Financial Administration and Investment Risk

Posted on May 13, 2024 in Economy

OBJECTIVE OF FINANCE

  • Maximize the value of the company’s market
  • Maximize the assets of the company
  • Maximize the wealth of the investor in the company
  • Maximize the return on short and long term investments and minimize the risk of the company

FUNCTIONS OF THE FINANCIAL ADMINISTRATION

  • Allocate funds, investment of short and long term
  • Obtain financial resources, worry about funding
  • Financial Planning; make short budget (budget of cash) and long term (capital budget).
  • Dividend Policy, Standards that provide a for-profit company in the distribution of profits. The company generates profits are rights acquired by investors (business owners). The utility can be withdrawn by the owners or reinvested in the company. The utility that is distributed to the owners is based on the amount of shares they have. That is, the utility to share is divided by the number of shares outstanding, resulting in the dividend per share. In Chile must distribute dividends for at least 30% of net profits.

THE DECISION TAKEN IN A COMPANY SHOULD BEAR IN MIND THREE ISSUES

  1. The investment returns that are generated
  2. The liquidity involving the decision
  3. The risk involved in the decision adopted. To assess whether an investment is good or bad, there are several decision criteria, including from the financial standpoint, there has been the following:

Investment Criteria

  • The time to recover the investment: if no investment is recovered, or recovered in a period greater than that required by investors, investment should be rejected.
  • The annual return on investment: if the returns that can generate investment exceeds the minimum return that the project is required to carry it out, you should make the investment. Faced with similar risk investments should be preferred for greater profitability.
  • The risk that the expected return is not given to make the investment: Faced with similar investment returns, choose the lowest risk. In relation to the objectives of this module, it will analyze the investment risk.

LIQUIDITY

Definitions

  • Is the Company’s ability to convert assets into cash. The sooner an asset can be transformed into money is said to be more liquid. Within the assets, the most liquid assets are current assets (these are converted into cash within one year).
  • Is the ability of the company to cancel its short-term debt to its assets.

Indicators

  • The liquidity shown in the balance of a company. If a company has higher proportion of current assets to fixed assets, one can say that it is has more liquidity. If Company A, AC = 100; AF = 1000, the proportion is 10%, however if Company B has a rate of 50% will say that the company
  • The relationship between assets and liabilities; This theme is called Working Capital (AC – PC). When the AC is superior to the PC, indicates that the company has the ability to cancel all debts of short-term assets that will be converted into cash within a year.

In general, the liquidity of a company or, more liquid assets tend to generate low returns.

The money in cash or current account investment generates returns in the fixed assets are made in order to increase sales and thus increase profits of the company. That is, fixed assets tend to generate more profitable than current assets. The liquidity is an inverse relationship with profitability. The greater liquidity lower profitability. If you want to maximize profitability should minimize liquidity, thereby generating a greater risk.

PROFITABILITY

Definitions

  • Is the relationship that occurs between the money generated by an investment and such investment. For example performs a time deposit of $ 1,000,000 for a period of 30 days, earning an interest of $ 100,000. The ROI for a month is 10% (100000/1000000) * 100.
  • In the financial statements of a company can observe the gains in output state, through the account Net Income. (In the state of result there are other utilities, such as Gross profit (difference between sales income and cost of sales. Also called operating margin d) operating profit (earnings from the company’s shift from her own , is called operating income or operating profit) Non-operating profit (earnings from the company for activities outside of the turn)

Indicators

  • In an assessment of profitability can be seen linking the various utilities that are presented in the income statement with different items, such as total assets, total assets and total sales revenue or operating income.

For example;

The net profits of a company is $ 10,000,000

Total assets of the company $ 100,000,000

Return on assets or on investment; 10.000.000/100.000.000 = 10%

RISK

Definitions

  • The possibility that the company failed to meet its financial commitments. A low liquidity is riskier.
  • The probability that an expected result does not occur.

Types of Risk

Capital investments are:

  • Long-term in nature
  • They involve a lot of money
  • Requires forecast cash flows for the lifetime of the investment
  • Always a possibility that the real budget does not match what the risk is an important factor to consider in evaluating investments

RISK:

Corresponds to the cash flow variability around an expected value.

  • Is the likelihood that cash flow comes to be above or below the expected or planned. The greater the magnitude of the deviation and the higher the probability that this happens, we say that the greater the risk of the investment or the value achieved.

Types of Risks

Operational Risk

Is that related to the business, with the current administration or future, with competition in the markets for their products, price and volume of sales, operating costs. The uncertainty in operating earnings is called operational risk.

Financial Risk

This has to do with the degree of use of debt for the company. The more money you borrow more likely to have difficulty making the required payments. The higher the risk associated with a project, the greater will be the required return to it (K). In other words, a level of risk must be associated with some level of incentive. Both have a direct relationship. The incentive amount required will depend on the degree of risk aversion of individuals. Increased risk aversion will require greater incentive.