Three Financial Theories That Can Help A Manager Make Business Decisions

Financial theories are the building strength and effective framework of today's corporate world. The essential building squares of finance theory establish the framework for some advanced devices utilized as a part of regions such resource estimating and venture. Financial theories such as; Ratio Analysis Theory, Modern Portfolio Theory (MPT), and Equilibrium Theory will help a manager and organization improve its operational processes.

Financial analysis and interpretation of Income statements and balance sheet of a particular accounting period helps in analyzing and understanding a company’s financial soundness, management, take perfect action, and decisions in terms of present business situation (Uechi, et al., 2015). One important tool to determine financial analysis is Ratio Analysis. Ratio analysis is very essential to build relationship between two accounting figures to highlight the important information to the management and users. “The primary function of ratio analysis is not in determining what is right or wrong, but is in identifying aspects of firm activity which do not seem just right and consequently indicating areas for further study and synthesis” (The Securities Institute Journal, 2000). It facilitates the accounting information to be summarized and simplified in a required form and highlights the interrelationship between facts and figures of various segments of the business (Uechi, et al., 2015). It helps eradication of waste and inefficiency from the business (The Securities Institute Journal, 2000).

Ratios point out the firm’s liquidity position to meet its short-term obligations and long-term solvency. Ratio analysis provides inter-firm comparison or comparison within us try averages by comparing the firm’s ratios with those of other competitive and progressive firms (Tamari, 1978). An inter-firm comparison exhibits the firms' relative position via-a-via its competitors (Tamari,?1978). If the comparison shows a variance, the possible reasons of variations may be identified and if results are negative the corrective actions may be initiated immediately to bring them in line (Sahu, & Charan, 2013).?

Ratio analysis enables a firm to take the time dimension into account (The Securities Institute Journal, 2000). In other words, it facilitates the management to know whether the firm’s financial position is improving or deteriorating or is constant over the years by setting a trend with the help of ratios (The Securities Institute Journal, 2000). The analyst with the help of ratio analysis can know the direction of movement whether favorable or unfavorable (Tamari, 1978). An analysis of the trend of strategic ratios may help the management in the task of planning, forecasting and controlling (Sahu, & Charan, 2013).

According to Igben (1999), “Accounting or financial ratio is a proportion or fraction or percentage expressing the relationship between one item in a set financial statements and another item in the financial statements. Accounting ratios are the most powerful of all tools used in analyzed and interpreting financial statements” (p. 423). Therefore, ratio analysis involves taking stats of number (or items) out of financial statements and forming ratios with them, to enhance informed judgments and decisions (Lasher, 1997).

Modern Portfolio Theory (MPT), is a hypothesis theory on how chance unwilling financial specialists can build portfolios to improve or expand expected profit based for a given level of market hazard, accentuating that hazard is an inborn piece of higher reward (Elton, 2011). MPT proposes how discerning speculators will utilize enhancement to improve their portfolios and how a benefit ought to be valued given its hazard with respect to the market.??

The fundamental ideas of the hypothesis are the productive wilderness, Capital Asset Pricing Model, beta coefficient the Capital Market Line, and Securities Market Line (Elton, 2011). “MPT models the arrival of an advantage as an arbitrary variable and a portfolio as a weighted mix of benefits the arrival of a portfolio is along these lines likewise an irregular variable and therefore has a normal esteem and a difference” (Hagin & Dow, 1979). Chance in this model is related to the standard deviation of portfolio return. Judiciousness is displayed by assuming that a financial specialist picking between a few portfolios with indistinguishable expected returns will incline toward that portfolio which minimizes hazard (Hagin & Dow, 1979).?

Utilizing the Modern Portfolio Theory, extra time hazard resources will give a higher expected rate of return, as pay to the speculators for tolerating a high hazard (Elton, 2011). The high hazard will in the end bring down gathering resource classes to the portfolio, along these lines decreasing the unpredictable hazard, and expanding the normal rates of return (Elton, 2011). Besides the motivation behind this hypothesis is to build up the most ideal ventures portfolio which would yield the most noteworthy rate of return while learning the hazard for the individual or corporate financial specialist. According to Lydenberg (2016), “This hypothesis impacts worldwide and household money related administrators by basing their portfolio utilizing capital market line, capital resource evaluating, and securities as an establishment for ventures”.?

On the off chance that speculators are given two arrangement of equivalent esteem that offer the same expected return, MPT clarifies how the financial specialist will favor and ought to choose the less hazardous one (Elton, 2011). Financial specialists accept extra hazard just when confronted with the possibility of extra return. MPT clarifies how speculators can decrease general hazard by holding a differentiated arrangement of advantages (Elton, 2011).?

For successful investing in the future, MPT must change. MPT is all about cutting down portfolio volatility. It says that one should diversify among non-correlated asset classes (Mauldin, 2017). According to Mauldin (2017), “That plan is great when asset classes are truly noncorrelated. It will be better to have different trading strategies that are not held to a buy-and-hold process for any particular asset classes” (p. 2). “Harry Markowitz’s seminal paper on Modern Portfolio Theory was published in 1952. But his work didn’t achieve importance until the early 1970s, when stocks and bonds got slammed at the same time” (Mauldin, 2017). This changed investors’ ideas of risk and return. It gave new life to his theories (Mauldin, 2017).

One important aspect of Markowitz’s work is the concept of utility and preference. It showed investors how to trade off risk and return on an “efficient frontier” (Mauldin, 2017). This is the act of knowing one’s portfolio risk profile and deciding what level of risk is appropriate (Mauldin, 2017). General Equilibrium Theory is general balance hypothesis endeavors to clarify the conduct of supply, request, and costs in an entire economy with a few or many associating markets, by trying to demonstrate that the cooperation of interest and supply will bring about a general balance (McKenzie, & NetLibrary, 2002). General Equilibrium reviews economies utilizing the model of balance valuing and tries to decide in which conditions the suspicions of general balance will hold (McKenzie, & NetLibrary, 2002).

At the same time, General Equilibrium investigation concentrates on the topic of how a market economy dispenses assets. This examination expands on the hypotheses of shopper and maker conduct created in the investigation of microeconomics by analyzing how the cooperation’s of monetary operators decide balance in the business sectors for all products all the while (Levin, 2006). The hypothesis likewise endeavors to give a comprehension of the entire economy utilizing a base up approach, which begins with an individual markets and specialists (Levin, 2006).

General Equilibrium exists when there is an interrelationship among all parts of the economy. In this theory it is assumed that all prices are in equilibrium; where in each consumer spends his given income in a manner that yields them the utmost satisfaction (Levin, 2006). According to Levin, J (2006), “Price plays the role of equilibrating demand and supply so that all buyers who want to buy at the going price can, and do, and similarly all sellers who want to sell at the going price also can and do, with no excess or shortages on either side” (p. 2). Further, all firms in each industry are in equilibrium at all prices and output; and the supply and demand for productive resources (factors of production) are equal at equilibrium prices (Levin, 2006). these assumptions general equilibrium can further be stated as a state where the demand for every commodity and service is equal to the supply for it. For instance, the adjustment in the cost of one great, say bread, may influence another cost, for instance, the wages of pastry specialists.

On the off chance that dough punchers contrast in tastes from others the interest for bread may be influenced by an adjustment in cooks' wages, with an ensuing impact on the cost of bread. Figuring the harmony equilibrium cost of only one great in principle, requires an examination that records for the majority of the huge number of various merchandise that are accessible. Decision analysis examination is the train of assessing complex decisions as far as qualities and instability (Citanna, 2006). Qualities are for the most part communicated financially in light of the fact that this is a noteworthy sympathy toward the administration. Besides, choice examination gives an understanding into how the characterized options vary from each other and after that produces proposals forbetter-than-ever options. Numbers evaluate subjective qualities and vulnerabilities, which empower us to comprehend the choice circumstance (Citanna, 2006).

These numerical outcomes then should be made an interpretation of over into words keeping in mind the end goal to produce subjective knowledge. Financial theories speculation has been used to show the self-thought in social cerebrum inquire about (Citanna, 2006). “Exactly when the self attributes including the self-thought constitute an inside and out extended portfolio, then mental outcomes at the level of the person, for instance, slant and self-respect should be more consistent than when the self-thought is undiversified” (Citanna, 2006). This desire has been certified in studies including human subjects. Starting late, front line portfolio theory has been associated with showing the helplessness and relationship between records in information recuperation (McKenzie, & NetLibrary, 2002).

The favorable circumstances in budgetary portfolios financial theories are for helpful purposes, interminably distinguishable while plan of errands are uneven (Citanna, 2006). For example, while we can enroll that the perfect financial theories portfolio position for stocks is, say 35%, 21%, the perfect position for a wander portfolio may not allow us to simply change the entirety spent on a wander (The Securities Institute Journal, 2000). Endeavors might be win or forget about it if nothing else have sensible units that can't be disconnected. A portfolio headway strategy would need to consider the discrete method for exercises (The Securities Institute Journal, 2000).

The advantages of cash related financial theories are liquid they can be assessed or re-studied at whatever time (Citanna, 2006). In any case, open entryways for driving new undertakings may be obliged and may happen in confined windows of time (McKenzie, & NetLibrary, 2002).??

With the help of ratio analysis conclusion can be drawn regarding several aspects such as financial health, profitability and operational efficiency of the undertaking. Ratio analysis is a fundamental means of examining the health of a company by studying the relationships of key financial variables (Sahu, & Charan, 2013). A firm's ratios are normally compared to the ratios of other companies in that firm's industry or tracked over time internally in order to see trends (Sahu, & Charan, 2013). “Ratio analysis stands for the process of determining and presenting the relationship of items and group of items in the financial statement” (Sahu, & Charan, 2013). It is a way by which financial stability can be judged.

Ratio Analysis Theory is described as the best theory. Ratio analysis plays an important role in the financial field of making investment and landing decision by banks, insurance companies, and it simplifies the accounting figures and highlights their interrelationship between different segments of the business.?

References

Citanna, A. (2006). Essays in dynamic general equilibrium theory: Festschrift for david cass (1st ed.). New York;Berlin;: Springer. doi:10.1007/b138734 Elton, E. J. (2011). Modern portfolio theory and investment analysis (8th, International student ed.). Chichester;Hoboken, N.J;: Wiley. Levin, J (2006). General Equilibrium. Retrieved from https://web.stanford.edu/~jdlevin/Econ%20202/General%20Equilibrium.pdf Hagin, R., & Dow J.,Irwin. (1979). The dow jones-irwin guide to modern portfolio theory. Homewood, Ill: Dow-Jones-Irwin. Igben, R. O. (1999). Financial Accounting Made Simple. Lagos ROI Publishers. Lydenberg, S. (2016). Integrating systemic risk into modern portfolio theory and practice. Journal of Applied Corporate Finance, 28(2), 56-61. doi:10.1111/jacf.12175 Mauldin, J (2017). Modern Portfolio Theory 2.0: The Best Investment Strategy Today. Retrieved from https://www.forbes.com/sites/johnmauldin/2017/06/01/modern-portfolio-theory-2- 0-the-best-investment-strategy-today/#4bbf21c71f8f McKenzie, L. W., & NetLibrary, I. (2002). Classical general equilibrium theory. Cambridge, Mass: MIT Press. Tamari, M. (1978). Financial ratios: Analysis and prediction. London: P. Elek