Understanding the Concepts
Professor Ingrid P. Nelson
Fin 100 Introduction to Finance
December 1, 2012
1. Imagine you are a small business owner. Determine the financial ratios that are important to the business. Compare your ratios with those that are important to a manager of a larger corporation. As a business owner, financial understanding is something that has to be studied before you decide that you are going to open or even start a new business. Small businesses in general run the finance operations of their business in a different way than the larger corporations. Most of the small businesses must rely on the personal investors or personal resources to access money needed to be a successful business. It does not matter if it is a small business or a corporation; being a successful business depends on having the capability to make more than what is being paid out. Now that we have a little understanding of what it will take to start the business; we must have knowledge of the different types of ratios that will help us with this. The main three ratios that are used in the business world are the current ratio, total debt ratio, and profit margin. The current ratio is a measure of the company ability to pay off its short-term debt as it comes due (Melicher & Norton). This ratio is computed by dividing the current assets by the current liabilities. Total debt ratio is just what you think it is; the total amount of debt the company has. The total debt ratios are total debt or total liabilities of the business and divide it by the total assets. Profit margin is simply how much profits (money) is made during the operation or while the business was open if you had to close it down. Net income is divided by sales in order to show the profit. All of the three ratios are used to no matter how big or small your company seems to be. 2. Explain the advantages and disadvantages of debt financing and why an organization would choose to issue stocks rather than bonds to generate funds. If you run into the problem of the current ratio showing that you have the inability to cover the costs of the business then, debt financing may be the best solution for this problem. As we know with all financial options, there are some advantages and disadvantages of any company or business. The first advantage for debt financing is that it allows the founders or the owners of the company to maintain control and ownership of the company. A second advantage would be that the interest paid on the loan may be tax deductible depending on the type of loan. The best part is the lenders you borrow money from do not share in your profits. The main disadvantage is the risk of credit ratings getting ruined or filing for bankruptcy (Peavler, n.d.) As an organization; they can choose to either issue stocks or bonds to help generate funds for the company. Most of the time they prefer to issue stocks over bonds. Stocks are a form of ownership; they represent participation in a company's growth (Investopedia). A bond is what company considers a form of debt. Bonds are contractual loans made between investors and institutions that, in return for financing, will pay a premium for borrowing, known as a coupon (Investopedia). When it comes to the obligation of repay the principle on the stocks you have none; now for the bond you must pay it on the date of maturity. The inertest of the bond has dividends, but the company only pays the dividends when the company makes a profit. The stocks have a fixed interest rate that has to be paid at a specific time. 3. Discuss how financial returns are related to risk.
We know that how the returns work is the greater the risk the greater the returns. The more you invest the more you will get back in returns. The relationship between financial risk and return is the gain or the lost from investments or securities. Just because you have chosen to take a higher risk does not mean that your return will be as high...
References: Beta Definition; Melicher and Norton, Introduction to Finance
Stock Definition; Investopedia. Retrieved December 1, 2012 from http://www.investopedia.com/ask/answers/124.asp#ixzz2DqxY4GIb
Bonds Definition; Investopedia. Retrieved December 1, 2012 from http://www.investopedia.com/ask/answers/124.asp#ixzz2Dr2ZoU2J
Narima, N. (2010, August 18). Systematic & Unsystematic Risk (Non-diversifiable and Diversifiable risk) Â« Northlands. Retrieved December 1, 2012, from http://narimanhb.com/2010/08/18/systematic-unsystematic-risknon-diversifiable-and-diversifiable-risk/
Peavler, R. (n.d.). Debt and Equity Financing - Advantages and Disadvantages.
Retrieved December 1, 2012 http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm
Risk and return are related - Wealth Foundations. (n.d.). Wealth Management, Wealth Advisors, Strategic Financial Planning - Wealth Foundations. Retrieved December 1, 2012, from http://www.wealthfoundations.com.au/foundations-of-financial-economics-risk-and-return.html
Stock Beta and Volatility. (n.d.). Careers, Finance and Investing: Money-zine.com. Retrieved December 1, 2012, from http://www.money-zine.com/Investing/Stocks/Stock-Beta-and-Volatility/
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2011). Accounting Principles (9th ed.). Hoboken, NJ: Wiley Custom Learning Solutions.
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