Financial Management Test 1 Whitledge MSState

Avg payment period (formula)

= Accounts Payable /(Cost of Goods Sold⁄365)

ROA & ROE (formulas)

= Net Inc/ Total Assets (or Total SE)

Change in net working capital (formula)

= ending NWC - beg. NWC

Partnership

A form of business ownership in which the business is owned by two or more persons

Ratio analysis

Absolute numbers vs ratios

Oversight and accountability

Additional independent auditors

Accounting equation

Also known as the Accounting Identity, Balance Sheet Equation, Balance Sheet Identity Assets = Liabilities + Owners' Equity

3 major elements of a balance sheet

Assets are probable future economic benefits controlled by an entity; used to generate revenue Liabilities are probable future economic costs owner's Equity is the residual interest in the net assets of an entity that remains after deducting its liabilities.

________ ________ may be the most important responsibility that a financial manager has

Capital budgeting

__________ is generally more readily available for a partnership, but there are still significant limitations on the ability to raise large amounts of ________

Capital, capital

Managerial compensation

Compensation (stock options, bonus, promotion, etc.) can be used to align interests

Profitability (financial ratio)

Controlling costs, operation

Key titles in SOX Act?

Corporate responsibility Corporate and Criminal Fraud Accountability Auditor independence Enhanced financial disclosures

Primary markets

Corporation is the seller Corporate stock or bond issues are almost always sold with the assistance of an investment bank.

Liquidity ratios

Current ratio, quick ratio, avg payment period

Disadvantages to a partnership

Difficult to reach decisions, gen. partners have unlimited liability, limited partners have less control

Agency Conflicts question

Do managers always act and make decisions that reflect stockholder's best interest?

Advantages to a partnership

Easy to establish, larger capital pools than sole proprietorship

In primary markets, new equity issues involve either

First time issues by firms whose shares are not currently traded (Initial Public Offerings) New shares issued by firms whose shares are already trading in the marketplace (Seasoned Offering) Private placement is a negotiated sale involving a specific buyer; generally, the buyer is a hedge fund

5 financial ratios

Liquidity Asset management Financial leverage Profitability Market value

Financial leverage (financial ratio)

Long-term Solvency Ratios How efficiently mgmt. is using debt

Agency conflict factors

Managerial compensation Oversight and accountability Control of the firm

Agents

Managers (people elected by owners to run company)

Goal of the firm?

Maximize shareholder wealth

Limited partnership

One or more general partners run business and have unlimited liability. Limited partners liability limited to contributions, and cannot help run the business

Principals

Owners (stockholders, equity holders, equity owners)

Financial securities (instruments)- claim to a cash flow

Primary market- $ goes to the company Secondary market- Claims are traded

Profitability ratios

Profit margin, return on assets, return on equity

Agency relationship

Relationship between principal and agent

Sources of agency conflict

Shirking by the agent (avoiding responsibilities) Diversion of resources by agent for private use Differential time horizon of the agent and principal Differential risk preferences of the agent and the principal

Liquidity (financial ratio)

Short-term Solvency Ratios Meet short-term obligations

To make financial comparison possible..

Standardize the financial statements A common way to do this is to use common-size statements

Capital budgeting

The process of identifying and evaluating capital projects where the cash flow to the firm will be received over a period longer than a year. The financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire

Capital structure

The specific mixture of long-term debt and equity the firm uses to finance its operations. Good understanding of the effects of equity and debt financing are important for financial managers.

Asset Management ratios

Total Asset Turnover, Inventory turnover, Avg payment period (Acc rec period)

Financial leverage ratios

Total debt ratio, equity multiplier, interest coverage/ times interest earned

Asset Management (financial ratio)

Turnover Ratios How efficiently mgmt. is utilizing assets

Control of the firm

Ultimately rests with shareholders Dissatisfied shareholders can fire management

Current liabilities include..

accounts payable taxes payable current portion of long-term debt

General partnership

all partners share in the gain or losses of the business and all partners have unlimited liability for all partnership debts and other legal obligations

Change in net working capital

amount spent on net working capital

Expenses are...

amounts incurred to generate revenue and include costs of goods sold, operating expenses, interest and taxes.

Revenues are...

amounts reported from the sale of goods and services

Agency costs

arise when management makes investment decisions that may result in a loss of value for shareholders Monitoring of management, restrictions on mgmt. actions, loan covenants

NYSE is a...

auction market. Have a physical location and attempt to match buyers with sellers

Financial market

brings together buyers and sellers of debt and equity securities

A firm's ________ __________ is really just a reflection of it's borrowing policy

capital structure

Current assets

cash and other assets that will likely be converted into cash or used up within one year or operating cycle. Presented in order of their liquidity Cash and cash equivalents (marketable securities), accounts receivable, inventories

Operating cash flows

cash flows that result from the firms day-to-day activities of producing and selling

NASDAQ is...

dealer market or over the counter. In a dealer market, most of the buying and selling is done by the dealer. System of computers

Net working capital

difference between a firm's current assets and current liabilities. Not enough working capital may indicate liquidity problems; Too much working capital may be an indication of inefficient use of assets.

Cash flow

difference between number of dollars that came in and went out

Disadvantages to a corporation

difficult to establish, double taxation, agency costs

Common-size balance sheet

divide all of the accounts by expressing each as a percentage of total assets

Common Size Income Statement

divide all of the items by revenues. All items are expressed as a percentage of sales.

Fixed assets

do not meet the definition of current assets because they will not be converted into cash or used up within one year or operating cycle Long-term assets

Advantages to a sole proprietorship

easy to establish, simple decisions, little regulation

Marginal tax

extra tax the tax payer would pay if they earned one more dollar

Use of debt in a firm's capital structure is called...

financial leverage. Increases potential reward, but increases risk of financial distress and business failure

Equity is created by...

financing activities (primary mkt transaction) and operating activities

Working capital

firm's level of current assets. Too little = liquidity problems Too much= inefficiency Effective working capital policies are crucial to LT growth and survival.

Financial statements are..

framework for calculating financial ratios Internal uses by managment External uses: Investors, suppliers, lenders

Financial managers make decisions that ________ the value of the owner's equity?

increase

Advantages to a corporation

limited liability, large amounts of capital, corporation's life is not limited to that of the owners

Intangible assets

long term assets that lack physical substance. Ex: goodwill, copyright, etc

Tangible assets

long term assets with physical substance Ex: plant, equip, natural resources, land

Secondary market is...

market where existing securities are offered for resale

Limitations of financial ratios

not useful in isolation Comparable ratios can be hard to find for companies in multiple industries must be analyzed relative to one another determining a range of acceptable values is difficult

Financial Statements

objective is to provide economic decision makers with useful information about a firm's financial performance and change in financial positions Source of information for managers, shareholders, creditors, and other stakeholders

Liabilities

obligations owed by an entity from previous transactions that are expected to result in an outflow of economic benefits in the future

Current liabilities

obligations that will be satisfied within on year.

Primary market is...

original sale of securities by governments and corporations. Initial Public Offering (IPO) Treasury Security Auction

Corporation

owned by stockholders, liability is legally limited to the amount of money invested. Can borrow money and own property, sue or be sued, enter into contracts

Tax Rates

prior to 2018, marginal system of varying rates; 2018 is a flat-rate tax Sole proprietorships and partnerships are taxed at individual rates; LLCs have different tax status

Financial ratios

provide a way to compare and investigate relationship between different pieces of financial information used for internal comparisons and comparisons across firms

Non current liabilities

provide information about the firm's long-term financing activities.

Assets

provide probable future economic benefits controlled by an entity as a result of previous transactions. Assets are used to generate sales (or revenue)

Secondary markets

provide the means for transferring corporate ownership. The better the secondary the market, the easier it is for firms to raise external capital in the primary market.

Net capital spending (net investment in fixed assets)

purchases of fixed assets minus the sale of fixed assets

Liquidity

refers to the ability to quickly convert investments into cash closest to fair market value Multidimensional: Ease of conversion and loss of value

Balance sheet

reports the firm's financial condition at a point in time. Snapshot

Income statement

reports the revenues and expense of the firm over a period of time (it measures flows) IS equation: Revenues - Expenses = Net Income

Stockholder's equity is...

residual interest in assets that remains after subtracting liabilities

Accrual method of accounting

revenue is recognized when earned and expense are recognized when incurred firms can manipulate net income by recognizing revenue earlier or later by delaying or accelerating the recognition of expenses.

Sarbanes-Oxley Act of 2002

set new and enhanced standards for all U.S public company boards, management and public accounting firms

Proprietorship

single owner with unlimited liability for debts and legal obligations.

Evaluating the _____, ______, and ______ of future cash flows is the essence of capital budgeting

size, time, risk

Three main forms of business

sole proprietorship, partnership, corporation

Stakeholder

someone (in this case, other than a stockholder or creditor) who potentially has a claim on the cash flows of the firm.. Ex. Employees, customers, suppliers, government

Average tax rate

tax bill (taxes due) divided by taxable income

Agency problem

the possibility of conflict of interest between the principal and the agent

3 types of ratio analysis

trend or time series cross-sectional industry average

Market value

true value of an asset, or the amount of cash that would be received if we sold the asset today

Disadvantages to a sole proprietorship

unlimited liability, limited capital pool, ownership is difficult to transfer

Book value

values on the balance sheet. How much it cost to obtain (historical cost)

OCF tells us...

whether a firm's cash inflows from its business are sufficient to cover its everyday cash outflows

Common-size financial statements

work with percentages instead of dollars