ANALYSIS OF THE BUSINESS CYCLE

Analysis of the Business Cycle

Analysis of the Business Cycle

Business Cycle

An appreciation of various examples of financial theory helps us to understand the market imperfections and conditions that explain why a particular capital structure is better than another. The practical considerations of gearing levels, risk, and debt level determination; sources of finance and company lifecycle stages then enable us to understand the fuller picture. This information provides us with the tools required to make an informed decision on financial strategy based on the specific dynamics of our company and the environment we operate. Although in practice it can be argued that capital structure is of importance, the Modigliani & Miller (MM) irrelevancy theory helps us gain an understanding of why various capital structures are better than others. MM's famous proposition I showed that in perfect capital markets financing decisions don't actually matter. Also MM ignores a variety of substantial implications associated with high gearing such as bankruptcy costs, agency costs, tax exhaustion and debt capacity. However, by understanding which of these conditions to take into account, the MM theory might be able to help a firm identify the approximate level of gearing that minimizes the cost of capital and maximizes market value. Richard J. Kachur, The Data Warehouse Management Handbook (Prentice Hall, 2000).

The Traditional view of company capital structure proposes that the Weighted Average Cost of Capital (WACC) proves that the cost of capital does depend on the level of gearing. This theory of capital structure suggests that each company has an 'optimal range' of financial gearing that it should try to achieve in order to minimize its cost of capital and, in an efficient market, to maximize its market value. It has been proved that announcements of new equity issues are often interpreted by the market as bad news and greeted by sharp declines in share prices. Agency Theory can become significant as companies incur costs to ensure managers operate in the best interests of the company and not individual gain.

The first thing you tend to do in the control process in an organization is somehow measure those results. You decide what it is about the business that you want to measure. Typically it's financial, but we would argue that it should be far wider than financial that you need information on your market places, on your customers, on your products and indeed a lot of you are getting that information in your enterprises today. But the first thing in the cycle is measurement. What to measure? Once you've got the measurement done, really the next thing you need to do is perform some type of analysis on that. You've measured all these things; what are the messages in those measures? D. Hunkeler, E. Huang, "LCA in Japan: An Overview of Current Practices and Trends Relative to the USA", Environmental Quality Management, Autumn 1996, 86 (1996).

Analysis is really the next stage. You take a lot of those, you look, you start looking for cause and effect, you ...