Question

1. Explain the core principles of business finance. In particular,

a. The goal of business

b. Both long-term and short-term major financial decisions.   

2. Ssas Shoes has a profit margin below the industry average, but its ROA equals the industry average. How is this possible?

Hint: recall DuPont Identity analysis.

Answer 1

1. (a) The very basic and fundamental goal of any business is to maximize the profits and well being of its owners and stakeholders. The profits should be looked in terms of the retained earnings and dividends paid to the shareholders. reatained earnings will provide with a long term sustainable growth rate which is quite essential among the goals of any business, while paying dividends would fetch equity finance to expand the business and would ultimately return.

(b) Major financial goals of any business are, mainly managing current accounts like assets, liabilities, liquidity management, inventory management etc. These are major factors responsible for the short term financial decisions. Managing all these accounts for a certain optimal value are decided in Short run.

For the long term, financial decisions comprise mainly of the investing and financing decisions. Various kinds of projects appraisal techniques, capital budgeting analysis and also how to finance this project through different optimal capital structure, etc are some of long run activities.

2. Profit margin is solely dependent on the sales revenue inversley,and also the net income (directly). while ROA is directly related to net income but inverse with total assets. Now for a particular business, income is same, but the sales revenue is may be more than that of the average of all. But the total assets may be lesser at the same time and thus increasing ROA keeping all other factors constant. Now suppose if ROA is higher then, it could be expected that very lesser of assets are there among the current and long term assets. This will increase the return or the revenue and this reduces the profit margin as the revenue would increase.