4-2 Case Study Assessing a Company\'s Future Financial Health - Copy PDF

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4-2 Case Study: Assessing a Company's Future Financial Health

Southern New Hampshire University FIN-320 Principles of Finance

2 Assessing a Company’s Future Financial Health Evaluating the long-term financial health of a firm is a crucial task that helps formulate goals and strategies as well for outsiders. Financial health refers to an essential evaluation of a company's ability to handle financial necessities and wants. A company should be aware of the general financial condition, create and manage finances with a reasonable budget, and make financial plans that entail regular investing. Noteworthy, risks are significant challenges that face businesses, and thus corporations must develop proper financial securities to curb these risks and keep the company thriving. Financial risks may also affect sales, consequently affecting the retained earnings and dividend policy. There are two types of risks in business, systematic and unsystematic risks. Systematic and Unsystematic Risk Systematic risks are risks that arise as a result of external and uncontrollable variances. According to (Todorov & Bollerslev, 2010). These risks are not security or industry-specific and impact the entire market and the overall economy, resulting in price fluctuations. Various external factors include sociological factors, political factors, and economic factors. These risks relate to the market, power of purchasing, interest rate, change in government policies. Systematic risks include interest risk, inflation risk, and market risk. On the other hand, unsystematic risks are a result of several internal factors within the organization. They are diversifiable, implying that they are controllable; they can be minimized and even avoided by the organization management (Kiselakova et al., 2015). The risks include higher operational costs, increased labor turnover, higher overhead costs, and manipulation in the company's financial statements. The unsystematic risks tend to affect the welfare of the company and even the industry. The chief sources of the risks are risks relating to business, finances, and insolvency at

3 large. Generally, the risks entail business and financial risks. Mainly, financial or leveraged risks emerge when there is a change in the company's capital structure. Exposure to financial risks entirely depends on the nature of a company's borrowing and the underlying business. The main risks that characterize the overall financial risks, encompass interest rate risks, economic risk, credit risk, and operational risk. Financial Risks First, interest rate risk is the potential for investment losses resulting from a change in rates of interest. In Tire City, the interest rate risk would reduce a bond's value or any other fixed-rate investment. Considering Mr. Martin plans to take a loan from MidBank to finance the warehouse's construction, a change in interest rates of the money borrowed would increase expenses and reduce the fixed-rate investment value. It is crucial for the company management to sensitively analyze to predict the profit or loss associated with interest rate changes. Secondly, economic risk is the risk due to changes in business or macroeconomic factors such as regulation by the government, political stability, or exchange rates. It mainly involves investment in foreign countries (Baek & Qian, 2011). In the case study, Tire City Company's finances would be affected if the exchange rates of the countries they export their tires would encounter variations. Also, if the export countries of Tire City products would experience political instabilities, it would have adverse effects on the sales, which reduces the finance flow. Thirdly, credit risk is the risk involved when a company gets losses due to failure to repay money borrowed (Brown & Moles, 2014). If Tire City failed to repay the loan borrowed from MidBank to finance warehouse construction, they would experience losses, maybe from bankruptcy. Lastly, operational risk is a financial risk associated with defaults in internal and external systems to monitor and convey financial reports. Considering that Tire City is a big company,

4 they are numerous and more extensive financial transactions. Thus, a default to effectively monitor these transactions would affect the company financially. Higher Growth/Lower Growth Impact Growth is very crucial for any company. It reflects the proper management of the company's resources and finances. However, a company could experience lower growth or higher growth. Essentially, growth has an impact on dividend policy and the retained earnings. As asserted by Ofori‐Sasu et al. (2017), a dividend is the amount of money paid to a company's shareholders out of its profits. Retained earnings is surplus finance reserved after paying dividends. Distinctly, in Tire City, low company growth shows a low level of sales. As evidenced by He et al. (2017), low sales indicate low profits, which affects the dividend policy by reducing the rates of dividends. Higher growth portrays an increase in finance and thus an increase in dividend rates. Moreover, Considering Tire City company, low growth indicates low profits, reducing retained earnings. On the contrary, higher growth indicates higher profits and thus an increase in the retained earnings. In summary, future financial health should be before any company. It helps the company meets its goals and adopt better strategies in the accomplishment of these goals. Financial health puts a company in a position to handle all the risks that could affect the business's general performance. Financial risk is a critical risk that may weaken any business. Tire City's plans to invest in expanding its warehouse show a significant step in altering the company's financial stability. Thus, the company should adopt better ways to manage its finances. The company should also focus on a higher growth rate to positively impact the dividend policy and increase the retained earnings, which can be used in investment opportunities. Basically, organization management should evaluate the general condition of finances for prosperity.

5 References Baek, K., & Qian, X. (2011). An analysis of political risks and the flow of foreign direct investment in developing and industrialized economies.

Economics, Management,

andFinancial Markets, 6(4), 60. Brown, K., & Moles, P. (2014). Credit risk management. K. Brown & P. Moles, Credit Risk Management, 16. He, W., Ng, L., Zaiats, N., & Zhang, B. (2017). Dividend policy and earnings management across countries. Journal of Corporate Finance, 42, 267-286. Kiselakova, D., Horvathova, J., Sofrankova, B., & Soltes, M. (2015). Analysis of risks and their impact on enterprise performance by creating an enterprise risk model. Polish Journal of Management Studies, 11. Ofori‐ Sasu, D., Abor, J. Y., & Osei, A. K. (2017). Dividend policy and shareholders’ value: evidence from listed companies in Ghana. African Development Review, 29(2), 293-304. Todorov, V., & Bollerslev, T. (2010). Jumps and betas: A new framework for disentangling and estimating systematic risks. Journal of Econometrics, 157(2), 220-235....