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1.Debt and equity financing of a venture requires a return to the providers. Describe the forms in which a provider of debt and the provider of equity receive their return. Which is more expensive for the firm? Which is more risky for the investor and for the company?
2.Which processes or concepts involved in developing forecasted financial statements can be applied to cash forecasting? Write a paragraph about the similarities and the differences. Should the same people be involved in both processes? Why or why not? Which process is critical for a small business owner? Why?
3.Opportunity costs are not usually quantifiable. Do you think that opportunity costs should have a place in the working capital or capital expenditure processes? Why or why not? If you were to suggest a way to quantify opportunity costs, what will your suggestion be?
Expert Answer
Answer 1:
Debt is the loan taken by the firm and is considered as an asset and has to be payed back through fixed payments and may usually include interest. Examples of debt instruments include government bonds, corporate bonds and mortgages.
Equity or stock are loans which are not considered as debt as the lender who buys equity by giving a certain sum to the borrower is actually owning that much of the firm and has claim on future profits made by the borrowing firm.
Bonds are considered to be less risky to the investor as bond markets are less volatile than stock market and if in case the company runs into any financial trouble, the bond holders are paid first.
On the other hand from the point of view of the company bonds are very risky and stock or equity holders prove to be less risky.
Answer 2:
Cash forecasting is essential for any company to understand where they stand in terms of cash flow, the amount of cash required at any particular time, the amount of cash that will be required for future activities, etc and this forecasting is required to understand the company’s liquidity at any given point. There are three ways that cash forecasting is done
- Cash flow foreccasting
- Balance sheet forecasting
- Income based forecasting
Forecasted financial statements are otherwise called as Pro-forma forecast and are calculated using
- income statements
- balance sheets
- cash flows
This a long term financial statement which takes into account all the financial activities of the comapany, business or the individual.
There are many methods to arrive at both the cash statemenst as well the forecasted financial statements and they can be broadly categorised into direct or in direct methods.
The proforma balance sheet(PBS) or the accrual reversal methor(ARM) can beused for forecasting cashas well as forecasted financial statements.Both of these statements can be used to compare the actual performance of the company in terms of cash flow. Therefore it is often advised that two separate departments or personnel be involved ingenerating these forecasting as there will not be chance for any discrepancy keeping the process transparent.
For a small business owner ,the cash flow forecasting using the direct method is very useful as it is ashort term cashflow statement and a small business requires and depends heavily on cash initially.
Answer 3:
Oppurtunity costs are costs that the company or business or person lost due to a different course of action taken during decision time. Idefinitely think that oppurtunity costs should be a part of working capital as at any given time the decisions made by the company or business can be stated interms of profits or loss and to strategically grow the business or company the decisions should always be towards growth. Any losses incurred due to oppurtunity cost should be taken as a learning for future decisions.
The oppurtunity cost can be calculated as
Oppurtunity cost= Return of most lucrative choice – Return of chosen option
