Financial intermediaries have to perform the task of financial innovation to meet the ever-changing requirements of the economy and to help the investors cope with the increasingly volatile market. Because of this reason there is a necessity for the financial intermediaries to innovate unique financial instruments. The following are the major reasons for financial innovation: Low Profitability: Profitability refers to the ability of a financial institution to maximize profits. The profitability of the major financial institutions have been declining in the recent times. So, the institutions are compelled to seek new products, which fetches high returns. Competition: The entry foreign and private players in the financial services sector have led to severe competition in the industry. This has compelled the institutions to innovate the financial instruments. Economic Liberalization: Economic liberalization such as, deregulation of exchange controls and interest rate ceilings etc, have made the industry more innovative. Customer service: To Continue reading
Financial Management Concepts
The Fundamental and Enhancing Qualitative Characteristics of Financial Information
The purpose of financial statements is to give financial statements information about the change in financial position, financial performance and financial position of the organization. These can provide data use in decision making such as investment, credit and economic decision making which are useful for various users. There are seven main groups of users which are public, investors, lenders, employees, customers, supplies, government and other agencies and the needs of information is different for each group, for instance, employee will interest on the profitability, retirement benefits and employment opportunities and so on. The qualitative characteristics can be categorized as fundamental (relevance and faithful representation) or enhancing (comparability, verifiability, timeliness and understandability) based on how they influence the usefulness of financial information. However, it can limited by two pervasive constraints which is cost and materiality in providing useful financial information. Fundamental Qualitative Characteristics of Financial Information Relevance: Relevant financial reporting information Continue reading
Importance of Price to Earnings Ratio (P/E Ratio)
Price to Earnings Ratio The most popular ratio used to assess the value of the equity is the company’s price equity ratio abbreviated as P/E ratio. It is calculated as the ratio of the firm’s current stock price divided by the earnings per share (EPS). The inverse of the P/E ratio is referred to as the earnings yield. Clearly the price earning and the earnings yield are required to measure the same thing. In practice earnings yield less commonly stated and used than P/E ratios. P/E Ratio = Market Value per Share/ Earnings per Share (EPS) Since most companies report earnings each quarter annual earnings per share can be calculated as the most recently quarterly earnings per share times four or as the sum of the last four quarterly earnings per share figures. Most analysts prefer the first method of multiplying the latest quarterly earnings per share value Continue reading
The Difference Between Agency Theory and Stewardship Theory
Agency Theory An agency correlation as a contractual set-up under which the business owner or the principal engaged a manager or the agent to execute some service on his behalf and may usually entail some decision making exclusively by the agent. The agency theory revolves on the basic proposition about humans, which deals with principals and agents as self-oriented focusing on exploiting their personal advantage. Agency theory described managers as opportunistic by seizing its optimum advantage for his appointment and role as the mover in the firm for its own benefit, at the expense of the principal. Both parties’ goal is to gain that personal advantage in every way possible with the least outlay and expenditure. These expenditures are defined as agency costs. This is the total of cash outflows made by the principal for its organization be it in budget proportions, auditing, or employee honorariums; the expenses incurred Continue reading
Valuation of Assets in a Demerger
A demerger scheme usually involves the allotment of shares in the transferee company to the shareholders of the transferor company, in lieu of their reduction of their interest in the transferee company having a mirror image of shareholdings. If post demerger as part of strategy, intention is to create holding subsidiary relationship or retain part stake than it is possible to allot shares of the transferee company to the transferor company. In the context of a demerger scheme, a valuation exercise is mandatory in order to determine the number of shares to be issued to the shareholders of the transferor company in consideration for the spin off/demerger of the undertaking or undertakings. If demerger is going to be in ‘Shell Company’, than valuation is primarily to determine the capital structure of the Transferee/Resultant Company. If the demerged and resulting companies belong to same group of management and shareholders are common, Continue reading
Asset Valuation Methods
There are various methods adopted across the globe, however we discuss some of the common and widely accepted asset valuation methods. 1. Discounted Cash Flow Method This valuation method based on free cash flow is considered a strong tool because it concentrates on cash generation potential of a business. This valuation method uses the future free cash flow of the company (after providing for changes in working capital and capital expenditures) and discounts it by the firm’s weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity) to arrive at the value of the enterprise as a whole. According to the discounted cash flow valuation model, the intrinsic value of a company is the present value of all future free cash flows, plus the cash proceeds from its eventual sale. The presumption is that the cash flows are used to Continue reading