Company Ownership, Enterprise Value, Current Ratio

Agency Problems

Owners of a Corporation

A corporation is owned by the shareholders who purchase the shares of the corporation. In return, the shareholders obtain a share certificate and are entitled to vote during the corporation’s annual general meetings. They also share in the dividends of the company in proportion to their ownership in the company. The shareholders vote in and remove the managers and auditors of the corporation (Heintz & Parry, 2016).

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The Process where the Owners Control the Firm’s Management

The owners control their corporation’s management by exercising their voting rights which they get by owning the corporation’s shares (Heintz & Parry, 2016). During the annual general meetings, the shareholders vote in their managers of choice by considering those who are likely to act in their interests, since the managers are involved in running the corporation on behalf of the shareholders.

Reasons why Agency Relationships Exist in Corporations

The agency relationship exists in corporations where the owners engage the managers to run the corporation on their behalf. This relationship exists because the owners are too many to be involved in running their corporation. They may also lack the expertise and experience in running the corporation. Furthermore, the owners of the corporation are geographically dispersed and may lack the time and means to be involved in the day-to-day running of the firm (Filatotchev & Wright, 2011).

Agency problems exist between the managers and the shareholders because the actions of the managers sometimes conflict with the intentions of shareholders. For instance, incentive problems may arise, where the directors and managers award themselves high salaries, which is contrary to the owners’ expectations. Also, they may commit funds in investments with different risk profiles from those expected by the shareholders. The managers may also focus on the management buyout, where they attempt to buy the business that belongs to their principal. Creative accounting can also be a problem, where the managers creatively report a high financial performance of the company to award themselves high perks (Filatotchev & Wright, 2011).

Enterprise Value

The reason why Enterprise Value is of Interest to Potential Purchasers

The enterprise value of a firm is essentially the theoretical price of a takeover if the firm is to be bought. It is a measure of the fair value of the firm and is seen as an alternative to the calculation of market capitalization. However, the market capitalization method fails to consider important factors such as the value of debt, which is borne by the purchaser if the firm is sold. The preferred equity amount is also omitted when calculating the value of a firm using the market capitalization method. Furthermore, the method does not deduct the cash and cash equivalents that form part of the selling package in case the firm is sold (Koller, Goedhart, & Wessels, 2010).

Thus, by taking into account the value of debt, preferred stock, and cash equivalents, enterprise value more accurately reflects the value of the firm. That is the reason the enterprise value figure is of particular interest to purchasers of firms as it helps them identify undervalued or overvalued companies.

Current Ratio

Explaining a Current Ratio of 0.50, 1.50 and 15.0

The current ratio is an expression of the relative proportion of the number of current assets to the number of current liabilities. A current ratio of 0.50 means that for every dollar worth of current liabilities, there is 0.50 dollars’ worth of current assets to offset it. In essence, the available current assets can offset half the amount of current liabilities. A firm could be said to be better off with a current ratio of 1.50 than 0.50 because it implies that for each dollar worth of current liabilities, there is 1.50 dollars’ worth of current assets to offset it. A current ratio of 1.50 is, therefore, an indication of financial liquidity.

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However, a current ratio of 15.0 is not good for the firm. While it is clear that a firm with a current ratio of 15.0 can easily offset its current liabilities, it is an indication that the firm holds too much of its assets as current assets, which should otherwise be invested to give a higher return on investment or used to pay dividends to its investors (Koller et al., 2010).

Sales Forecasts

Reasons why Long Term Planning Begins with Sales Forecasts

Sales forecasting is important in long term planning because it is from sales revenues that the other business costs and expenses are offset. By first making a forecast for sales, it is possible to make forecasts of the other cost elements such as purchases and expenses to ascertain whether the business will be profitable in the long term. Also, forecasting the sales amount helps to set the pace of the business operations so that a sense of direction is instilled in the employees of the company as they strive to achieve the target sales (Heintz & Parry, 2016).

Thus, the future amount of sales is the key input because the long term survival of the business depends on its ability to make sales. It is only after the sales revenues exceed the costs and expenses that the business can be said to be profitable. If the level of sales forecasts fails to meet the costs to be incurred, then the business adds no value to its owners, and the venture should not be undertaken.

References

Filatotchev, I., & Wright, M. (2011). Agency perspectives on corporate governance of multinational enterprises. Journal of Management Studies, 48(2), 471-486.

Heintz, J. A., & Parry, R. W. (2016). College Accounting. Boston: Cengage Learning.

Koller, T., Goedhart, M., & Wessels, D. (2010). Valuation: measuring and managing the value of companies. Hoboken: John Wiley and sons.

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