Financial considerations 1

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	Accounting: Financial considerations

Financial considerations

Risk and Return

When evaluating the financial position of a company you always have to consider the balance between risk and return. As a financial investment, the enterprise must earn a sufficient profit to compensate those investing in it for the variability, and uncertainty attached to dividend payments. These are paid at the discretion of directors - and can only be paid from 'distributable profit' so that companies cannot pay dividends from capital. During years in which companies make a loss dividends may still be paid out of profits retained from previous good years, but this cannot be sustained for many years. The variability of trading conditions faced by a company will clearly have a major influence on its ability consistently to earn profits.

However, the nature of the company's financial structure and operational characteristics will also affect the impact that changed trading conditions will have on profit.

Capital gearing

Where a company is financed by a large amount of debt (bank loans, debentures etc.) it is likely to have more variable profits than a company purely financed by shareholders' funds (equity). This is because the interest payments on debt finance are fixed and must be paid regardless of the trading conditions. These loans will be secured against the assets of the company so that any default in payments would probably result in the company being put into the hands of administrators, receivers or liquidators.