Finance
Business finance has three main areas of concern:
1. Capital budgeting 2. Capital Structure 3. Working Capital management
Four Finance Assumptions
1. Cash is King 2.Money has a time value 3. Risk requires a reward 4. Market prices are generally right
Externally raised capital examples
1. Financial securities 2. Debt Securities 3. Equity Securities
Working Capital Management is...
1. Managing short term assets and liabilities 2. Inventory and receivables
Capital budgeting
1. planning and managing long term investments 2. determining if the value of the cash flows from the investment exceed its costs 3. Evaluating the size, timing and risk of future cash flows
What should you keep in mind when examining an income sheet?
GAAP, cash versus non-cash items, time and costs
For a publicly held company, the goal of the firm is to:
MAXIMIZE SHAREHOLDER WEALTH
How is the market-to-book ratio calculated?
Market value per share/book value per share
Profit margin
Net Income / Sales
Return on equity (assets)
Net Income / Total Equity
Retention ratio
Net income - Dividends / Net income
Which decreases net income but does not affect the operating cash flow of a firm that owes no taxes for the current year?
Noncash Item
The DuPont identity tells us that ROE is affected by three things:
Operating efficiency (as measured by profit margin). Asset use efficiency (as measured by total asset turnover). Financial leverage (as measured by the equity multiplier).
What factors affect a firms ability to sustain growth?
Profit margin Total asset turnover Financial Policy Dividend Policy
Formula for computing sustainable growth rate
ROE x b / 1 - ROE x b
Internally raised capital example
Retained Earnings
Risk Requires a Reward
The greater the risk the greater the return
Marginal tax rates are the most important because
The reason is that any new cash flows will be taxed at that marginal rate. Because financial decisions usually involve new cash flows or changes in existing ones, this rate will tell us the marginal effect on our tax bill.
According to the originators of the corporate US tax code, the only tax rates are:
read
Total asset turnover
sales / total assets
Operating cash flow is defined as
the cash that a firm generates from its normal business activities
Net working capital =
the difference between a firm's current assets and its current liabilities
What does it mean when a firm has a days sales in receivables of 45?
the firm collects its credit sales on average in 45 days
Changes in capital spending can be negative if:
the firm sold off more assets than it purchased. The net here refers to purchases of fixed assets net of any sales of fixed assets.
Financial leverage increases:
the potential return to stockholders
Capital Structure is
the right mix of debt and equity
Financial leverage refers to a firms.....
use of debt in capital structure
Cash is King means
value of an asset is based on future cash flows
Your average tax rate is your tax bill divided by:
your taxable income, in other words, the percentage of your income that goes to pay taxes.
Total debt ratio
Total assets - total equity / total assets
T or F: Free cash flow is very similar to cash flow from assets?
True
T or F: Operating cash flow does not include depreciation or interest?
True. To calculate operating cash flow (OCF), we want to calculate revenues minus costs, but we don't want to include depreciation because it's not a cash outflow, and we don't want to include interest because it's a financing expense. We do want to include taxes because taxes are, unfortunately, paid in cash.
Long term solvency ratios are also known as
financial leverage ratios
Market value is most important to the
financial manager
Depreciation is the accountants estimate of the cost of ____ used in the production process matched with the benefits produced from owning it
fixed assets/equipment
Over the past year, a firm decreased its current assets and increased its current liabilities. As a result, the firm's net working capital:
had to decrease
The major downside of using financial statements for analysis is that the data is based off of:
historical and book values
Under GAAP, assets are usually carried on a firms balance sheet at both:
historical cost and book value
Info needed to compute profit margin can be found on the
income statement
If sales increase while there is no change in accounts receivable, the receivables turnover ratio will ____
increase
The goal of financial management in a for-profit business is to make decisions that increase the value of the stock, or more generally...
increase the market value of the equity
Cash flow to creditors =
interest paid less net new borrowing
Cash flow to creditors is defined as:
interest paid minus net new borrowing.
Assets are listed in order of
liquidity
The price at which willing buyers and sellers would trade is called the ____ price
market
How is PE ratio computed?
market price per share/earnings per share
Market Prices are Generally Right
market price represents true value
The P/E ratio is a _______ ratio
market value
What is the purpose of the income statement?
measures performance over some period of time, usually a quarter or a year
net capital spending is just
money spent on fixed assets - money received from the sale of fixed assets
Shareholders' equity is equal to:
net fixed assets minus long-term debt plus net working capital.
Cash flow from assets is defined as:
operating cash flow minus the change in net working capital minus net capital spending.
Cash flows from assets involves three components:
operating cash flow, capital spending, and change in net working capital
If a company has had negative earnings for several periods they might choose to use a _______ ratio
price-sales
The market value of an asset tends to
provide a better guide to the actual worth of that asset than does the book value.
Liquidity has two dimensions:
ease of conversion versus loss of value.
Non-cash items are ___ that ___ cash flow
expenses; do not directly affect
Your marginal tax rate is the:
extra tax you would pay if you earned one more dollar.
Inventory turnover
COGS / Inventory
Dividend payout ratio
Cash dividends/ net income
Times interest earned ratio
EBIT / Interest
Which are classified as fixed assets on the balance sheet?
Equipment, land, buildings
GAAP matching principle requires revenues to be matched with:
Expenses
According to GAAP, which revenue is recognized on an income statement?
When the value of an exchange of goods or services is known or reliably determined, when the earnings process is virtually completed
The quick ratio provides a more reliable measure of liquidity than the current ratio especially if the companys inventory takes __________ to sell
a long time
Depreciation is
a systematic expensing of an asset based on the assets life expectancy
In the long-run costs must be considered as:
all variable
Period costs are specifically allocated to
an interval of time
The cash flow identity states that cash flows from _____should equal cash flows to creditors and equity investors.
assets
Non-cash items do not affect
cash flow
Which one of the following has nearly the same meaning as free cash flow?
cash flow from assets
Money Has a Time Value
cash in hand is of more value now than the future
Quick ratio
current assets - inventory / liabilities
current ratio
current assets/current liabilites
The cash ratio is found by dividing cash by
current liabilities
The more debt a firm has, the greater its...
degree of financial leverage
The cash coverage ratio adds ____ to EBIT for a better measure of how much cash is available to meet interest obligations
depreciation
Net working capital is the
difference between current assets and current liabilities
Cash flow to stockholders is defined as:
dividends paid minus net new equity raised
Debts are listed in order
due