Question

Explain how rapidly expanding sales can drain the cash resources of a firm? Discuss the relative use of credit between large and small firms. Which group is generally in the net creditor position, and why? What approaches can be taken in valuing a firm’s stock when there is no cash dividend payment?

Answer 1

There is more and more need for investment in current asset to support the rapidly growing sales and most of this increase in current assets will be permanent in nature. There will be need for more raw material purchases and stock, more work in progress inventory and more finished goods inventory. Rapid growing sales will also lead to substantial increase in receivables. Hence, rapidly expanding sales needing a buildup in assets to support the growth will drain the cash resources of the firm.

Larger firms tend to be in a net creditor position because they have the financial resources to be suppliers to credit. The smaller firm must look to the larger manufacturer or wholesaler to help carry the firm's financing requirements, so the use of credit is relatively larger in large firm comparatively to small firm.

The creditor usually identifiy by the nature of their balances of payments, that is by the net credit or debit in service account.

Relative valuation model, should be taken in valuing firm's stock when there is no cash dividend payment. As Absolute valuation models  focus on such things as dividends, cash flow, and the growth rate for a single company – and not worry about any other companies whereas Relative valuation mode operate by comparing the company in question to other similar companies. These methods involve calculating multiples and ratios, such as the price-to-earnings multiple, and comparing them to the multiples of similar companies.