Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.
Financial Strategy in Accounting
Molly, a certified public accountant with a Chartered Global Management Accountant (CGMA) certification, is facilitating a class for students wishing to follow her success. She starts by telling them that the CGMA certification has over 37 topics, but they will focus on financial strategy today. Financial strategy outlines an organization's financial short and long-term goals.
For the rest of this lesson, we will follow along as Molly explores the three components of financial strategy: financing, investment and dividends.
Molly asks the students to identify two ways an organization finances assets. One student mentions 'debt' while another states 'equity.' Molly affirms and explains that debt falls into two categories: obtaining a loan or selling bonds. Organizations can seek a loan from financial institutions, which is dependent on their credit rating and the health of their financial statements. The benefits of financing assets with a loan include increased credit rating if payments are paid on time and retaining cash. Drawbacks include the loan's interest payments and having a contractual arrangement, which means creditors have legal stance to enforce the contract.
Bonds are similar to a loan, whereby an organization receives money from investors with a promise to repay sometime in the future. The organization pays interest to the investor and the partnership represents a contractual arrangement, which are disadvantages to the organization. A benefit of selling bonds is the delay in repayment, which can have a longer term than a loan, sometimes extending 20 to 30 years.
Next Molly explains that financing with equity includes selling stock. When investors purchase stock, the organization receives cash to finance their assets. She groups students and asks them to identify the advantages and disadvantages of selling stock. One group states that there is no guarantee of dividends (a percentage of the company's earnings) or increase in the stock price. However, a disadvantage includes a lack of demand to purchase the stock.
One student raises her hand and wonders if organizations can use both debt and equity to finance assets. Molly says, 'absolutely, but they must find the most optimal mixture.'
Now let's explore investments.
Just as individuals invest in organizations, organizations invest in each other, buying stocks and bonds. Molly posts the following statement on the board: 'Cash is a bad investment!' She asks students to explain. One student states that cash in a bank account receives little interest, while stocks, bonds and other investment vehicles provide higher interest rates. Molly agrees and provides an example of an insurance company who invests cash premiums, since the monies are not paid out in claims immediately. Just like individuals investing in stock, investors expect monies in the form of dividends and/or an increase in stock price. Additionally, they require interest payments for their investment in bonds.
Next, let's look at dividends.
Finally, Molly tells her students that when investors purchase stocks they expect two things: an increase in the stock price and dividends. Dividends are monies from an organization's earnings paid to investors in return for their investment in stock. As mentioned earlier, dividends are not guaranteed; however, they are expected. Dividends are usually paid quarterly and can be automatically reinvested based on the investor's preference.
Molly asks the class if they have any questions, then thanks them for participating.
Financial strategy outlines an organization's financial short and long-term goals. There are three main components of a organization's financial strategy: financing, investment and dividends. Financing involves determining if using debt, equity or a mixture of both is advantageous for purchasing assets. Investment focuses on making a profit, where stock dividends or bond interest represents the investor's profit.
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