Once strategies are formulated capital budgeting decisions are required to

Once strategies are formulated capital budgeting

This preview shows page 29 - 31 out of 142 pages.

Once strategies are formulated, capital budgeting decisions are required to successfully implement strategies. The financing decision determines the best capital structure for the firm and includes examining various methods by which the firm can raise capital (for example, by issuing stock, increasing debt, selling assets, or using a combination of these approaches). The financing decision must consider both short-term and long-term needs for working capital. Two key financial ratios that indicate whether a firm‘s financing decisions have been effective are the debt-to-equity ratio and the debt-to-total-assets ratio. Dividend decisions concern issues such as the percentage of earnings paid to stockholders, the stability of dividends paid over time, and the repurchase or issuance of stock. Dividend decisions determine the amount of funds that are retained in a firm compared to the amount paid out to stockholders. Three financial ratios that are helpful in evaluating a firm‘s dividend decisions are the earnings-per-share ratio, the dividends-per-share ratio, and the price-earnings ratio. The benefits of paying dividends to investors must be balanced against the benefits of internally retaining funds, and there is no set formula on how to balance this trade-off. For the reasons listed here, dividends are sometimes paid out even when funds could be better rein-vested in the business or when the firm has to obtain outside sources of capital: Paying cash dividends is customary. Failure to do so could be thought of as stigma. A dividend change is considered a signal about the future. Dividends represent a sales point for investment bankers. Some institutional investors can buy only dividend-paying stocks.
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James Okumu Oyiengo Page30 Shareholders often demand dividends, even in companies with great opportunities for reinvesting all available funds. A myth exists that paying dividends will result in a higher stock price. Basic Types of Financial Ratios Financial ratios are computed from an organization‘s income statement and balance sheet. Computing financial ratios is like taking a picture because the results reflect a situation at just one point in time. Comparing ratios over time and to industry averages is more likely to result in meaningful statistics that can be used to identify and evaluate strengths and weaknesses. Trend analysis is a useful technique that incorporates both the time and industry average dimensions of financial ratios. However, all the ratios are not significant for all industries and companies. For example, accounts receivable turnover and average collection period are not very meaningful to a company that primarily does cash receipts business. Key financial ratios can be classified into the following five types: 1. Liquidity ratios measure a firm‘s ability to meet maturing short -term obligations. Current ratio Quick (or acid-test) ratio 2. Leverage ratios measure the extent to which a firm has been financed by debt. Debt-to-total-assets ratio, Debt-to-equity ratio, Long-term debt-to-
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