The Sinister Motive Behind Cashless Society
Cashless society is the latest buzzword in global finance. At the present moment, only 15% to 20% of the world’s money exists in the form of currency notes. This itself is an absurdity. However, many central banks and governments all across the world have pledged to bring the cash percentage down to zero. This means […]
The Rise of Flat Tax
Governments all over the world generally levy graduated taxes on their population. This means that as the income being taxed increases, the tax rate also increases. Under a graduated tax structure, some amount of income is exempted from the tax. Then, there is a different tax slab, which becomes applicable as soon as the income […]
Multiplier Effect: How Fractional Reserve Banking Creates Money ?
The modern banking system is considerably different from what the average person believes it to be. Banks are not institutional moneylenders. They do not simply collect money from people and lend them to others. Instead, banks in the modern world have the power to create money when they lend it out. The process by which […]
The 4 Basic Types of Derivatives
In the previous articles we discussed about what derivative contracts are and what are the uses of such contracts? However, one important point needs to be noticed. Today, if a new person wants to buy a derivative contract, they will be bewildered at the sheer amount of choice that they will have at their disposal. […]
Behavioral Portfolios
There is a fundamental difference in the way portfolios are viewed in traditional financial theories and the way in which they are viewed in behavioral finance. At the technical level, a portfolio is nothing but a collection of investment instruments such as stocks, bonds, real estate, etc. However, the purchase of these instruments and the […]
As we have seen earlier that there is a wide variety of financial ratios available. They fall into many categories and if variations are included there are hundreds of types of ratios that are common in practice. However, all the ratios are not used by everyone on a regular basis. There are some ratios which are more important to some user groups than they are to other user groups. This article explains why this is the case:
The management of the company may not be so concerned with the results. They are usually more interested in the cause. This is because while other classes of stakeholders do not have control over the working of the firm i.e. the cause, the management does. All the other stakeholders question the management at the annual general meeting. Hence, management tries to get as much insight into the ratios as possible. They create operating performance ratios and compare it to their previous performance and to the performance of others to learn from the past as well as to be able to give satisfactory answers to the investors.
Shareholders, for obvious reasons, are most concerned about profitability. Their investments are at risk and they expect to gain the maximum. Investors scrutinize profitability numbers and pounce upon the slightest signs of mismanagement. For the shareholders, the profitability ratios are the beginning point. They then follow the trail the ratios leave. However over the past two decades the focus has been steadily shifting towards cash flow ratios.
Debt holders and suppliers are concerned whether they will be paid the amount promised to them at the date that was promised to them. It is for this reason that they are very concerned about the liquidity of the firm. Slightest signs of liquidity issues are met with supply cutbacks from suppliers.
The fact that debt holders are concerned about the same ratios creates a self reinforcing negative loop for the company. This is because at the same time when suppliers cut credit and supplies, debt holders refuse to lend more money and the whole situation becomes a cash crunch.
While debt holders are suppliers are concerned about short term liquidity and cash flow, credit rating agencies go a step ahead. They use solvency ratios to rigorously analyze whether the company will be able to make good its obligations in the long run.
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