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