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TOC o “1-3” h z u HYPERLINK l “_Toc325750832” Ratios
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HYPERLINK l “_Toc325750833” Liquidity Ratio PAGEREF _Toc325750833
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HYPERLINK l “_Toc325750834” Debt To Assets Ratio PAGEREF
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HYPERLINK l “_Toc325750835” Return On Assets PAGEREF _Toc325750835
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HYPERLINK l “_Toc325750836” Gross Profit Margin PAGEREF
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HYPERLINK l “_Toc325750837” Operating Profit Percentage PAGEREF
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HYPERLINK l “_Toc325750838” Debt Financing PAGEREF _Toc325750838
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HYPERLINK l “_Toc325750839” Advantages Of Debt Financing PAGEREF
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HYPERLINK l “_Toc325750840” Disadvantages Of Debt Financing
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HYPERLINK l “_Toc325750841” Investment In Stocks PAGEREF
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HYPERLINK l “_Toc325750842” Financial Return And Risk PAGEREF
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HYPERLINK l “_Toc325750843” Beta PAGEREF _Toc325750843 h 5
HYPERLINK l “_Toc325750844” Difference Between Systematic And
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HYPERLINK l “_Toc325750845” Investment Of $1 Million PAGEREF
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RATIOS
Business owners and managers track progress of companies in relation to
unexpected trends and potential problems using financial ratios.
Businessmen like bankers and investors analyze companies’ ratios while
deciding on whether or not to lend money and invest in a particular
company. Financial ratios give insight into each and every financial
component in a company ranging from its productivity to the efficiency
of the accounts receivable department. Following a few ratios is
important to analyze performance of small businesses.
LIQUIDITY RATIO
This includes current and quick ratio. Current ratio measures a
company`s ability to pay its short-term debts by making comparison of
its available current assets to current liabilities. Quick ratio also
known as the acid test evaluates current assets less inventory to
current liabilities in order to decide how eagerly a company can convert
its current assets to cash to pay current debts.
DEBT TO ASSETS RATIO
This ratio assists in measuring a company’s reliability on borrowing
to finance operations.
RETURN ON ASSETS
This ratio measures the amount of income generated by investment of
assets.
PROFITIBILITY RATIOS
This includes gross margin ratio and operating profit ratio. Gross
margin ratio measures the amount of each and every dollar that exceeds
expenses, overheads and profit. Operating profit ratio measures the
productivity of company’s core business.
DEBT FINANCING
As every business is special from the other so it is probable to acquire
a practical plan of how much cash a business needs by considering a few
key factors. In making out how to fund a business, a business man
considers following certain matters for instance which information will
be attractive for debt and equity financers? How do the requirements of
debt and equity financing differ? What should be the leverage of the
company? (Administration, 2007)
ADVANTAGES OF DEBT FINANCING
debt financing benefits by letting the business owner to keep hold of
the company. Business owner is at liberty to all earnings of the company
and have eventual management authorities. Many entrepreneurs start
businesses for exactly this reason as it provides them with some
monetary freedom his debt is restricted to the loan reimbursement
period. After the loan is repaid, the lender is left with no further
claims on business. Though loan is to be repaid to the lender but there
are no penalties like additional fees, poor credit rating etc, on late
payments. (Administration, 2007)
DISADVANTAGES OF DEBT FINANCING
Debt financing brings disadvantage of making monthly payments on a loan.
In this case cash may be inadequate and expenses may be higher than
expected. Still the lender has to be repaid on time. One other
disadvantage of debt financing is the complexity in acquiring them.
Lenders generally give preference to invest in established businesses
and when a business is new, the lender may charge a high interest rate
or may reject to give the entire amount of loan at a time.
(Administration, 2007)
INVESTMENT IN STOCKS
Businesses usually prefer to invest in stocks rather than bonds because
investment in stocks provides high return in short-term whereas bonds
provide return in long-term. Investment in stocks provides business
owners with the good amount of return without waiting for a longer time
period.
FINANCIAL RETURN AND RISK
The connection between risk and return is an important factor in
financial decision making. Investments undertaken by firms must offer a
high return, at least as high as the return on a similar risky
investment in financial markets or shareholders would decide to put in
the financial markets instead of investing in the firm. Gain or loss on
investments specifies the relationship between risk and financial
return. Low risk investment brings small amount of return whereas highly
risky investment brings high amount of return on investment. (Glogger,
2008)
Risks greatly impact financial returns in a sense that expected return
has risk-free return rate and a risk premium therefore expected return
on an investment directly depends on its riskiness. Investment that
involves unique or unsystematic risk can bring out high return by
reducing risk by diversification of portfolio whereas market risk cannot
be reduced by diversification and return cannot be increased on the
investment that have market or systematic risk.
BETA
Element of measuring varying trends on returns which cannot be
eradicated through diversification relative to risk factors on a
portfolio is known as beta. It consists of the risk factors widely
spread to all assets in the speculations. In other words beta
articulates the sensitivity of the portfolio comparative to the market.
It is believed that the market has a beta of 1.0 and a portfolio that
rolls more than the market over a time has a beta higher than 1.0. On
the other hand if a portfolio shifts less than the market, beta of the
portfolio gets less than 1.0. Portfolios with high-beta have high risks
but they are likely to offer higher returns whereas on the other hand
portfolios with low-beta possess less risk and eventually offer lower
returns on investments. This shows that beta is positively related to
returns.
DIFFERENCE BETWEEN SYSTEMATIC AND UNSYSTEMATIC RISK
Investments bring two kinds of risks with them the systematic risk and
unsystematic risk. Systematic risks are the risks which have the ability
to influence the entire stock market because of which it cannot be
eliminated or reduced by diversification. For instance several worldwide
chaos affect the entire stock market and not only single stock, like any
alteration in the interest rates have an effect on the entire market
leaving some sectors of the market more affected then others. As
diversification cannot reduce this risk therefore it is known as non
diversifiable risk. (Difference between Systematic and Unsystematic
Risk)
On the other hand unsystematic risk measures the range of
unpredictability in the stock return in relation to factors unique to
the company. For instance it is possible that management of a company
may perform poor or workers may go on a strike. These circumstances will
lead to losses and poor performance of the company. As these issues
influence only one company, therefore these types of risks can be
diversified away by put in money in more than one company as each
company is diverse from the other. Thus this type of risk is called
diversifiable risk. (Difference between Systematic and Unsystematic
Risk)
INVESTMENT OF $1 MILLION
In order to get high return on the investment of the amount of $1
Million, it would be mandatory to invest it in a sensible ensuring the
element of risk being reduced. For the sake of doing this, firstly a
market study will be conducted to find out which organizations and
financial markets are performing well with promising good amount of
return on investments.
After making the market analysis the amount will be divided proportions
depending upon the performance of the markets. 10% of the amount will be
invested in metal of gold and silver of bullion market, 20% will be
invested in bonds. The reason behind investing in bonds is that these
are long-term low risk financial instruments. 40% of the amount will be
invested in stocks of financially strong companies to get the good
amount of return in short-term and 30% of the amount will be invested in
money market. Investment in such ways will reduce the level of
systematic and unsystematic risk.
REFERENCES
Administration, U. S. (2007). Financing For The Small Business. Small
Business Administration.
Difference between Systematic and Unsystematic Risk. (n.d.). Retrieved
May 24th, 2012, from LetsLearnFinance:
http://www.letslearnfinance.com/difference-between-systematic-and-unsyst
ematic-risk.html
Glogger, M. (2008). Risk and Return.
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