INDIVIDUAL ASSIGNMENT:

CLASS ASSIGNMENT (TEST)

PRITIKA GUNASEGARAN
PBS20101010

FIN 7101 FINANCING BUSINESS

DATO’ DR. MOHD PADZIL HASHIM
PUTRA BUSINESS SCHOOL

11TH JULY 2021

 Class Assignment: PBS20101010

Table of Contents

Table of Contents (i)

Question 1: Profit and Wealth Maximization 1
Question 2: Cash Flows Are Important Than Profits 2
Question 3: Financial Ratios 3
Question 4: Three Forms of Stock Market Efficiency 4
Question 5: Systematic and Unsystematic Risks 5
References6

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1. Explain the main differences between the ‘profit maximization’ and

‘wealth maximization’ goals of corporations.

Profit maximization is defined as “the process of increasing earnings

capability of a company” (Sewak, n.d.); whereas wealth maximization is
“the ability of a company to increase the value of its stock for all
stakeholders” (Sewak, n.d.). Basically, the principal objective for every
business or organization is maximizing their profit or their income, which
provide short-term benefits. However, wealth maximization is where the
stakeholders, specifically shareholders, of a business are taken care of.

Based on Sewak (n.d.), these 2 goals have their own focus either for
private or public listed companies. The major focus of profit maximization
goals of a corporation is that the company wanted to earn high income in
short-term and it is normally within 12 months. In contrast, wealth
maximization focuses on long-term benefit, where the stakeholders’
value can be increased over time. In general, public listed companies
focuses more on maximizing their shareholders’ wealth, whereas private
corporation will aim upon profit maximization.

Referring to Biswal (2016), the wealth maximization goal is much

superior as compared profit maximization as the ultimate aim of the
corporations are to improve the values of the shareholders of a
company. Profit maximizing corporation do not consider about the risk
and uncertainty; however, wealth maximization organizations do take
into account the risks as it is relevant for the long-term sustainability.
Moreover, maximizing profit is aiming at improving the daily efficiency of
business operation as compared to wealth maximization, where the
companies will plan for their company’s future worth (Sewak, n.d.).

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2. Why are cash flows more important than accounting profits in

financial decisions?

Cash flow is the cash inflows and outflows from a business; whereas
accounting profit is the surplus of a business after deducting all the
related expenses from the revenue generated (Beers, 2021). Referring
to Boex (2015), cash flows is significant as it will provide relevant
information on the financial availability of a business from the statement
because it is a direct report on the availability of cash. However,
accounting profits can be easily manipulated as it includes non-cash
items, such as depreciation, upon arriving on the profit (Boex, 2015).

Based on Barclays Business (2019), cash flows are more important in

making financial decision because cash flows (1) will help with business
growth and expansion, (2) difficult to manipulate, (3) provide healthy
business future, (4) able to avoid debts, and (5) ability to attract new
investors (Coombes, 2016). Basically, cash flow will enable a business
to keep operating in the market, which will generate profit.

According to Coombes (2016), the positive or negative cash flows will

provide insights on the operational issues within a business, which is
unable to identify through accounting profit. Thus, with the cash flow
statement, reliable assurance will be provided to the management when
making financial decision as it is not prepared in accordance to accrual
concept like accounting profit.

In short, cash flows will shows the exact cash received and cash
payment within a business during a financial year, where all the non-

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cash items will be added back to the accounting profit, to determine the
cash availability.

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3. In what ways financial ratios can become a useful tool in analyzing

firms on the verge of financial stress / insolvent?

Referring to Ingram (2019), financial ratios are financial tools that can be
used to determine the company’s strength by performing simple
computation from the financial statements, such as balance sheet. Ang
et al. (2021) had explained that financial ratios have the ability to extract
the relevant information that are not obvious from the financial
statements. Thus, financial ratios are one of the ways that can be used
to analyze the firm’s financial stability.

There are 5 categories of financial ratios, which are profitability ratios,

asset management ratios, liquidity ratios, debt management ratios and
market value ratios. These ratios will provide insightful information to the
management as well as the investors on the firm’s performance over the
years (Ingram, 2019). At the same time, financial ratios will provide red
flags on the financial statements and early warning that the firm is
struggling with insolvency and financial distress.

According to Investopedia (2021), these financial ratios will give

warnings related to the firm’s financial stress or a signal of impending
bankruptcy. As an example, the debt management ratios will measure
the ability of the company in handling their financial obligations. Ingram
(2019) had further mentioned that financial ratios will go beyond the
numerical values and assess the health of the company despite their
size, market shares and sales volume.

So, it is important that the financial ratios computed should be analyzed

over a few years’ trends and benchmarked against the industry ratios.

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4. Explain the three forms of stock market efficiency i.e., strong form,
semi strong and weak form.

Market efficiency is defined as “the degree to which prices reflect all

available, relevant information about the actual value of the underlying
assets” (Investopedia, 2020). This shows that all investors will receive
the same information in an efficient market. In general, there are 3 forms
of market efficiency, which are (1) weak form, (2) semi-strong form, and
(3) strong form.

Firstly, weak form of stock market efficiency is where the current prices
of the securities or stock prices are affected by past information in the
market (Finance Train. n.d.). Based on Investopedia (2020), the past
information is not useful in forecasting the future prices as the past data
had been incorporated in the stock prices (Finance Train, n.d.).

Next form of stock market efficiency will be semi-strong, where the

stocks adjust quickly to absorb new public information including past
information (Investopedia, 2020). Referring to Marverick (2021), the
investors are unable to make profit by trading on the information as there
will be no impact from the insider information.

Lastly, strong form of stock market efficiency means that the securities
had included privately and publicly available information (Mahmud
Shaikat, n.d.). Referring to Marverick (2021), there is no special
information provided, which enable investors to gain abnormal profits.

In short, the market efficiency depends on the degrees of the information

available as well as the number of participants in the market.

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5. What are the significant of systematic risk and unsystematic risk in

assets portfolio analysis?

Systematic risk is defined as “the risk inherent to the entire market or

market segment” (Chen, 2021); whereas unsystematic risk is “risks that
are unique to a specific company or industry” (Chen, 2021). Vaidya (n.d.)
had explained that the systematic risks cannot be controlled and
applicable to all sectors. He further stated that the unsystematic risks
can occur at any time and can be controlled (Vaidya, n.d.). Some
examples of systematic risks are changes in taxation laws and natural
disasters. As for unsystematic risks are new entrants to the market and
changes in the regulations that affect one industry.

Referring to Chen (2021), systematic risk cannot be avoided through

diversification as it is only can be done via hedging and correct asset
allocation strategy; however, unsystematic risk can be done through
diversification. To reduce the whole portfolio risk, it is better to reduce
systematic risk by asset allocation and unsystematic risk by
diversification (Kenberry, 2020). Furthermore, portfolio optimization
should be done by the management without accepting additional risks
that will jeopardize their rewards (Kenberry, 2020).

Basically, risks plays an important role in decision making as it will allow

the investors to optimize their returns (Bowman, 2021). Bowman (2021)
had further explained that the more risk that can be quantified, the more
capital can be allocated to the riskier assets that bring higher returns. In
short, with the identification on the portfolio risks regardless of the
systematic or unsystematic risks, the management are able to choose to
be a risk seeker, risk averse or risk neutral when investing.

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References:

Ang, S.-K., Hong, J., Koh, A., Brigham, E. F., & Ehrhardt, M. C. (2021).
Financial management: theory and practice. Cengage Learning.

Beers, B. (2021, May 16). What's More Important, Cash Flow or Profits?
Investopedia.
https://www.investopedia.com/ask/answers/111714/whats-more-
important-cash-flow-or-profits.asp

Biswal, A. (2016, June 26). Profit Maximisation and Wealth

Maximisation.
LinkedIn. https://www.linkedin.com/pulse/profit-maximisation-
wealth-anshuman-biswal

Boex, A. (2015). Why cash flow is more important than profit. Nebraska
Business Development Center, 1–3.
https://www.unomaha.edu/nebraska-business-development-
center/_files/publications/cash-flow.pdf

Bowman, R. (2021, April 7). Portfolio Risk - How to measure & manage
risk of your investment portfolio. LEHNER INVESTMENTS.
https://catanacapital.com/blog/portfolio-risk-measure-manage-
investment-portfolio/

Chen, J. (2021, May 19). Systematic Risk Definition. Investopedia.

https://www.investopedia.com/terms/s/systematicrisk.asp/

Chen, J. (2021, May 19). Unsystematic Risk. Investopedia.

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https://www.investopedia.com/terms/u/unsystematicrisk.asp
Coombes, B. (2016, July 7). Why cash flow can be more important than
profit. accountants daily.
https://www.accountantsdaily.com.au/columns/9285-why-cash-
flow-can-be-more-important-than-profit

Ingram, D. (2019, February 12). The Advantages of Financial Ratios.

Small Business - Chron.com.
https://smallbusiness.chron.com/advantages-financial-ratios-
3973.html

Investopedia. (2020, October 23). Market Efficiency Defintion.

Investopedia.
https://www.investopedia.com/terms/m/marketefficiency.asp

Investopedia. (2021, June 27). Financial Ratios to Spot Companies

Headed for Bankruptcy. Investopedia.
https://www.investopedia.com/articles/active-
trading/081315/financial-ratios-spot-companies-headed-
bankruptcy.asp

Kenberry, K. F. (2020, December 9). Systematic Risk, Unsystematic

Risk,
Probability, and Expected Value. Arbor Asset Allocation Model
Portfolio (AAAMP) Value Blog.
https://www.arborinvestmentplanner.com/systematic-and-
unsystematic-risk-probability-and-expected-value-4

Mahmud Shaikat, M. N. (n.d.). What are the Three Forms of Market

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Efficiency. ORDNUR. https://ordnur.com/academic-

study/finance/what-are-the-three-forms-of-market-efficiency/
Market Efficiency and Its Three Forms. Finance Train. (n.d.).
https://financetrain.com/market-efficiency-and-its-three-forms/

Maverick, J. B. (2021, June 29). The Weak, Strong, and Semi-Strong

Efficient Market Hypotheses. Investopedia.
https://www.investopedia.com/ask/answers/032615/what-are-
differences-between-weak-strong-and-semistrong-versions-
efficient-market-hypothesis.asp

McClure, B. (2021, June 26). Financial Ratios to Spot Companies In

Financial Distress. Investopedia.
https://www.investopedia.com/articles/financial-theory/10/spotting-
companies-in-financial-distress.asp

Sewak, M. (n.d.). Wealth Maximization vs Profit Maximization.

WallStreetMojo. https://www.wallstreetmojo.com/wealth-
maximization-vs-profit-maximization/

Vaidya, D. (n.d.). Systematic Risk vs Unsystematic Risk.

WallStreetMojo.
https://www.wallstreetmojo.com/systematic-risk-vs-unsystematic-
risk/

Why cash flow is more important than profit. Cash flow vs profit |
Barclaycard Business. (2019).
https://www.barclaycard.co.uk/business/news-and-insights/why-is-
cash-flow-important

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