Question

Answer the questions in your own words.

1. What advantages do sole proprietorships and partnerships offer? What is a major drawback of these types of organization? (10 points)

2. In a corporate governance, what group has the ultimate responsibility for monitoring management and protecting the stockholders' interests? Who elects this group? (10 points)

3. What is meant by maximizing owner’s equity value (shareholder wealth)? Why are maximizing just net income, or just profit, inappropriate goals?   (10 points)

4. List and describe the four major financial statements. (20 points)

5. Why do financial managers and investors find cash flows to be more important than accounting profit? (10 points)

6. What information does time series analysis provide for firm managers, analysts, and investors? (10 points)

7. Define the following ratios and explain their significance. (30 points)
   1. Quick ratio
   2. Average collection period
   3. Return on equity
   4. Debt ratio
   5. Profit margin

Answer 1

1. Sole proprietorship:

Advantages- • it is easy to form and dissolve as registration of the organisation is not required ,

• decision making is simpler because there is only one person running the business/ organisation,

• business and the owner are one entity.

Disadvantages- • there is unlimited liability on part of the owner ie sole proprietor,

• the life of the business is limited, and so are the resources.

• it is normally on small scale.

Partnership:

Advantages: • business and the owner are two separate entities,

• there is limited liability on the shoulders of the partners,

• easy formation. Requirement of registration depends on the type pf the partnership firm,

• less/ limited responsibilities on partners.

• larger resources and better management

Disadvantages- • delay in decision making,

• joint responsibility,

• lack of trust and secrecy,

• arguments or chaos between partners.

..

2. The Board of Directors has the ultimate responsibility for monitoring management and protecting the stockholders interests. The board of directors are appointed by the shareholders only, as someone to protect their interests on their behalf. The general power of the board to make decisions and take actions is also decided by the shareholders in a general meeting. The board has the power to make calls on shareholders, can issue shares or debentures, can borrow money from the market, can invest the funds of the company, provide for loan securities etc.

3. Maximizing owner’s equity value or shareholder wealth means increasing the worth of the firm’s wealth thereby increasing the worth for the shareholders and the money invested by them in the company. Increasing shareholders wealth is one of the most important objectives of an organisation and it’s beneficial because it attracts more shareholders and eventually the amount invested in the company. In simple words, increase in market price of a share attracts more shareholders and means increase in shareholders wealth. It also means efficient utilisation of the firm’s resources. Overall it is an easy concept to understand.

4. Four basic financial statements are:

1) income statement - It shows revenues, expenses, profits or losses generated in the current financial year or current year. Also known as profit and loss statement. Helps  to know the net profit or net loss generated by the company.

2) cash flow statement - it shows the total cash inflow and cash outflow in a current financial year.it reflects the financial situation of the company and comes handy when applying for loans. The cash flows are classified into 3 types of activities that a company involves into - operating, investing and financing.

3) balance sheet - it reflects the financial position of a company at a given point of time. That’s why it is known as ‘Statement of Financial position’. It provides a clear insight into the company’s assets and liabilities and owners equity. Assets are listed on the left side while liabilities and equity on the right side.

4) Statement of Retained Earnings - this Statement shows the change in owner’s equity in the specified financial year. It consists of paid up share capital and retained earnings. It shows the opening balance of all owner equity accounts, the change, the reason for the change and then the closing balance.