Finance analysis
Question a
Using the cash flow evaluation model, the formula for finding the cash flow is given by subtracting the capital expenditure from the operation value.
Formula for cash flow (FCF) = Net income
+ Non-cash expenditures
-Increase in capital spent on work
-Capital expenditures
Therefore from the above model of the cash flow, the working capital and capital expenditures are some of the capital avenues that can affect the value of the cash flow. The increase in capital expenditures and the working capital will result in reduced cash flow.
Question b
1)
The business risk refers to the factors that are threats to the profitability of the given organization or Company, thus failing the firm. The phenomenon that has got any form of danger on the operation, objectives and the target of the given Company refers to the real definition and understanding of the business risk.
Some of the factors that can influence the business risk of the given organization include:
- The diversification of the product.
When the Company depends only on one form product is most likely to be affected by the business risk as compared to the one that produces a variety of products.
- The size of the business.
It is usually challenging for a smaller organization to compete on the market and adopt some of the environmental factors. Therefore the small business is most likely to be affected by the business risk as compared to the larger companies.
- The competition intensity.
When there is a higher rate of competition on a given business, the higher chances of being affected by the business risk.
- Growth prospect.
The companies whose growth and expansion are deficient as compared to others are more prone to be affected by the business risk.
- A higher fixed rate of the cost structure.
When the Company a higher fixed cost structure, it is more vulnerable to be affected by the business structure.
2)
Operating leverage refers to the measure of how a company or organization can increase the operating income by making some corresponding increase in the revenue.
When the Company has got higher operating leverage, it means that there is a rapid increase in the operating profits. When an organization has got less operating, it means that there is a decrease in the operating profits.
Let us consider the Company that has got a fixed cost of 200 dollars, the sales price of 15 dollars, and the variable cost of 10 dollars. The operating leverage of the Company will be given by:
(Sales price – variable cost) ÷ (sales price – fixed cost)
= (15 – 10) ÷ (15 – 200)
= – 0.02703
Various concepts are related to the study of the business risk of the given Company or organization. An organization that has got the higher magnitude of being affected by the aspect the business risk, it should make a wise decision by selecting a business structure that has got a lower ratio on the commercial distribution to meet all its financial objectives and obligation over the given time. Business is directly linked with the general operation of the given entity of the business. In consideration of the business risk, the manager of the given organization or Company should make critical decisions concerning all the elements or factors that can affect the profitability of the business.
The operating leverage, in conjunction with the aspect of the fixed cost of the Company, is essential factors that influence the business of the given organization. As per the degree of the operating leverage of this particular Company understudy, it has a deficient degree of the operating leverage of the value -0.02703. Therefore the Company is at a higher risk of being influenced by the business risk. Some of the recommendations that are appropriate to curb this challenge include:
- The Company should come up with a strategy handling the credit risk. Some of the clients of the given Company usually tend late payment, thus interferingwith the steady operation of the business. Therefore the Company can come up with a strategy of paying before accessing the services or products.
- The Company should also increase the rate of sales from $55.63 to a higher amount that can lead to an increase in the degree of the operating leverage.
- The Company should also decrease the rate of the fixed cost to increase the degree of leverage, thus reducing the chances of being influenced by business risks.
All these recommendations we picked since they will increase the degree of the operating leverage, which increases the profit income of the business, thus reducing the tendency of being affected by the business risks.
Reference