Finance Exam 1 (Chapters 1-4)

4 Basic Areas of Finance Corporate FinanceFinancial InstitutionsInvestmentsInternational Finance
Financial Institutions Companies that specialize in financial matters. – Banks- Brokerage Firms- Insurance Companies
What is involved in the Investments side of Finance? Stocks and BondsValuing Financial Assets
Capital Budgeting Decision What long-term investments should the business take on?
Capital Structure Decision How should we pay for your assets?Debt or Equity?
Working Capital Management Decision How do we manage the day-to-day finances of the firm?
3 Forms of Business Organization Sole Proprietorship PartnershipCorporation
What is the Goal of Financial Management? -Maximize the current value per share of the companies stock- Maximize the value of the existing owners’ equity
What is the Agency Problem Conflicts between the Principal (Stockholder) and Agent (Managers)
What is another name for Principal? Stockholder
What is another name for Agent Manager
What is the Balance Sheet? Snapshot of the firms Assets and Liabilities at any given point
Balance Sheet Identity (Equation) Assets = Liabilities + Shareholders’ Equity
Debt vs. Equity (Equation) Shareholders’ Equity = Equity – Liabilities
Net Working Capital Current Assets – Current Liabilities
What is Liquidity? Speed and ease of conversion to CASH
Book Value vs. Market Value Book Value: The BALANCE SHEET valueMarket Value: The TRUE value in the market
Income Statement Equation Net Income = Income – Expenses
What is the income statement? Measured performance over a specidied period of time
Noncash Items Expenses charged against revenue that do not affect cash flow AKA Depreciation
GAAP Matching Principle -Recognize revenue when it is fully earned -Match expenses required to generate revenue to the period of recognition
Marginal vs. Average tax rates Marginal – % tax paid on the next dollar earnedAverage – total tax bill / taxable income
Cash Flow (Equation) Cash Flow from Assets = Cash Flow to Creditors + Cash Flow to Creditors
Common-Size Balance Sheets All accounts = percent of total assets (%TA)
Common-Size Income Statements All line items = percent of sales or revenue (%SLS)
Current Ratio Current Assets / Current LiabilitiesDo they have resources to pay their debts over the next 12 months
Quick (Acid Test) Ratio Current Assets – Inventory / Current LiabilitiesHow quickly could they retire their current liabilies with what they have
Cash Ratio Cash / Current LiabilitiesCash and near cash in comparison to their liabilites
Total Debt Ratio Total Assets – Total Equity / Total AssetsPercentage of companies assets that are financed by debt
Equity Multiplier Total Assets / Total EquityMeasurement of their financial leverage. High means that a larger portion of their assets are financed through debt
Times Interest Earns Ratio EBIT / InterestA measure of a company’s ability to honor its debt payments
Cash Coverage Ratio EBIT + Depreciation / InterestA ratio of the cash available to the amount of interest to be paid. To show a sufficient ability to pay, the ratio should be substantially greater than 1:1.
Inventory Turnover Cost of Goods Sold / InventoryA measure of the number of times inventory is sold or used in a time period such as a year
Days’ of Inventory 365 Days / Inventory Turnoverhow long it takes a company to turn its inventory into money
Receivables Turnover Sales / Accounts ReceivableUsed to measure a firm’s effectiveness in extending credit as well as collecting debts
Payables Turnover COGS / Accounts PayableHow quickly are they paying off their suppliers
Days’ of Receivables 365 Days / Receivables TurnoverThe average number of days that a company takes to collect revenue after a sale has been made
Days’ of Payables 365 Days / Payable TurnoverThe average number of days a company takes to pay its suppliers
Total Asset Turnover Sales / Total AssetsThe higher the ratio, the better it is, since it implies the company is generating more revenues per dollar of assets.
Cash Conversion Cycle (CCC) Measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand customer sales
Profit Margin Net Income / SalesAmount by which revenue from sales exceeds costs in a business
Operating Margin Operating Income / RevenueProportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc
Return on Assets Net Income / Total AssetsThe percentage of profit a company earns in relation to its overall resources
Return on Equity Net Income / Total EquityThe amount of net income returned as a percentage of shareholders equity
Price – Earnings Ratio Price Per Share / Earnings Per Share
Price-Sales Ratio Price Per Share / Sales Per Share
Enterprise Value Total Market Value of the Stock + Book Value of all Liabilities – CASH
DuPont Identity Profit Martin (How well do they manage their costs)x Total Asset Turnover (How well do they manage their assets)x Equity Multiplier (Financial Leverage)
4 Determinants of Growth -Profit Margin (operating efficiency)-Total Asset Turnover (asset use efficiency)-Financial Leverage (choice of optimal debt)-Dividend Policy (how much to pay to shareholders vs. reinvesting in the firm)
5 Major Categories of Ratios – Liquidity – Solvency- Efficiency- Profitability- Valuation
Problems with Financial Statement Analysis Conglomerates -No readily available comparablesGlobal competitorsDifferent accounting proceduresDifferent fiscal year endsDifferences in capital structureSeasonal variations and one-time events

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