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