratios are equally applicable in for-profit and nonprofit organizations. Even though nonprofit organizations obviously would not have returnon- investment or earnings-per-share ratios, they would routinely monitor many other special ratios. For example, a church would monitor the ratio of dollar contributions to number of members, whereas a zoo would monitor dollar food sales to number of visitors. A university would monitor number of students divided by number of professors. Therefore, be creative when performing ratio analysis for nonprofit organizations because they strive to be financially sound just as for-profit firms do. Nonprofit organizations need strategic planning just as much as forprofit firms.
The investment decision, also called capital budgeting, is the allocation and reallocation of capital and resources to projects, products, assets, and divisions of an organization. Once strategies are formulated, capital budgeting decisions are required to successfully implement strategies. The financing decision determines the best capital structure for the firm and includes examining various methods by which the firm can raise capital (for example, by issuing stock, increasing debt, selling assets, or using a combination of these approaches). The financing decision must consider both short-term and long-term needs for working capital. Two key financial ratios that indicate whether a firm’s financing decisions have been effective are the debt-to-equity ratio and the debt-to-total-assets ratio
Dividend decisions concern issues such as the percentage of earnings paid to stockholders, the stability of dividends paid over time, and the repurchase or issuance of stock. Dividend decisions determine the amount of funds that are retained in a firm compared to the amount paid out to stockholders. Three financial ratios that are helpful in evaluating a firm’s dividend decisions are the earnings-per-share ratio, the dividends-per-share ratio, and the price-earnings ratio. The benefits of paying dividends to investors must be balanced against the benefits of internally retaining funds, and there is no set formula on how to balance this trade-off. For the reasons listed here, dividends are sometimes paid out even when funds could be better reinvested in the business or when the firm has to obtain outside sources of capital:
The investment decision, also called capital budgeting, is the allocation and reallocation of capital and resources to projects, products, assets, and divisions of an organization. Once strategies are formulated, capital budgeting decisions are required to successfully implement strategies. The financing decision determines the best capital structure for the firm and includes examining various methods by which the firm can raise capital (for example, by issuing stock, increasing debt, selling assets, or using a combination of these approaches). The financing decision must consider both short-term and long-term needs for working capital. Two key financial ratios that indicate whether a firm’s financing decisions have been effective are the debt-to-equity ratio and the debt-to-total-assets ratio
Dividend decisions concern issues such as the percentage of earnings paid to stockholders, the stability of dividends paid over time, and the repurchase or issuance of stock. Dividend decisions determine the amount of funds that are retained in a firm compared to the amount paid out to stockholders. Three financial ratios that are helpful in evaluating a firm’s dividend decisions are the earnings-per-share ratio, the dividends-per-share ratio, and the price-earnings ratio. The benefits of paying dividends to investors must be balanced against the benefits of internally retaining funds, and there is no set formula on how to balance this trade-off. For the reasons listed here, dividends are sometimes paid out even when funds could be better reinvested in the business or when the firm has to obtain outside sources of capital:
- Paying cash dividends is customary. Failure to do so could be thought of as a stigma. A dividend change is considered a signal about the future.
- Dividends represent a sales point for investment bankers. Some institutional investors can buy only dividend-paying stocks.
- Shareholders often demand dividends, even in companies with great opportunities for reinvesting all available funds.
- A myth exists that paying dividends will result in a higher stock price.
In the second quarter of 2012 alone, 505 U.S. companies boosted their dividends, after 677 firms boosted their dividends in the first quarter. In fact, 70 percent of the stocks in the S&P 500 raised their dividend in 2012. S&P companies are on average today paying out 31 percent of their earnings in the form of dividends, but that is down from 52 percent of earnings in some years.21For calendar 2013, companies in the S&P 500 are expected to pay at least $300 billion in dividends, topping 2012’s $282 billion. Companies are also buying back their own stock (called Treasury stock) at record levels.
Basic Types of Financial Ratios
Financial ratios are computed from an organization’s income statement and balance sheet. Computing financial ratios is like taking a picture because the results reflect a situation at just one point in time. Comparing ratios over time and to industry averages is more likely to result in meaningful statistics that can be used to identify and evaluate strengths and weaknesses. Trend analysis, illustrated in Figure 6-3, is a useful technique that incorporates both the time and industry average dimensions of financial ratios. Note that the dotted lines reveal projected ratios. Some websites, such as those provided in Table 6-5, calculate financial ratios and provide data with charts.
Basic Types of Financial Ratios
Financial ratios are computed from an organization’s income statement and balance sheet. Computing financial ratios is like taking a picture because the results reflect a situation at just one point in time. Comparing ratios over time and to industry averages is more likely to result in meaningful statistics that can be used to identify and evaluate strengths and weaknesses. Trend analysis, illustrated in Figure 6-3, is a useful technique that incorporates both the time and industry average dimensions of financial ratios. Note that the dotted lines reveal projected ratios. Some websites, such as those provided in Table 6-5, calculate financial ratios and provide data with charts.
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