Financial ratios determine how effective the management of any business is. They provide the business owners with a quantitative analysis of their company who can use it to create benchmarks for comparative evaluation. The financial ratios also allow the business owners to compare their business with other similar competing businesses. This competitive analysis helps the business in question to strategize on operational and financial operations for the future or the adjacent financial period. Lenders to any business evaluate its worthiness by looking at its financial ratios (Brigham and Houston, 2009). The lender can get the creditworthiness of the business by analyzing the ratios of assets to liabilities and the ratios of lender-investor to owner-investor. Financial ratios kept by a small company differ from those kept by a large business. The difference comes in due to the variance in capital access. The finances kept by small businesses include among others the quick ratio, gross profit margin, rate of stock turnover, and liquidity as well as profitability ration. The quickuick ratio is the ratio of the assets to that of all the liabilities.
It shows the viability of business operations in the funding of overall business operations. In case this ratio is smaller, the direct interpretation is that the business is making debts on its operations. This ratio keeps on fluctuating, but in the case where it is constantly recording negative growth, it indicates that the business heads to a chief financial problem (Brigham and Houston, 2009). This ratio suits the smaller businesses as it involves small amounts of capital. This ratio also needs constant review over time like in the case with small businesses. The liquidity ratio is another ratio used in a small business. It provides a business with information that regards its ability to meet a short-term financial obligation. It shows how well a business operates under short-term economic conditions. The liquidity ration includes both the current and the quick ratios. Profitability ratio, used in a small business calculates the money spent to earn gain from the sale of goods to customers. Profit margin, which is an example of the profitability ratio, represents the business owner as the percentage of the gross income. High profitability ratio indicates that the business has more money to pay for its expenses and invest in other fields. Other financial ratios commonly used in small businesses are the current ratio, debt coverage ratio, and account payable turnover.
Unlike the small businesses, a large business uses other complex financial ration in the provision of financial information for comparison purposes. Examples of these ratios include return on investment, return on assets, and debt to equity. These ratios are outcomes of the quotient between one financial statement and another one. The outcome measurements occur in financial statements like balance sheet, income statement, and Cash flow statement in the owner’s equity (Melicher & Norton, 2011). Unlike the ratios in small businesses, businesses use this information to determine internal goals as well as in the overall industry. These records are hard to calculate and require professional knowledge to comprehend.
Debt financing is the funding investment or expenditure using capital borrowed from an external source. This borrowed capital has to get a refund with the corresponding interest. According to the principle of debt financing, the debtor receives the due amount and agrees to refund with the accrued interest. The borrower must have collaterals. Using debt financing has both advantages and disadvantages. The advantages of using the service are: retained-profit, limited obligation of the borrower, tax deduction on timely payment, and easing plans of the business without having capital as a limiting factor. The same service has attached cons which include mandatory payment whether the borrower makes a profit or not. In some cases, the fixed interest rates are exceptionally high. Thus, the borrower may realize remarkably little or no profit from the investment. Businesses that depend on debt financing experiences restricted cash flow regardless of profits, losses, or delayed payments within the company. The business must also present collaterals, and the risk outlook increases the business liabilities. Most businesses prefer to use the stocks to raise capital as compared to bonds because of varied reasons. The real first reason is that bonds are debts to the company in question whereas stocks are equity ownership (Melicher & Norton, 2011). Therefore, most companies prefer to use stocks, as they are safer than accumulating debts. Preference to stock can also be explained by its risk free nature. Other merits attached to stocks are their higher payout ceiling, and enables one to grow his money faster.
Financial returns and financial risks
Financial risk is the loss assumed that could arise from market price changes or other market defaults. Simply it is the loss expectations that could source from the unfavorable economic development with respect to operational activities of the investor. Returns relating to the profit expressed in percentage realized by an investor in any transaction. Both financial risk and return relate in their gain or lose nature in the investment (Bini and Danielle, 2011). Financial risk indicates that the investor has chances of losing money whereas return includes the profit that the investor may obtain form the same investment. Investment in a low risk security fetches low returns likewise if the risk involved is high, the potential returns must be high.
Concept of Beta
Beta is the volatility or the risk associated with security or portfolio in the market. Beat analysis the individual stock risk with respect to the overall risk found in the market. The Beta concept can denote the financial elasticity of a business. Analysts to get the stock risks profile use the Beat measure (Brigham and Houston, 2009). The measurement also gives a better understanding in case the price in the market is more or less volatile. This enables the trader to evaluate before stocking a certain commodity in the portfolio.
Systematic and unsystematic risk
Systematic risk affects the whole market in fields like the investment policy changes and investment policy from foreigners. Unsystematic threats refer to due factors that affect the firm or the industry as a whole in pricing and marketing strategy (Bini and Danielle, 2011). Systematic risk is beyond the influence by the investors whereas the management portfolio can influence the unsystematic risk. No investor in the market can avoid the systematic risk and likewise the market makes no compensation over such a risk. A large, systematic risk denotes a sizeable return.
Diversifying capital across a variety of investment is extremely beneficial as it reduces the risk and limits the potential losses without compromising the potential gains. From the lawsuit, I would diversify my investment to involve numerous sectors. I would go for variety, not quantity. I would invest in stocks, bonds, mortgage funding, and other international securities. The stocks would facilitate the growth of my portfolio and the real estate will rise when the stocks fall or would provide a hedge against inflation (Melicher & Norton, 2011). Bonds would bring in the desired income whereas the international investment would provide the growth and boost the purchasing power in the globalized world. I would have emergency kitty for precautionary purposes. I would also effect the thumb rule and then diversify within any investment by balancing the risk and return. I would give myself permission to take a risk, as this would assure additional income to my investment.
Bini, L and Dainelli, F. (2011). The Informational Capacity of Financial Performance Indicators in European Annual Reports. Santarcangelo: Maggioli Editore.
Brigham,E and Houston, J. (2009). Fundamentals of Financial Management. New York: Cengage Learning.
Melicher, R and Norton, E. (2011). Introduction to finance. Hoboken: John Wiley &Sons.