Mar 16

Why Is Corporate Finance Important

Corporate finance is that part of financial management which deals with methods and applications which assists in undertaking financial decisions in the corporate world. Corporate finance also assists risk management, planning and analyzing the financial performance of a business. The main concepts includes in corporate finance are as follows:

1.Liquidity Ratios A liquidity ratio is a technique when applied enables to ascertain the companys abilities to maintain cash and working capital liquidity to meet immediate requirements like short term expenses. Liquidity ratio includes Current ratio (current assets/current liabilities), Net working capital (current assets current liabilities), Net working capital to total assets ratio (Net working capital/total assets), cash ratio (sum of cash + other current assets + debtors/current liabilities).

2.The Efficiency Ratios These ratios represent the efficacy of the use of assets. It enables to ascertain the productivity of the assets which in turn determines the uses and return of investment on them. The efficiency ratios are calculated through asset turnover ratio (sales/average total assets) this ratio compares the revenue of the sales with the capital invested in assets, inventory turnover ratio (cost of the goods sold/average total assets), inventory turn over ratio (cost of goods sold/average inventory), days sales inventories (average inventory/(average inventory/cost of goods sold * 365).

3. The Profitability Ratios Profitability ratios are a set of ratios which determines the profitability of an organization in relation to its earnings. Profitability ratios helps in understanding the financial performance on a brief scale based on which one can conclude that if the organization is profitable or not. The profitability ratios are calculated through net profit margin ratio (sum of net income and interests/sales) this ratio represents the revenues which are transformed into final revenues, return on assets (sum of net income and interests/average of assets) This ratio is very relevant to analyse the financial statements. Effectivelly, this ratio compares the net income with the assets already invested to measure the performance of the firm., return on equity (net income/average equity), return on capital employed (earnings before interest and tax/sum of shareholders funds and long term liabilities), solvency ratio (sum of net profit after tax and depreciation/long term liabilities and short tem liabilities) The retun on capital employed (the R.O.C.E.) calculates the profitability of the companys capital investments. This ratio should be higher than the interest rate to be profitable.


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