I need an explanation for this Economics question to help me study.
A. Annotated bibliography on each article
According to Graham & Harvey (2002), CFOs within an organization are responsible for capital budgeting. The chosen article is credible because it has been published in the reputed “Journal of Applied Corporate Finance.” The authors are professors of Duke University, and therefore, the findings have been derived after conducting proper research. The authors have conducted a survey consisting of 392 CFOs to understand the practices prevalent in corporate finance. The findings are somewhat predictable yet contrasting. It has been found that the discounted cash flow technique has wider usage. The technique used to be taught in business schools about 20 years ago. The findings also highlight that the payback method is still popular despite the existing disadvantages. While establishing a policy for capital structure, the CFOs are less likely to emphasize formal methods that include benefits and costs. They are more likely to emphasize informal standards like financial flexibility and credit ratings. Hence, it is evident that contradictions exist between practice and theory. Nevertheless, big corporations are increasingly employing methods such as NPV and DCF techniques. The authors at the end of the article suggested that financial theory and practice are gaining corporate acceptance. Corporations are using real methods for understanding the application and various aspects related to financial theory. They are also considering the technique of corporate investments. In the future, further modifications are expected.
The second article on financial analysis highlights that in U.S companies, conservatism has been slowing increasing, and in the past decades, it has reportedly increased by two-fold (Givoly & Hayn, 2002). The paper has been published in the “Financial Analysts Journal,” and therefore, the findings are authentic. The researchers have chosen a sample consisting of 900 companies. Various measures related to accounting conservatism, such as rate of accumulation and the consequences of including good as well as bad news in the reported earnings. The findings highlight that conservatism led to the decline of profitability in the firm. Losses increased, and the dispersion of earnings has increased as well. Again, loss related incidences along with instability are likely to rise in the organization. Hence, the researchers suggested that within the company’s reporting system, relevant information should be included. This, in turn, will enhance the valuations so that investment strategies are good enough.
B. A brief discussion
After analyzing the article on corporate budgeting, it has been understood that CFOs play a vital role in corporate budgeting. From resource planning to budgeting, a CFO wears multiple hats. Managing a range of financial actions and tracking the cash flow, as well as financial planning, is the duty of the CFO (Froot & Stein, 1998). All companies possess weaknesses as well as strengths, and the CFO is responsible for taking corrective actions. The role is somewhat similar to a controller or treasurer. Without their involvement, the accuracy of a project cannot be ensured. Overseeing the taxation related issues and managing every decision associated with financial planning and cash flow is the CFO’s role.
Similarly, after evaluating the findings of the second article on financial analysis, it could be suggested that the concept of conservatism can be useful. It mainly involves bookkeeping guidelines that allow the company to follow a direction before making legal claims to profit. Despite the fact that the conservatism principle emphasizes on preparing the company to take cautionary measures and ensures verification. Nevertheless, the application of the concept of conservatism has affected the process of financial analysis. Excessive caution while preparing finances might lead to uncertainty as well.
C. Ways in which article-related concepts can be used by a manager
The concept of capital budgeting can be used by a manager to make business choices after considering the limited nature of resources. The concept allows managers to make cautionary choices before investing capital. This, in turn, would create value for the organization. One of the most powerful tool in finance is capital budgeting. Before investing in any capital asset or new corporation and project, it is vital to understand the role of shareholders as well. It allows managers to make comparisons related to the project investment (Givoly & Hayn, 2002). It would be possible to predict the future cash flows as well. High potential for the creation of value in the organization exists as well. The only requirement is to investigate further and extract the value.
The concept of conservatism can be utilized by a manager during financial analysis. The principle can be useful because it can help managers recognize additional liabilities and expenses along with any uncertainties. It would be viable for managers to recognize estimates and make decisions. During financial analysis, it is vital to predicting the outcomes of a decision. At that moment, the principle of conservatism helps to make the right decisions. Under this principle, a manager can record a loss in case of uncertainty.
Froot, K. A., & Stein, J. C. (1998). A new approach to capital budgeting for financial institutions. Journal of Applied Corporate Finance, 11(2), 59-69.
Givoly, D., & Hayn, C. (2002). Rising conservatism: Implications for financial analysis. Financial Analysts Journal, 58(1), 56-74.
Graham, J., & Harvey, C. (2002). How do CFOs make capital budgeting and capital structure decisions?. Journal of applied corporate finance, 15(1), 8-23.
LaFond, R., & Watts, R. L. (2008). The information role of conservatism. The Accounting Review, 83(2), 447-478.
A. Annotated bibliography
According to Klammer (1973), the techniques used in capital budgeting can be associated with the overall performance in a firm. As per the study, sophisticated capital budgeting techniques can improve the way of doing business. The article has been published in the journal of “The Accounting Review,” and the article has been reviewed by anonymous authors. The purpose of capital budgeting is to derive optimum solutions to the issues prevalent in the firm. The author has conducted both secondary and primary research to understand the association. Commonly accepted techniques, including payback, have been in practice. The study has been undertaken to understand the degree of association between the usage of sophisticated tools and techniques and a firm’s performance. The existing relationship between capital budgeting procedures and performance can direct the future of the firm. Investment-related decisions can be taken. In order to achieve the purpose of the study, the researchers have created a questionnaire and used the regression analysis method to analyze the findings. It has been inferred that steps used in capital budgeting can derive the outcome or performance of the firm. At first, risks prevail; however, during project implementation, cash flow estimation should be accurate to prevent the risk.
As opined by Filbeck (2000), financial management and financial analysis are related. The paper has been published in the “Family Business Review,” and both the authors are a professor of Finance. Hence, the credibility of the source is evident. In this article, the researchers have explored a range of financial management techniques in the context of a family business. The survey has been conducted on techniques related to risk adjustment as well as capital management. These are vital techniques of financial analysis. The researchers have found that a large family business consists of non-family members as well as the board of directors. These members are in the position of a decision-making role in comparison to smaller family businesses. Small businesses are less likely to use or employ sophisticated techniques of financial management. Furthermore, it has been found that financial analysts are the ones who make recommendations by assessing the financial data of a company. Large companies are more likely to use a range of financial analysis techniques such as cash flow, rates of return, variance, vertical, horizontal, efficiency, and valuation. The large family businesses are more likely to ensure the usage of best practices because handling large data sets can be a challenge for the firm.
B. Discussion on the articles
Based on the article on capital budgeting, it has been learned that the future survival of a firm depends on the techniques used in capital budgeting. If organizations fail to understand the compatibility between firm characteristics and the procedures of capital budgeting, it is impossible to ensure its survival (Haka, Gordon & Pinches, 1985). In order to select the best procedure for capital budgeting, it is necessary to understand the type of investment required for the successful completion of a project. Similarly, the external environment also plays a critical role in budgeting procedures. Secondly, a firm’s structure, including reward systems and information systems, could be vital for decision making as well. It can be inferred that a firm’s performance would decline if the critical characteristics of the firm are not in sync with the budgeting procedures.
Similarly, an analysis of the article on financial management and analysis suggests that within both small and large-sized firms, financial analysts play a key role. From analyzing historical data to making projections regarding the future performance of the firm, a financial analyst would be entirely responsible for improving a firm’s performance. For example, the rate of return is a useful financial tool, and a financial professional can use the tool for assessing the assets and gain.
C. Usage of the concepts by a manager
A manager could make quality decisions for a firm by using the capital budgeting technique. For instance, during an ongoing project, decisions related to investment in equipment can be made effectively by the manager. It is different from long-term investment-related decisions as it will not affect the performance of an organization. Hence, a manager is mainly involved in the process of analysis deeply as a company’s funds are involved. As per the concept of money and its time value, scholars highlight that the value of a dollar today is far more than the value of a dollar tomorrow. Hence, a manager needs to analyze the outcomes before making investments.
The financial analysis process also involves evaluation of the business, and a manager makes a financial statement based on the future impact of a decision. For instance, the cost-volume-profit (CVP) the analysis offers the manager a deeper understanding of the association between variable costs, fixed costs, and manufactured volume of a product. The manager can thereafter prepare a financial statement as it will provide data required for CVP analysis (Subramanyam, 2009).
Filbeck, G., & Lee, S. (2000). Financial management techniques in family businesses. Family Business Review, 13(3), 201-216.
Haka, S. F., Gordon, L. A., & Pinches, G. E. (1985). Sophisticated capital budgeting selection techniques and firm performance. In Readings in Accounting for Management Control (pp. 521-545). Springer, Boston, MA.
Klammer, T. (1973). The association of capital budgeting techniques with firm performance. The Accounting Review, 48(2), 353-364.
Subramanyam, K. R. (2009). Financial statement analysis. Includes index.