Aspects of Financial Management

Introduction

This article addresses the different elements of the cash flow statements and their importance to an investor. The chief contents of a cash flow reports include cash acknowledgment documents from the main trading sources and cash expenditure. Its preparation period may be quarterly, semi-annually, or even annually. In addition, the article offers more information to creditors, investors, and other related parties concerning the making of rational decisions (Motlagh 112). It shows the cash generated from operation activities. Cash flow statements offer relevant information that relates to dividend distribution, debt repayment, or reinvestments to enhance growth or a firm’s operating capacity. Any business failure or success is dependent on the cash amount generated within a specific trading period. Moreover, to examine the monetary feasibility of an upcoming venture to be implemented, an estimated cash financial plan is established. This projected cash flow statement is important when seeking funds from a financial institution.

My understanding after reading the article is:

• Preparation of the cash flow statement is important because it discloses whether the business is experiencing a cash surplus or shortage in advance. This knowledge assists in planning on surpluses through putting the extra money into investment or even as bank deposits.
• The cash flow statement assists in planning by comparing it with that particular year’s budget to find out whether the allocated money is being mismanaged or misbudgeted. The information is used in realigning the process of financial planning.
• In the short run, cash flow statements are more important compared to the fund flow statements. In fact, cash is essential in the short run compared to the working capital. For instance, if a business requires to pay off a debt in a month’s time, it is easier to pay through cash instead of doing asset liquidation, which is mostly time-consuming.

Determinants of Working Capital Investment Levels in the Manufacturing and Construction Firms Listed at Nairobi Securities Exchange

This article’s main aim is to analyze working capital’s effect on profits for manufacturing and construction businesses. Working capital denotes a firm’s resources, which support a business’ daily operations. Such capital is calculated as the current assets minus the current liabilities. Short-term liquidity, convertibility, economic elements, and operational factors significantly determine how working capital is managed in a firm.

My understanding after reading the article is:

• Investors and policymakers of businesses should always concentrate their attention on working capital areas, which require improvement to enhance profitability.
• According to Pius, for a firm to progress, certain factors such as the management of payables, receivables, and inventories are paramount (2). Therefore, some operational policies on creditors, conversion of inventory, and debtors majorly influence profitability, including economic factors such as interest rates and the gross domestic product (GDP). The economic factors influence the level of receivables. For instance, high-level payables increase the current liabilities. Hence, they lower the working capital and vice versa.
• It is better to diversify debt financing because it assists in lowering earnings volatility since the cash flow that cuts across different markets experiences imperfect correlation. This situation enables the firms to use more debts in their capitalization pursuit.
• In capital markets, the prevailing frictions increase the external capital cost in relation to funds generated internally. This situation induces firms that have an insufficient financial power to shun or forego valuable opportunities for investment. Thus, a firm that has recorded substantial debts leaves managers with less free cash flow to pursue investments in new upcoming markets. It also has fewer chances of getting external capital to fund the investments.

How Capital Structure influences Diversification Performance: A Transaction Cost Perspective

This article seeks to analyze how debt and liquidity influence diversification. Specifically, debt not only inhibits diversification but also predicts the consequences of an opposing performance according to the extant theory (O’Brien et al. 1014). On the other hand, the agency theory argues that debt should result in better performance for diversifying businesses. The transaction cost economics (TCE) further predicts that increased debt will reduce firms’ performance when they are expanding into new territories. In summary, from the extant theory, debt is binding. It obligates managers on a contractual basis to a previously agreed upon repayment schedule. If they default, lenders have the right to recoup from their debtors through bankruptcy. The agency theory argues that the high- powered incentives posed by the threat of bankruptcy make managers shun high-level diversification by only targeting at matters that enhance business value. However, according to the transaction cost economics, debts lead to lower performance. However, the two theories agree that arrears slow down diversification.

My understanding after reading the article is:

• Both the relative mix of debt and equity financing create a firm’s capital structure, which is an imperative governance mechanism where monitoring and incentives are deduced. However, the structure has a major impact on the corporate diversification strategy.
• Debt financiers employ governance mechanisms, which safeguard their investments, just as the equity financiers do. In fact, debt accounts for a considerably high percentage of all new external financing. Hence, it can be more salient.

The Cost of Capital of the Financial Sector

The standard factor pricing models in the financial stocks’ financial average returns do not capture the common time series. Adrian, Friedman, and Muir present a five-element asset-pricing model, which complements the normal and standard pricing framework (2). The five-factor model assists in the alleviation of anomalies in pricing for stock in the financial sectors. It also performs positively for non-financial sector stocks, especially when compared to the Hou, Xue, and Zhang’s four-factor models or the Fama and French’s five-factor framework. Comprehension of the outlay of assets for monetary organizations is imperative for economic strength issues and fiscal expansion and control. However, the main question is whether an increment in capital requirements will adversely influence the cost of resources for banks that are featured prominently in the discussion on the economic sector’s optimal regulation. As much as a quorum is available to the extent that an increase in capital requirements will make the banking sector safer, a significant number of people will disagree on how the situation affects the banks’ cost of capital. Therefore, the practitioners agree that the cost of capital will rise whereas academicians assert that the claim is a mere fallacy. In this regard, as much as contention is witnessed concerning the issue, it is factual that banks’ cost of capital will directly influence their lending capacity and therefore affect credit availability to the population. The outcome has a potentially negative macroeconomic impact.

My understanding after reading the article is:

• Regarding capital adequacy, the market-based cost of assets affects it minimally or does not affect it at all, whereas the accounting-based measures are totally relied upon. The reason for this scenario is that when firms analyze the financial regulations’ impact, they associate such effect with the return on equity (ROE) in favor of market-derived cost of capital measures.
• The ordinary outlay-of-assets frameworks are unable to approximate monetary organizations’ value of shares since they fall short when it comes to demonstrating cross-sectional disparities in the universal time-series deviations in proceeds or the anticipated profits. Besides, the models, which occur from financial and non-financial stocks, do not explain the average returns in their financial portfolios.

Capital Budgeting Theory and Practice: A Review and Agenda for Future Research

The topic of capital budgeting theory has attracted the attention of many researchers. The capital budgeting theory, which is also referred to as the investment appraisal theory, refers to the process of planning that is used to determine whether the long-term investments of a firm such as new plants and other non-current assets are valuable to receive funding through the organization’s capitalization structure (Kengatharan 15). However, some previously correct arguments are not applicable today due to advancement in technology, environmental changes, and globalization. Many of such theories and models are challenged based on their applicability such as capital structure theorems and the Capital Asset Pricing Model (CAPM), which are not technically compatible in the real business environment.

My understanding after reading the article is:

• CAPM is neither an absolute nor an accurate determinant of long-term investment decisions. Presently, complex methods are used to make capital budgeting decisions. Some theories such as the payback period hypothesis among others that are used in CAPM have become obsolete due to advanced technology, demographic, and macro-environmental factors.
• Making financial decisions has become more difficult in the last 20 years due to numerous challenges such as the global financial meltdown of 2009, advanced technology, exchange rates, inflation rates and interest rates risks, and dramatic shift in the business and economic sector for both global and local markets.
• Capital budgeting is not a short-term process since it is prepared in advance for a year. It can be extended to five or more years in the future.
• The most common capital budgeting techniques include the accounting rate of return (ARR), payback period (PB), net present value (NPV), internal rate of return (IRR), profitability index (PI), and the benefit-cost ratio (BCR).
• It is better to receive a lower value payment today, rather than a relatively higher value, which disregards the element of inflation in the future. However, capital budgeting techniques are employed to calculate the future value of capital borrowed in the present. The goal is to improve the efficiency of calculating the higher future value or the net present value of finance.

Works Cited

Adrian, Tobias, Evan Friedman, and Tyler Muir. The Cost of Capital of the Financial Sector. 2014. Web.

Kengatharan, Lingesiya. “Capital Budgeting Theory and Practice: A Review and Agenda for Future Research.” Applied Economics and Finance 3.3(2016): 15-37. Print.

Motlagh, Aghdas. “Accounting: Cash flow Statements.” OSR Journal of Business and Management (IOSR-JBM) 7.4(2013): 109-116. Print.

O’Brien, Jonathan, Parthiban David, Toru Yoshikawa, and Andrew Delios. “How capital structure influences diversification performance: A transaction cost perspective”. Strategic Management Journal 35.7(2014): 1013-1031. Print.

Pius, Stephen. Determinants of Working Capital Investment Levels in the Manufacturing and Construction Firms Listed at Nairobi Securities Exchange, Nairobi, Kenya: Strathmore University, 2014. Print.