FIN 310 Chapter 1-4 for Exam 1

Asset Turnover Ratios

- FATR = Sales/Net Fixed Assets (PPE) -TATR = Sales/TA (All Assets) Multipliers that tell us how many times the assets turn ober each year (how many times the profit margin is earned each year)

Profits vs. Cash Flows

-"Profits" subtract depreciation (a non-cash expense) -"Profits" ignore cash expenditures on new capital (the expense is capitalized) -"Profits" record income and expenses at the time of sales, not when the cash exchanges actually occur -"Profits" do not consider changes in working capital

Sole Proprietorship Disadvantages

-100% liability -Hard to raise capital -Difficult to transfer -No distinction between personal and business income

Asymmetric Information: Adverse Selection and Moral Hazard

-Adverse selection occurs before a transaction occurs -Moral Hazard arises after the transaction has developed -Agency theory analyses how asymmetric information problems affect economic behavior Long run forecasts are full of volitility

Investing Section in the Statement of Cash Flows

-All activities involving long-term assets -Purchase of sales of short term investments -Lending and collecting on notes receivable

Types of Financial Managers

-CFO -Treasurer -Controller

Free Cash Flow

-Cash available for distribution to investors after firm pays for new investments or additions to working capital -The amount of cash that could be withdrawn without harming a firms ability to produce future cash flows =Net Income + Interest + Depreciation - Additions to NWC - Capital Expenditures

Partnership Disadvantages

-Each partner is 100% liable -Selling business is difficult -Any partner can dissolve the partnership

Partnership Advantages

-Easier to raise capital than a proprietorship -Inexpensive to establish -Flexible decision making (relative) -Profits split between few partners ***Often set up through LLCs/LLPs

Determinants of savers' decision in determining which securities to utilize

-Expected return -Risk -Liquidity -Taxability -Maturity

Tools to Reduce Adverse Selection Problems

-Gov't regulation increase information -Financial intermediation -Collateral and net worth -Incentive compatibility

Corporation Disadvantages

-High startup costs -Heavily regulated -Usually double taxation -Separation of ownership and decision making

Financing Section of the Statement of Cash Flows

-Increases in short-term debt (inflow) -Increases in long-term debt (inflow) -Payment of dividends (outflow) -Stock repurchases (outflow) -Other...

Sole Proprietorship Advantages

-Keep all profits -Little regulation -Flexibility in decision making -Few startup requirements

Corporation Advantages

-Limited liability -Easily transferred -Much easier to raise capital

Tools to Reduce the Principle-Agent Problem

-Monitoring -Gov't regulation to increase information -Financial intermediation -Debt Contracts

Operating Section in the Statement of Cash Flows

-Net Income -Depreciation and Amortization -Inventory Changes -Acct. Rec. Changes -Acct. Pay. Changes -Changes in other Current Liabilities

Financial Management Goals

-Survive -Beat the competition -Minimize cost -Maintain/increase earnings growth -Avoid financial distress -Maximize sales or market share -Maximize profits

Organizational Concerns for Businesses

-Taxes -Ease of Formation -Longevity -Capital Access -Liability -Regulation -Control (Decision Making)

Function of Financial Markets

-Transporting cash across time -Risk transfer and diversification -Liquidity -Payment Mechanism -Provide information

Why is Operating Income (Profit) Important

-Usually a major element in determining management compensation -If an acquisition is under consideration, it gives a value for the firms operations -Less volatility than total income

Sources of External Finance for Non-Financial Businesses

1. Bank Loans 2. Non-Bank Loans 3. Bonds 4. Stocks

Financial Management

1. Cash raised from investors 2. Cash invested in firm 3. Cash generated by operations 4a. Cash reinvested (retained earnings, for example) 4b. Cash returned to investors

1. Private V. 2. Public

1. Worked out directly between parties 2. Standardized contracts are traded on organized exchanges

Debt Market

2-3x larger than the equity market Contractual loan agreement

Indirect Transfers

3rd party has your funds and makes the transfer -Depository institutions, contractual savings, investment intermediaries

Return on Invested Capital (ROIC)

=EBIT (1-t) / Total Invested Capital

Operating Margin

=EBIT / Sales Measures operating income per dollar of sales

Times Interest Earned Ratio (TIE)

=EBIT/Interest Payments

Return on Equity

=Net Income / Common Equity OR =ROA x EM

Profit Margin

=Net Income / Sales OR Measures net income per dollar of sales

Return on Assets

=Net Income / Total Assets

Day Sales Outstanding (DSO) Turnover: Average Collection Period

=Receivables/Avg. Daily Sales Measures the average length of time a firm must wait after a sale to receive payment

Inventory Turnover Ratio (ITR)

=Sales/Beginning Inventory Shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. It measures how many times a company sold its total average inventory dollar amount during the year.

Receivable Turnover

=Sales/Beginning Receivables Measures the number of times over a given period that a company collects its average accounts receivables

Equity Multiplier (EM)

=Total Assets/Total Current Equity Tells us what portion of assets are financed by common equity. Thus, it shows how much a firm relies on debt to drive profitability. Higher number indicates more debt financing and more financial leverage

Total Debt to Total Capital Ratio

=Total Debt/Total Debt + Equity

Corporate Tax

A levy placed on a firms profit by the government, a progressive structure

Financial instruments that are higher risk will have ________

A lower price

Ratio Analysis

A quantitative method of gaining insight into a company's liquidity, operational efficiency and profitability by comparing information contained in its financial statements.

What is a Market

A venue where goods and services are exchanged A place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds VOLUNTARY negotiations

Common-Size Balance Sheet

All items in the balance sheet are expressed as percentage of total assets

Primary Market

Any new issue of debt or equity Investment banks underwrite securities in primary markets

Real Assets

Assets used to produce goods and services

Securities are ________ for the person who buys them, but are ________ for the individual or firm that issues them.

Assets;Liabilities

In the US, the macroeconomic agent responsible for issuing the most securities in terms of dollar value is_______________

Business Firms

Uses of Ratios

Calculate and interpret key measures of operating efficiency, leverage, and liquidity

Working Capital (WC)

Current Assets

Net Working Capital (NWC)

Current Assets - Current Liabilities

Investment Decision

Decision to invest in real (tangible or intangible) assets that (hopefully) add value Assets used to produce G&S AKA: Capital budgeting (expenditure) decision ((CAPEX))

Financing Decision

Decisions on the sources and amounts of funding Financial assets give claims to the income generated by the firms real assets Failures of financial assets may lead to claims on the firms real assets Capital structure; the mix of long-term debt and equity financing

Ownership V. Management

Difference in information and objectives Info: Stock prices vs. returns, dilution of ownership, dividend policy, financing decisions Object: Managers vs. stockholders, top managers vs lower managers, stockholders vs. banks and lenders

Economic Value Added (EVA)

Economic profit -Considered a better measure than accounting income since it includes the opportunity cost of capital and can be applied to individual projects as well as the firm as a whole -Used as an indicator of how profitable company projects are and it therefor serves as a reflection of management performance

Purpose of Financial Markets

Efficient surplus transfer from lender/savers to borrower/spenders and eventually back to the lender/saver -Promotes economic efficiency by producing an efficient allocation of capital, which increases production -Directly improve the well-being of consumers by allowing them to time purchases better

Investment Intermediaries

Finance companies, mutual funds,money market mutual funds

Financial Assets

Financial claims to income generated by real assets

Financial Leverage

Firms with relatively high debt ratios have higher expected returns during economic expansions but experience lower returns and possibly fail during recessions

Organized Market

Greatest monetary value NYSE, CBT Secondary

Over the Counter Market

Greatest number of transactions

Book Value (BV)

Historical values reported on financial statements

Stock Prices

In equilibrium, a stocks value should be equal to its intrinsic (true) value To the extent that investor perceptions are incorrect, a stocks value in the short run may deviate from its intrinsic value

Net Income

Income after all expenses and taxes has been deducted -Most frequently viewed figure in financial statements -Net profit

Intrinsic Value

Intrinsic value is the true value It is a long-run concept--Equilibrium

Capital Market

Longer term debt instruments with maturities > 1 year

Manager Conflicts; What Affects Managerial Behavior

Managers are inclined naturally to act in their own best interest (not always the same as the interest of stockholders) -Managerial compensation packages -Direct intervention by shareholders -The threat of termination -The threat of takeover

Stockholder-Manager Conflicts

Managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run

Spot Market

Markets in which assets are bought and sold for immediate delivery at some current price (filling your car with gas)

Futures Market

Markets in which participants agree to buy and sell a certain amount of assets at a specific date and price

The Financial System

Matches agents who have surplus with those agents who want to borrow and use the surplus temporarily -Securities, intermediaries, and markets exist to match savers and borrowers

Firm Goal

Maximize shareholder wealth by maximizing value, particularly intrinsic value over time Managers recognize that being socially responsible is not inconsistent with maximizing shareholder value

Net Operating Working Capital (NOWC)

Operating Current Assets - Operating Current Liabilities (CA-Excess Cash, CL-NP)

Forms of Business Organization

Proprietorship (73.1%) Partnership (8%) Corporation (18.7%, c-5.6%, s-13.1%) This class focuses on C-Corps because they generate the most profits and the most jobs Other Types: B-Corp (non-profit seeking corporation), LLC, LLP

Balance Sheet

Provides a snapshot of a firms financial position at one point in time from and accounting perspective (monthly/quarterly/annually)

Statement of Cash Flows

Reports the impact of a firms activities on cash flows over a given period of time by showing the firms cash receipts It shows how the balance sheet and income statement affect the firms cash flows

Secondary Market

Resale of existing security Creates liquidity Brokers and dealers Traded in organized exchanges or OTC The stock market

Controller

Responsible for budgeting, accounting, and taxes

Treasurer

Responsible for financing, cash management, and relationships with banks and other financial institutions

Money Markets are for _________________________

Short -term debt securities such as treasury bills and commercial paper

Money Market

Short term debt instruments with maturities < 1 year

Statement of Stockholders Equity

Shows how much of a firms earnings were retained, rather than paid out as dividends

Stockholder Conflicts

Stockholders are more likely to prefer riskier projects, because the receive more of the upside if the project succeeds. By contrast, bondholders receive fixed payments and are more interested in limiting risk.

Income Statement

Summarizes a firms revenues, expenses, and net income over a given period of time from an accounting perspective

CFO

Supervises all financial functions and sets overall financial strategy

Secondary markets for financial instruments are important because, among other things, ________________

The create liquidity by allowing for the relatively easy resale of financial instruments

Market Value Added (MVA)

The excess of the marker value of equity over its book value MVA = MV - BV

Detivatives

The value of a security comes from the price of another security (options and futures) Can be used to hedge or reduce risk Speculators can use these to bed on the direction of future stock prices, interest rates, exchange rates, and commodity prices

Market Values

The value of assets or liabilities were they to be resold in the market

Total Debts to Equity Ratio

Total Debt/Equity

Earnings Before Interest and Taxes (EBIT)

Total revenues + other income - costs - depreciaiton aka operation income

T/F Equity and Asset "Market Values" are Usually Higher Than Their "Book Values"

True

Book Values-Historical Values

Value of assets or liabilities according to the balance sheet

Hedging

When this is used properly is reduces risk and transactions costs

Direct Transfers

You have your funds and make the transfer -Investments banks, brokers, dealers