Are Firms Now Vulnerable to an Economic Slowdown free essay sample

With due respect, I would like to inform you that I have completed the Financial Management report on â€Å"Rapidly Rising Corporate Debt: Are Firms Now Vulnerable to an Economic Slowdown†. It is immense pleasure for me because I have successfully completed this report by receiving your continues guideline as a supervisor. I have endeavoured to prepare this report from my level of best to accumulate relevant insightful information. If I am included any wrong information in unconsciously so please forgive me as your student. It is a great experience for me to make this report. I have tried to make the report comprehensively with in the schedule time limited recourse. I make to ensure you that if you have any query about any matter collecting information regarding this report so please ask me and I will best try to answer you. You’re Sincerely Farhana Haque ID: 0920141 MBA (Major in FIN) Independent University Bangladesh (IUB) Executive Summary Financial management is an exciting, challenging, planning directing, monitoring, organizing, controlling and ever-changing discipline. We will write a custom essay sample on Are Firms Now Vulnerable to an Economic Slowdown or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Changing technology and increased globalization are dramatically transforming financial practices and markets. Financial management is concerned with the acquisation, financing and management of assets with some overall goal in mind. Basic financial management includes activities such as managing the day-to-day operations of a business, such as paying suppliers, cost of capital, and budgeting. It also includes making long-term investments in plant and equipment and obtaining the money or financing for your operations. New business leaders and managers have to develop at least basic skills in financial management. Expecting others in the organization to manage finances is clearly asking for trouble. Basic skills in financial management start in the critical areas of cash management and bookkeeping, which should be done according to certain financial controls to ensure integrity in the bookkeeping process. New leaders and managers should soon go on to learn how to generate financial statements and analyze those statements to really understand the financial condition of the business. Financial analysis shows the reality of the situation of a business seen as such; financial management is one of the most important practices in management. This topic will help you understand basic practices in financial management, and build the basic systems and practices needed in a healthy business. If you are inexperienced in financial management, then you should get an accountant initially to help you set up your bookkeeping system, generate financial statements and do some basic financial analysis. But dont count on an accountant to completely take over your responsibility for financial management! The accountant can help you set up a bookkeeping system, generate financial statements and analyze them, but you have to understand financial data to the extent that you can understand the effects of your management decisions, the current condition of your business and how decisions will affect the financial condition of your business in the future. While a well-organized bookkeeping system is vital, even more critical is what you do with it to establish your methods for financial management and control. Introduction: The title of the case is Rapidly Rising Corporate Debt: Are Firms Now Vulnerable to an Economic Slowdown. Name of the author is Carol Osler Gijoon Hong. It was published in June 2000. Venue is Current Issues in Economics Finance, Federal Reserve Bank of New York . Venue type is conference. The rapid growth in corporate debt during the late 1990s raises questions about the financial health of the sector and, indirectly, about the sensitivity of other sectors to economic troubles. The increase of debt in the late 1990s has raised concerns about the U. S. nonfinancial business sector’s health and its weakness to economic downturns. An investigation of the segment suggests that while little firms are experiencing some weakness, corporations as a collection are in superior financial shape. U. S. corporate debt has developed rapidly in current years. Between 1995 and 1999, the exceptional debt of nonfinancial corporations rise a hefty 46 percent—a trend typified by last year’s boost of 12 percent. Viewed as a share of GDP, such debt has now reached extraordinary heights. This apparently high level of debt has concerned some observers, who speculate whether it has made the nonfinancial corporate sector financially weak and vulnerable to economic downturns. Such concerns have gained integrity from the recent deterioration of other. Main Issue: The main issue of this study is we investigate whether concerns over the buildup of U. S. corporate debt are in fact reasonable. The health of the nonfinancial corporate sector on a firm-by-firm basis, focusing chiefly on three key measures of health: leverage, liquidity, and overall solvency. This study analysis suggests that the sector as a whole is in good shape, and that its financial health has actually improved during the late 1990s. Consider how the corporate sector might fare in the face of an economic challenge such as a major stock market correction or a large rise in interest rates. Nonetheless, the health of small firms is not as robust as that of large ones, and small firms are continuing to experience a decline in health. Theme of the study: From this case, we can understand clearly that if the debt in the financial economics increases than the proportion of debt also increases in non-financial companies. Due to these many firms faces loss, but in this loss, mostly small firms are bigger sufferers compared to big firms. To over come this loses; they carry out some research, which are leverage, equity and overall solvency. In small, on-financial firms the above following proportions of the researches are not accurate, but in small firms the proportions of this research are usually less, but also as the debt ratio is more in non-financial small firms, so for that the debt default happens more. As the health size in non-financial firms are smaller so for that they are suffering financially. Analysis and interpretation: U. S. corporate debt has grown rapidly in recent years. Between 1995 and 1999, the outstanding debt of nonfinancial corporations rose a hefty 46 percent—a trend typified by last year’s increase of 12 percent. Viewed as a share of GDP, such debt has now reached unprecedented heights. Average leverage for nonfinancial firms declined fairly steadily—from 0. 35 in late 1995 to 0. 22 in September 1999—despite the concurrent rise in overall debt. In essence, nonfinancial corporations in September 1999 on average had debt liabilities with a face value only slightly more than one-fifth the value of their outstanding equity. Moreover, average corporate leverage for the nonfinancial sector was rather low relative to the post-1974 average of 0. 47. Turn to a measure of average corporate leverage that uses asset values to determine earnings capacity (Chart 3, top line). By this measure, the average leverage ratio declined modestly during the late 1990s and—at 0. 23 in September 1999—was still slightly below its historical average of 0. 25. Although this measure has fallen less dramatically than our central measure and remains closer to its own historical average, it nonetheless suggests that the leverage of the nonfinancial corporate sector is not high. Despite differences in the liquidity ratios, all three confirm that the liquidity risk of the nonfinancial corporate sector has not risen sharply during the late 1990s. In addition; the ratios suggest that the sector’s liquidity risk presently is not very high. To measure solvency, economists typically compute a summary measure of corporate health called a Z-score. This score is a combination of five accounting ratios that assess leverage, liquidity, sales, working capital, and retained earnings. The first and most familiar Z-score was published by Altman (1968). More recently, alternatives have been offered by Begley, Ming, and Watts (1996) and Shumway (1999). To calculate Z-scores, one multiplies each ratio by a number—for example (in the case of Altman’s Z-score), 1. 00 for the sales ratio, 3. 30 for the retained earnings ratio—and sums the resulting products. Since Z-scores measure solvency, a higher score indicates a lower risk of bankruptcy. Three Z-scores for the U. S. nonfinancial corporate sector, computed using the methods of the researchers cited above, show that the likelihood of bankruptcy in this sector declined on average in the late 1990s. As we see from this Chart, the financial health of small firms did indeed worsen during the late 1990s. Leverage ratios for the smallest 20 percent of firms (ranked by market value) rose sharply after 1995 and are now fairly high by historical standards. Liquidity measures confirm that the decline in health is concentrated in the smallest firms, as do solvency measures such as Altman’s Z-score. This sizable deterioration can explain why measures such as default rates rose in the late 1990s, even as overall leverage declined. Table Years Rapidly Rising Corporate Debt 1995 to 1999 58% outstanding debt of nonfinancial corporations. 1995 to1999 0. 35 to 0. 22 average leverage for nonfinancial firms declined fairly. 1974 to 1998 Average 0. 47 leverage for nonfinancial firms declined fairly. 1990 to 1995 2. 6 % growth rate that easily exceeds. 1975 to1995 1. 9% growth rate that easily exceeds. 1974 to 1995 0. 5% leverage of the nonfinancial corporate sector remains below. 1990 to 1995 0. 80 to 1. 04 corporate healths, an employment weighted incense. 1974 to 1998 0. 83 to 1. 34 leverage according to this measure is still well below 1996 to1999 1. 00 to 3. Z-scores sales ratio is the retained earnings ratio—and sums the resulting products. 1995 to 1999 3. 2 to 5. 2 % while the average value recovered from defaulted debt. 1995 to 1999 9. 7 to 3. 3 Z-score, solvency still more than double the historical average 1990 to 1999 57 % average stock price decline implied by this scenario Generation of Questions: Why are US firm using more short term debts? How to determining of short term debt financing? What is the condition of financial sector? Is the condition of financial sectoring better them non-financial sector? How to handle short term debt? What type of necessary of resource or examine help to reduce debt default level? Is there any another way to solve this situation? How to improve the situation? How big is the debt overhang problem? Is the raise of leverage level solving this problem? Summary: By analysing US corporations had seen as the outstanding debt has increased so the economic factors are also being suffered. The main reason for this is the repayment of debt is not being done so for that the big firms are able to operate their work properly but as the capital of the small firms are also small. So as they are giving loans, they are not getting back the Amount of loan from their receivers so for that their debt increases. As the debt increases, the interest rate is increasing; equity risk is also increasing so also the leverage amount is decreasing as debt increases. Conclusion: The nonfinancial corporate sector is in good financial health. Some weakness, however, exists among the sector’s smallest firms. The sector as a whole would likely withstand a major stock market correction without a huge disruption, but a large rise in interest rates could bring the sector’s liquidity risk back to the relatively high levels common in the 1980s. December 1995 to December 1998 is the most recent period for which we have reasonably comprehensive employment data. Financial firms, by their nature, borrow heavily, so their leverage is generally extremely high. By excluding financial firms from our analysis, we avoid distortion comparisons. The impact of an interest rate rise makes no allowance for likely negative effects on business activity, so the actual increase in liquidity risk would likely be even higher than these figures suggest. Corporate finance theory currently cannot prescribe a â€Å"correct† level of borrowing for individual firms, and thus it cannot define an absolute level of leverage that would be safe or appropriate for the economy as a whole. Even more noteworthy is the possibility that the ratio would Approach the 1980s average of 0. 190; corporate liquidity during this decade was a source of widespread concern. Policy Prescriptions: Financial firms, by their nature, borrow heavily, so their leverage is generally extremely high. By excluding financial firms from our analysis, we avoid distortion comparisons. In addition, except where noted, 1999 data were available only through the third quarter. Further examination of the firm-by-firm data suggests that there are no noticeable patterns of change across industries aside from those related to size. Interest expense is reported in the aggregate for each firm. Cash flow is operating income before depreciation. By excluding capital expenditures from our measure of cash flow, we do not change our overall conclusions. So the actual increase in liquidity risk would likely be even higher than these figures suggest. Directions for Future Research: Here are some future researches given below: Current liabilities are primarily notes payable, debt due in one year, accounts payable, income taxes payable and accrued expenses. Current assets are mainly cash and short-term deposits, accounts receivable, inventories, and prepaid expenses. Interest expense is reported in the aggregate for each firm. Cash flow is operating income before depreciation. By excluding capital expenditures from our measure of cash flow, we do not change our overall conclusions. Set up a payment plan. Your creditor sometimes will do this for you, but in some casessuch as when you make a large purchase at no interest for the first year. Decide whether you want to distribute the payments evenly or whether you want to pay more at the beginning or end. Consider whether you should consolidate your debts into one payment. If you have several short- and long-term loans that you are trying to repay, it might make sense to consolidate your loans. This allows you to make one easy payment and might spread out the loan over a longer term. Reduce your expenses. With a short-term loan, you want to apply as much money as you can toward paying it off. To do this, you should try to reduce your expenses for the duration of the loan. Consider whether you should refinance your home to include the short-term debt. If youre worried that you wont be able to pay off the short-term loan on time, you might be able to refinance your home to get the money that you need. If you use your home equity to pay off the short-term debt, the money will become part of your mortgage payments. Apply all extra money to paying off the debt. When you cut back on your costs, be sure that you use the extra money to pay off the debt. This will decrease the time that it takes to repay your loan.