Accounting and finance are two very important factors that exist in every company out there that is commercialized. Every firm needs to do accounting and manage its finance well in order to continue operating, an organization cannot run without any funds. The management of the company will need to evaluate the accounts and finance of the company to make important decisions, such as whether to invest in a certain stock or to buy more of a particular item to sell. In this report, we will be looking at some of the methods that are commonly used or should be used in using accounting and finance for decision making.
Accounting and Budgeting Information
Accounting and budgeting information can play a key role in how a company calibrates and ultimately implements strategy. This is the case for any company, but let us use the fictional example of a computer manufacturing company (“Tell”) in order to understand how this information can be used.
Tell wants to a know a number of things in order to produce computers and components for its consumers. First, it wants to know what the allocation of capital should be to different divisions in the company. For example, should the company merely focus on the production of the product, or should it also focus on marketing and sales? The answer is likely both; however, the budget will decide which of these activities is emphasized by allocating resources to it. A substantial budget given to marketing will indicate that marketing is a priority of the company, and a strategy will then need to be promulgated in order to use those resources effectively. If the company wants to focus on production as an OEM producer, then the firm may decide to allocate majority of resources to the production department.
Another key question that budget and accounting information answers is: how should the company finance itself? This is likely the most important question the company will answer in its attempt to balance the advantages and disadvantages between equity, debt, and internal financing to finance its operations.
Financial Leverage and Bonds.
Financial leverage is a controversial topic. Indeed, if one looks at the major reason why so many banks and financial institutions needed government bailouts post-2007, egregiously high levels of leverage are a prime explanation. Many banks levered existing assets beyond ratios of 30:1 (debt to actual assets), a financial position that destroyed many institutions that were unable to find financing when asset values plummeted and other forms of financing dried up.
Leverage, however, is a common business strategy outside the financial industry. Indeed, when used prudently and invested in real assets, leverage can provide a firm with a key competitive edge. In order to understand how leverage is used, as well as some of the benefits and weaknesses of using leverage, the example of Caterpillar will be used.
Caterpillar is a typical industrial manufacturing company: The company produces industrial machinery (e.g., cranes and tractors) for a number of different uses; at the same time, Caterpillar’s reach is quickly growing globally. This means that the company not only needs a financing strategy that promotes the scaling up of manufacturing, but also needs to do so in a relatively fast manner in order to keep with orders around the world. Besides financing an expansion in operations through an existing cash pile, a company has two main decisions: to issue equity or bonds.
A company usually will hesitate to issue equity, particularly in the current macroeconomic environment, due to the impact on existing investors and the price to the company. Equity is considered “expensive” in that it dilutes other stock holders in the company, while at the same time increases the base for the distribution of dividends and other residual assets of the company. Thus, many firms choose to issue debt (via bonds) that allows the...
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