Introduction Accounting and finance are two very important factors that exist in every company out there that is commercialese. Every firm needs to do accounting and manage Its finance well in order to continue operating, an organization cannot run without any funds. The management of the company will need to evaluate the accounts and finance of the company to make important decisions, such as whether to Invest In a certain stock or to buy more of a particular Item to sell. In this report, we will be looking at some of the methods that are commonly used or should be used In using counting and finance for decision making.
Accounting and Budgeting Information Accounting and budgeting Information can play a key role In how a company calibrates and ultimately Implements strategy. This Is the case for any company, but let us use the fictional example of a computer manufacturing company (“Tell”) In order to understand how this information can be used. Tell wants to a know a number of things in order to produce computers and components for its consumers. First, it wants to know what the allocation of capital should be to different divisions in the company.
For example, should the company merely focus on the production of the product, or should it also focus on marketing and sales? The answer is likely both; however, the budget will decide which of these activities is emphasized by allocating resources to it. A substantial budget given to marketing will indicate that marketing is a priority of the company, and a strategy will then need to be promulgated in order to use those resources effectively. If the company wants to focus on production as an MEMO producer, then the firm may decide to allocate majority of resources to the production department.
Another key question that budget and accounting information answers is: how should the company finance itself? This is likely the most important question the company will answer in its attempt to balance the advantages and disadvantages between equity, debt, and internal financing to finance its operations. Financial Leverage and Bonds. Financial leverage is a controversial topic. Indeed, If one looks at the major reason why so many banks and financial Institutions needed government bailouts post-2007, egregiously high levels of leverage are a prime explanation.
Many banks levered existing assets beyond ratios of 30:1 (debt to actual assets a financial position that destroyed many Institutions that were unable to find financing when asset values plummeted and other forms of financing dried up. Leverage, however, Is a common business strategy outside the financial Industry. Indeed, when used prudently and invested in real assets, leverage can provide a firm some of the benefits and weaknesses of using leverage, the example of Caterpillar will be used. Caterpillar is a typical industrial manufacturing company: The company produces industrial machinery (e. G. Ranges and tractors) for a number of different uses; at the same time, Caterpillar’s reach is quickly growing globally. This means that the company not only needs a financing strategy that promotes the scaling up of manufacturing, but also needs to do so in a relatively fast manner in order to keep with orders around the world. Besides financing an expansion in operations through an existing cash pile, a company has two main decisions: to issue equity or bonds. A company usually will hesitate to issue equity, particularly in the current macroeconomic environment, due to the impact on existing investors and the price to he company.
Equity is considered “expensive” in that it dilutes other stock holders in the company, while at the same time increases the base for the distribution of dividends and other residual assets of the company. Thus, many firms choose to issue debt (via bonds) that allows the company to gain needed capital, while also not increasing the equity base of the company. When a company takes debt onto its balance sheet, it is known as leverage. There are numerous advantages a company accrues when taking on debt.
First, debt, at least in the United States and other countries, affords certain tax advantages in hat the interest payment of the bonds may be written off. This means that companies essentially pay less than the prevailing interest rate when they issue bonds. Another benefit accrues when a company, such as Caterpillar, takes leverage onto its balance sheet. For a company such as Caterpillar, the company has substantial fixed costs due to the machinery and assets needed to manufacture large-scale equipment; that is, Caterpillar has a high proportion of fixed assets.
The benefits of operating leverage emerge when Caterpillar can essentially produce machinery at a rower overall unit cost because it already has the existing infrastructure to do so. That is, it can ramp up production with relative ease, and as a result, the company will also have larger margins. While both financial and operating leverage can offer tangible benefits, there can also be downsides. The gains achieved in efficiency can be offset by the financial instability offered by such a structure. That is, excessive debt on a company’s books can make it difficult for the company to survive during difficult economic times.
The double-edged sword of leverage was witnessed during the financial crisis. Although banks and firms were able to make substantial profits during good economic times, as soon as demand slowed down and capital markets deteriorated, many of those same firms experienced severe difficulty. This is because they were able to service debt when revenues were high and aided by the assets that the debt purchased; with the leverage firms took on in better times. Thus, the issue regarding leverage is not necessarily one related to being “good” or “bad”, but rather an issue related to what extent.
Firms such as Caterpillar would be well served to take on some type of average, although it should also be careful about the amount it takes on. Cash Flow Statements and Financial Statement Analysis The cash flow statement is one component of three that is typically used to evaluate the financial health of a company. The balance sheet, which lists a company’s assets and liabilities, is one source of information that investors typically evaluate. The profit and loss statement shows whether a company made or lost money over a specified time period.
Finally, the cash flow statement shows how a company used cash over a period of time. In order to conduct this exercise with a real company, I have selected the cash flow statement from Amazon (2011-2012). I have pasted the cash flow statement in the appendix of this paper. Looking at Amazon’s cash flow statement, one can see that there is substantial variation in the cash that Amazon had on its books for the 2011-2012 fiscal year: the company started out with roughly $2. 1 billion in cash at the end of 2012 after starting with roughly $1. 6 billion at the start of 2011.
The analysis will now continue looking at the three different categories that typically compose the cash flow statement: cash room operating activities; cash from investing activities; cash from financing activities. The next major category is “Net Cash Provided by Operating Activities”: there are three main items that contribute to that total: 1) an increase in the depreciation of fixed assets; 2) a substantial loss in inventory (which can be good or bad depending on whether it was actually sold or simply written of; 3) a substantial increase in accounts payable- which is likely the most disturbing increase (nearly $1. Billion) over the year. The second major category is investing activities. Looking at Amazon’s statement, two main items stand out: 1) the purchase of fixed assets for a total of roughly $1. 3 billion; 2) a nearly $6 billion loss in sales and maturities of marketable securities and other investments. Both of these items worked against the net cash flow.
The third major activity is financing activities: Although Amazon is a large company, there is nothing out of the ordinary in these financing activities: there is a small loss due to repayment of long-term debt, and there is a small gain accrued under the fixed assets acquired under capital assets. While the cash flow statement is useful in showing how Amazon spent cash over the ear, including the more accurate accounting of such items such as depreciation that can prevent a full accounting, it does not present a full picture.
In order for that to addition to the cash flow statement, in order for it to make sense. Indeed, Amazon’s cash flow statements helps to raise a number of flags including a substantial loss in inventory, an increase in accounts payable, and a substantial loss in the purchase of marketable securities. These items should be compared against the other statements to understand the long-term trend and the magnitude of changes that emerge over mime.
