Understanding the Concepts

Understanding the Concepts

Introduction

The main purpose of this paper is to make an analysis on the financial ration of a company and discuss these rations with the other large corporation. The paper also makes discussion on the advantages and the disadvantages of debt financing and the ways through which the financial returns are related to risk. The paper is a description of the concept of beta, contrast systematic and unsystematic risk.

Financial Ratios

Following are the financial ratios of a small business:

Year

2011

2010

2009

Profitability ratios:

 

 

 

Return On Shareholders' Funds (ROSF)

15.32%

13.02%

12.44%

Return On Capital Employed

23.47%

21.40%

20.63%

Operating Profit Margin

12.18%

10.36%

10.21%

Gross Profit Margin

29.37%

30.13%

25.20%

On the other hand, following are the financial ratios of a large corporation which are important to a manager:

Year

2011

2010

2009

Profitability ratios:

 

 

 

Return On Shareholders' Funds (ROSF)

29.32%

26.02%

27.44%

Return On Capital Employed

34.47%

33.40%

34.63%

Operating Profit Margin

28.18%

27.36%

22.21%

Gross Profit Margin

39.37%

40.13%

35.20%

If we compare the ratios of the small business and the large corporation than it is evident that there is a great difference between these ratios. The return on the shareholder's fund is increasing in both the firms since last two years. However, there is a great difference between the values of the return on shareholder's firms of these two companies. The return on shareholder's funds of small company was 29.32% in 2011; whereas, it was the return on shareholder's funds of large corporation were 15.32 in 2011. The main difference in these values is the size of the company. A large organization is involved in different businesses; therefore, in case of returns its profit margin exceeds. As the capital employed in the large organization is greater than the capital employed in a small organization; therefore, in case of the return of capital it will be always greater.

Advantages and Disadvantages of Debt Financing

Following are the main advantages of debt financing:

The cost of debt is not dependant on earning; therefore, debt holders do not suffer in case of the loss in business. In other words, it can be said that in case of the profit soar, the company still has the obligations to make payment of interests on the debt.

The deduction of the tax from the interest payments decreases the risk adjusted component of the cost of debt as compared to the cost of common stock.

It is not necessary for the owner of the corporation to share control in cases when the debt financing is used in business (Schuermann, 2008).

On the other hand, following are the main disadvantages of using debt financing in the business:

As the debt service is considered to be a fixed charge; therefore, the decrease in the revenues may result in the insufficient cash flow for the purpose of meeting the requirements of debt service. This can also lead towards the increase of bankruptcy.

Financial leverage results in the increase of the riskiness of any firm, hence its cost of both the debt and equity also increases.

For any organization it is beneficial to go for the stocks rather than bonds for the purpose of generating the funds. For any company, it is not necessary to repair the debts; however, for the companies it ...