In finance, growth is powerful.
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To help investors assess the potential investment returns and determine the long-term outlook, formulate expectations for risk and return of various asset classes.
There are two strategies to consider here, strategic and tactical.
A strategic asset allocation strategy is a long-term strategy that necessitates regular rebalancing to ensure you do not deviate from your goals.
A tactical asset allocation strategy, on the other hand, takes a more active approach that reacts to changing market conditions. This means that despite having a long-term plan, you make frequent changes for short-term gains.
Any changes are thoroughly examined to ensure they are consistent with long-term objectives.
A portfolio manager should regularly monitor and evaluate risk exposures within the portfolio to rebalance it according to the strategic asset allocation.
Evaluating a portfolio using absolute and relative returns gives a complete picture of its strengths and weaknesses. Such help portfolios reach their full potential and give investors the confidence that their funds are managed well.
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This strategy helps reduce the risk profile of an investment as it spreads out the portfolio over multiple asset classes or sectors.
The goal of diversification is to lower portfolio volatility without sacrificing overall returns. In this way, investors can benefit from holding a combination of stocks and bonds, as asset classes tend to perform differently in varying market conditions.
Investment portfolio management is a crucial part of any long-term investment strategy, as it plays a major role in helping individuals and organizations to minimize risks and maximize returns.
Rebalancing is a strategy that regularly reassesses the asset allocation and cash holdings in a portfolio according to predetermined goals.
This helps keep the composition of a portfolio in line with its objectives, such as capital growth or income generation, and helps minimize risk exposure and take advantage of new opportunities.
By reviewing different types of investments within an overall portfolio and shifting money from sections that have exceeded their target proportions back into those that have dipped below them, savvy investors can work to maintain optimum performance over time.
Portfolio management is the process of creating and maintaining a well-diversified collection of investments that align with an individual's financial goals and risk tolerance.
These include monitoring performances, setting goals, analyzing risk factors, and devising investment strategies.
There are four main portfolio management types:
A successful portfolio management process involves careful planning, execution, and feedback.
Investment strategies can assist investors in making an educated choice about an investment. The key strategies involved in portfolio management are
Consider speaking with a financial advisor who can assist you in analyzing your investment needs and developing an investment plan, should you not be in a position to do so yourself.
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February 27, 2023
A change in working capital is the difference in the net working capital amount from one accounting period to the next. A management goal is to reduce any upward changes in working capital, thereby minimizing the need to acquire additional funding. Net working capital is defined as current assets minus current liabilities. Thus, if net working capital at the end of February is $150,000 and it is $200,000 at the end of March, then the change in working capital was an increase of $50,000. The business would have to find a way to fund that increase in its working capital asset, perhaps by selling shares, increasing profits, selling assets, or incurring new debt.
How to Alter Working Capital
Here are a number of actions that can cause changes in working capital:
Credit Policy
A company tightens its credit policy, which reduces the amount of accounts receivable outstanding, and therefore frees up cash. However, there may be an offsetting decline in net sales. A looser credit policy has the reverse effect.
Collection Policy
A more aggressive collection policy should result in more rapid collections, which shrinks the total amount of accounts receivable. This is a source of cash. A less aggressive collection policy has the reverse effect.
Inventory Planning
A company may elect to increase its inventory levels in order to improve its order fulfillment rate. This will increase the inventory investment, and so uses cash. Reducing inventory levels has the reverse effect.
Purchasing Practices
The purchasing department may decide to reduce its unit costs by purchasing in larger volumes. The larger volumes increase the investment in inventory, which is a use of cash. Buying in smaller quantities has the reverse effect.
Accounts Payable Payment Period
A company negotiates with its suppliers for longer payment periods. This is a source of cash, though suppliers may increase prices in response. Reducing the accounts payable payment terms has the reverse effect.
Growth Rate
If a company is growing quickly, this calls for large changes in working capital from month to month, as the business must invest in more and more accounts receivable and inventory. This is a major use of cash. The problem can be reduced with a corresponding reduction in the rate of growth.
Hedging Strategy
If a company actively uses hedging techniques to generate offsetting cash flow, there are less likely to be unexpected changes in working capital, though there will be a transactional cost associated with the hedging transactions themselves.
Who is Responsible for Working Capital?
Monitoring changes in working capital is one of the key tasks of the chief financial officer, who can alter company practices to fine-tune working capital levels. It is also important to understand changes in working capital from the perspective of cash flow forecasting, so that a business does not experience an unexpected demand for cash.
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What Is Capitalization Change?
Capitalization change refers to a modification of a company’s capital structure — the percentage of debt and equity used to finance operations and growth. Debt includes bond issues or loans, while equity mainly consists of common stock, preferred stock, and retained earnings.
KEY TAKEAWAYS
Capitalization change refers to a modification of a company’s capital structure — the percentage of debt and equity used to finance operations and growth.
Usually, a company starts out with equity and then, as its prospects strengthen and it matures, gradually starts adding debt to its balance sheet.
Each type of capital comes with benefits and drawbacks and it is important for company management to find a suitable balance.
Investors can use capitalization ratios to measure and keep tabs on the risks associated with changes to a company’s capital structure.
How Capitalization Change Works
Companies have two main ways to raise money: debt and equity. Generally, a company starts its life with capital contributed by the founder(s), family, and friends. As the company grows, it may seek funds from venture capital investors. Any new capital injected into the business will lead to a capitalization change — simply, a greater amount of equity at this point.
Should this company progress on a profitable path where cash flows and assets build, it would then be in a position to seek bank loans or even issue debt. The addition of debt to the balance sheet would represent another capitalization change.
As the company continues to mature, its financing needs become more sophisticated, calling for various adjustments, even transformations depending on the growth of the firm and the dynamics of the industry, to the capital structure. The issuance of new shares and assumption of debt for a large acquisition, for example, could fundamentally alter the capitalization of a company.
Capitalization changes can impact the returns companies generate for shareholders, as well as their survival prospects during recessions.
Equity vs. Debt
Each type of capital comes with benefits and drawbacks. Issuing equity is expensive, especially when interest rates are low, and dilutive, decreasing existing stockholder's ownership percentage. However, it doesn’t need to be paid back and provides extra working capital that can be used to grow a business.
Debt financing, meanwhile, offers a cheaper way to raise money, creates tax shields, and allows a business to retain ownership and not cede control. It also comes with repayment obligations, though, that if steep could cripple the company should it ever run into trouble.
Special Considerations
The Right Balance
A responsible company strives to balance the amount of equity and debt in its capital structure according to its needs. The goal is to acquire an optimal capital structure to finance operations, maximizing a company’s market value while minimizing its cost of capital.
A company that changes its capital structure, theoretically, must keep the interests of its shareholders foremost in mind, and be careful about not taking on too much financial risk. Investors can keep tabs on these risks by using capitalization ratios: indicators that measure the proportion of debt in the capital structure.
Capitalization Ratios
The three variants of the capitalization ratio are debt-to-equity (total debt divided by shareholders' equity), long-term debt-to-capitalization (long-term debt divided by long-term debt plus shareholders' equity) and total debt-to-capitalization (total debt divided by shareholders' equity).
What is reasonable in terms of the capitalization ratio depends on the industry and the future prospects of the company. A company, for example, could have a relatively high ratio compared to its peers, but stronger near-term profitability capacity to pay down debt and reduce the ratio to a comfortable level.
High leverage ratios are risky. However, it’s also true that aggressive capital structures can lead to higher growth rates.
By DANIEL LIBERTO Updated July 28, 2021
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The factor that influences capital structure decisions are as follows:
The risk related to cash insolvency arises due to the failure in paying the fixed interests in liabilities. Usually, the higher proportion of the debt in the capital structure compels the firm to pay a higher rate of interest on the debt, irrespective of the fact whether the fund is available or not. The non-payment of the charges in interest and the principal amount in time invites the liquidation of the company.
The abrupt withdrawal of debt funds from the organization can cause cash insolvency. In the determination of capital structure, the risk factor of a company has an important bearing, and it can be avoided if the project was financed by the issues of equity share capital.
The higher the obligation contained in the capital structure of an organization, the higher will be the danger of variety in the normal income accessible to value investors. On the off chance that arrival on venture on absolute capital utilized (i.e., investors' reserve in addition to long term debt) surpasses the loan cost, the investors get a better yield.
Then again, if loan cost surpasses the degree of profitability, the investors may not get any arrival whatsoever.
The cost of capital refers to the cost of raising capital from various different sources of funds. It is the price paid for utilizing the capital. A business must generate sufficient revenue to fulfil its cost of capital and then finance the growth in the future. The finance manager must consider the cost of all sources of funds while designing the capital structure of a business.
The thought of holding control of the business is a significant factor in capital structure choices. On the off chance that the current value investors don't care to weaken the control, they may incline toward obligation money to value capital, as previously has no democratic rights.
The utilization of fixed enthusiasm bearing protections alongside proprietor's value as wellsprings of the fund is known as exchanging on value. It is a course of action by which the organization targets expanding the arrival on value shares by the utilization of fixed enthusiasm bearing protections (i.e., debenture, inclination shares, and so on).
On the off chance that the current capital structure of the organization comprises predominantly of the value shares, the arrival on value offers can be expanded by utilizing acquired capital. This is so on the grounds that the intrigue paid on debentures is a deductible use for personal expense evaluation, and the after-charge cost of debenture turns out to be extremely low.
Any abundance of income over the expense of obligation will be signified the value investors. In the event that the pace of profit for complete capital utilized surpasses the pace of enthusiasm on obligation capital or pace of profit on inclination share capital, the organization is supposed to exchange on value.
Capital structure is usually influenced by Government policies, rules, and regulations of SEBI and the lending policies of financial institutions that change the financial pattern of the company completely. The government's monetary policy and the fiscal policy also affect the decisions related to capital structure.
The size of the company influences the availability of funds. It is difficult for a small company to raise debt capital. The terms of long-term loans and debentures are less favorable for businesses. Small companies depend more on equity shares and retained earnings.
On the contrary, large companies issue different types of securities despite the fact that they have to pay less interest because the investors consider large companies less risky.
While choosing a capital structure, the money related conditions and brain science of various sorts of financial specialists should be remembered. For instance, a poor or working-class speculator may just have the option to put resources into value or inclination shares, which are for the most part of little groups, just a monetarily stable financial specialist can bear to put resources into debentures of higher divisions.
A mindful financial specialist who needs his money to develop will lean toward equity shares.
The capital structures of an organization ought to be with the end goal that it can raise assets as and when required. Adaptability gives space to development, both as far as lower sway on cost and with no noteworthy ascent in chance profile.
The period for which account is required likewise impacts the capital structure. At the point when assets are required for term debt long (say ten years), it ought to be raised by giving debentures or preference shares. Assets ought to be raised by the issue of equity shares when it is required permanently.
It has an extraordinary impact on the capital structure of the business, organizations having steady and certain profit lean toward debentures or preference offers, and organizations having no guaranteed pay rely upon inward assets.
The finance manager must comply with the legal provisions while designing the capital structure of a company.
The capital structure of an organization is likewise influenced by the motivation behind the financing. On the off chance that the assets are required for assembling purposes, the organization may secure it from the issue of long haul sources. At the point when the assets are required for non-fabricating purposes, i.e., government assistance offices to labourers, similar to a class, clinic, and so on, the organization may acquire it from inward sources.
At the point when corporate pay is liable to charges, obligation financing is good. This is made in light of the fact that the profit payable on value share capital and inclination share capital are not deductible for charge purposes, while intrigue paid on the obligation is deductible from pay and lessens an association's duty liabilities. The expense of saving money on premium charges decreases the expense of obligation reserves.
Besides, an organization needs to pay a charge on the sum conveyed as profit to the value investors. Because of this, complete income accessible for both obligation holders and investors is more when obligation capital is utilized in the capital structure. Along these lines, if the corporate assessment rate is sufficiently high, it is judicious to raise capital by giving debentures or taking long term debt advances from money related organizations.
The capacity of the business also affects the selection of capital structure in business for the purpose of generating cash flows. It also analyses the solvency position and the capability of the companies to meet its charges.
The provision related to the future requirement of capital must also be considered amidst the planning of the capital structure of a business enterprise.
The optimal capital structure of a company is a combination of debt and equity financing that maximizes the market value of the company by minimizing the cost of the capital.
However, a hefty amount of debt increases the financial risk to the shareholders, and the return on equity that they need.
The difference specified between the working capital for the two reporting periods is specified as the change in working capital. The changes in the working capital are included in cash flow operations because companies usually increase and decrease the current assets and current liabilities for funding their ongoing operations.
