Question

What advantages do sole proprietorships and partnerships offer? What is a major drawback of these types of organization? (10 points)

In a corporate governance, what group has the ultimate responsibility for monitoring management and protecting the stockholders' interests? Who elects this group? (10 points)

What is meant by maximizing owner’s equity value (shareholder wealth)? Why are maximizing just net income, or just profit, inappropriate goals? (10 points)

List and describe the four major financial statements. (20 points)

Why do financial managers and investors find cash flows to be more important than accounting profit? (10 points)

What information does time series analysis provide for firm managers, analysts, and investors? (10 points)

Define the following ratios and explain their significance. (30 points)

Quick ratio,Average collection period ,Return on equity,Debt ratio, Profit margin

Answer 1

Answer 1

Advantages of Sole Proprietorship and Partnership

A.Sole Proprietorship

Advantage

a. Starting a sole proprietorship is easy. Unlike other business structures, starting a sole proprietorship requires less paperwork and time to create a legal sole proprietorship.

b.Owners have complete and direct control over all decision making. Because the owner is the business, the owner makes all  decisions for the business rather than sharing power with a partner or corporate board. This allows owners the freedom to drive the business in the direction they desire.

c.There are some tax benefits for a sole proprietorship. Instead of the business having to file its own tax return, sole proprietors claim businesses gains and losses on their own individual tax return

Disadvantage

a.Owners are fully liable. If business debts become overwhelming, the individual owner’s finances will be impacted. When a sole proprietorship fails to pay its debts, the owner’s home, savings, and other individual assets can be taken to satisfy those debts.

B.Partnership

Advantage

a. Partnering with someone can give you access to a wider range of expertise for different parts of your business. A good partner may also bring knowledge and experience you may be lacking, or complementary skills to help you grow the business.

b. A prospective partner can bring an infusion of cash into the business. The person may also have more strategic connections than you do. This may help your company attract potential investors and raise more capital to grow your business.

c. By sharing the labor, a partner may also lighten the load. It may allow you to take time off when needed, knowing that there's a trusted person to hold the fort. This can have a positive impact on your personal life.

Disadvantage

a.While you likely enjoy being in total control of your business, in a partnership, you would now share control with a partner and important decisions would be made jointly.

Answer 2

The board of directors is elected by the shareholders of a corporation to oversee and govern management and to make corporate decisions on their behalf. As a result, the board is directly responsible for protecting and managing shareholders' interests in the company.

Answer 3

Shareholder wealth is defined as the present value of the expected future returns to the owners (that is, shareholders) of the firm. These returns can take the form of periodic dividend payments and/or proceeds from the sale of the stock. Shareholder wealth is measured by the market value (that is, the price that the stock trades in the marketplace) of the firm's common stock.

It is not necessary that profit should be the only objective, it may concentrate on various other aspects like increasing sales, capturing more market share, return on capital etc, which will take care of profitability. So, we can say that only profit maximization is inappropriate and is a subset of wealth and being a subset, it will facilitate wealth creation.

Answer 4

The financial statements are comprised of four basic reports, which are as follows:

• Income statement. Presents the revenues, expenses, and profits/losses generated during the reporting period. This is usually considered the most important of the financial statements, since it presents the operating results of an entity.

• Balance sheet. Presents the assets, liabilities, and equity of the entity as of the reporting date. Thus, the information presented is as of a specific point in time. The report format is structured so that the total of all assets equals the total of all liabilities and equity (known as the accounting equation). This is typically considered the second most important financial statement, since it provides information about the liquidity and capitalization of an organization.

• Statement of cash flows. Presents the cash inflows and outflows that occurred during the reporting period. This can provide a useful comparison to the income statement, especially when the amount of profit or loss reported does not reflect the cash flows experienced by the business. This statement may be presented when issuing financial statements to outside parties.

• Statement of retained earnings. Presents changes in equity during the reporting period. The report format varies, but can include the sale or repurchase of shares, dividend payments, and changes caused by reported profits or losses. This is the least used of the financial statements, and is commonly only included in the audited financial statement package.

Answer 5

Financial managers and investors are far more interested in actual cash flows than they are in the somewhat artificial, backward-looking accounting profit listed on the income statement.

Movements in cash flow can sometimes indicate operational, as opposed to sales-related, issues.

As an example, what may appear to be a quiet month revenue-wise might actually be a large number of clients neglecting to pay on time. Those same clients may all decide to pay at once in the following month, making it appear that revenue is back on track when in actual fact it’s just that your cash flow is out of balance.

Answer 6

Analyzing ratio trends over time, along with absolute ratio levels, gives managers, analysts, and investors information about whether a firm's financial condition is improving or deteriorating.

Answer 7

Quick Ratio-

The quick assets are defined as those assets which are quickly convertible into cash. While calculating quick assets we exclude the inventories at the end and other current assets such as prepaid expenses, advance tax, etc., from the current assets. Because of exclusion of non-liquid current assets it is considered better than current ratio as a measure of liquidity position of the business.

Average Collection period

The average collection period is the amount of time it takes for a business to receive payments owed in terms of accounts receivable. The average collection period is calculated by dividing the average balance of accounts receivable by total net credit sales for the period and multiplying the quotient by the number of days in the period.

As a standalone figure, the average collection period does not hold much value; instead, it is a metric best suited for comparison over time. A company experiences the greatest benefit from calculating the average collection period by maintaining the metric over time and searching for trends. In addition, the calculation may be compared to competitors and other businesses in the industry. Similar companies should produce similar financial metrics, so the average collection period can be used as a benchmark against another company's performance.

Return on Equity

Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders' equity. Because shareholders' equity is equal to a company’s assets minus its debt, ROE could be thought of as the return on net assets.

Relatively high or low ROE ratios will vary significantly from one industry group or sector to another. When used to evaluate one company to another similar company the comparison will be more meaningful. Even within the same industry group, comparing the ROE of a company that pays a large dividend with a firm that doesn’t can also be misleading.

Debt Ratio

Relatively high or low ROE ratios will vary significantly from one industry group or sector to another. When used to evaluate one company to another similar company the comparison will be more meaningful. Even within the same industry group, comparing the ROE of a company that pays a large dividend with a firm that doesn’t can also be misleading.

Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries such as the technology sector.

Profit Margin

Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries such as the technology sector.

From a billion-dollar publicly listed company to an average Joe’s hot dog stall operating on the street, the figure is widely used and quoted by all kinds of businesses across the globe. Beyond individual businesses, it is also used to indicate the profitability potential of larger sectors and of overall national or regional markets.