Finance Forum Post RepliesFinance Forum Reply #1
By using ratios, financial analysts are able to “predict financial variables and to evaluate relative performance” when looking at financial statements (Giacomino and Mielke, 1993). This provides the advantages of being able to evaluate the strength and profitability of a company, as well as being helpful in identifying and predicting possible bankruptcy and financial distress (Giacomino and Mielke, 1993).
A disadvantage of using financial ratio analysis is that to be effective, a company has to have another company to compare to. Without comparison, all of the financial data analyzed for a particular business could be useless. This is especially the case with small, niche-type businesses (Accounting Explained, 2013). Another disadvantage of using financial ratio analysis is that it is analyzing historical information, while the users of the data are more interested in “current and future information” (Accounting Explained, 2013).
Giacomino, D. E., & Mielke, D. E. (1993). Cash flows: Another approach to ratio analysis. Journal of Accountancy, 175(3), 55.
Accounting Explained (2011-2013). Advantages and Limitations of Ratio Analysis.
Finance Forum Reply #2
Making a choice of a ratio is determined on the present need and purpose of the individual. Liquidity, leverage and investment return are what can be used to study the usage of ratios. Strong liquidity, cash and capital help with the financing that a company has for any given project.
In the article by James Horrigan, it provides a short history of financial ratio analysis. It tells of the five financial ratios that are used for the studies. The financial ratios are: working capital-to-current liabilities ratio (WC/CL) for short term liquidity; cash flow-to-current liabilities ratio (CFCL) for cash position; net worth-to-total liabilities ratio (NW/TL) for long-term solvency; return on total assets (EBIT/TA) for profit-generating ability; and revenue-to-total (REV/TA) for managerial performance (Halim, Jaafar& Osmon). Ratios are formed to be simple and are an advantage with analysis.
In the article by Paul Barnes he gives two principals for using ratios, 1. To control for the effect of size on the financial variables being examined. The use of ratios was necessarily based on a hypothesis about the relationship between the numerator variable and the denominator size variable. 2. To control for industry-wide factors. Ratios aid comparisions between subject firm and its industry. As financial ratios are constructed from two accounting variables, the joint distribution will depend on the behavior of both the numerator and the denominator and on the relationship between these two coordinates.
1. Horrigan, J. O. (1968). A Short History of Financial Ratio Analysis. Accounting Review, 43(2), 284-294..
2. Barnes, P. (1987). THE ANALYSIS AND USE OF FINANCIAL RATIOS: A REVIEW ARTICLE. Journal Of Business Finance & Accounting, 14(4), 449-461.
Finance Forum Reply #3
Anro’s Floor Maintenance
The key thing from the video that stood out to me about Anro’s Floor Maintenance was the rising cost of fuel and travel distance, which both affect profitability. The first ratio I would use in analyzing this business would be gross profit margin. By looking at this ratio, Anro’s could determine whether to charge more or less for floor cleaning based on whether the profit margin is going up or coming down in response to fuel prices and travel distance.
The other ratio I would look at would be inventory turnover. I think a business like Anro would benefit from having a just-in-time inventory, which invests less cost in inventory, reduces warehouse space, and reduces labor needed to store and retrieve the inventory needed for floor maintenance (Hickman, Byrd & McPherson, 2013, pg. 288). The net result of this is freeing up money for other expenses within Anro’s, such as high fuel prices.
Hickman, K. A., Byrd, W. J., & McPherson, M. (2013). Essentials of Finance. San Diego: Bridgepoint Education, Inc.
Finance Forum Reply #4
In this video The Rose Chong Costume is a company that makes their own costume without a big factory production. This will take a lot more time to produce than a factory with machines to make the cloths at a big quantity level. Byrd, Hickman and McPherson note that the profitability ratios measure the income of operating success of the company. In the case of Rose Chong Costume it is pertinent for the company to know what the operating success of the company. This will let the company know in the stand of the custom clothing are being made and the profitability of the clothing based on the sales, the cost of the products and the actual cost. Since Rose Chong Costumes does not have investors she will be the owner and holder of all her trading stocks.
Hickman, K. A., Byrd, J. W., & McPherson, M. (2013). Essentials of finance. San Diego, CA: Bridgepoint Education Inc.
Finance Forum Reply #5
The money supply is measured in aggregates. They are grouped into two different categories, the M1 Aggregate and the M2 Aggregate. The M1 Aggregate is the amount of currency in use in traveler’s checks, deposits in checking accounts, and currency; the M2 Aggregate indicates the amounts in M1 and “time deposits with a value of less than $100,000, savings accounts, money market deposit accounts, and noninstitutional money market mutual fund shares” (Hubbard, 2013, p. 33). When the amount of currency increases, prices will increase.
The video Feducation: Money and Inflation, explains it as a function. MV = PQ, where M is equal to the money supply, v is the velocity or the amount of times it is spent in a year, p is the price, and q is the quantity. “If there’s a change of the variables in one side of the equation, then this must be reflected by a change on the other side of the equation in order to keep MV equal to PQ” (Snippet, 2013, para. 15). If the money supply increases but the velocity and quantity do not change, the price level increases. This is what happens in inflation. The prices on most things increase across the board because the money supply has increased. We see this happen quite frequently with the increasing and decreasing prices on goods and services.
Money was invented as a way to exchange goods and services among individuals in a modern society. “Money serves four key functions in the economy: 1. It acts as a medium of exchange. 2. It is a unit of account. 3. It is a store of value. 4. It offers a standard of deferred payment” (Hubbard, 2013, p. 26). As it explains in the textbook, money made is possible to move away from the inefficiencies of the barter system. People could specialize in a given area of expertise in exchange for money. This allowed them the ability to purchase goods and services more easily with the currency they received in return for their services or for the goods they sold. It also allowed individuals to save their money until such time when they need it. A person using currency is able to put it in a savings account, as opposed to some other means of payment that may have been used in the barter system, like wheat, which would have spoiled after a given amount of time. In addition, not everyone may have wanted to trade for what you may have had to use as payment. Currency made it easier to obtain the items you need.
Hubbard, R. (2013). Money, Banking, and the Financial System (2nd ed.). New York, N.Y.: Pearson. ISBN: 9780132994910
Snippet, U. O., & C. (2013). Feducation: Money and Inflation. Federal Reserve Bank of St. Louis | Economic Data, Monetary Rates, Economic Education. Retrieved from http://www.stlouisfed.org/education_resources/feducation-money-and-inflation/
Finance Forum Reply #6
The money supply is measured in aggregates. The aggregates are measured by levels of liquidity, with M1 being most liquid and working backwards.
M1 – This level is for money in circulation or checking accounts.
M2 – M1 + savings accounts, CD’s, etc. The accounts in M2 allow for liquidty, but there is normally not a day to day purpose of the funds.
M3 – M2 + plus CD’s over 100k, and institutional holdings. Think large scale for M3. The funds that some companies hold are astronomical amounts, but it is not something the can become liquid in a matter of minutes.
If most peoples funds are in cirucaltion or in checking accounts, that means the majority of the money supply is changing hands day to day, but savings may not be occuring at a high enough rate, which lets financial institutions know that they may need to change rate sor terms to be more effective. The same works the other and if money isn’t changing hands a stimulus needs to help people to spend more.
Four key functions of money
1. Acts as a medium for exchange – Prior to this we used a barter system where goods and services were traded. This way was inefficient, because those with more valuable trades were often on a losing end because the needs they had overrode the profit they could have made.
2. Unit of account – Defining wealth is hard to do, but our accounts and wealth allow for purchass and other services that would not be available without this accounting.
3. Store of value – Building wealth is about collecting more and more currency. The more we save, the more ability we have to purchase something later on with the funds we have collected.
4. Standard payment – Using currency allows everyone to operate on the same scale. If a product cost $20, then whatever currency is out there that totals the $20 will be accepted for payment.
Finance Forum Reply #7
Bond terms and rates are fixed, so while owning bonds, the payout of the coupon is constant. If I buy a bond with 5% interest because that is where the market is then my bond is par value. Six months later bond rates go up to 7%. If I paid $1000 for my 5 % and others are paying $1000 for 7%, I will need to adjust my price so that my bond becomes attractive to another seller. This is important to think about as well, because while you may not always have the top return, it is also possible to get discounted bonds that others do not want at a much cheaper price.
Inflation – If bond interest rates are low, investors need to weigh risk return, because in some cases the interest being earned on the bond is not in line with inflation, meaning that while you earn constant returns it is not enough with the growth of inflation.
Maturity – This is important as well because when the bond comes to maturity, the owner usually receives one last interest payment along with the face value back. If a bond can be purchased at a discount and then those funds are used to purchase a more attractive bond, it could possibly increase the overall ROI.
Risk – Bonds carry a fixed rate of return which helps keep risk down, but higher interest rates can make your investment look less than ideal. The risk associated with bonds is a lower interest rate than what the market is offering.
Finance Forum Reply #8
There is an inverse relationship between the bond yields and bond prices. “[Y]ields to maturity and bond prices move in the opposite directions” (Hubbard, 2013, p. 69). Therefore, if bonds that are issued have higher interest rates than bonds that are already in existence the price of the bond that exists will fall and the opposite is also true. This is because when bonds are issued that have a higher interest rate than bonds in existence, the existing bonds are no longer as desirable because there are newer bonds that will pay a higher interest rate. When new bonds are issued with a lower interest rate, then the existing bonds are more desirable because they are paying a higher interest rate, in which case the existing bonds would be worth more.
Changing interest rates will affect the price of an existing bond because the current interest rates are used to calculate how much the bond is now worth, or for what price it can be sold. In other words, present value calculations are used on existing bonds, with the new interest rate and the number of years until it matures. The amount of years until the bond matures will affect the value of the bond.
Risk is also a factor that effects the value of the bond because the interest rate is determined by the amount of risk involved in the bond. When investors believe there is a higher amount of risk involved, they will only buy the bonds if the interest rate is higher.
Inflation is also a key factor in the determination of the interest that will be paid on the bond. If it is determined that inflation will occur, interest rates will increase. This is because the value of the dollar will buy less. Therefore, the cost of borrowing will increase because the value of the money invested will be worth less when it matures. This will compensate investors for the use of their money when prices are increasing. When interest rates increase, as previously mentioned, the price of existing bonds will decrease because of their lower interest rates. The interest rate on a bond that has already been issued will not change; this is why newly issued bonds influence the worth of the bonds that have already been issued.
Hubbard, R. (2013). Money, Banking, and the Financial System (2nd ed.). New York, N.Y.: Pearson. ISBN: 9780132994910