Business Finance: Chapter 1-3
Ch.1 Four Basic Areas of Finance
1. Corporate Finance 2. Investments 3. Financial Institutions 4. International Finance
Ch.3 What are the four determinants of growth?
1. Profit Margin 2. Total Asset Turnover 3. Financial Policy 4. Dividend Policy
Ch.3 Five types of financial ratios
1. Short-term solvency, or liquidity 2. Long-term solvency, or financial leverage 3. Asset Management, or turnover 4. Profitability ratio 5. Market Value ratio
Ch.2 What are the four current tax rules?
15%, 25%, 34%, and 35%
Ch.1 Define Corporation (and Advantages and Disadvantages)
A business created as a distinct legal entity owned by one or ore individuals or entities. Disadvantage: double taxation Advantage: ease of ownership transfer, limited liability, easy to raise capital
Ch.1 Define Sole Proprietorship (and its risks)
A business owned by one person. Risks: unlimited liability, life is limited to owner's life span, limitations of insufficient funds/capital
Ch.1 Define Partnership (and its risks)
A business owned by two or more people. Same risks as the sole proprietorship.
Ch. 2 Define Cash Flow to creditors
A firm's interest payments to creditors less net new borrowing
Ch.1 Define Working Capital
A firm's short-term assets (inventory) and liabilities (money owed to suppliers)
Ch.2 A negative operating cash flow indicates...
A sign of trouble
Ch.3 Define Common-Size Statements
A standardized financial statement presenting all items in percentage terms. Balance sheet items are shown as a percentage of assets and income statements items as a percentage of sales.
Ch.2 Cash Flow to stockholders
Dividends paid - Net new equity raised =Cash flow to stockholders
Ch.2 Operation Cash flow equation
EBIT +Depreciation -Taxes =Operation Cash flow
Ch.3 Earnings-per-share ratio equation
EPS= Net Income / Shares Outstanding
Ch.3 Market Value Measure ratios
Earnings-per-share ratio Price-earnings ratio Price-Sales ratio Market-to-Book Ratio
Ch.2 Two types of Assets
Either Fixed or current. Fixed can be tangible and intangible.
Ch.1 Examples of Stakeholders
Employees, customers, suppliers, and even the government
Ch.2 Change in Net Working Capital equation
Ending NWC -Beginning NWC =Change in NWC
Ch.2 Capital Spending equation
Ending net fixed assets -Beginning net fixed assets +Depreciation =Net Investment in fixed assets
Ch.3 Equity multiplier equation
Equity multiplier = total assets / total equity $1/0.72= 1.38 times
Ch.2 Define Noncash items
Expenses charged against revenues that do not directly affect cash flow, such as depreciation
Ch.2 What is GAAP?
Generally Accepted Accounting Principles: the common set of standards and procedures by which audited financial statements are prepared.
Ch.2 What is the matching principle?
If we manufacture a product and then sell it on credit, the revenue is recognized at the time of sale.
Ch.2 What is the income statement?
Income Statements measures performance over some period of time.
Ch.1 What is Sarbanes-Oxley Act? What are the repercussions of the act?
Intended to strengthen protection against corporate accounting fraud and financial malpractice. CFO must sign off on all reports. Repercussions: Many companies went dark and are no longer traded in major stock markets or they opened in other countries.
Ch.2 Cash Flow to creditors equation
Interest paid - Net new borrowing =Cash flow to creditors
Ch.3 Inventory turnover ratio equation
Inventory turnover = Cost of goods sold / inventory
Ch.3 Types Asset Management, or Turnover Ratios
Inventory turnover ratio Days' sales inventory Receivable turnover Days' sales in receivables Total asset turnover
Ch.2 What is the balance sheet?
It is a snapshot of the firm. It has the assets, liabilities, and equity.
Ch. 3 Market-to-book ratio equation
Market-to-book ratio = Market value per share / book value per share (book value per share is: total equity/#of outstanding shares)
Ch.2 What is the last item on the income statement?
Net Income
Ch.2 Cash Flow from assets equation
Operation cash flow -Net capital spending -Change in NWC =Cash flow from assets
Ch.1 Dealer markets are also called...
Over-the-Counter (OTC) (long term debt)
Ch.3 Price-Earning Ratio equation
PE Ratio = Price per share / earnings per share
Ch.3 Internal Use of analyzing financial statements
Performance evaluations Planning for the future
Ch.3 Price-Sales Ratio equation
Price- Sales ratio = Price per share / Sales per share
Ch.3 Profit Margin Ratio equation
Profit Margin = Net income / sales
Ch.3 Profitability Ratios
Profit Margin ratio Return on assets return on equity
Ch.3 Quick Ratio Equation
Quick ratio = (Current Assets - Inventory) / Current Liabilities
Ch.3 Another Return on Equity Equation
ROE = Profit Margin x Total asset turnover x equity multiplier
Ch.3 Other Return on Equity Equation
ROE = ROA x Equity Multiplier = ROA x (1+Debt-Equity ratio)
Ch.3 Receivable turnover ratio equation
Receivable turnover = Sales / Accounts receivable
Ch.1 Define Primary Market
Refers to the original sale of securities by governments and corporations
Ch.1 Define Secondary Market
Refers to those in which these securities are bought and sold after the original sale
Ch.3 Define financial ratios
Relationships determined from a firm's financial information and used for comparison purposes
Ch.3 Return on Assets Ratio Equation
Return on assets = Net Income / total assets
Ch.3 Return on Equity Ratio equation
Return on equity = Net income / total equity
Ch.2 What is the income statement equation?
Revenues - Expenses = Income
Ch.2 What is the shareholders' equity equation?
Shareholders' equity = Assets - Liabilities
Ch.1 Define Stakeholder
Someone other than a stockholder or creditor who potential has a claim on the cash flows of the firm
Ch.1 Investments deal with...
Stocks and Bonds
Ch.2 Example of figuring out Marginal and Average tax
Taxable income: $200,000 0.15 ($50,000) = $7,500 0.25 ( 75,000 - 50,000) = 6,250 0.34 ( 100,000 - 75,000) = 8,500 0.39 ( 200,000 - 100,000) = 39,000 -------------------------------------- $61,250 Average tax rate: 61,250/200,000 = 30.625% Marginal rate is 39 percent.
Ch.2 Define Net working capital
The difference between a firm's current assets and its current liabilities.
Ch.2 Define Cash Flow
The difference between the number of dollars that came in in and the number that went out.
Ch.2 Define Equity
The difference between the total value of the assets and the total value of the liabilities
Ch.1 What is the goal of Financial Management?
The goal of financial management is to maximize the current value per share of the existing stock OR Maximize the market value of the existing owners' equity
Ch.3 Define sustainable growth rate
The maximum possible growth rate a firm can achieve without external equity financing while maintaining a constant debt-equity ratio.
Ch.3 Define internal growth rate
The maximum possible growth rate a firm can achieve without external financing of any kind
Ch.1 Define Capital Structure
The mixture of debt and equity maintained by a firm
Ch.1 Agency Problem
The possibility of conflict of interest between the owners and management of a firm.
Ch.1 Define Capital Budgeting
The process of planning and managing a firm's long-term investments.
Ch.1 Agency Relationship
The relationship between stockholders and management
Ch.2 Cash Flow from assets
The total of cash flow to creditors and cash flow to stockholders, consisting of the following: operating cash flow, capital spending, and change in net working capital
Ch.1 What does the treasurer do?
They are responsible for managing the firm's cash and credit, its financial planning, and its capital expenditures
Ch.1 What does the controller do?
They handle cost and financial accounting, tax payments, and management information systems.
Ch.2 Define Earnings Management
They might take steps to overstate or understate earnings at various times to smooth out dips and surges-- controversial
Ch.3 2 Types of Benchmarks
Time-Trend Analysis (History) Peer Group Analysis (identify firms similar as they compete in the same markets, have similar assets, and operate in similar ways)
Ch.3 Times Interest Earned ratio Equation
Times interest earned ratio = EBIT / Interest
Ch.1 What is the primary purpose of an auction market?
To match those who wish to sell with those who wish to buy.
Ch.3 Total asset turnover
Total Asset Turnover = Sales / Total Assets
Ch.3 Total Debt Ratio equation
Total Debt Equity = (Total Assets - Total equity) / Total assets
Ch.3 Types of Financial Leverage (Long-Term Solvency ratios)
Total Debt Ratio Times Interest Earned Ratio Cash Coverage
Ch.3 External Use of analyzing financial statements
Used for short-term and long-term creditors and potential investors Suppliers use to extend credit Acquiring another firm
Ch.2 Product Cost examples
raw materials, direct labor expense, and manufacturing overhead- reported on the income statements as cost of goods sold
Ch.2 Operating cash flow
refers to the cash flow that results from the firm's day-to-day activities of producing and selling
Ch.2 Capital Spending
refers to the net spending on fixed assets
Ch.2 Define Market Value
the amount of cash we would get if we actually sold it
Ch.2 The change in net working capital
the amount spent on net working capital
Ch.2 Define Liquidity
the speed and ease with which an asset can be converted to cash.
Ch.2 Period Cost examples
they are incurred during a particular time period and are reported as selling, general, and administrative expense. `
Ch.2 Define average tax rate
total taxes paid divided by total taxable income
Ch.3 Problems with the Financial Statement Analysis
-There is no underlying theory to help us identify which items or ratios to look at and to guide us in establishing benchmarks. -Peer Groups in an industry are scattered around the globe -Different GAAP/ accounting/ record keeping procedures -Different fiscal years
Ch.1 Financial Institution examples...
Banks and Insurance companies
Ch.3 DuPont Identity
Breaking ROE into three parts: operating efficiency, asset use efficiency, and financial leverage
Ch.1 Who is the top financial officer?
CFO Chief Financial Officer
Ch.1 What are the three areas of corporate financial management?
Capital Budgeting, Capital Structure, and Working Capital management
Ch.3 Cash Coverage ratio equation
Cash Coverage = (EBIT + Depreciation) / Interest
Ch.3 Cash Ratio
Cash Ratio = Cash / Current Liabilities
Ch.2 Net Working Capital Equation
Current Assets - Current Liabilities = Net Working Capital
Ch.3 Types of Liquidity (Short-term Solvency ratios)
Current Ratio Quick Ratio Cash Ratio
Ch.3 Current Ratio Equation
Current ratio = Current Assets / Current liabilities
Ch.3 Days' sales inventory ratio equation
Days sales in inventory = 365 days / inventory turnoever
Ch. 3 Days sales in receivables ratio equation
Days sales in receivables = 365 days / Receivables turnovers
Ch.1 What are the two types of secondary markets?
Dealer and auction markets
Ch.3 Debt-Equity ratio equation and example
Debt-Equity ratio = Total debt / total equity A firm has $0.28 in debt for every $1. So, ($1-0.28=0.72) 0.28/0.72= 0.38 times
Ch.2 Examples of Liabilities
Accounts payable (current) Bonds (long term)
Ch.2 Examples current assets
Accounts receivable and cash
Ch.2 Define marginal tax rate
Amount of tax payable on the next dollar earned
Ch.2 Define Free Cash Flow
Another name for cash flow from assets
Ch.2 Balance Sheet Equation
Assets = Liabilities + Shareholders' equity