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A brief discussion on – Financial Analysis and Capital Budgeting

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A brief discussion on – Financial Analysis and Capital Budgeting

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  1. 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 highlights 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.

  1. 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.

  1. 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 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 predict the outcomes of a decision. At that moment, the principle of conservatism helps to make right decisions. Under this principle, a manager can record a loss in case of uncertainty.

 

 

References

Froot, K. A., & Stein, J. C. (1998). A new approach to capital budgeting for financial institutions. Journal of Applied Corporate Finance11(2), 59-69.

Givoly, D., & Hayn, C. (2002). Rising conservatism: Implications for financial analysis. Financial Analysts Journal58(1), 56-74.

Graham, J., & Harvey, C. (2002). How do CFOs make capital budgeting and capital structure decisions?. Journal of applied corporate finance15(1), 8-23.

LaFond, R., & Watts, R. L. (2008). The information role of conservatism. The Accounting Review83(2), 447-478.

 

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