Vocabulary and practice of organizational finance

Posted: September 3rd, 2013

Vocabulary and practice of organizational finance

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Vocabulary and practice of organizational finance

Financial calculations are done because they clearly show how the company is performing. The calculations are simplified by using ratios, which are easier to understand. The ratios are divided into various groups depending on what they are evaluating. For example, to measure a company’s liquidity one should calculate current ratio or acid test (Braggs, 2007). These two companies are average performers, although they need to improve on some areas. Arrow Company’s liquidity is strong. According to the rule of thumb, a business or company should have a current ratio of 2:1. This means that in every two assets there should be one liability. However, the company does not have to maintain this it can upgrade it quality and have a better ratio. Plume Inc. has a current ratio of 0.5. This is a risky financial position. In every two liabilities, there is only one asset. It is an indication that the company is not in a position to pay its debts. There could be several reasons why this is so but the company should make adjustments to be financially secure.

The other group of ratio measures the safety of the company. The ratios used are debt to equity and debt to asset. When the company wants to determine its net worth to that of investors and creditors, these two are suitable. If the ratio is high, it shows the company is unstable but low ratio means company is financially stable. The debt on assets for the two companies is relatively low hence; it shows that the company is stable. However, the debt on equity ratios of both companies is quite high, which is risky. Ratios used to measure profitability include ROA, ROE and gross margin (Libby et al, 2011). They tell the rate at which the company is getting profits and how its equity and assets are useful. The ROA and ROE ratios are favorable but more improvement is required. The gross margins also indicate a stable flow of profits. Other ratios like collection period, inventory turnover and fixed assets turnover determine the efficiency of the company. The inventory turnover is quite low. It shows that the companies take long before they buy more inventories. It could be because inventory take too long before it is consumed or sold. On the other hand, it could be a good sign. The company may be buying a lot of inventory and only needs to replace it few times in a year (Braggs, 2007).

This exercise is very important for students. Personally, it has enabled me to evaluate some skills and knowledge acquired from this module. I have learnt how to study information, analyze and interpret it. Sometimes theory is different from practical work. For example, I realized Plume Inc. is not in accordance with the thumb rule. Using actual case studies is good exposure of learning about companies. However, there are more ratios and other vital calculations, which are used in finance. This exercise does not expose the student to them. Such exercises should be done regularly for students to sharpen their skills. Each time they are held, the tutor should introduce something new.

Reference:

Bragg, S. M. (2007). Business ratios and formulas: A comprehensive guide. Hoboken, N.J: Wiley.

Libby, R., Libby, P. A., & Short, D. G. (2011). Financial accounting. New York: McGraw-Hill/Irwin.