2.1 The Chinese Financial System

2.1.1 Chinese Macro Financial System
The financial services in China have grown fast primarily because of the rapid development of the Chinese economy. By the end of 2011, the total assets of Chinese banks and financial institutions amounted to RMB 113trillion, an 18.9% growth as compared to 2010. In addition, the total liability of the Chinese banks and financial institutions was above RMB 106 trillion, an increase of 18.6% as compared with 2010 (CBRC, 2011).

The banking sector has benefited from the Chinese economic growth and played a leading role in the Chinese financial activities and allocation of Chinese credit resources (Banking Industry in China, n.d.). China started to reform its financial system after the implementation of the “open and reform” policy. In 1979, the central government decided to establish state-owned specialized banks. During the four decades development, the banking industry became the most important component in the Chinese financial system. As stated by the Boyreau-Debray (n.d.), the volume of intermediation by the Chinese banks is one of the highest worldwide, even higher than most of developed countries. It indicated that the Chinese banks play a significant role in the Chinese financial systems.

One primary feature of the Chinese banking system involves the prominent state involvement. (Geretto & Pauluzzo, 2008). The main financial institutions are state-owned and directly controlled by the central government. “The structure of the bank systems is like a pyramid” (Geretto & Pauluzzo, 2008). As the figure1 shows, the top of the pyramid presents the People’s Bank of China (PBOC), which is the central bank of China that exclusively focuses on monetary policy issues and the China Banking Regulatory Commission (CBRC), established to deal with the regulatory and supervisory activities (Geretto & Pauluzzo, 2008). The Chinese financial activities are responsible for four types of financial institutions including commercial banks, state policy banks, credit cooperatives and other financial institutions. Commercial banks and state policy banks are the central part of the banking system, both operating under the state ownership.

Commercial banks are responsible for providing financial services to the public. The four large state-owned commercial banks include the Bank of China (BOC), Agricultural Bank of China (ABC), China Construction Bank (CCB) and the Industrial & Commercial Bank of China (ICBC). These four banks are the major players in the Chinese banking industry. According to the CRBC, the total assets of the four large stated-owned banks represent 47.3% of the total assets linked to the Chinese banking institutions, with an amount of RMB 53.6trillion. The total liabilities apparently are RMB 50.3 trillion, accounting for 47.7% of the total liabilities of the Chinese banking institutions (CBRC, 2011). The large state-owned banks’ absolute amount however increased, while their proportion of the banking institution was decreasing. In comparison to other commercial banks (share-holding commercial banks and city banks), their total assets and liabilities percentages in relation to the total amount of the banking institution has been increasing. In consequence, this indicated that the small commercial banks play a great role within the Chinese financial market.

Besides the four large state-owned banks, the commercial banks have other important bank categories including the Joint Stock Commercial Banks and City Commercial banks under the ownership of the state, local authorities and other investors. Some of them had placed their shares on the stock markets and due to their dynamism and management efficiency, they have been growing fast, currently holding a market share of 16% (Geretto & Pauluzzo, 2008). Their rapid growth rate attracted great interest from the foreign banks such that 50% of the 13 Joint Stock commercial banks in China comprise foreign investor shares. City Commercial banks were exclusively operating in the major urban city within China, under the local government and companies’ ownership, with approximately 5% market share (Geretto & Pauluzzo, 2008).

Another key player in the Chinese banking system involves the Rural Credit Cooperatives (Geretto & Pauluzzo, 2008). The country has around 40,000 cooperative banks with a market share of 10%. The banks serve primarily serve the distant SMEs’ financial activities. Until a few years ago, cooperative banks were under the control of the Agricultural Bank of China. Apparently, the banks are under the supervision of the PBOC (Geretto & Pauluzzo, 2008).

After China enrolled into WTO, the government established a financial system that has fostered the rapid expansion of the foreign banks. Although the unit numbers of the foreign banks has increased rapidly, they account for only 2% of the market share (Geretto & Pauluzzo, 2008).

2.1.2 The Bank Loan Business in China
The bank loan in China is under the supervision of the government agency (i.e. the Central Bank of China). According to the annual government’s macro economy adjustments plan and its monetary policy, the central bank of China sets the goals and provides suggestions to the commercial bank regarding the total amount of bank loans allowed annually. Since 1984, the central bank of China has been using credit scale management as the main credit policy in supporting the implementation of the monetary policy. The implementation of this policy helped in assigning the loan size and regulated the credit structure for each financial institution.

The main purpose of the credit policy is controlling the credit scale. The previous year’s total amount of deposits in each bank is the most important index for the current year’s loan granted. In other words, if the bank has larger amount of deposit, it could give larger loans to the public (Zhang & Wang, 2002). In 1998, in order to loosen the government’s supervision of the credit market and decrease the governmental influence, the Chinese government abolished the written regulations for credit scale. The Central Bank of China nevertheless is still the major director of the bank loan business and the supervisor to the Chinese credit market (Brife introduction of Chinese Credit Policy, 2009). The implication from this is that the central bank canceled the written documents concerning the limitation of loan size but still controls the chinese commerial banks’ creidt scale partly.

According to the Financial Statistic Report of January 8th, 2012, the amount of credit expansion in 2011 is RMB 7.74 trillion (Financial Report in 2011, 2012). Zhong, the deputy director of the Bank of China internationl finanical institue stated that the credit expansion in 2012 is in line with the expectations and this loan amount is apporpriate, having an increase that range between 13% to 14%. This amount not only satsfies the needs of the national economy development, but also prevents the economy from overheating and avoids the risk of inflation (Financial Report in 2011, 2012). In addtion, the loan size in the 4th quarter 2011 had a huge increase indicating that the loan lending gradually increase to offer support to the economy thereby increasing the market confidence (Financial Report in 2011, 2012). Since the global financial crisis, the governement published a series of regulations and measures to support the economy. In 2009, the government released RMB 9.6 trillion new loans, which was the highest record in the recent years. Based on the forecast, the government will keep the economy in a stable development and the credit expansion will range between 8 and 8.5 trillion in 2012 (The new loans size will be lightly expanded, 2012).

2.1.3 The SMEs Bank Loan Business in China
2.1.3.1 The Status of SMEs Bank Loan
In 2007, the China Banking Regulatory Commission published regulations that aimed to clear the terms of SMEs loan and widened the scope of SMEs loans. It defined the SMEs loans to be less than RMB 5 million. The scope of the SMEs size should not exceed total assets of RMB10 million or the total sales less than RMB 30 million (The guide of SMEs loans for the bank, 2007). To the commercial banks, they separated SMEs loans and the large firms loan, classifying their standards to define SMEs while also providing SMEs loan services. Besides the present definations of SMEs, the commision also has other standards to the commercial bank that define the SMEs. The Bank of China for example define SMEs as the total assets, less than RMB10 million or the annuals sales, less than RMB 30 million (Wang, 2011). Considering that commerical banks set different classification standards to define SMEs, the service scope of the commercial bank is different. The classification mainly however accord to the firms total assets and the amount of lending (Zheng, 2009).

At the end of 2010, the total SMEs loan lending was RMB17.68 trillion, which was an increase of 22.4% from the last year. Although the increase of SMEs loan was less than that in 2009 (30.1%), the SMEs loan from banks is still much higher as compared to that from other financial institutions(19.9%) and from the informal financial institutions (15.3%) (Shi, 2010). Compared to the SMEs loans size, the small business loans have increased faster, a 29.3% increase from 2009, amounting to RMB7.55 trillion (Shi, 2010).

The proportion of SMEs total lending in financial insitutions’ total lending was increased. In 2010 for instance, 36.91% of financial institutions’ loan involved the SMEs lending, 36.05 % in 2009 and 36.50% in 2008. The percentage of SMEs loans in all the RMB loans also increased, which was a 15.76% of total RMB loans in 2010, 14.59% in 2009 and 14.57% in 2008 (Shi, 2010). The number indicated that the governemnt is gradually strengthening the support of SMEs development by providing more credit to the SMEs. Although the SMEs loan was increased annually, it only occupied about 30% of the banks total lending in 2010, compared to its economic role in the Chinese economy that represents more than 99% of the enterprises in China, implying that the lending for SMEs is still inadequate.

In order to further development of the commercial bank services for the SMEs in 2011, the PBOC 60% regulated bank credit expansion need to integrate into the real economy. The SMEs loan further should be more than 30% of the banks’ total credit lending (Xinhua News, 2011). Moreover, the central government required the commercial bank to set up an independent department to faciliate the SMEs financing. By the end of 2010, there were about 109 commercial banks that set up an independent financial department for serving SMEs. The central government also required the commercial bank to release their informatin about the SMEs lending, called the “2+2+2” model. It required the commercial banks to publish the lending information about the types of enterprises (i.e. small or medium size), the amount SMEs deposit or lending, the number of SMEs total amount and the account for the percentage levels (Shi, 2010).

2.1.3.2 The Loan Requirements from Banks
Whenever SMEs are borrowing money, they will sign a lending contract with a bank containing all the constraint of both size including the total loan size, the interest rate, the amount of collateral required and the repayment terms.
The Central Bank of China has regulated the standard interest rate for the bank loan. According to regulations, the government allowed the bank loans to increase about 30% of the interest rate. This implies that the interest rate of the bank loan is about 130% of the standard interest rate. The premium of the interest rate for bank loans was decided by the bank, aligning to the financial situation of the borrower, the loan risk and other factors. For example, the range of the Bank of China’s premium interest rate for SMEs lending is -10% to 70%, while the interest rate of bank loan is usually 130% of the standard interest rate (Wang, 2011).

The bank also has a requirment of the loan size, that usually depends on the company’s total assets and their collateral amount. For example, the maximum amount of the Bank of China’s SMEs loans is 70% of the firms’ collateral value. If the firm wishes to get a larger loan size, they will be required to buy an insurance provided by a recognized insurance companybut the large lending requires a higher interest rate.
Most banks prefer capital assets such as lands, equipment and plants to serve as the collateral because it is easy to sell-off once the borrower fails to payback the money. Besides, they also could provide other kinds of collateral such as the sales contracts, account recievable and other intangible assets. The lending for SMEs loans are usually short term loan usually with a duration of one year.
To lend loans, the SMEs not only need to fulfill the requirtments of the “ General Rule for Bank Loan”, but also must meet the requirements for the bank rules. Commercial banks have different requirements for accessing business loans as compared to the requirements for the large four state-owned commercial banks.

The general requirements for commerical banks are similar despite the fact that they have few different specifities. They all set a requirement for the debt to asset ratio, a sound operating context and a viable financial condition, among others. For example, the ICBC ( Industrial and Commercial Bank of China) has other five entrance criterias for providing bank loans. The details requiremnts are as follows:
The firm needs to meet all the requirements for the “General Rule for Bank Loan” and the subsequent requirements
The firm needs to have a grade above A, according to the ICBC’s credit assessment,
The Debt to Asset ratio should be below 70% plus a large-sized production or business operation
The ratio of production and sales should be higher than 95% in the succeeding three years, have a positive net incomes, good reputation and ability for timely repayment of the interest and principal
Prohibition of using the current assets to fixed assets’ investment. (Xiong, 2010)
In addtion, according to the Bank of China, the SMEs needs to provide the following materials when they are handling the application of a bank loan. The checklist for the Bank of China is as follows (Wang, 2011):

1. Business license, organizational code certificate and tax registration certificate.
2. The contract between the borrower, the guarantor’s firms or the firm’s constitution and the capital verification report
3.The materials for credit rating of borrower and guarantor
4. The loan card and all the information of loan card
5. Identification document of borrower and the borrower’s credit report
6. One year record of the main bank settlement account
7. The list of collateral and the certification of the collateral
8. Two years financial statement and the latest monthly financial statement
9. Other necessary materials

Requirements for the bank loan indeed are so complex and restricted making most of SMEs reluctant to borrow loans from the banks. Liu (2009) conducted a research to examine the bank loan requirements among 1000 SMEs in China. In his paper, according to the “Commercial Bank Law” and “General Rule of Bank Loan”, the individual listed 35 requirements for acquiring bank loan. He found that, in general, SMEs are only able to meet 10 requirements while the 25 loan requirements for SMEs are hard to reach. Moreover, the 25 requirements are the basic criteria for applying bank loan. The inability to satisfy the bank loan requirements serves as one major reason why SMEs are unable to access bank loans.

2.1.4 The Small and Medium Sized Commercial Banks
2.1.4.1 The Definition of Small and Medium Commercial Banks
The definition of small and medium sized commercial bank is wide. This report defines the small and medium sized commercial banks as all commercial banks except for the four large State banks. Although the asset scale for those banks is relatively small and hold smaller market share in China, their development is very fast. Compared to the four large state-owned banks, the small and medium-sized banks have some advantages in terms of operations and management. They have a more flexible system, a faster market response, higher efficiency in decision-making and operations plus better skills in customer relationship management. Such advantages make the banks to secure faster development within the Chinese banking industry.

The function of the small and medium-sized banks involves not only approving loans and bank services, but also, the most important, bringing in new ideas and method to facilitate better operations of the Chinese banks (Lu, 2009). The participation of small and medium-sized banks results to a condition that allows the transformation of the Chinese banking industry to become competitive. In consequence, the services level improved across the whole banking industry through the benign competition.

2.1.4.2 The Small Banks are more suitable for financing SMEs
There is a rule for the credit services: the larger the bank is, the more the preference to serve large companies, while it is uneconomical for the large sized banks to serve SMEs (Chen, 2001). Many scholars supported the “small bank advantage” hypothesis through studying the bank’s decision on serving small businesses. Compared with large banks, small banks tend to provide more loan services for the small businesses, in terms of the share of their total assets and the share of the total lending amount (Berger & Udell, 1995; Strahan & Weston, 1996 and Peek & Rosengern, 1998). This is because small banks, especially the local small banks have higher ability to collect the “soft information”. Chen (2001) added that it is uneconomical for small banks to compete with the large banks for clients from large companies. The author also provided an illustration that many American small banks were focusing on financing the small businesses, while the large banks were focusing on large companies. The Bank of America for example focuses on financing the SMEs and has a high return on assets ratio.

The theory of “relationship lending” also provided a proof that the small banks have advantages in serving small businesses as compared to the large banks. Berger and Udell (1995) divided the loan types into four types. Three of them could view loans as the transactions-based lending, which highly rely on the “hard information”, such as the companies’ financial statements and total volume of collateral in assessing the banks. The relationships between the banks and companies are distant in those three types of lending. The information collected from the banks relies heavily on the companies’ documents in hand while in contract, the relationship lending relies more on the “soft information”. The soft information is normally incapable of collecting information from the companies’ public document.

The banks therefore acquire this information by prior relations with the firm’s owners or other connections with the firms’ shareholders or relationships with the local community. This soft information could help the banks gain more information about the company, which could make up the shortfalls of the “hard information” collecting. Cole, Goldberg and White (1999) studied the lending behaviors of large banks to small businesses. The findings showed that the large banks approve their small business loans relying more on the “hard information” and less on the “soft information” as compared to the small banks and tends to prefer transactions-based lending.

 

Chinese scholars also have different opinions about the relationships between the bank size and small business lending. Lin and Li (2001) argued that due to SMEs’ incomplete financial management system, they are unable to provide the reliable financial information to the large banks, while this financial information is the hard information that the large banks require when lending credit to SMEs. The information asymmetry between banks and firms is the major reason why large banks are unfit for financing SMEs. Therefore, they advocated developing small financial institution and establishing a small bank oriented banking system to support the SMEs finance (Lin & Rongjun, 2001). Li (2002) proposed an enterprises credit model and concluded that the homogenization of SMEs, the loan to value ratio and the number of the large firms’ project are the major factors affecting the SMEs loan in the large banks. Under the situation of credit crunch, the larger banks will decrease the amount of SMEs loan, while the introduction of the small banks and financial institutions could help to solve the problem of SMEs financing.

The small banks and financial institutions have advantages to gain information. Moreover, there is a positive relationship between the number of small financial institution units and the total amount of the SMEs lending. Li (2002) stressed that, for a long run, developing a bank system, based on the small banks and small financial institutions can serve as the foundational solution to the SMEs financing problems (Li, 2002).

Liang (2007) similarly thought that small banks have advantages in relationship lending because their flat organization structure benefits or gain from the SMEs’ soft information. The author also applied the conclusion from Jayaratne and Wolken (1999) that stated that the ratio of large banks for SMEs lending is smaller as compared to the small banks. Liang (2007) also provided a proof in the conclusion using the evidence from an American bank’s financial report. The report showed that the ratio of total SMEs lending to total assets in the small bank is 9%, while the ratio is less than 3% in large bank thereby indicating that the SMEs lending in small banks is three times that of the large banks.

Through such articles’ opinions, there was an agreement that the small banks have more advantages in gaining the soft information from the SMEs, tending to provide the financing services to SMEs in comparison to large banks. In addition, under the conditions of Chinese financial system, the small banks are more suitable for financing SMEs. Lu (2010) studied the relationships between small banks and SMEs and stated that the small banks are the best financial providers for SMEs because they have similar scales in the market and can satisfy the SMEs financial needs while also providing better financial services. The author moreover argued that the nature of small banks is helping to serve the SMEs, based on the Chinese financial history, through which the small banks developed to facilitate SMEs financing at the beginning.

Shu (2011) also stated that “Guangxi” (relationships), a prominent Chinese business culture, is a key factor affecting the Chinese social activities. The relationship lending system therefore is effective and fits the Chinese culture. Meanwhile, the small banks are good at gaining soft information, applying the relationship lending in small banks loan business under the win-win situation. Chinese banking system in the large bank is more hierarchical. This multilayer organizational structure makes the information hard to transfer between the high and low level, thus resulting to information irregularities. In addition, the organizational setting in large banks based on the region implies that the information-transfer needs a relatively longer time. As a result, the relationship lending is unsuitable for application by the large banks. In contrast, the small banks are the main intermediary in providing or facilitating relationship for the SMEs.

2.2 The Current Finance Situation of SMEs
2.2.1 The Definition of SMEs
The definition of SMEs differs from one country to another, usually based on the number of employees, the volume of sales, the value of assets or the use of energy. In China, the definition of SMEs has undergone adjustments a number of times since 1949. In June 18, 2011, a new Standard on the Small and Medium-Sized Enterprises document was published for the Chinese government agencies under the approval of the State Council in China (New Standards on Small and Medium Enterprises, 2011) (Table1). The standards apply to all relevant government agencies for work and replace the old classification standards, which came into effect in 1993. According to the new stipulation, the scope of the medium-sized companies narrow and the small-sized companies expand. In general, the SMEs is defined as having up to a maximum of 2000 people, with an annual revenue not exceeding RMB 800 million and total assets not exceeding RMB1.2 billion (New Standards on Small and Medium Enterprises, 2011). Those numbers however vary from one industry to another because of the diverse industrial nature. Although the SMEs definition includes relatively large firms, defined in other countries, the labor intensity of production and huge sized companies in China still make these firms relatively small.

The new classification standard also created a new category, the micro-sized companies. Based on the new stipulation, companies are regarded as micro-sized enterprises if they employ fewer than 5 people, earn less than 10 million yuan in annual sales and have asset less than 10 million yuan (New Standards on Small and Medium Enterprises, 2011). Creation of the new category of micro-sized enterprises will give more support to smaller companies while preventing some well-capitalized medium-sized firms from grabbing resources from the smaller ones (Zhong & Zhang, 2010). The new definition of SMEs gives smaller companies wider access to policy and financial support worth tens of billions of yuan (Zhong & Zhang, 2010).

The definition of SME is quite complex in China since it is also classified to facilitate administrative purposes. Chinese SMEs include various types of corporate forms, such as state-owned, urban concentration, township enterprises, private and individual enterprise, among others (Zhou, Guo, & Lu, 2010). In general, SMEs can divide into two major categories including the “rural” and “urban”. Rural SMEs include almost township and village enterprises with community ownership and self-employment. Urban SMEs include small and medium-sized state-owned enterprises (SOEs), self-employed, private firms and other ownership forms. Nonetheless, majority of SMEs in China are non-SOEs since the number of small and medium-sized SOEs is small while majority of them are large corporations (Li, 2011).

2.2.2 SMEs play an increasing important role in Chinese economy
Chinese economic and enterprise reforms since 1978 has caused changes in many Chinese enterprises’ structures. Some of the remarkable changes of the Chinese economy involve the decline in the number of state owned enterprises (SOEs) plus the dramatic increase in small businesses. In addition, since the Deng Xiaoping’s Southern Tour in 1992, the economy has experienced another reform. The new environment has introduced a new class of private and collective firms that is very different from the SOEs and is more entrepreneurial. During this period, a large number of new business enterprises have emerged under the shadow of the dominant SOEs. The rapid rise in this new type of businesses reveals that the Chinese economy is under transition, from the state to private enterprise domination. Further, in 2001, China joined the World Trade Organization and this has facilitated rapid growth of the economy thereby creating an attractive environment for the development of small businesses (Anderson, Li, Harrison, & Robson, 2003).

The increasing role of the small businesses in the Chinese economy is evident from its significant contribution to the Chinese national income and employment. According to the Xinhua News report, in 2010, 99 percent of the country’s 10.3 million companies in China are SMEs, accounting for more than 80 percent of the urban employment and producing 60 percent of GDP in China (New Standards on Small and Medium Enterprises, 2011). Presently, SMEs have become engines of China’s rapid economic growth and the major force in facilitating the economic growth. Besides SMEs development providing additional sources of income to the community, they also motivate or stimulate firms to adopt the appropriate technology (Li, 2011). Development of SMEs moreover leads to effective capital resource allocation and converts local savings into local investment thereby helping to facilitate the economic development of the community.

Economic development of one area will consequently affect the local community’s development and the living standards of the local populations. Local community environment however is a highly influential factor on the development of the local economy. Government, individuals and businesses, who are the basic community components stand separately in the three point of a power triangle (figure 1). The components interrelate and interact with one another implying that the development of SMEs is not only beneficial to firms but also relates to the entire community’s development.

2.2.3 Government Support for SMEs Financing
In recent years, the Chinese government has adopted a series of promotion regulations and measures in order to solve the financing problem faced by SMEs. In 2003, Chinese government enacted the “Promotion of Small and Medium-sized Development Law”, which lays the groundwork for public support for SMEs. Under the law, the government protected the legal rights of SMEs, as well as identifying priority sectors for SMEs development (LIU, n.d.). In 2004, the People’s Bank of China expanded the fluctuation range of annual interest rate to SMEs’ external lending that aimed to enhance the positivity of the commercial banks and financial insitututions lending for SMEs. This policy helps SMEs alleviate the difficulties of getting external finance to some extent; however, financing difficulties faced by SMEs persisted and did not radically offer solutions (Xiong Z. , 2010). In 2006, the government published the SMEs Growth Project whose one of its major objectives was to solve the financing difficulties affecting SMEs (LIU, n.d.). In the later years, Chinese government has published more policies to support and protect the developement of SMEs, allocating a state budget for SME financing and setting up an SME development fund. In addtion, the government has been providing other preferential policies to the SMEs including the tax incentives and establishment of a credit guarantee system for SMEs (LIU, n.d.).

Since 2008 the Chinese Central government has pushed proacitve fiscal policies and moderately easy monetary policies, as well as a series of measures to stimulate the Chinese economy. The SMEs are the most vulnerable among Chinese enterprises but the government provision of the unprecedented financial support for the SMEs helped to counter such difficulties. The provision included enlarging the support to the credit granted company through capital investment and risk compensation by local government, establishing the multiple echelons management of the loan guaranteed funds for SMEs, increasing the amount of SMEs borrowing as well as tax exemption for the legal credit guaranteed companies (Zheng, 2009).

The Central Bank of China, China Banking Regulatory Commission (CBRC) and commercial banks adopted various policies to help the Chinese SMEs overcome the financing dilemma. For example, the Central Bank of China used micro adjustment to support SMEs financing, including diversifying money policies, guiding the financial institutions to provide more services for SMEs and promoting the credit system establishment. In addition, CBRC also required the large and medium-sized to establish special departments for serving SMEs plus increased tolerance of the SMEs’ non-performance loan, in relation to improving the financial environment of the SMEs (Zhou, Guo, & Lu, 2010) (LIU, n.d.).

Although the government adopted a series of promotional policies and regulations to support SMEs, the financial situation of SMEs did not appear optimistic. In a long time, Chinese SMEs have been facing financial difficulties, especially when requiring external financial sources. Under this unfavorable condition, the capabilities of development to SMEs are highly limited. Moreover, the 2008 global financial crisis made the SMEs’ financing situation worse while making them face serious capital shortages consequently making many small businesses bankrupt or close down. According to the statistic from CBRC, the amount of credit expansion in 2008 increased by 18.76%, with 4.91 trillion RMB, while only 0.5% of incremental credit was for SMEs with an amount of only 22.5 billion RMB. In the early periods of 2009, the loan situation for SMEs was worse such that the incremental credit from four state commercial banks accounted for 34% of the total lending, while only 6.6% of this new loan was from SMEs (The Central Bank of China).

Despite the fact that the SMEs’ share of the new lending is shaky, SMEs still rely heavily on bank loan as their major external financial resource and 80% of the SMEs capital generates from banks. Meanwhile, the bank policies changes are making the problem facing SMEs more obvious. Since the global financial crisis, more SMEs have been feeling that the supply of the bank loan is inadequate while perceiving that it is more difficult to access bank loan than before. According to the Ministry of Industrial and Information Technology’s survey, 60% of the 4000 interviewees (SMEs) considered that the financial difficulties are the largest obstacles to their survival and development.

2.3 Why SMEs face Difficulties in Accessing Credit Loan from Banks
Chinese SMEs loan business is underdeveloped such that without considering the few successful projects and examples, most SMEs have been struggling and trapped in financial difficulties or dilemma for a long time. Although many commercial banks have great desire to conduct the credit loan business and the government has published many policies and measures to support SMEs finance, the SME loan operations remain worrying. Several hurdles could help in explaining this situation and the illustration for this portion will follow three major perspectives to elaborate those reasons, including SMEs, Bank and government.

2.3.1 Reasons from SMEs.
2.3.1.1 Low Operation Capacity
According to the Chinese Ministry of Industrial and Information technology report of 2011, low risk resistance capacity was one of the major reasons for SMEs difficulties in accessing loans. The SMEs usually operate with under problems including small operation size, scarcity of product mix, low technical level, volatile raw material cost, changes in industrial situations and other unknown factors, which have a vital affect on the SMEs survival and development. During the operation process, the capital chain is easy to break down thereby making the firms to suffer external risks. It has a considerable portion of SMEs operating under the stipulated standards while earning little profits or even at the break-even point, they may lack the ability to absorb cash or working capital to support their daily operations.

Moreover, the financial resources in some SMEs do not afford to maintain their firms’ daily operations, let alone to accumulate enough capital for technological innovation. The firms’ life cycle therefore is short and unable to continue or progress (Zheng, 2009). According to statistics (2005), in Guangdong province, there are about 150,000 private enterprise-start ups, while more than 100,000 went bankrupt. About 60% of total enterprises lasted only five years while about 85% lasted 10 years thereby making the average lifetime of the enterprise to be 2.9 years. For a bank, security, stability and profitability are the core principles for lending loans. In order to avoid risks and improve the loan quality, banks usually refuse the loan requirement from the SMEs.

2.3.1.2 Unstandardized Management and Informational Opaque
The research report also mentioned that the unstandardized management makes many small enterprises to lack a complete financial management system (Research reported for SMEs financing situation in Guangdong province, 2011). Due to most of the managers increasingly relying on their personal experiences and lacking systematic financial management knowledge such as risk management and credit sense, they usually do not have a long-term plan to manage their finance. In addition, the informational opaque presents difficulties for them to access credit from banks. Majority of the small private companies are unwilling to publish their financial information thereby presenting difficulties for banks to access the company’s information or inability to know the company’s credit level. In order to make sure there is capital security and risk avoidance therefore, the banks are unwilling to lend loans.

2.3.1.3 Lack of Tangible Assets Pledge as Collateral
The financial institutions prefer to use capital assets as collateral, such as land, equipment and plants considering that such assets are easier to sell off (Zheng, 2009). However, most SMEs are lacking such kinds of capital assets because they are unable to meet the lending requirements consequently attracting challenges when borrowing money. Only 40% of the firms could pledge plants or equipment as collateral when borrowing money in Guangdong Province (Research reported for SMEs financing situation in Guangdong province, 2011). In other words, SMEs have less property to serve as security while also suffering weaknesses in relation to assumed liability ability making them unable to fulfill loan acquisition requirements.

2.3.1.4 No Reliable Credit Reference
The Chinese financial system is in its infant stage and its credit reference system is imperfect such that most of the companies have no credit reference in the bank’s record (Xiong Z. , 2010). In addition, basic characteristics of SMEs, small operation scale, frequent change of the organizational structure, chaos in the internal financial system and unstandardized financial management makes it difficult for banks to grade companies’ credit level. Worse still, there are many examples of SMEs operating illegally. For example, there are issues of avoiding creditor by sham bankruptcy. Such negative examples reduce the enthusiasm of the banks operating loan business for SMEs. Most of the SMEs businesses also are trading by cash without contracts thereby making banks to face difficulties while investigating the company’s financial situation.

2.3.2 Reasons from Bank
To banks, both commercial banks and other form of banks are carriers of the government financial policies such that their operations suffer restrains from the government agencies. On the other hand, banks as business players are responsible for the risk such that their capital risk management is the primary task for their operation.
2.3.2.1 SMEs Loan is High Costs but Low Profits
Maximizing profit is the core principle for the commercial bank’s operation and earning profits is their ultimate target (LU, 2006). In order to gain more profits, commercial banks should not only arrange their capital structures rationally but should similarly decrease their operational costs. Under the supervision of the China Bank Regulatory, the banks have to follow a series of prescriptive processes to approve a loan.

In addition, regardless of how much the loan is worth, the approval process is exactly same. This means that the costs of each loan from the banks are almost the same regardless of whether it is a large or a micro loan. Due to the fact that SMEs loan are usually of smaller amount, the cost on providing loans to SMEs is higher as compared to providing loans to large firms. The SMEs loan is for short term with a small amount such that the profits generated by the banks are relatively small. In addition, SMEs have frequent demands for loan, thereby increasing the operational costs and the workload of debt collection. The costs of SMEs loan is more than five times higher that of large companies loan (Sun, 2009). Under the business principle of commercial bank, banks therefore prefer to provide large loan for the companies.

2.3.2.2 The Bank have restricted Requirements for Loans
The credit assessment is a basic requirement for accessing credit. Currently, each bank has an explicit requirement for applying credit under the regulation of the head offices. However, regardless of how much a loan is worth, there are standard metrics for all the applicants. One of the application requirements is providing a three-year financial statement and the applicants should reach a higher level in relation to the banks’ credit assessment. Most SMEs however operate without a completed financial management. Worse still, most of them have operated for less than three years such that they are unable to provide three-year financial statements. In addition, in order to secure the loan quality, most banks only provide the working capital loan for the SMEs with fixed assets collateral. However, majority of the SMEs are weak in relation to capital ability, with less property for loan security. As a result, many SMEs cannot access bank loans because the overall strict access requirements make it challenging or impossible for SMEs to apply bank loan.

2.3.2.3The Bank Lack of Risk Management Skill for SMEs Loan
Banks are unable to effectively control the risk of SMEs loan (Sun, 2009). Under the situation of information asymmetric, the bank can only rely on the firm’s finance report to understand the firm’s business situation, which is an important information used in verifying the loan request. SMEs however lack the completed financial management thereby incapacitating them in providing complete financial information for the bank (Sun, 2009). In addition, to gain a loan successfully, the applicants tend to exaggerate the firm’s financial performance while hiding their weakness thus raising some questions regarding the information provided by the firm. Further, the lack of strict financial supervision and management from reliable regulators makes the banks unable to acquire all the credit information from loan applicants subsequently making banks to take relatively high risks in providing the SMEs loan. Meanwhile, the government’s supervision agencies restricts to the non-performing loan ratio in commercial banks. Under the security principle for the bank operation, the bank is more careful when granting loans to SMEs.

2.3.2. 4 The Bank’s Unsound Incentive Mechanism
The restriction and incentive mechanism is asymmetrical within the banks. In order to secure a loan and ensure the loan’s quality, banks restrict the funds lending at the cost of leaving the profits opportunities. Until the market of large company loan business was saturated, commercial banks did not have to make efforts in providing an incentive for the banks to expand the SMEs loan business (Sun, 2009). Due to the rigorous government regulations and the unsound incentive mechanism, the commercial banks are not interested in expanding the loan business for SMEs.

Lacking financial channels for SMEs financing is a universal phenomenon of the Chinese financial institutions. The unsound incentive system made the commercial banks uninterested in developing the loan business (LU, 2006). As a result, the credit loan products or financing channels provided for the SMEs are rare. In addition, some of banks financing SMEs aim to meet the requirements from the government (LU, 2006). Therefore, they are reluctant to expand the SMEs loan business because this business is unprofitable.

2.3.3 Reason from the Government
To start with, the uncompleted financial environment affecting the SMEs bank loan business whereby the government agencies fully control the financial system and have series of regulations constraining the banks’ operations (Sun, 2009). For example, the PBOC use the ratio non-performance loan (NPL) in assessing the banks’ operation performance. This policy makes the banks to be strict on their authority to control its funds in securing the quality of its loan that discourage the enthusiasm for the bank in financing SMEs. The banks moreover will decrease the proportion of SMEs loan while tightening up the requirements for the SMEs loan in order to decrease the risk and the NPL ratio.

Secondly, the uncompleted credit assessment system makes the banks uninterested in the SMEs loan business (Zheng, 2009). SMEs engage in a wide range of industries such that they have their own industrial attributes. It is hard to use the same standard to verify their operation situation. In order to secure the loan, the banks must have the strength in dealing with the SMEs’ owners while also knowing well the SMEs’ situation and the flexibly management ability. It is actually an expensive business for the banks. It is however imperative to note that the banks could not find a standard in assessing the firms risk possibilities in relation to lending money, especially when the companies have limited knowledge. On the other hand, the SMEs could not find sufficient evidence to prove their credit without a reliable credit assessment thus making the banks unwilling in adopting this business.

Thirdly, the uncompleted regulation framework could not protect the lenders. Due to the uncompleted regulations, there are many non-performance loans from the SMEs. In addition, many SMEs evade payment for debt by taking legal loopholes. Recently, the Chinese government adopted a series of measures in support of the SMEs although the financial system is under-developed. In consequence, majority of the financial sources pull to the large enterprises thus making it hard for SMEs to access the financial resources.

 This law was issued by the Central Bank of China in June 28th, 2009. This law stated the basic requirements for giving bank loans. The details could be checked in the Central Bank of China website. The link is http://www.pbc.gov.cn/rhwg/19961202f.htm
 Chinese Banking Regulatory Commission.
 Taken form Wang report on the Second Lu JiaZui Conference, Ministry of Industry and Information Technology

 

Reasons for International Difference in Financial Reporting

1.0 Introduction
The articles which will be described in this paper are all geared towards financial reporting in the international market which companies prefers at various capacities. All of them shall be focused on institutional theory which is a key feature in financial reporting in the international market. Christopher Bobes concentrates on classification and international accounting, Christian Leuz regulations and standards while Harrison and MacKinnon touches on corporate reporting regulations and accounting policy formulations. New technological framework which has been introduced in the financial market in corporate accounting and regulations will as well be considered. The study of corporate reporting is considered since it’s viewed in the perspective of social systems as well as change analysis paramount in such a system. Its consideration as a social system is facilitated by the fact that norms are examined, values highly regarded in study of the inter-dependence which exists both internally as well as in other social systems (Gernon & Wallace, 1995).

Various countries adopt various methods of reporting regulations in their financial systems which are based on the institutional framework in existence in these nations. Various clusters do exist among nations in their corporate reporting systems which will be discussed in details later in this analysis. However, there is usually a divergence in the global corporate reporting which has no sign of converging to an agreed central system due to the institutional variations despite numerous efforts to harmonize these standards. Various enforcements in play across the globe as well make the convergence of financial reporting difficult. Due to these divergences without near hope of convergence, firms and corporate bodies can adapt a global player segment where firms abide by certain agreed reporting rules while been subjected to same enforcements (Schmidt & Tyrell, 1997).

Lastly this analysis shall assess the various existing modeling literatures in support of divergence corporate financial reporting in accountancy. Accounting systems used to refer to financial reporting are some of the issue to be addressed in the analysis and reasons behind these demarcations. It’s observed that a country may as well adopt various systems at various times which focuses analysis not between countries but systems in the same country. This mostly occurs when the specific country is not under any international enforcement which requires consistency and accountability to certain levels. In accounting systems, various variables are recommended to be at play while considering corporate reporting following some universal enforcement and agreed systems and structures. These variables include the degree of cultural dominance among nations and strengths of equity market in across the global markets. The following section analysis into details issues discussed above (Smith, 1973).

2.0 Discussion
The following section shall consider each and every article under review with it’s their individual thesis statements. Background of issues addressed in each article shall as well be discussed and their rationale critically examined with its main theory emphasized. However it’s worth noting that, all the three articles by Leuz, Nobes, Harission and MacKinnon focused o a larger picture of institutional theory which will well addressed by consideration of individual and specific thesis statements. Individual analysis of the articles is described below linked with the general understanding of institutional theory.

2.2 Institutional theory
2.2.1 Social system and structures
Social structures and corporate accounting and reporting systems are highly regarded by Harrison and MacKinnon in their article: Culture and Accounting Change. They have emphasized on new methodologies in corporate reporting regulations as well as accounting policies and their formulations both at national and international levels. In their analysis, corporate reporting and regulations are categorized as social systems understood in the context of change analysis which forms an essential component in such a system. In this system, there is usually individual examination of system’s values and norms plus the nature of their inter-dependence as individual social units. Their internal mechanisms of workings in an institutional set up are a vital property that accords them classification. The holistic process and classification is a sensitive component due to the central theme of culture and its effect to the functioning and formation of these systems of corporate financial reporting (Harrison & MacKinnon, 1999).

Policy formulation has been considered a social process die to the outcomes realized from complex interactions of all parties interested in accounting affairs or affected by all accounting standards. The development of accounting is determined by the changes affected in accounting procedurals and reporting standards to conform to international standards. The changes in accounting are mostly necessitated not by the accounting missions but by the innovations and pressures present in accounting procedures.

The existing research focuses on corporate reporting and necessary regulations in existence in context of framework change. Later in this analysis, discussion concerning change in social systems and value addition associated with study of such systems shall be focused with consideration of change in its contextual perspective (Harrison & MacKinnon, 1999).

2.2.2 Existing Approaches to Accounting change
Ronger and Shoemaker (1972) are credited to have established a model in study of accounting change. In their theory of diffusion of innovation, they discussed the concepts of new accounting standards and methods which in several instances were conceived as innovations. Diffusion of innovation in accounting is regarded as the spread of a new idea or an approach from the inventors to be consumed and used by the adaptors. Cultural influences are predominant evident to influence the whole process of accounting change and adoption of new approaches in corporate financial reporting. There is a strong correlation between culture and corporate guidelines in financial reporting requirements (Harrison & MacKinnon, 1999).

2.2.3 Elements of Social Systems
In consideration of social systems, three vital elements are described which includes norms and values, interdependence and finally the cultural determinants of behaviors. In the study of corporate reporting and its underlying regulations of a certain country, such elements form the foundational study in identification of nature and operations of such a system. In the general hierarchy of systems, it’s observed that social systems are usually located at the top characterized by high echelons of complexities with a continuous inter-dependence. This interdependence is not only present to interactions involved among the groups which makes up these systems but also the interactions witnessed among the systems themselves as well as systems in the neighboring (Harrison & MacKinnon, 1999).

Social systems are considered paramount in financial reporting due to their demonstration of strong norms and values that guides the procedures. Various values ad norms may be accepted by different individuals and groups which guides them in corporate financial reporting hence they are usually not universal accepted due to this diversity. These systems are also sensitive especially to the cultural determinant of behaviors while various systems of change are considered in diverse environment and settings.

2.3 Financial systems
Nobes analyzed international difference prevalent in accounting procedures in various financial systems. In his argument, he explored terminological challenges which facilitated him in developing parsimonious model to explain reasons behind split of accounting systems into two major and broad categories. When Nobes used accounting systems, he referred to financial reporting practices which are used by corporate, firms and enterprises. It’s acceptable for a country to adapt several of such systems over different durations in any given financial year. Hence he emphasized on system classifications as opposed to country classifications. The variables and classes used in financial systems and its analysis are the degree of cultural dominance and secondly the strengths of equity in various markets (Nobes, 1998).

2.3.1 Reasons behind Differences in International Accounting Systems
Various factors have been considered to have the variations hence difference in financial system and accounting practices. These factors are the nature of financing systems and business ownership, taxation, colonial inheritances, stage of economic development, inflationary pressures, legal systems, level of education, influence of certain theories, religion and finally the political systems as well as social climate under which a corporation may be operating (Nobes, 1998).

2.3.2 Some Terminological Issues
The greatest challenge in identifying the reasons behind the differences and maybe classifying the various accounting systems is the deficit and absence of clarity concerning the elements being classified or examined. In using accounting practices in this context, the discussion is referring to published financial reporting used by various companies. In some instances, rules used in financial reporting may be similar or identical with various firms or countries; however, in absence of these rules, the company may choose to make a choice on whatever method or practice to adapt in preparation of financial reporting (Nobes, 1998).

Systems are also used in this context to refer to regulatory agencies, corpus involved in accounting and rules and practices adopted by firms and various corporations. Therefore the use of accounting system is used to refer to the set of practices that are commonly used in the published annual reports. Other terminology under scrutiny is whether it’s prudent to separate the company disclosures (which include cash flow statements and earnings per share) from the measurement practices used in financial reporting (Seligman, 1983).

2.3.3 Financing Systems
The purpose of financing systems viewed from a country perspective is the need to determine the purposes of financial reporting. They are usually three types of financing system widely used and recognized; first is the capital market based where all prices are determined in the market by competitive forces. Secondly is the credit based system or governmental where all resources to be availed in the economy are administered by the government and thirdly is the credit based financing system or financial institutions where banks and other financial institutions plays a dominant role (Nobes, 1998).

2.3.4 Financial Reporting Systems
Accounting and financing systems may be broadly categorized into two major classes, class A and B. These classes have been categorized according to various criteria and widely labeled as Anglo-Saxon accounting as class A and Continental European as class B. In this classification, there are usually various features used with respect to how they are treated and reported at any given time in financial trading period of any corporation or a country. Provisions for depreciations and pensions, class A states that all accounting practices should differ from tax rules while in class B, all accounting practices strictly follows tax rules. Long term contracts are calculated as a percentage of completion method in class A while completed contract method is used in class B. In class A, all unsettled currency gains constitutes to a corporations’ income while the same in class B is deferred or not recognized at all hence isn’t reflected in the published financial statement neither is it reported. Finally it is mandatory for cash flow statements to be prepared under class A while the same is not necessary in class B (Nobes, 1998).

2.4 Enforcement
This theme is mostly emphasized by Christian Leuz who considered differences in various countries approach used in reporting regulations. Their origin is also explored and reasons behind their continuous existence. Leuz provided a framework which explains the various differences why corporate reporting is regulated through a descriptive with stylized evidence on various regulatory as well as institutional differences observed among countries. Despite efforts aimed at converging and harmonizing various international reporting practices, they is a tendency of divergence of the same practices. This divergence in reporting standards are mostly attributed by the various and different enforcement in existence at various levels in different countries at the international market.

They ought to be another convenient way that will ensure harmonized reporting standards without exerting pressure and ostensibly pushing a strong demand for convergence of these standards and practices. The idea is best regarded as creation of a global player segment where firms and corporations are subjected to similar reporting rules as well as similar enforcement measures. This segment proposed can best work while been administered by a supra-national body created with consensus of all players involved (Leuz, 2010).

Although numerous changes have been witnessed in corporate reporting regulations, many of these changes were inevitable in consideration of various scandals and shortcomings experienced with any financial crisis cutting across the world. There are various approaches which may be employed in regulation of financial reporting where regulators are faced with numerous choices depending on the nature of business environment present (Radebaugh & Gray, 1993).

2.4.1 Need for Regulation in Financial Reporting
Regulators across various forms of economy do face a challenge in choosing whether to regulate of not in the financial reporting of corporate entities. Regulation should not be based on need for firms to disclose their financial information but also to help firms operate at cost effective levels which will offer incentives both to firms and clients. Since many regulators used disclosure clause as a backing to their actions, it’s observed that individual firms do enter into private contracts with interested investors for various disclosures for mutual benefits. However external interference with private contracts and disclosures may be necessary when parties are asymmetrically and informed ex ante.

Secondly, if the market demands an externality especially from the third party and finally where the state controlling the economy has more remedies of market disequilibrium than private sector. Mostly the regulations especially in developed countries are directed towards public traded companies to safeguard the public. It’s mandatory for these firms to have disclosures of certain financial statements to the public and investors. Also private limited countries may be subject to the authority of such regulation like the firms in jurisdiction of European Union (Leuz, 2010).

2.4.2 Objective of Regulation and Enforcement
The major goal why enforcement is paramount is the need for protection of unsophisticated and small firms against business harassment of better informer insiders as well as promoters. This was the main force for regulations to be introduced in US market in 1930s. With time lapse, regulators require to consider and design corporate reporting enforcement and regulation geared towards promoting institutional investors and financial analyst due to their contributions in the international economy. In many economies, regulation is introduced to safeguard the stability of financial sector in the country and to maintain the investor confidence in the economy (Leuz, 2010).

3.0 Framework Linking the Articles
In consideration of financial reporting, the above discussion has been interlinked through institutional framework and theory for financial reporting. While Harrison and MacKinnon concentrated on social systems and structure, Nobes discussed emphasized the need for enhanced financial systems and finally Leuz contributed to the need for regulation and enforcement of corporate financial reporting. The linking of these three concepts to form a comprehensive institutional theory in any given economy is a vital tool which guarantees investor confidence in the economy. When the regulations are based on researched facts in consideration of all social systems and structure prevalent in such economy, the financial reporting systems are beneficial not only to the corporate but also to investors, customers, and public but also the government for taxation purposes. Without proper consideration of social systems and structures prevalent in an economy, the enforcements and regulations imposed on the same economy may not serve the interests of all and probably may be resented by stakeholders. Hence firms may as well not corporate with these regulations witnessing a destabilized financial system within the economy which would spill over to other economies hence destabilizing international trade (Shank & Copeland, 1973).

4.0 Strengths and weaknesses of each article
Harrison and MacKinnon while discussing social structures and systems with relation to financial reporting brought out the need to study the economy holistically which is a vital component. They have also helped in the understanding of foundational framework of how economies operate at various levels. However their article never clearly demonstrated how economic entities may benefit from study of social structures and systems as well as sociological components of a society.

Nobes demonstrated clearly the benefits for enhanced financial systems in an economy. His article is credited by the fact that, he demonstrated the benefits of classification of financing systems which plays a significant role in financial reporting. With proper classifications discussed in his article, firms are able to identify week areas hence necessity for improvement. However his article brought out the weakness of inability to explain behind his logics and arguments. He never gave the reasons for classification of financial systems either in class A or B.

Financial regulation and market enforcement of firms in an economy are vital and important components that ought to be considered. This is a strong fact that has been discussed by Leuz in his article of need for enforcement in the economy. The challenge with the article is that, Leuz never conclusively gave clear guidelines of how these regulations ought to be carried out. The article also did not clearly state who ought to regulate who and how far the regulation should be enforced.

4.1 Critic of the Articles
4.1.1 Harrison and MacKinnon
Various scholars have come out to critic the works of these writers in accounting change, regulations and corporate financial reporting. Harrison and MacKinnon research of accounting as social change with corporate reporting as structures for this change has been criticized due to their reliance of various models which did not take in to cognizance the paramount sociological variables especially those underlying necessary communication channels. Other factors which were over looked are the anthropological variables of values and culture in corporate accounting and reporting procedures. In addition this article never explained the relationship or the nature of interdependence between cultural changes with the changes in accounting and corporate financial reporting. The extent of social source innovations which forms major proponents of the social change system are also unexplained in the diffusion theory of innovation.

Secondly, the process of diffusion advocated by this article does not explain the causes and origin of changes in the accounting practices, in addition, it’s deficient in explaining how the stimulus of change is accommodated in the whole system to produce its desired results. The consequences and repercussions of the proposed change are not highlighted whatsoever. Lastly, the diffusion innovation as a process used to explain this change concentrates on the singular concept of change which renders the whole process as a “planned change” as opposed to natural change which ought to be embraced and adopted in the system.

4.1.2 Nobes
In his financial systems, he only considers measurement practices only rather than incorporating various company disclosures (which includes cash flow statements and earnings per share) as vital components in the financial and accounting reporting systems. Though the disclosures are vital in an economy, making them paramount like Nobes suggests in his literature may jeopardize market mechanisms which are necessary a free economy.

4.1.3 Leuz
Leuz is credited with considering the need for regulation in corporate financial reporting for mutual benefit of players involved. However this article concludes that, it’s only enforcement and regulation that may create stability in the economy. Various economies across the world in a free market have been observed to perform even better that regulated economies hence his assertion is not universally correct. His discussion of regulation was based on protection of unsophisticated small firms which are not longer in the same state, hence need to review regulation design with financial analysts and institutional investors is a requirement.

5.0 Conclusion
Financial reporting is a vital component in an economy especially in the international market where diverse firms in various industries converge for business. Hence the study of social systems and structures is paramount to devise ways and means of a harmonious interaction for mutual benefits. Social structures and systems are of significance in the study of international economics since it allows firms, public, investors and government in rationale decision making. From thorough study of institutional structures and systems, a general corporate financial reporting system may be agreed upon. Financial systems are paramount in reporting of corporate statements since they provide a clear picture of true state of either individual or general economic position in the international market.

However, financial reporting ought to be conducted in a certain manner following certain guidelines for successful results to be achieved that state the true factual position of economies. Hence need for regulation and enforcement in corporate financial reporting standards. Although there is central convergence brought together by a harmonious system of financial reporting, various corporate and firms should follow certain guidelines, rules and practices in their publication and reporting of financial statements.

6.0 References
Harrison, G., & MacKinnon, L. (1999). Culture and Accounting Change: A New Perspective on Corporate Reporting Regulation and Accounting Policy Formulation, New York: Routledge
Leuz, C. (2010). Different Approaches to Corporate Reporting Regulation: How Jurisdictions Differ and Why? New York: Cengage Learning
Nobes, C. (1998). Towards a General Model of the Reasons for International Differences in Financial Reporting, New York: Routledge
Shank, J., & Copeland. R. (1973). Corporate Personality Theory and Changes in Accounting Methods: An Empirical Test, The Accounting Review 2(1): 194-500.
Smith, A. D. (1973). The Concept of Social Change (London: Routledge & Kegan Paul. 1973 ).
Schmidt, R., & Tyrell, M. (1997). ‘Financial systems, corporate finance and corporate governance’. European Financial Management, 3: 333-361.
Seligman, J. (1983). ‘The historical need for a mandatory corporate disclosure system’. Journal of Corporation Law,
Gernon, H., & Wallace, R. (1995). ‘International Accounting Research: A Review of its Ecology, Contending Theories and Methodologies’, Journal of Accounting Literature, Vol. 14,
Radebaugh, H., & Gray, S. (1993). International and Multinational Enterprises, Wiley.

Financial Reporting 16

 

US Financial Crisis

 

Introduction
Financial crisis refers to a situation where financial institutions and assets plunge into huge financial loss and a sharp decline of their market value. Over decades, the world has experienced numerous financial crises which have been associated by bank panic, recessions, malpractices by market players or even a combination of more than one factor. Other cases of financial crisis in the world have been characterized by financial bubble burst, currency crisis, stock market crashes and finally the presence of sovereign defaults. During the past, most financial crisis in the world has been characterized by actual loss of paper wealth which translates changes in real economy when the crisis escalates to extreme cases plunging the economy into a recession or a depression. According to Walbush (34), various explanations, theories and their prevention have been offered by renowned world

economists. Despite these efforts, financial world crisis have been a common occurrences (IMF 3).
The start of the global financial crisis may be traced back in mid 2007 spilling through 2008 when the full effect manifested. The origin of this financial crisis may be traced back from United States (U.S) due to collapse of the real estate market as a result of bubble burst which extended in the financial sector. The crisis spread fast to other sectors of the economy and countries as well. Financial crisis of 2007 was described as the worst since the great depression of 19430s. The crisis threatened world economies and its stability due to its magnitude and effect on the major sectors of the economy like real estate and banking. The crisis resulted to major collapse of the world stock market, collapse of large financial institutions while others were bailed out. The concern of many was the fact that those responsible for the crisis were the one being bailed out with the effects of global financial meltdown adversely affecting common citizens across the world. The following section concentrates on identifying business practices prior to the crisis which can be attributed as main triggers of the crisis (The Financial Crisis 18).

Business Practices Prior to the Crisis
The 2008 US financial crisis may be attributed to a number of factors from policies, market structures, inadequacy of international policy coordination and the role of ethics in business. However for the purpose of this paper, we shall confine ourselves to the business practices that might have led to the crisis in US. Although businesses were profit driven, some business malpractices were experienced by large multinational corporations to maintain their influence on the global market. Corporations like Citigroup, Fannie Mae, Freddie Mac, Lehman Brothers, and Wall Street banks just to mention a few engaged in macroeconomic imbalances, inconsistent macroeconomic policies and self-fulfilling prophecies to safeguard their reputation in the international market. Major corporations are also accused of engaging in balance sheet mismatch for their own gain at the expense of proper market practices. Currency mismatch, maturity mismatch and capital structure negligence are some of the practices common with multinationals prior to the crisis (Driffill and Zazzara 97).

More importantly, financial sector experienced structural dynamics like the financial innovations and the famous emergence of the shadow banking. These institutions cared less on professional, moral and ethical practices in doing business and concentrated on their profits. Other factors at play that contributed to the crisis may be listed as utilization of complex financial products in the market, indiscriminate lending, and use of high leverage by firms and reduced transparency especially with the regulatory agencies. US firms as well engaged in business practices of over-reliance on self regulations, free market operation allowed firms to go unchecked and finally the deregulation of the market caused firms to operate without checks and balances. Hence firms engaged in business malpractices to maximize their profits with less consideration of proper moral, ethical and professional conduct in doing business. They was also the rapid rise of capital markets including in the non-banking financial institutions like Fannie Mae and Freddie Mac, which dominated the mortgage industry advancing mortgages at lower prices without consideration of customer’s capabilities to surface the mortgage (IMF 6).

Firms prior to this period engaged in cyclical practices where they offered services at excessively low risk free rates of interests to their advances towards customers. In the years preceding the crisis, the US market experiences unreasonably low credit risks which firms were willing to spread it over across several instruments to clients over long period of time creating a hypothetical hope and growth potential in the market. Businesses also experienced a widening gap between high returns on capital compared to low cost of capital especially with input of the labor market. Firms capitalized on this widening gap to maximize their profits without considering consequences of their practices. Finally firms capitalized on trading with complex products and highly engaged in speculative trading taking advantage of defective incentive programs and schemes that were readily available. Firms as well engaged in growing securitization and the use of well developed structured investment vehicles (Baur and Schulze 507).

Firm’s Contribution to the Crisis
The market failures discussed in this paper are some of the mechanisms firms utilized to benefit themselves while fueling the crisis. As discussed in this paper, Fannie Mae and Freddie Mac are the two largest mortgage companies in the United States. The crisis could be traced to the imminent collapse of these two giant mortgage companies souring the interest rates and rendering millions of US citizens homeless. In the years leading up to the crisis, the two firms engaged in unreasonably very low interest rates on mortgage to customers for a period of almost one decade. The firms were the kings of leverage since they took advantage that they were government sponsored hence could engage in malpractices without much restrictions.

Fannie’s and Freddie’s combined had a leverage ratio which stood at 75 to 1 including loans they guaranteed and owned by 2007. The national mortgage debt doubled from 2001 to 2007 for the two firms with household mortgage debt rising by 63 percent from $91,500 to 149,500 with their wages essentially remaining stagnant. When the financial downturn took full effect, heavily indebted households and firms were adversely affected with firms experiencing collapse and households losing jobs and homes (The Financial Crisis 23).

When the debt crisis was at all high levels, the financial institution took over the debt burden which exacerbated the situation risking the assets they acquired especially using those debts. The mortgage firms while over burdened by the debt crisis with mortgage and real estate markets getting deeper and deeper in risky situations, financial institutions continued advancing loans to them at very low interest rates (IMF 9).

Firms used lack of transparency from regulators to advance more and more loans magnifying the problem. This two mortgage firms engaged in massive short term borrowings heightening the collapse of real estate and financial systems which was imminent. Finally these behaviors resulted to the burst of real estate bubble due to lack of transparency, presence of short term loans, extraordinary debt loads and risky assets.

Economies of Market Failures
The market is responsible in balancing between the traders and buyers in the economy with market elements playing their role especially in a free market economy. Economies of market failures refer to the inadequacy of the market mechanisms to regulate players (firms and customers). When the US economy was liberalized, market mechanisms took a leading role in their quest to set a balance and bring sanity in the world economy. However in the years prior to the crisis, market failures can be solely responsible as having contributed greatly to the 2008 crisis that hit the economy devastating economic activities resulting to loss of employment as well as homes. Market failures of excessive borrowing, lack of transparency and risky investments placed financial system in course of the crisis (Cardarelli and Lall 19).

The crisis was aided by failures of corporate governance as well as little or no regulation. The years leading to the crisis experienced many households and financial institutions borrowing to the hilt. This situation left them vulnerable to the financial distress incase of decline of value for their investments. For instance in 2007, five major financial institutions were allowed to operate with very thin capital contrary to the accepted standards in the market. The markets sup up by this time (2007) allowed them to operate on a ratio of 40 to 1 that means for every US $40 that they held in assets, the available finances available to cover incase of losses was only US $1. This market failure left financial institutions vulnerable to be wiped out just by less than 3 percent drop in asset value (The Financial Crisis 29).

The situation was complicated by the lack of market protective mechanism to guide the borrowing rates for these institutions. Hence with this inadequacy in market mechanisms, firms engaged in short term overnight borrowing of huge sums of money. This implied that firms could renew their borrowing daily a situation not health and unfavorable in the market. For instance, at the end of 2007, Bear Stearns held $11.8 billion as equity share against $383.6 billion it held in liability as the same time. Considering the overnight market, the same firm was borrowing as much as $70 billion. This was a great failure of market mechanism to regulate the behaviors of firms especially in the financial sector. This firm behavior may be equated with a small business worth $50,000 in equity borrowing up to $1.6 million with just $296,750 to operate each an every day. The market failures of checks and balances failed to detect these problems with firms using the available loopholes to conceal their dealings. The leverage was usually hidden in off-balance sheet entities, derivative positions, and finally “window dressing” of their financial statements and reports especially to appeal the investing public (IMF 11).

The Role Government Regulator Played During the Crisis
The role played by regulators in the 2008 financial crisis is an important question even as treasury department took over bank regulations when the crisis was fully taking its toll on businesses and households. Many blame the 2001 banking regulation rule for loading banks mostly with toxic mortgage backed securities. The financial crisis may be seen as a result of too much regulation by the government. For instance two policies have been identified as hindrances to free market sanity in the market. The Community Reinvestment Act of 1997 was cited as one factor that contributed to the crisis due to the pressure it hipped on private banks to advance risky loans. Secondly, the Government Sponsored Enterprises exerted pressure in the market forcing the GSEs to purchase risky loans which exacerbated the problem (Cardarelli and Lall 21).

According to Center for Public Integrity (2009), lobbying against tighter regulations especially in the mortgage industry allowed the reckless behaviors in the ending market to thrive. Banks were also involved in lobbying against tighter regulations especially when the financial industry was struggling with huge amount of debts. The regulator however bored to these pressures and allowed the debt crisis to exceed uncontrollable levels resulting to bubble burst in the real estate market. These anecdotes indicate that regulatory failure by the authorities may have contributed to the 2008 financial crisis especially due to the political influence and its participation in the financial industry. This crisis started as a US problem but later escalated globally posing as the worst global financial instability after World War II (IMF 11).

The government also contributed to the financial crisis by implementing its housing policy. The regulator allowed financial institutions and firms to use excessive leverages, practice overnight lending and borrowing involving huge sums of money. The regulator also failed in risk management, risk taking as well as use of excessive leverages by firms. The regulator did nothing when mortgage companies advanced risk or subprime loans to households which are estimated to be more than half of all mortgages in United States (The Financial Crisis 33).

In 1992, congress enacted a bill famously came to be known as the “affordable housing goals” which were to be administered by Freddie Mac and Fannie Mae. The Federal Reserve allowed the interest rates to be as low as 2 percent which was beyond the required threshold set in the 1992 by the congress. Due to the practices preceding the crisis, the bubble was highly inflated and the bursting came with the collapse of major multinational companies including bail out of major financial institutions.

Effects of Dodd-Frank Bill on the Market
Dodd-Frank Wall Street Reform and Consumers Protection Act was a bill passed by congress in 2010 for consumer protection and the public against malpractices carried out by firms for their own gain. The bill has several highlights as discussed below. First it seeks to establish consumer protections which possess authority and independence through a neutral watchdog against malpractices in the market. This watchdog is tasked with ensuring consumers get all the necessary information they require to purchase a mortgage, credit cards as well as other vital financial products. The bill also seeks to offer protection to consumers against hidden charges, deceptive practices and abusive terms in their transactions with firms (Dodd-Frank 2).

Secondly the bill seeks to protect taxpayers money especially when a bail out is to be provided to troubled firms in case of a crisis. It seeks to achieve this by creating a safe way to liquidate failed financial institutions and firms, leverage the requirements a firm requires to make it undesirably too big and finally imposition of new capital requirements for establishment of any public and private firm to ensure consumer confidence. Further the bill seeks to establish a strict, rigorous and standard supervision process for all public and private institutions. Creation of a strong independent Council to identify and address possible systemic risks advanced by large and complex enterprises, products and their services before they escalate to a level of threatening economic stability (Dodd-Frank 2).

The bill as well seeks to establish transparency and accountability that will eliminate and close all loopholes that tolerate abusive and risky practices to thrive unnoticed and unregulated. This will close all loopholes including asset backed securities, payday lenders, over the counter derivatives and hedge funds which firms utilizes at their own benefits. The establishment of corporate governance and executive compensation plans will provide shareholders with much say on corporate affairs. In order to protect investors and businesses, tough rules are introduced by the bill to enhance accountability and transparency. Lastly the bill seeks to ensure regulation of company books of accounts are inspected to aggressively pursue conflicts of interest, financial frauds, and system manipulations aimed at benefiting special interests at the expenses of the general public wellbeing (Dodd-Frank 3).
When this bill is indeed signed into law will bring sanity in the public sector. Some firms used to window dress their books of account to gain public confidence and attract investors will be long gone due to the rigorous scrutiny enforced by the bill.

 

Conclusion
The world economic crisis of 2008 has been termed as the worst since the end of Second World War and the great depression of the 1930s. The crisis can be traced as observed above from the burst of housing bubble experience in the US real estate industry at the end of 2007. In the years leading to the crisis, the US housing industry had experienced unprecedented growth due to unreasonable low interest rates that prevailed in the market for at least a decade. Firms took this opportunity and engaged in malpractices to exploit the public which resulted to high levels of debt to unsustainable levels hence inflating the bubble and finally resulting to credit crunch and debt crisis. The first indication of the crisis was experienced when Citigroup sought a bail out from its financial problems. This followed the near collapse of the major and biggest mortgage companies in the US market Freddie Mac and Fannie Mae. This plunged millions of American in debt crisis to a point they were unable to service their mortgages with millions losing their homes and jobs. The government came to the troubled firms’ rescue by bailing them out. However to avoid a repeat of what happened, the congress in 2010 proposed Dodd-Frank Wall Street Reform and Consumers Protection Act to safeguard against business malpractices against consumers.

Work Cited
Baur Daniel and Schulze Neil, Financial Market Stability – A Test, Journal of International Financial Markets, Institutions & Money, 2009, (3), 506-519
Cardarelli Elekdag, and Lall Schole, Financial Stress and Economic Contradictions, Journal of Financial Stability, Elsevier, Forthcoming, 2010
Dodd-Frank, Wall Street Reform and Consumers Protection Act, Retrieved on 17th, February 2012 from: http://banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf
Driffill Rotondi, and Zazzara Crul, Monetary Policy and Financial Stability: What role for future markets? Journal of Financial Stability, 2006, (2), 95-112
International Monetary Fund (IMF), Global Financial Stability Report, Washington
Investment”, European Economic Review, 2009, No. 40, Vol. 6
The Financial Crisis, Final report of the national commission on the causes of the financial and economic crisis in the United States, Retrieved on 17th, February 2012 from: http://www.gpoaccess.gov/fcic/fcic.pdf

Insert Surname Here 11

 

Equity Analysis for Ford and Microsoft

 

Profitability ratiosRatioFormulaNet Profit MarginNet Income before Noncontrolling interest, Nonrecurring Items and Equity Income—————————————————-Net SalesOperating Income MarginOperating Income————————-Net SalesReturn on Total EquityNet Income before Nonrecurring Items – Dividends on Redeemable Preferred Dividends—————————————————-Average Total Equity

Profitability RatiosCompanyFord Motor CompanyMicrosoft CorporationRatio 20092010201120122009201020112012Net Profit Margin2.35.0914.834.2224.9330.0233.123.03Operating Income Margin-2.395.165.14.6934.8538.5738.8329.52Return on Total Equity--281.6236.5838.4243.7644.8427.51

Financial Strength ratioRatioFormulaCurrent RatioTotal Current Assets———————————-Total Current LiabilitiesDebt RatioTotal Liabilities——————-Total AssetsDebt/EquityTotal Liabilities————————Total EquityFixed Charge CoverageRecurring earnings, Excluding Interest Expense, Tax Expense, Equity Earnings, and Noncontrolling Interest + Interest portion of Rentals—————————————————-Interest Expense, Including Capitalized Interest + Interest portion of Rentals
Financial Strength RatiosCompanyFord Motor CompanyMicrosoft Ratio 20092010201120122009201020112012Current Ratio2.962.672.642.111.822.132.62.6Debt RatioDebt/Equity__5.464.540.090.110.210.16Fixed Charge Coverage

Valuation RatiosRatioFormulaPrice/Earnings RatioMarket Price per Common Share——————————————–Diluted Earnings per Share, before Nonrecurring ItemsMarket/Book RatioStock Price——————————————–Total Assets – Intangible Assets and LiabilitiesEnterprise Value – to – EBITDAEnterprise Value——————————————–Earnings Before Interest, Taxes, Depreciation, And Amortization 
Valuation RatiosCompanyFord Motor CompanyMicrosoft CorporationRatio 20092010201120122009201020112012Price/Earnings Ratio11.8914.29Market/Book Ratio3.23.64Enterprise Value – to – EBITDA10.448.74

Ford Motor Company Industry Averages
Ford Motor CompanyRatio Company IndustryPrice/Earnings TTM11.913.3Price/Book3.21.7Operating Margin % TTM4.691.2Net Margin % TTM4.224.6ROE TTM36.5812.6Debt/Equity4.540.8Enterprise Value – to – EBITDA10.447.52
Price to earnings ratio
Ford motor company price earnings ratio of 11.9 is lower than 13.3 that are found in the Auto manufacturers industry.
Market to book ratio
Ford motor company market to book ratio of 3.2 is higher than that observed in the industry (1.7).
Operating margin ratio
Ford motor company operation profit margin is 4.69, which is higher than the industry average of 1.2. This is a strength that ford motor company has because it makes more profits than the ones anticipated in the industry. This means that the company has addition funds to divest into various business units. A strong financial position is a competitive advantage in any industry.

Net Margin Ratio
Ford motor company net margin ratio of 4.22 is lower than the industry average of 4.6. This is a major weakness for the company because it indicates that the company is incurring more expenses than other firms in the industry are. If the company is inefficient then its expenses will increase causing a decline in the operating profits of the company. High expenses are the main cause of a low profit margin meaning that ford company expenses are quite high. This reduces the company price advantage in the industry.

Return on Equity
Ford motor company of 36.6 is higher than the industry average of 12.6. This ratio indicates the ability of ford motor company to generate revenue based on its total equity. A high ratio like the one for ford indicates that the company is able to generate more revenue based on its equity compared to other firms in the industry. This is an advantage because a high return on equity incites more investors to invest in the company because they know their equity will generate high returns.

Debt to Equity Ratio
Ford motor company has a debt to equity ratio of 4.54, which is higher than the industry average of 0.8. A high debt to equity ratio is a bad sigh for any firm because it indicates that a large portion of the firm’s equity is compromised by debt. A high debt leaves ford motor company vulnerable to the wishes of its creditors. The company also will be disadvantage when it wants to generate any new capital using its capital because if restrictions from its current creditors.
Enterprise Value–to–EBITDA
Ford motor company Enterprise Value–to–EBITDA of 10.44 is higher than the industry average of 7.52. This is strength for ford motor company because a high enterprise value is attractive to investors.
Microsoft Corporation Industry Averages
Microsoft CorporationRatio Company IndustryPrice/Earnings TTM14.2915.8Price/Book3.643.9Operating Margin % TTM29.5233.6Net Margin % TTM23.0326.3ROE TTM27.5126Debt/Equity0.160.3Enterprise Value – to – EBITDA8.749.04
Price to Earnings Ratio
Microsoft Corporation has a price to earnings ratio of 14.29, which is lower than the industry average of 15.8. This means that the company’s stock earn lower earnings than other companies in the industry do.

Market to Book Ratio
Microsoft Corporation market to book ratio of 3.64 is lower than the industry average of 3.9.

Operating Margin Ratio
Microsoft Corporation operating profit margin of 29.52 is lower than the industry average of 33.6. This indicates that the company is performing poorly as compared to the industry. The ratio indicates that Microsoft Corporation is incurring high operational expenses as compared to the industry. This is a weakness to the company because other firms in the industry have the advantage of pricing their products better than Microsoft Corporation.
Net Margin Ratio
Microsoft Corporation is still disadvantaged in the industry because it has a lower net margin of 23.03 compared to the industry average of 26.3. This indicates that the company is unable to meet the industry profitability targets.

Return on Equity
Microsoft corporation return on equity is 27.51, which is higher than the industry average of 26. This is a positive indication on the company because it is able to generate more return based on its capital than the industry can. This shows that the company has attained operation efficiency that allows it to maximize on its assets in order to generate more returns as compared to the industry.
Debt to Equity Ratio
Microsoft corporation debt to equity ratio of 0.16 is lower than that of the industry of 0.3. This is also a positive sign and strength for the company. The reason is that a majority of the company assets are not comprised of debt. This means that the company has more freedom to engage in any lucrative investments opportunities without much monitoring from its debtors. The company also has a better chance of acquiring debt in the industry as compared to other companies with a high debt to equity ratio.
Enterprise Value–to–EBITDA
Microsoft Corporation Enterprise Value–to–EBITDA of 8.74 is lower than the industry average of 9.04.

 

Indication of market to book ratio
Ford motor company has a high market to book ratio indicting that it is a growth firm. This means that the company stocks are selling at a value higher than the book value the market expects its value to raise. On the other hand, Microsoft Corporation is a value stock because its stocks are priced relatively cheaper than those in the industry are. This means that investors prefer to invest in other stocks in the same industry as compared to the ones of Microsoft Corporation. This is indicted by the low market to book value of Microsoft Corporation of 3.64 compared to the industry average of 3.9.

Comparison of Valuation Ratio
Valuation RatiosCompanyFord Motor CompanyMicrosoft CorporationRatio 20122012Price/Earnings Ratio11.8914.29Market/Book Ratio3.23.64Enterprise Value – to – EBITDA10.448.74
The Price earnings ratio of Microsoft Corporation of 14.29 indicates that it is performing better than ford motor company is. This means that Microsoft Corporation is able to generate more earning based on the company’s stock. This indicates that one stock of Microsoft corporation stock generate more earnings as compared to one stock of ford motor company. Comparison of the market to book ratio of Microsoft Corporation and ford motor company is impossible because there are in two different industries the comparison will be irrelevant because the amount of assets needed to generate earnings in the two industries vary.

EQUITY ANALYSIS FOR FORD AND MICROSOFT 12

Running head: EQUITY ANALYSIS FOR FORD AND MICROSOFT 1

The Role of Financial Documents in Decision Making

Financial statements are formal records or reports that represent the financial records or activities of a person, a business or an entity. They are reports that indicate the performance of an organization. These written reports help in quantifying the financial strength, performance and the liquidity of an enterprise. Financial statements can be said to reflect on the effects of business transactions and other events that are carried out by the business. The four major financial statements include the balance sheet, the income, cash flows and the stock holders’ statements.

Balance sheet
A balance sheet is also called a Statement of financial position and it represents the financial position of the company at a given date (Brechner 488). In short it is a snapshot of a company’s financial position at a given time. For example balance sheet dated December 31, 2012 reflects the instantaneous position of the financial position of the company as at December 31, 2012 (Porter 15-17). The information provided in the balance sheet is important in the planning, controlling and decision making of the organization in the sense that it helps the various stakeholders including the creditors on what the company owns as well as what the company owes to other parties. To the banker, the information is vital as it helps in determining whether the company is going to be advanced with extra loan, or if the company qualifies for a given loan.

The government is interested in the balance sheet of a company as it helps in knowing the amount of tax that the company ought to pay. Other persons like the investors, management, customers and competitors use the information in determining the viability, and the survival options of the company in the market. It also helps the company in planning how to pay government taxes and how much to be paid.
A balance sheet contains various elements including the assets which represent what the business owns. This is expressed in terms of cash, inventory, and machinery among other assets. The information on a balance sheet helps a company in making investment decision and also in controlling the assets of a company. The information also helps the company in planning for acquisitions, requesting for loans and purchase decisions.

Liabilities represent entails what the business owes to other entities including creditors, banks and other loans. This information is important as it helps the company and other stakeholders in determining who to pay and how much, it also helps in planning other investment decisions.
Equity represents what the business owes to its owners and this is the amount that remains when assets have been used to pay the liabilities. This is vital as it stipulates the net worth of a company.

Income statement
The income statement is important because it shows the profitability of a company at a given date. It is also referred to as the profit and loss account, statement of income or a statement of operation (Khan 48). The income statement reports the financial performance of the company in terms of net profit or loss over a specified given time. It comprises of various elements including the income and the expenses of the company including the depreciation. The income statement indicates what the business has earned over a given period of time and this includes any revenues and gains from the operating activities of a company. Gain is the extra proceeds from the sale of long term assets or the proceeds that arise from the transactions that are outside the primary obligation of the business.

Revenues on the other hand includes the gains from primary activities like trading as well as the secondary sources which include the rent obtained from rent, dividends, idle cash amount other sources. It should be noted that net profit or loss is obtained after deducting the expenses from the incomes and this information is vital in the making of investment decisions, controlling the underperforming activities as well as planning for the future of the company.

The information contained in the income statement is vital in the planning of how the organization will utilize the revenue obtained from the transactions of the business. At the same time, by knowing the income sources, a company is able to make informed decisions since actual revenue can be ascertained. In case the company is making losses, the information can be used to reduce some activities or how to invest.
Salaries, wages, depreciations, rental charges payable among other payables represents expenses that the company has to pay. The information on the expenses is vital as it helps the company in identifying the total payables by the company, it also identifies depreciation that the company is facing in the course of its trading.

Cash flow statements
Cash flow statement or rather a statement of cash flow represent the movement in cash and bank balances over a given period d of time (Bhattacharyya 203). It contains various elements that are vital in the planning, controlling and in the decision making of a company and they include the following.
Operating activities represent the cash that is obtained from the primary sources of a business. Operating activities usually converts those items that have been reported in the income statement from the accrual basis of accounting for cash (Maßing 1-11). This information is vital to a business as it helps the investors in making the investment decision in the sense that when the cash being generated is consistently high, then, the notion becomes that the company is able to increase its dividends. The information is also important also help in determining whether the company has enough cash to pay debt and other liabilities. It therefore helps in planning for the future of the company. The rate of cash flow from the operating activities also helps in controlling the movement of cash in an organization by helping the management of an organization make various decisions regarding the company.

Statements of cash flows also contain the investment activities that represent cash flow from the sale and purchase of assets that take a long term mode (Carmichael 13). Financing activities contains a report on cash flow activities that includes the issuance and the repurchase of the company’s/business own bonds, stock and dividend payment. This information is vital in the planning of how much dividends and interests are to be paid to the stakeholders, the amount used in the purchase of company assets as well as the sale of the same. Cash flow statement is also vital as they indicate the cash at hand by a company and indicates the activity level of the company and the outside world. This is vital as it helps in controlling the assets and in the payment of expenses.

Statement of stock holders’ equity
This is also known as the statement of retained earnings and shows the movement of the owners’ equity over a given period of time. It is the book value statement of the company and it is obtained by subtracting the total liabilities from the total assets or treasury shares deducted from the share capital together with the retained earnings. It consists of the net profit or loss for a period specified in the income statement, share capital that was issued or repaid during the trading period, payments of dividends, gains from equity and any effects that may have arisen from the correction of an accounting error.

Since the stockholders’ equity represents the interests of the company to the shareholders, it is important in the planning by the company during reinvestment strategies. This therefore is vital in decision making as it shows the net worth of the company. The statement also indicates whether the company is growing or not and helps in determining the stake that the shareholders will be given in the retained earnings.

Work cited
Carmichael, D R, and Lynford Graham. Accountants’ Handbook, Financial Accounting and General Topics. Hoboken: John Wiley & Sons, 2012. Internet resource.
Brechner, Robert A. Contemporary Mathematics for Business and Consumers. Australia: South-Westen/Cengage Learning, 2012. Print.
Porter, Gary A, and Curtis L. Norton. Financial Accounting: The Impact on Decision Makers. Australia: South-Western Cengage Learning, 2011. Print.
Khan, M. Y., and Pramod Kumar Jain. Basic financial management. Tata McGraw-Hill Education, 2005.
Bhattacharyya, Debarshi. Management Accounting. Pearson Education India, 2011.

Surname 5

General Motors: Balanced Scorecard & Finance Perspective

General Motors Corporation is one of the largest multinationals in the case of the United States. It engages on the development, production, and marketing of cars, automobile parts, and trucks (General Motors Company SWOT Analysis, 2013). The corporation is also active in the provision of automotive financing services. The corporation operates majorly in areas such as South America, Europe, and North America. General Motors recorded massive revenues of about $152,256 million in relation to the fiscal year ended December 2012. This is an increase of about 1.3 percent in relation to the fiscal year ended December 2011. The company also recorded an operating loss of $30,363 million for the fiscal year ended December 2012 as well as operating profit of $5,656 million for the year ended December 2011 (General Motors Company SWOT Analysis, 2013).

The net profit of the company for the year ended 2012 was about $4,859 million thus a decrease of approximately 35.9 percent in 2011 (General Motors Company SWOT Analysis, 2013). The mission statement of the entity indicates that General Motors is a multinational corporation with the ability and capacity to engage in socially responsible operations across the globe. The organization commits to the provision of services and products of high quality with the aim of offering superior value to the consumers while employees and business partners focus on sharing the success. The shareholders or stockholders will obtain sustained massive return on the substantive investment (Brahim et al, 2011).

General Motors Corporation also has an extensive vision statement with the aim of enhancing its operations towards the achievement of the goals and objectives as well address the needs and preferences of the consumers. The vision statement indicates that General Motors has been a leader in relation to the global automotive industry. In the next 100 years, the institution plans to integrate effective factors with the aim of maintaining success as in the case of the previous century (Brahim et al, 2011). This is because the corporation commits itself to leading the industry in alternative fuel propulsion.

General Motors has three critical strategies towards maximization of the goals and objectives in the market. The first business strategy is brand re-structuring while focusing on the core business: Cadillac, Buick, and Chevrolet. The second business strategy is to focus on development of fuel efficient products in relation to effects of global warming and green technology (Datamonitor, 2011). Finally, the organization focuses on the integration of cost effective products through reduction of General brands and models thus an opportunity to gain significant cost savings.

Finance Objectives
ObjectiveMeasureTargetAction Manage the operating budget with the aim of reducing annual operating expenses
 This will be measured by maintaining an operating expense below $10,115,202 and ability of the entity to maximize car-technology $10,115,202Utilization of car-technology
Promote quality and value in relation to products and services to the consumers and other stakeholders Manage expenditures under the minor capital expenditure
 This will be measured by the ability of the company to achieve the target of $150,000 and below $150,000 and belowIntegration of cost effective approaches to reduce cost of operations
Increase the volume of production and distribution Enhance the ability of the board in meeting its objectives  This is measurable through increase in effectiveness and efficiency in delivery of quality products and services to the consumers translating to quality revenues and profit levels at the end of the financial year. 80 percent through raising the application of Vida’s email billing service
improvement of effectiveness and efficiency in the service delivery

References
General Motors Company SWOT Analysis. (2013). General Motors Corporation SWOT Analysis, 1-9.
Brahim, H., Heard, N., & Blanksby, B. (2011). Exploring the General Motor Ability Construct. Perceptual & Motor Skills, 113(2), 491-508.
Datamonitor: General Motors Company. (2011). General Motors Corporation SWOT Analysis, 1-11.

GENERAL MOTORS 5

Running head: GENERAL MOTORS 1

Battle of mortgages frauds

Various aspects of financial security come into play when one talks about loans from financial institutions or loans from individuals. A mortgage is a loan security instrument presented by the borrower to the lending institution in form of real property and as collateral for proof of future repayment as specified within the loan terms of agreement. In certain instances, the lending institution my identify some form of fraudulence in pact of the mortgage presented by the borrower or a borrower may realize that the financial institution has some ill motives contrary to the underlying terms of agreement (Roberts, Ralph & Rachel 98). Mortgage fraud however, is a part commonly played by borrowers of finances and therefore the lending institution must act in accordance to the outlined jurisdictions in identification and control of such instances in order to prevent occurrences of certain predicaments over loan repayment.

Mortgage fraud occurs due to intentional misrepresentation of one or all of the following outlined details to the lender by the borrower:
Wrong application details- in this part, the borrower produces wrong details that encompasses vague income details, wrong personal identity, the purchase price of the mortgage property, the intended business function or personal occupation. Once an individual refuses to disclose some of these details on his or her intent to acquire mortgage loan, then the replica would be mortgage fraud. Similarly, one may not be in a position to give the value of the real property presented as collateral (Roberts, Ralph & Rachel 107). Still on the property value, the borrower may decide to present an inflated value or fail to disclose the purchase discount of the property from the initial developer. Lastly, the borrower may present wrong information on ownership of the property. As far as disclosure of property ownership is concerned, the person may decide to manipulate the property details or may as well collude with conveyances for fraud purposes. Identification of the above mentioned cases present perfect basis for mortgage fraud investigation and control before uncertainties set in.

Various financial institutions involve investigations on the real property before settling for any agreement with an aim of identifying the real details and ownership of the property. The investigations step takes into account an in-depth study of mortgage fraudulence based on historical wealth experience. Per see, the borrower must have had a link to his or her current wealth status, which the society must also have known. The next step would take into account the possibility of using highly specified and secured data to analyze the presented property value and connect with the requested loan for proof of validity (Roberts, Ralph & Rachel 112). The expectation is that the property value should show some form of consistency with the loan amount requested. This final stage would involve the use of software as dictated by the clients’ needs.

The main idea here is to provide necessary proofs that the borrower is the actual owner of the real property and is therefore liable to loosing the property in case of default in terms of agreement. Without any valid information, the borrower may not be held responsible in which case the financial institution becomes the losing party. With uncertainties involved in loan operations, businesses must be very careful with the details presented by their clients for loan acquisition. Once a mortgage fraud is conducted, the lend institution may decide to give loan or completely refuse the proposal depending on viability of the contract.

Work cited
Roberts, Ralph R, and Rachel M. Dollar. Protect Yourself from Real Estate and Mortgage Fraud: Perserving the American Dream of Homeownership. New York: Kaplan Pub, 2007. Print.

Surname 4

Statement of Changes in Stockholders’ Equity

The statement of changes in stockholders’ equity is a financial statement that illustrates the movements in individual equity balances in a given financial year. Where however the retained earnings is the only capital account that has movements, we usually prepare a statement of retained earnings instead of a statement of changes in stockholders’ equity

Most annual financial reports present the statement of changes in stockholders’ equity as a formal financial statement that comes immediately after the statement of financial position (balance sheet) and the statement of comprehensive income. Other firms will however include the statement of changes in stockholders equity in the notes to the financial statements

The table below records the amounts in the statement of changes in stockholders’ equity for the following items as shown in Dillard’s statement of changes in equity:

Current Year Previous Year 3 Years Ago

Beginning Balance $2,052,019 $2,086,720 $2,304,103
Shareholders’ Equity

Net Income (Net Loss) $335,962 $463,909 $179,620

Other Income $7,759 $(21,204) $4,468

Issue Stock Options $112,498 $23,753 $23,048

Purchase Shares $(102,683) – –
Treasury Stock $(185,536) $(491,157) $(413,889)

Dividends (if any) $(249,844) $(10,002) $(10,630)

Balance $1,970,175 $2,052,019 $2,086,720
Shareholders’ Equity

Cash dividends may be paid to more than one class of stock during the year (for example, to common and preferred stock). The table below shoes the split for cash dividends in the last three years from Dillard’s statement of changes in equity.

Class of Stock Current Yr Dividends PreviousYr Div 3 Yr Ago Div

Common $(249,844) $(10,002) $(10,630)
Preferred – – –

Other – – –

Were there any items other than income or dividends that changed the amount of retained earnings? If so, describe the nature of these items.
Other than the income and dividend, the other items that affected the amount of retained earnings for Dillard’s statement are
Issue of Stock Options – stock options is a form of employee compensation that is given to certain employees or all employees in a company. Stock options are normally issued over a given period known as a vesting period. The purpose of issuance of stock options is embedded in the agency theory that seeks to align the interests of the employees and those of the shareholders, effectively giving a part of the ownership of the company to employees. Although in most cases stock options have little effect on the income statement therefore little effect on the retained earnings, it will have an effect on the net stockholders equity since the new shares awarded to the employees become part of the net shareholding of the company. Where the company purchases back or pays out the stock options, cash is given out and this affects the retained earnings. In Dillard’s statement of changes in stockholders equity, stock options worth $112,498 were issued in 2012, $23,753 in 2011, and $23,048 in 2010.

Purchase of treasury stock – treasury stock in financial accounting is the name used to describe those shares of the company that were previously sold to external investors but have been reacquired by the company through a share repurchase plan. When a firm repurchases some of its previously issued shares, a transaction that has an effect on the retained earnings takes place. This is because in many cases, the company will use the cash from retained earnings to pay for those shares it has bought back. This transaction will only fail to affect the retained earnings if the company borrows capital to use for the repurchase. In Dillard’s statement of changes in shareholders’ equity, different amounts have been spent every year on treasury stock, which include $185,536 in 2012, $491,157 in 2011, and $413,889 in 2010.



STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY 3

Running Head: STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY 1

4

 

Evaluation of a government strategy

Common Wealth of Australia. (2008). Better Practice Guide:Developing and Managing Internal Budgets. Canberra: Australian National Audit Office.From: http://www.anao.gov.au/uploads/documents/Developing_and_Managing_Internal_Budgets1.pdf

The article, “ Better Practice Guide:Developing and Managing Internal Budgets” is a strategy document of Australian government which provides a framework of reference regarding internal budgeting of domestic organizations in the Common wealth of Australia, Australian Local governments,the public, and the private sectors. The strategic vision of this policy document is that effective implementation of internal budgeting in Australian organizations will contribute to the organization’s achievement of set objectives and goals.

An internal budget is the projected financial performance of an organization, its financial position and cash flows allocated on the basis of activities and responsibility areas(Common Wealth of Australia, 2008, p.3). Thus an internal budget is used in establishing and communicating funding priorities, supporting decision making process, and monitoring financial performance.
This policy document details the best practices in public financial management to ensure high accountability and prudent decision making that guarantees returns on investment of public funds in the common wealth of Australia. There are three strategic priorities set out in the document; integration of internal budgeting process into planning and management of an organization, development and implementation of internal budget, and monitoring and evaluation of internal budget’s performance (Common Wealth of Australia, 2008, p.44).

Integration of internal budgeting process into planning and management of an organization
This strategic policy explores internal budget as a financial planning tool and a tool for setting financial projections and controls, identification of costs and prices, and evaluating the performance of each financial manager in an organization. As a tool for organizational planning and management, the policy document provides a conceptual framework of relationship between an organization and its internal and external environment that can be integrated in the internal budget. The integrated planning shows the relationship between budgeting and organizational planning and between reporting and budgeting within and outside an organization. The strategic actions of the document under this priority strategy is integration of organization’s internal budget into planning, integration of capital and operational budgets, alignment of an organization’s internal budget and its responsibilities and roles, harmonization of organization’s budget and reporting, and engagement of organization’s shareholders in the internal budget.

Integration of internal budgeting process into planning and management of an organization is effective in promoting accountability and transparency in public finance management because it enhances distribution of organizational resources according to its priorities through close alignment of internal budget with strategic planning process (Common Wealth of Australia, 2009). This ensures that the funds of an organization are allocated diligently and each manager in an area of responsibility is held accountable for the budget of his area of domain. The high accountability practices ensures that only feasible development plans which are consistent with long term objectives and goals of the organization are approved in the budget with high guarantee of return on investments (Eccles, Ioannou,& Serafeim, 2012).

Another critical premise of integrating internal budgeting process in the long term planning of the organization concerns workforce plan. The document underscores that many organizations in Australia rely on baseless assumptions on the required staffing capacity. This becomes a major challenge in the current labor market characterized by high turnover. The issue has made it difficult for organizations to make accurate estimates regarding the required number of employees. A workforce plan is proposed as the most effective way of estimating required staffing level. The rationale behind the proposal is that the workforce plan will link the needs of the organization to the required number of employees. The relationship between staffing and organizational objectives and goals forms a basis of budgetary allocation regarding the required number of employees at any one time in an organization.

The alignment of internal budget of an organization with its roles and responsibilities helps in establishing a hierarchy of responsibility in an organization. This hierarchy is helpful in instilling accountability in the management of public funds in Australian organizations because it holds each manger in the hierarchy responsible for the decisions made. For instance, the hierarchy will hold the Financial Officer of the organization responsible for his financial advices given to the organization. This will ensure that the personnel advices the organization on investment opportunities with the highest feasibility only. The strategic vision of the budgeting plan is to avoid contingency budgeting approach in organizations characterized by exclusive budget control by executive managers who in most cases do not have real facts on the performance of the organization. The policy proposal will ensure that executive managers are allocated minimum contingency funds and they are held accountable for the funds.

Another way through which this strategic priority policy can improve the management of organizational funds is alignment of organizational budgets with outcomes or outputs of areas of responsibility. This implies that each area of responsibility will receive funds proportional to its productivity (National Audit Office, 2008). This will ensure objectivity in budgeting and high commitment to performance among the responsibility areas because each of those areas will know that the approval of their annual budgets including salary reviews, increments and bonuses will be based on performance.

An integrated budget will also help improve accountability in the management of public funds in Australia because it displays full financial effects or impacts of budgetary decisions. The proposed policy will ensure that non-cash elements such as asset depreciation are allocated to responsibility areas, prudent appropriation of revenues from disposals and independent sources is strictly observed by responsible operational areas, and allocation of assets and liabilities to each operational area. This public accountability system will replace the old system of centralized management of non-cash items, revenues from disposals, and assets and liabilities. The involvement of operational managers in the new policy will ensure high accountability in the management of the organizations’ resources.

Integrated budgeting proposes engagement of the shareholders of the organization in internal budgeting processes. Involvement of shareholders enhances wider consultation in decision making process. This will ensure that decision made concerning funds allocation and investments are made on an informed basis. Involving shareholders ensures high accountability and transparency in the management of organizational resources consistent with public financial management act (Australaian Public Service , 2010).

Development and implementation of an internal budget
This strategic priority proses a three-step comprehensive process of developing and implementing an organization’s budget to ensure effective decision making based on informed counsel. The steps include proper planning and coordination, construction of the budget, and review and communication.
According to the strategy in the policy document, planning and coordination will be undertaken by a team of professionals headed Chief Financial Officer in each organization whose main responsibilities will be development and issuance of a framework of reference and guidelines on the preparation of the budget, developing assumptions in planning for the organization, provision of technical advice to the senior management of organizations regarding budgeting, advising and assisting operational areas in budgeting, preparation of budgetary estimates that were not catered for at operational areas, preparing of the budget document, and reviewing its processes (Common Wealth of Australia, 2008, p.34).

Concerning budget construction, the policy document proposes a hybrid of top-down and bottom-up approach where senior organizational management sets broad objectives, goals, and constraints upon which line managers and their areas of responsibility make their area budgets.
Budgetary review and communication prescribes prudent procedures and guidelines to be followed in the approval process of the budget. The procedures include approval guidelines, oversight budgeting, provision, of policy advice to the executive management of the company, evaluation and assessment of budget bids, and recommendation and approval of final budgets (Common Wealth of Australia, 2008, p.41).

The policy document also provides a prudential guideline in the determination of effective approach to organizational budgeting. While traditional tools focused on the use of incremental budgeting, budgeting based on activities, zero-basis budgeting, and budgeting on the basis of performance, the strategy document proposes automation approach due to the inherent lapses in the traditional tools. The weaknesses of the above listed traditional tools of budgeting include assumptions that organizational activities are static in a dynamic business environment, complexities in implementation that requires managers to understand the tools well, and replication of errors if budgetary allocation measures are not well stipulated (Common Wealth of Australia, 2008, p. 38).

Automation of organizational budgeting will expedite the above difficulties will require managers to have high knowledge of the tools. Digitalized budgeting system will employ the use of software packaging in allocation of resources in organizational budgeting in a timely and effective manner. The flexibility of the proposed system will reduce the amount of resources committed to the task because the softwares are customized to auto-detect variances in the organizational performance immediately it happens. This would take a very long time and a lot of resources in traditional approach. The softwares also make environmental prediction easy through simulation by manipulation of budgetary items to see the likely future occurrences.

The improved effectiveness, accuracy, and efficiency of budgeting due to automation, and the reduction in amount of resources involved in budgeting improve public financial management practices.
Electronic budgeting will make it easy to share organizations’ budgets through internet-based media such as e-mailing, and sharing them on computerize electronic networks. The easy of sharing and storage in electronic media will make improve accountability and transparency in the management of organizations’ funds (International Federation of Accountants , 2012).

According to the Association of Chartered Certified Accountants (2010), the rigorous and analytical process involved in the development and implementation of the internal budget ensures that all decisions made regarding management of organization’s funds are sustainable. The use of Chief Financial Officer-led team in budgetary planning and coordination ensures that availability of professional expertise in budgeting. The advice of the committee will help line managers of the organizations to prepare their budgets based on informed decision. This will ensure high prudence in the management of organizational funds. The guidelines developed by the budgeting committee led by Chief Financial Officer will ensure uniformity and consistency in organizational budgeting since the policy document forms a framework of reference for all responsibility areas in the organization.

Uniformity and consistency ensures that parameters of budget estimates are uniform. This will promote transparency and accountability in budgeting process of the organization (Shah, 2007).
The proposed approach to organizational budgeting provides an opportunity to the management of organizations to assess and examine practices of work and eliminate those that do not add value to organization (Bernthal, Rogers, & Smith, 2003). The practice will improve efficiency and effectiveness of organizational engagement leading to increased financial accountability. The high involvement of senior managers, middle level managers, and ground mangers in organizational budgeting ensures wider consultation regarding allocation of funds. Consultation is essential in promoting accountability and transparency in the management of organizational resources (Shah, 2007).

The budget design also proposes the use of performance-based approach which establishes a link between organizational inputs and outputs and then allocates finances and other resources on the basis of existing efficiency. This ensures that maximum productivity is attained in the organization because highly productive responsibility areas and activities will be allocated more resources than those which are less productive (Australia, 2008, p.38).
Oversight budgetary review and communication ensures that all internal budgets from various responsibility areas are cross-checked for errors and inappropriate or infeasible estimates before compilation of an overall budget document for the organization. Budgetary review ensures high accountability and tight control of funds in an organization. This promotes public financial management practices.

Monitoring and evaluation of the performance of organizational budgets
This strategic priority provides a guideline for organizational managers to monitor and carry out an evaluation of actual performance against approved budget estimates and provide a framework of reference regarding future decision making process. The key elements of the guideline include assessment of the performance of the organization against its internal budget to measure the attainability of the set objectives and goals, maintaining high accountability practices through comparison of actual results and budgetary estimates and revising the organization’s internal budget, carrying out a financial forecast to identify changes in the organizational environment and their effects on its performance (Common Wealth of Australia, 2008). The changes are used in adjusting the internal budget to ensure that performance gaps between budgetary estimates and actual results are reconciled.

On effective monitoring of changes in the performance of the organization against its internal budget, the policy document proposes that all managers in any organization should develop routine monitoring culture to assess the performance of organizations against initial set objectives. This practice is critical in prudent financial control and identification of areas of operation that requires change. According to the policy document, reporting of organizational performance should be carried out routinely to avail information for change in decision making (Common Wealth of Australia, 2008). Monitoring and reporting of organizational performance is essential in ensuring high financial accountability and transparency in the organization because it provides a basis of policy rectification to ensure productivity of the organization in question (Zahran, 2011).

Besides monitoring and reporting, the policy document proposes that each organization undertake a routine analysis and explanation of any budget variances and their implication for future budgeting. This information will be used in adjusting decision making process to ensure that the organizations achieve their objectives and financial goals. The implementation of the routine practice will promote public accountability in the management of funds (Australian public Service Commision, 2007).

On carrying out a financial forecast to identify changes in the organization’s environment and their effects on its performance, the policy document proposes that all Australian organizations, including government agencies, should carry out internal and external environmental analysis whenever there is a variance between actual results and budgetary projections to identify the variance drivers (Fello &Austin, 2011). The findings will be used in formulating a future strategy in financial estimation to expedite the difference. The act in itself is a prudential undertaking in effective management of public funds because bridging the mismatch in performance helps in protection the organization against possible losses due to continuous deviation (Common Wealth of Australia, 2008, p.52).

Lastly, the policy document proposes a routine review of the internal organizational budget to measure its effectiveness against set objectives and identify improvement opportunities. Improvement will entail deletion of budgetary items which do not add value to the organization and those whose return on investment does not have a significant effect on the overall organizational productivity. Deletion of budgetary items which do not add value to an organization safeguards shareholders’ investments against possible losses. The implementation of this policy will improve public financial management in Australia (Ortiz, Gorita, & Vislykh, 2004).

References
Association of Charted Certified Accountants. (2010). Improving public sector financial management in developing countries and emerging economies. London, United Kingdom: The Association of Chartered Certified Accountants.From: http://www.accaglobal.com/content/dam/acca/global/PDF-technical/public-sector/tech-afb-ipsfm.pdf
Australian Public Service Commision. (2007). Office of the Commissioner for Public Employment :State of the Service Report 2006-2007. Canberra: Northern Territory Government of Australia.From: http://www.ocpe.nt.gov.au/__data/assets/pdf_file/0008/51938/State_of_Service_Report.pdf
Australian Public Service Commision.(2010). Implementing Machinery of Government Changes: A good practice guide. p.1-64. From: http://www.publications.parliament.uk/pa/cm200708/cmselect/cmpubacc/519/519.pdf
Bernthal, P., Rogers, R.,& Smith, A. (2003). MANAGING PERFORMANCE:Building Accountability for Organizational Success. Development Dimensions International, HR Benchmark Group Volume 4, Issue 2 , p.1-38. From: http://www.ddiworld.com/DDIWorld/media/trend-research/managing-performance_fullreport_ddi.pdf?ext=.pdf
Common Wealth of Australia. (2009). Better Practice Guide :Innovation in the Public Sector:Enabling Better Performance, Driving New Directions. Canberra: Australian National Audit Office.From: http://www.anao.gov.au/bpg-innovation/pdf/BPG-Innovation.pdf
Common Wealth of Australia. (2008). Better Practice Guide:Developing and Managing Internal Budgets. Canberra: Australian National Audit Office.
Eccles, R., Ioannou, I., & Serafeim, G. (2012). The Impact of a Corporate Culture of Sustainability on Corporate Behavior on Corporate Behavior. Harvard Business School Publication , p.1-57. From: http://www.hbs.edu/research/pdf/12-035.pdf
Fellow, M., & Austin, M. (2011). Performance Management in Nonprofit Human Service Organizations. p.1-34.From: http://www.mackcenter.org/docs/Performance%20Management.pdf
International Federation of Accountants. (2012). Public Sector Financial Management Transparency and Accountability: The use of International Public Sector Accounting Standards . Public Financial Management: A Whole System Approach, Volume 1 , p.1-6. From: http://www.ifac.org/sites/default/files/publications/files/Policy%20Position%20Paper%204%20For%20Issue.pdf
National Audit Office. (2008). Managing financial resources to deliver better public services. canberra: The Comon Weath of Australia.
Ortiz,E., Gorita, I., & Vislykh, V. (2004). Delegation of Authority and Accountability:Series on Managing for Results in the United Nations System. United Nation’s Joint Inspection Unit publication , p.1-27. From: http://www.unjiu.org/data/reports/2004/en2004_07.pdf
Shah, A. (2007). Public Sector Governance and Accountability Issues:Performance Accountability and Combating Corruption. Washington: The International Bank for Reconstruction and Development / The World Bank.From: http://siteresources.worldbank.org/PSGLP/Resources/PerformanceAccountabilityandCombatingCorruption.pdf
Zahran, M. (2011). Accountability Frameworks in the United Nations System. United Nations Joint Inspection Unit 2011/5 , p.1-60. From: http://www.unjiu.org/data/reports/2011/en/en2011_5.pdf

Evaluation of a government strategy 2

The United States and the National Debt

Introduction
The national public debt of the US involves the sum of funds borrowed by the US Federal Government at any given time via the issuance of securities by her Treasury as well as the other agencies of the US federal government. The national public debt of the US composes of two components: the intragovernmental debts or debt held by the government accounts and the public held debts.

The public held debts include of the Treasury securities issued to investors’ external to the federal government such as corporations, individuals, Federal Reserve System (FRS) and state, foreign, and local governments. On the other hand, the intragovernmental debts or those held by the government accounts includes the non-marketable securities held in federal government-administered accounts, owed to such program beneficiaries as Social Security Trust Fund (GAO, 2012). The figure below represents the total debt held by the federal government as well as its components by the end of 2011 fiscal year:

(GAO, 2012, Para 2)
There is so much debate on the US national debt in the modern days, but the reality is that majority of the Americans still struggle grasping the reality that their national debt is horrific. In 2010, the national debt of the US was rapidly approaching $14 trillion making it the single biggest debt ever in the world history (Michael, 2010). This debt has increased for a whooping fifty-three consecutive years, with sufficient evidence that it gets worse with every single month. Prior to the 2008 economic crisis, things were quite bad for the US but the crisis only added to the American wooes by raising the debts into stratosphere. Currently, the US is running more than a trillion dollars deficit each year and there is no expectation of a conclusion to this trend in sight. As such, the US is literally running short of potential lenders (McEachern, 2012). Below is a chart demonstrating the national debt growth of the US over the past few decades:

(Michael, 2010, Para 2) The purpose of this paper is to examine the US and her national debt in terms of the factors contributing to the growth of this debt and the ways of fixing it.
Factors contributing to the National Debt
There are numerous factors accounting for the need of borrowing money in the US with a key one being the US imports more goods than how it exports. Such imports have high demand and they are imported irrespective of their cost. A major cause of this problem is the tax cuts by Bush administration in 2001 and 2003.

These tax cuts have added an approximate 1.6 trillion dollars towards the national debt. The policies of Bush administration, especially the debt-financed tax cuts, clearly compose the lion’s share of US debt problem. This has been growing and thus their tab builds every year (Gearhardt & Gates, 2010). Besides the tax cuts, US debts have been increased by the growing health care entitlements. The democrats steadily harp about the tax cuts by Bush administration, although the rates existed in 2007, while that year’s deficit accounted for 10% of the 1.6 trillion dollars budget shortfall of 2011.

The only changes to this end include the added federal bureaucracy, regulation, and new Medicaid as well as other entitlements, which have pushed up spending by the federal government by about 1.1 trillion dollars, 900 billion dollars over the requirement of inflation (Rosenberg, 2012). Actually, the US health-entitlement explosion will continue accounting for large proportions of the US debt problem. Related to this is the medicare prescription benefit of drugs that has added about 300 billion dollars towards the national debt. Such expanding healthcare entitlement as Medicare, or 2010’s package of health-care reform, is a particularly alluring mechanism for running up debts by the US Congress. Since the lawmakers do not map out effective revenue strategies for funding such benefits, they end up being shielded from political cost of paying for such new programs (Gearhardt & Gates, 2010).

Another contributing factor is the US devotion to fight against terrorism and dictatorships across the world. The classic examples on this are the recent wars against Afghanistan and Iraq, which accounts for about 1.3 trillion dollars. These ways have led to excessive expenditure and some ways are pointless in that they waste time, man power, and money instead of using them in other effective areas. In essence, this has been a chief chunk of new, unanticipated spending over the past decade. These wars have cost the US quite substantially and they are usually financed with borrowing, consequently adding up to the US national debt (Rosenberg, 2012).

Another factor is the economic stimulus introduced by President Obama’s administration in 2009 and cost about 800 billion dollars. Moreover, Obama entered an agreement of tax cuts with the Republicans in 2010 that reduced payroll taxes and extended jobless benefits leading to an additional 400 billion dollars to the US national debt. The government had also incurred another 200 billion dollars in 2008 to bail out the financial industry, as well as the government’s efforts of softening the Great Recession’s blow amount towards one of the leading debt build-up chunks. The budget of the US federal government was like a single year away from striking a balance but since the economic stimulus’ enactment, Democrats and Obama in the Congress move the objective out of reach (Gearhardt & Gates, 2010).

The great recession has also contributed towards the national debts. Some of the gaps in spending came from the factors external to the control of the White House and Congress. As the US government spent so heavily in order to boost the national economy, it took in billions of dollars less in tax proceeds than expected, due to the fact that the Great Recession had eroded the income and spending of the Americans (Rosenberg, 2012). Recession is also related to the surging fuel prices across the globe, which make it hard for the Americans to maintain a comprehensive budget since it keeps changing due to fuel-related issues (Gearhardt & Gates, 2010).

Ways of Fixing the Issue of National Debt
The US spends so many resources on maintaining its world power’s position. However, the nation makes less money than it spends and this leads to borrowing making the national debt to be always high. The government must address this issue and come up with an effective strategy of maintaining it position as opposed to resorting into huge debts as discussed above. First, the US government is the leading donor in the whole world through giving aids to the other nations every year. Some of these funds should be directed towards payment of the national debts as opposed to offering help while the nation struggles under huge national debts.

Secondly, the US needs to review its entitlement rolls and revamp its Medicare/Medicaid and Disability since these system attract epic scales of abuse. Related to this factor is the need to put an ending to the imbursement of the untold hundreds of billions of dollars towards education, medication, and general betterment of thousands of individuals who are not legitimate US citizens. Legal immigration assisted in building the nation and making it strong but illegal inundation witnessed in the recent past is so close to an invasion act (Pozen, 2010).

The government should offer no more financial and economic bailouts to the financial institutions as it has happened in the past economic meltdowns. This practice forces governmental borrowing, which ends up spoiling the nation’s budget balance. Another way of minimizing government borrowing is reducing the current payments for the elected officials as they can willingly take the pay cuts and live within the new remunerations. Some people, particularly the conservatives have questioned government spending, and the US government must come up with effective mechanisms of portraying transparency in the government spending. This could help in eliminating any loopholes allowing corruption and embezzlement of public funds, which if well used could cater for some other expenses that force national borrowing activities (Rosenberg, 2012).

The conservatives claim or believe that the US national deficits as well as long-term debt facade an existential threat towards the nation and this demands being tackled with immediate effect. They further argue that the messed-up US finances are as a result of the runaway huge governmental spendings on diverse social programs. As such, their solution lies in shredding the safety net, dismantling the medicare, and if possible, social security, as well as generally minimizing government size. These are tough choices but they might be the only means of saving the current US situation (Gearhardt & Gates, 2010).

Conclusion
In conclusion, the US has unbelievable debts to individuals, corporations, or other nations and within its departments to a tune of over 15 trillion dollars. The main cause of this deficit is the spending model of the government and thus the need of adjustment of diverse issues to streamline government spending and borrowing.

References

GAO US Government Accountability Office. (2012). Federal Debt Basics, retrieved on 7 August 2012 from, http://www.gao.gov/special.pubs/longterm/debt/debtbasics.html#largefeddebt
Gearhardt, M., & Gates, W. (2010). The financial tsunami: Will it drown us in a wave of debt?. Bloomington, IN: AuthorHouse.
McEachern, W. A. (2012). Economics: A contemporary introduction. Mason, OH: South-Western Cengage Learning.
Michael. (2010). The National Debt of the United States, retrieved on 7 August 2012 from, http://thedebtweowe.com/the-national-debt-of-the-united-states
Pozen, R. C. (2010). Too big to save: How to fix the U.S. financial system. Hoboken, NJ: Wiley.
Rosenberg, J. C. (2012). Implosion: Can America recover from its economic & spiritual challenges in time?. Carol Stream, Ill: Tyndale House Publishers.

The United States and the National Debt 3