Business Finance Finals
The situation presented in the situation with client one is the for a business to survive a proper cash flow should be in place. The behavior of the person involve would also be barrier or a good mark on how they handle their financial management. As this is noted in the study of (Almeida, Campellow and Weisbach. 2004) in which they captured that “two important areas of research in corporate finance are the effects of financial constraints on firm behavior and the manner in which firms perform financial management”. In the line of the different of profits and cash it is observed these two are different in their concepts out layering different results. When we say profits these looks at your income and expenses at a certain time this is usually tiered by the end of the financial year. Whereas, cash flow is different, it is more dynamic in the sense that we are looking at the timing of the movement of money in and out of the business every day. We know that comes a several sources namely from sales, loan proceeds, investments etc., Profit in this line comes in when the money that is left over after your business expenses have been paid.
It is therefore imperative to create the proper cash flow as this will forecast as this will map out when cash comes in and when it has to be paid out and this is also relevant as to know when your business need cash on hand. In one of the study of (Ryan and Ryan. 2002) they made mention that Capital budgeting is one of the most important decision that is faced by the financial manager. It is likewise seen that in the four decades of studying this phenomenon depicted that financial manager prefer method such as internal rate of return or non-discounted payback models over net present value the model that academics would consider as superior It is said in one of the journals that the stark difference of the implied cash policies of constrained and unconstrained firms that allow to formulate an empirical prediction about the effect of financial constrained on firms financial policies. In this way the study further digest that they have proposed the cash flow sensitivity of cash as for financially unconstrained firms should not be able to display a systematic propensity to save cash while noted in this that there are firms that are constrained should have a positive cash flow sensitivity of cash in this case cash flow sensitivity will be able to provide a theoretically justified, empirically implementable measure on the importance of financial constraints.
The proponents of this system have uttered that in using this system this avoids some of the problems associated with the investment cash flow , further to this they explained that cash is a financial variable as this causes differences that the explanatory power of cash flows over cash policies ascribed to the ability to forecast future business conditions. Though this system seems to be promising research survey have seen on the Fortune 1000 Chief Financial Officers finds net present value to be the most preferred tool over internal rate of return and all other capital budgeting tools . It is further discussed that the net present value (NPV) is portrayed as the sum of the present values of incoming and outgoing cash flows over the period of time , this also ally with the time value of money in which case have a direct link or impact on the value of cash flows an example will be when the lender may give you a $1.00 for the promise of receiving $ 100 a month for now but the promise to receive that same dollar 20 years in the future which would be much less today to the same person( lender) even if the payback in both cases was equally certain. On the other hand, the internal rate of return (IRR) is a metric used in capital budgeting measuring the profitability of potential investments, added to this IRR calculation is based heavily on the same formula as NPV does.
As concluded by the research, cash flow is very important for a business to survive, especially for constrained firms. It is also important to change cash flow patterns with the business cycles. While, financially constrained firms should try and retain cash after macroeconomic shocks, unconstrained firms should not. A firm’s cash flow sensitivity of cash has been proven to be an important parameter to capture the financial constraints of a firm. 4
On the situation 2, it is observable to most organizations that capital investment involves a prime activity though it may be explicit. Some examples would be related to machinery, IT equipments and buildings. It is salient in the company to identify its opportunities especially in the case of capital investments. In the world of capital investment Risk is a norm that is why it is important projects should be able for investment appraisal are executed. It is seen that culture have a lot to say into this as there is an organizational change that will have as accounting is a close system and this subject to the changes of the environment. The proponents of the study further observe this that accounting change will result from the events arising within the organization. In this line, we should be able to identify opportunities this stressed in which the culture that is based on the identification of potential capital investments with the organization is important. It is key that a search should take place regularly to identify opportunities so that better investment proposals will be developed. Though some companies utilize multidimensional methods a pivotal investment inclusive of the larger appraisal process. The last of the said process implementation and review this is where investments will be times to minimize disruption the organization. There should be a review on how they are made in order to enhance future investments.
There are several techniques for capital investment, and different organizational practices depending upon the company size, managerial knowledge and organizational change arising from expansion. 5 Investment behavior of firms is understood by considering both external capital availability and the process of investment allocation of the internal and externally available capital. the details of the capital budgeting procedure are critical in determining the actual capital allocations. The capital budgeting procedure governs the way in which various managerial staffs generate and communicate information related to proposed investments. Capital Budgeting procedure also determines the decisions and constraints in the investment process.6
A survey conducted by Gitman and Forester Jr. chose large US business firms based on the stock price growth and total capital expenditure. The study was primary focused on finding the capital budgeting techniques which showed that Net Present Value (NPV), Profitability Index or the Benefit/Cost ratio and Internal Rate of Return (IRR) or Discounted Rate of Return are the most elite techniques for capital budgeting because of their explicit consideration of Time value of Money.7 This research concluded that Internal Rate of Return is the most dominant technique in use for capital budgeting.
Following four stages can be considered as the steps in capital budgeting process:7
Project Definition and Estimation of Cash Flows
Project Analysis and Selection
Defining the projects and estimating their cash flows is the most challenging task in the capital budgeting process. An important consideration in the capital budgeting process to account for the risks and uncertainties associated with the project. Several methods are used for adjusting risks and uncertainties of the projects like Increasing the minimum rate or return or Cost of Capital, Using Expected Values of Cash Flows (Certainty Equivalents), Subjective adjustments of cash flows and decreasing the minimum payback period.7
An elaborative research program to determine interaction of firms’ internal control system to discipline managers with product factor markets, the capital markets and the legal/political/regulatory systems and its effect on investment appraisal has also been suggested. Another factor to consider is the decision-makers’ cognition and the investment environment and their effect on capital appraisal and finally capital acquition.8
Sangster, A., 1993. Capital investment appraisal techniques: a survey of current usage. Journal of Business Finance & Accounting, 20(3), pp.307-332
Ryan, P.A. and Ryan, G.P., 2002. Capital budgeting practices of the Fortune 1000: how have things changed? Journal of business and management,8(4), p.355.
6- MILTON HARRIS and ARTUR RAVIV . 1996.The Capital Budgeting Process: Incentives and Information.Journal of finance, LI(4), pp. 1139-1174
7- Lawrence J. Gitman and John R. Forrester, Jr.A survey of capital budgeting techniques used by major US firms. Forecasting and Evaluation: Practices and Performance,pp 66-73
8- Susan, F. Haka.2006. A Review of the Literature on Capital Budgeting and Investment Appraisal: Past, Present, and Future Musings. Handbook of Management Accounting Research.pp.697-728
Almeida, H., Campello, M. and Weisbach, M.S., 2004. The cash flow sensitivity of cash. The Journal of Finance, 59(4), pp.1777-1804