As such morally managers should pursue policies that enhance shareholder value with the primary objective focused on stockholder lath minimization. B) Managers make key day-to-day decisions to maximize shareholder value. But how do the owners of a business know that managers are operating to maximize shareholder value? This lack of Information is known as the principal-agent problems. The agent performs the tasks on shareholders’ behalf yet the shareholders like. Agency costs as related to a corporation refers to the costs of preventing agents (e. . Managers) pursuing their own interests at the expense of shareholders. There might be conflicts between shareholders and the company managers. Shareholders who re owners want the managers to make decisions which will increase the share value. Managers who receive salaries prefer to expand the business with the view to increase their salaries which may not necessarily increase the share value. Thus, agency costs tend to decrease the value of a corporation because the rising costs make the share price low when there is substantial debt involved.
Costs of monitoring will increase and thus reduce wealth minimization of shareholders. C) Business ethics is the acceptable set of moral values and corporate standards of conduct in running a business organization. It includes proper business policies and raciest such as corporate governance, as a check against insider trading, bribery, discrimination and covers corporate social responsibility and fiduciary responsibilities. Business ethics is a basic framework providing proper conduct, it may be guided by law or put in places as to gain public confidence and acceptance.
An example of business ethics is when an employee lie to a potential client to get him to sign for services or purchase the product offered. Business ethics is important to a corporation because it will determine its reputation. It will give public confidence towards the corporation. It is essential for the long-term survival and success of the corporation in business. Implementing an ethical program will foster a successful corporation culture, values and enhanced profitability.
Business ethics will also influence the way the corporations conduct its business and affect all including customers, employees, suppliers, competitors, etc. D) Advantages I) There is no maturity period in common stock. Thus, eliminating future repayment obligation and enhances the desirability of common stock financing. I’) There is no obligation for repayment of the funds. Instead, there are others to share the risk of he business investment with. Since there is no debt obligation, there is no finance fee. Iii) Issuing common stock can increase firm’s borrowing power.
The more common stock is sold, the larger the firm’s equity base. Therefore, the more easily and cheaply long-term debt financing can be obtained. Iv) Once capital is raised through stock, the corporation is free to use the proceeds in any way it pleases. Disadvantages Dividends are not tax-deductible and common stock is a riskier security than either debt or preferred stock. It) Potential effects of dilution on earnings and voting power. When a company or corporation issues more shares, its financial results must be divided by a larger number of shares, causing dilution.
This is because selling of shares of the company means giving each investor a piece of ownership. Because they own the share of the company, the investors have the right to demand explanations and Justifications for business decisions. Iii) Market perception that management think. Management issues involve examining perceptions about management and perceptions by management. It includes various Judgments regarding the competence of current and future management team as well as issues elated to insider buying such as future strategies to increase operations and market share.
When management makes large purchases of their own stock with private funds, investors may feel that the company is undervalued or that a favorable company event will occur soon. E) The three main users of ratio analysis I) Owners: The owners of a firm are mainly interested in the firm’s profitability, liquidity and hence survival. Therefore, they need financial ratios to test the performance of their company such as profitability ratios to find therefore management is able to convert sales dollars into profits and cash flow.
The common ratios are gross margin, operating margin and net income margin. The gross margin is the ratio of gross profits to sales. The operating margin is the ratio of operating profits to sales and net income margin is the ratio of net income to sales. The return-on-asset ratio, which is the ratio of net income to total assets, measures a company’s effectiveness in deploying its assets to generate profits. The return-on-investment ratio, which is the ratio of net income to shareholders’ equity, indicates a company’s ability to generate a return for its owners.
These ratios are useful to owners of companies. I’) Creditors Creditors are interested in a firm’s ability to pay their debts over a short period of time. The ratio analysis will evaluate the firm’s liquidity position. Creditors use liquidity ratio, which is the ratio of current assets to current laboriousness’s the ability of the company to pay its short-term bills. A ratio of greater than one is usually a minimum because anything less than one means the company has more liabilities than assets. Ii) Management Management team comprising financial managers regularly use ratio analysis to responsibilities of the management team to make sure available resources are used cost effectively and efficiently and that the financial positions of the company is sound. Management uses profitability ratios to analyze the company’s ability to convert sales dollars into profits and cash flow. For example, the return-on- investment ratio, which is the ratio of net income to shareholders’ equity, indicates a company’s ability to generate a return for its owners.
Examples of ratio formula: Example 1: Gross margin ratio Gross Margin – Gross Profit Revenue Gross profit and revenue figures are obtained from the income statement of a business. Alternatively, gross profit can be calculated by subtracting cost of goods old from revenue. Thus gross margin formula may be restated as: Gross Margin – Revenue – Cost of Goods Sold Example 2: Operating margin ratio Operating income is same as earnings before interest and tax. Operating income and revenue figures is available from the income statement of a company.
Operating Margin ; Operating Income QUESTION 2 a) There are five different categories of financial ratios. They are: I) Liquidity ratio is used to measurements ability to pay its short-term debt obligations. As such, they focus on the firm’s current assets and current liabilities on the balance sheet. The most common liquidity ratios used is the current ratio mainly to give an idea of the company’s ability to pay back its short-term liabilities such as debt and payable with its short-term assets such as cash, inventory and receivables. Obligations. The ratio indicates what proportion of debt a company has relative to its assets.
The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load. Iii) Financial leverage ratio measure the extent to which a business or investor is using the borrowed money. A company having high leverage is considered to be at sis of bankruptcy in the event the company is unable to repay the debts. The most common financial leverage ratio is the debt-to-equity ratio calculated as total debt divided by shareholders equity iv) Asset efficiency or turnover ratios measure the efficiency a company uses its assets to produce sales.
The most common asset efficiency ratios are the inventory turnover ratio, the receivables turnover ratio, the days’ sales in inventory ratio, the days’ sales in receivables ratio, the net working capital ratio, the fixed asset turnover ratio, and the total asset turnover ratio. ) The profitability ratios measure the company’s ability to generate a profit and an adequate return on assets and equity. The ratios measure how efficiently the firm uses its assets and how effectively it manages its operations.
An example is the Net profit margin ratio is a ratio of profitability calculated as after-tax net income (net profits) divided by sales (revenue). It shows the amount of each sales dollar left over after all expenses have been paid. Limitations of financial ratios I) Although financial ratios can be effective tools for gauging financial performance and managerial effectiveness, they rarely provide answers. Ratios will not say why something is going wrong and what to do about a particular situation; they only pinpoint where a problem is. I’) There is no international standards on the use of financial ratios.
Limitation of ratios interpretation emerges when a particular set of ratios of a company is compared to other company or business. For example, for calculating the inventory turnover one company may use the cost of goods sold as the numerator, while another may use its sales figures. A company may use the operating profit to calculate its total assets turnover, while another may use the net income after taxes. Ii) Benchmark for assessing company’s financial position is needed. Different operating methodologies may be employed to run a company may render the comparison of financial ratios irrelevant.
Example, a company prefers to lease most of its assets while another company may own them. Thus, some of the ratios, such as debt to total assets, fixed-charge coverage, total assets turnover, and return on total assets, would be unrelated. Inventory turnover may have deteriorated over a three-year period; the problem may not due to the increase in physical inventory, but rather, to increase in the cost of the goods. ) Effect of an increase in a company’s debt ratio to its return on equity. An increase on debt-ratio will be increase in the return of equity.
