Bears in the Bond Market
If certain high profile fund managers and bond investors are to be believed, then the bond market has just slipped into a bear market. They are not talking about the usual tightening of the Fed’s interest rates. Interest rates have risen several times over the past few years. However, every time they return to normal. […]
The Big Fat Bitcoin Bubble
If you are an investor who is even remotely connected to financial markets, the odds are that you have heard about the spectacular rise of Bitcoin. The crypto-currency has grown from $10,000 to $17,000 in a week. Many believe that this is a bubble. However, there are others who believe that the rise of Bitcoin […]
The Barnewall Model
The traditional financial theory assumes that all investors are rational. Hence, they believe that all investors will reach the exact same conclusion with regard to investment decisions. However, we see evidence of the opposite happening in the marketplace. Even if different people have the same information, they tend to process the information differently and come […]
Financing Needs of Infrastructure Projects at Different Stages
Infrastructure projects typically last for many years. It is not uncommon for these projects to last for decades. These long term projects have different phases. Each of these phases has unique needs from a finance point of view, as well. In this article, we will explain how the financing needs of an infrastructure project depending […]
Financial Systems and Economic Development
Financial institutions and markets are together called the financial system. This financial system is the backbone of the national economy. This is because the efficiency with which the financial system works plays a very important role in the economic development of a nation. The role of the financial system may not be apparent since we […]
As we have seen earlier that there is a wide variety of financial ratios available. They fall into many categories and if variations are included there are hundreds of types of ratios that are common in practice. However, all the ratios are not used by everyone on a regular basis. There are some ratios which are more important to some user groups than they are to other user groups. This article explains why this is the case:
The management of the company may not be so concerned with the results. They are usually more interested in the cause. This is because while other classes of stakeholders do not have control over the working of the firm i.e. the cause, the management does. All the other stakeholders question the management at the annual general meeting. Hence, management tries to get as much insight into the ratios as possible. They create operating performance ratios and compare it to their previous performance and to the performance of others to learn from the past as well as to be able to give satisfactory answers to the investors.
Shareholders, for obvious reasons, are most concerned about profitability. Their investments are at risk and they expect to gain the maximum. Investors scrutinize profitability numbers and pounce upon the slightest signs of mismanagement. For the shareholders, the profitability ratios are the beginning point. They then follow the trail the ratios leave. However over the past two decades the focus has been steadily shifting towards cash flow ratios.
Debt holders and suppliers are concerned whether they will be paid the amount promised to them at the date that was promised to them. It is for this reason that they are very concerned about the liquidity of the firm. Slightest signs of liquidity issues are met with supply cutbacks from suppliers.
The fact that debt holders are concerned about the same ratios creates a self reinforcing negative loop for the company. This is because at the same time when suppliers cut credit and supplies, debt holders refuse to lend more money and the whole situation becomes a cash crunch.
While debt holders are suppliers are concerned about short term liquidity and cash flow, credit rating agencies go a step ahead. They use solvency ratios to rigorously analyze whether the company will be able to make good its obligations in the long run.
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