What is Corporate Finance? – Meaning and Important Concepts
Corporate finance is one of the most important subjects in the financial domain. It is deep rooted in our daily lives. All of us work in big or small corporations. These corporations raise capital and then deploy this capital for productive purposes. The financial calculations that go behind raising and successfully deploying capital is what […]
Structuring a Public Issue
One of the responsibilities of an investment banker is to set up the basic ground rules which will have to be followed while going public. Some of these rules are imposed by regulatory and governing bodies, whereas some other rules are self-imposed. The setting up of all these rules and communicating it to the relevant […]
Dividend Discount Model: Disadvantages
The dividend discount model also has its fair share of criticism. While some have hailed it as being indisputable and being not subjective, recent academicians and practitioners have come up with arguments that make you believe the exact opposite. Recent studies have unearthed some glaring flaws in what was considered to be a perfect valuation […]
The Fall of an Ambani Scion
Dhirubhai Ambani was the perfect rags to riches story that India had ever seen. He had started out with nothing. However, he ended up becoming the richest man India has ever seen. During his meteoric rise, Dhirubhai Ambani, owner of the Reliance group of companies, beat some of the richest and most politically well-connected men […]
Redlining: Americas Racist Financial Policies
America is a developed country and an inclusive society. It should ideally no longer face the problems of racism and social inequality and yet it does. It is no accident that a large number of poor and destitute consist of people from African American and Latin American communities. In fact, it is a result of […]
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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