W3 Discussion Principles of Finance I
Principles of Finance I WEEK 3: Discussion Prompt #1
Generally, companies require financing in order to operate. They thus get equity and debt from an investor. A financial leverage is set by a company in order to borrow money for the well-being and growth of the business. Thus before a company is given a loan by the investor, it needs to provide or bring forth a leverage that will cover for the debt and be a source of security for the loan. When the loan is great then the financial leverage is greater. A company is more likely to do well because it generates more income. In cases where the firm needs a loan, returns of the business are highly balanced in correlation to the increasing risk (Wood et al, 2008).
When a company does well such that the return rate of the loan is higher than the interest rate, then the debt is dubbed to be helpful to the firm and is growing profits. Financial leverage gives the privilege to stock holders to control a company as they control their investment in the firm. Capital can be leveraged in a firm when it gets more profits from debt. This is usually a clear indication that the firm does well. The management of the firm may not be interested in the outcome but put more consideration on the cause. The stakeholders would inquire from the management and have an understanding on the ratios.
The debt can be rationed using debt or equity ratio. This ratio divides the total stock holder’s equity with the firm’s liability to measure the financial leverage. This ratio is used to illustrate the amount of input used to finance the firm to the equity of the shareholder. The category of the firm has to be put to consideration as well because different firms require different amount of money to finance it. Some of these investments are usually not consistent with the liabilities of the firm, thus a ratio is needed to give clear clarification.
Principles of Finance I WEEK 3: Discussion Prompt #2
Ratio analysis helps the stock holders of a firm analyze and prepare them for the firm’s financial expectations. These ratio analysis is used to illustrate and identify the performance of a firm financially. The information gathered helps the management to give a clear direction and success of the firm. It compares the progress of the firm with other firms within the same industry. This gives the stock holders an opportunity to evaluate and see whether the firm has a potential or not, whether they can invest in the firm or not. The stock holder will thus make a decision that is considered best.
Shareholders are always interested in the profit margin. They wouldn’t risk their money into something that doesn’t have potential. The investors will use the ratio to evaluate on the numbers and take keen interest in the mismanagement of firm’s resources. The investors would follow a consistent outcome on the past decades.
The ratio will also help stock holder discover whether the firm can pay their debt. Under the agreed specific period. This will also gauge and confirm that the assets the firm owns relates to the debt to be given. The firm’s financial performance will be analyzed they and presented through the ratio analysis(Wood et al, 2008). It will assist the stockholders and management to give a clear judgement on the firm, whether the firm has been doing well and whether it is worth investing in. whether the firm has used its resources effectively well and have earned good profits.
The ratio can give the investor an insight on the firm’s current stock, making it more attractive to the investors. It gives a clear picture on the cost, and when the cost is less expensive it becomes a more attractive ground for the investment. This evaluates the stock of the firm in comparison of the other industries in the market. These ratios make better sense to the shareholders compared to presentations.
Wood, F., & Sangster, A. (2008). Frank Wood’s business accounting 1
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