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102 Cards in this Set
- Front
- Back
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The 3 major forms of business in the US.
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-sole proprietorship
-partnership -corporation |
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Business owned by a single person.
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sole proprietorship
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Business formed by two or more individuals or entities.
-Limited partner’s liability be limited to the amount contributed. |
partnership
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Business created as a distinct legal entity composed of one or more individuals or entities.
-Limited liability company: to operate and be taxed like a partnership but retain limited liability for owners |
corporation
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Advantages of Corporation
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Separation of ownership and management
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Disadvantages of corporation
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Survive?
-Avoid financial distress and bankruptcy? -Maximize market share? -Maintains steady earnings growths? -Minimize costs? -Maximize profit? -Timing: Short-term or Long-term profit? -Problems: Manipulation; We’re all dead! -Sarbanes-Oxley (Sarbox) Act in 2002 to protect investors from corporate abuses (e.g., Enron) but it increases audit costs. |
Possible financial goals of corporation
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maximize the current value of the company’s stock.
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Goal of financial management
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What long-term investments should the firm take on?
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investment decisions
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Where will we get the long-term financing to pay for the investment?
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financing decisions
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How will we manage the everyday financial activities of the firm?
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working capital management decisions
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The top financial manager within a firm is usually the
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Chief financial officer
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oversees cash management, credit management, capital expenditures, and financial planning
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treasurer
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oversees taxes, cost accounting, financial accounting and data processing
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controller
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Capital budgeting
-What long-term investments or projects should the business take on? -Capital structure -How should we pay for our assets? -Should we use debt or equity? -Working capital management -How do we manage the day-to-day finances of the firm? |
What do financial managers decide?
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Principal hires an agent to represent his/her interests
-Stockholders (principals) hire managers (agents) to run the company |
Agency Relationship
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Conflict of interest between principal and agent
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Agency Problem
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Incentives can be used to align management and stockholder interests
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Managerial Compensation
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Board of Directors
-Corporate control: The threat of a takeover -proxy fight -Large blockholders -Other stakeholders -creditors, suppliers, employees |
Monitoring of Managers
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markets in which financial assets are traded.
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financial market
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What is the role of financial markets?
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efficient transfer of funds from those who have excess funds to those who need it.
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in which original sale of securitiesby government and corporations happens (e.g., IPO, SEO).
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primary market
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in which issued securities are traded.
-Dealer vs. auction markets -Listed vs. over-the-counter securities |
secondary market
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is a snapshot of the firm’s assets and liabilities at a given point in time
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balance sheet
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Assets = Liabilities + Stockholders’Equity
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Balance Sheet Identity
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Current Assets –Current Liabilities
-Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out -Usually positive in a healthy firm |
Net working Capital
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Ability to convert to cash quickly without a significant loss invalue
- Liquid firms are less likely to experience financial distress - But liquid assets earn a lower return - Trade-off to find balance between liquid and illiquid assets |
Liquidity
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is the price at which the assets, liabilities ,or equity can actually be bought or sold.
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market value
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is more like a video of the firm’s operations for a specified period of time.
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income statement
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GAAP says to show revenue when it accrues and match the expenses required to generate the revenue
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matching principle
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Corporate tax rates are not strictly increasing.
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Tax Reform Act of 1986
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----- can be one of the largest cash outflows from a firm.
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taxes
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the percentage paid on the next dollar earned
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marginal tax rate
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the tax bill / taxable income
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average tax rate
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Cash Flow to Creditors + Cash Flow to Stockholders
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cash flow from assets (CFFA)
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Operating Cash Flow (OCF)
-net capital spending -changes in NWC |
cash flow from assets
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EBIT + Depreciation –Taxes
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OCF (i/s)
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ending net fixed assets
–beginning net fixed assets + depreciation |
NCF (b/s and i/s)
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ending NWC –beginning NWC
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changes in NWC
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OCF –NCS –NWC
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CF from assets
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interest paid –net new borrowing
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CF to creditors (b/s and i/s)
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dividends paid –net new equity raised
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CF to stockholders (b/s and i/s)
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are less likely to experience financial distress
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liquid firms
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CF=
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cash flow
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OCF=
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operating cash flow
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Cash inflow – occurs when we “sell” something
Decrease in asset account (Sample B/S) Accounts receivable, inventory, and net fixed assets Increase in liability or equity account Accounts payable, other current liabilities, and common stock |
Sources
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Cash outflow – occurs when we “buy” something
Increase in asset account Cash and other current assets Decrease in liability or equity account Notes payable and long-term debt |
Uses
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statement that summarizes the sources and uses of cash
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Statement of Cash Flows
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– includes net income and changes in most current accounts
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Operating Activity
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– includes changes in fixed assets
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Investment Activity
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– includes changes in notes payable, long-term debt, and equity accounts as well as dividends
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financing activity
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Compute all accounts as a percent of total assets
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Common-size Balance Sheets
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Compute all line items as a percent of sales
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Common-size Income Statements
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make it easier to compare financial information, particularly as the company grows
are also useful for comparing companies of different sizes, particularly within the same industry |
Standardized Statements
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Standardized Financial Statements
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Common-size Balance Sheets
and Common-size Income Statements |
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also allow for better comparison through time or between companies
are used both internally and externally |
ratios
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liquidity ratios
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short-term solvency
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financial leverage ratios
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long-term solvency
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turnover ratios
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asset management
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Short-term solvency or liquidity ratios
Long-term solvency or financial leverage ratios Asset management or turnover ratios Profitability ratios Market value ratios |
Categories of financial ratios
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= CA / CL
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current ratio
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=(CA – Inventory) / CL
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quick ratio
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= Cash / CL
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cash ratio
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= NWC / TA
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NWC to Total Assets
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= CA / average daily operating costs
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Interval Measure
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= (TA – TE) / TA
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Total Debt Ratio
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= TD / TE
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Debt/Equity
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= TA / TE = 1 + D/E
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Equity Multiplier
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= LTD / (LTD + TE)
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Long Term Debt Ratio
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= EBIT / Interest
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Times Interest Earned (Interest Coverage Ratio)
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= (EBIT + Depreciation) / Interest
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Cash Coverage
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= Cost of Goods Sold / Inventory
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Inventory Turnover
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(Average Inventory Processing Period)
= 365 / Inventory Turnover 365 / 6.66 = 55 days |
Days Sales in Inventory
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= Sales / Accounts Receivable
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Recievables Turnover
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(Average Receivable Collection Period)
= 365 / Receivables Turnover 365 / 5.23 = 70 days |
Days Sales in Receivables
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= Sales / Total Assets
It is not unusual for TAT < 1, especially if a firm has a large amount of fixed assets |
Total Asset Turnover
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= Sales / NWC
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NWC Turnover
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= Sales / NFA
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Fixed Asset Turnover
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= Net Income / Sales
689 / 5,000 = 13.78% Gross, or Operating, Profit Margin |
(Net) Profit Margin
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= Net Income / Total Assets
689 / 5,394 = 12.77% |
Return on Assets (ROA)
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= Net Income / Total Equity
689 / 2,556 = 26.96% |
Return on Equity (ROE)
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= Price per share / Earnings per share
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PE Ratio
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= market value per share / book value per share
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Market-to-Book Ratio
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= NI / TE
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ROE
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ROE = NI / TE
Multiply by 1 (TA/TA) and then rearrange ROE = (NI / TE) (TA / TA) ROE = (NI / TA) (TA / TE) = ROA * EM Multiply by 1 (Sales/Sales) again and then rearrange ROE = (NI / TA) (TA / TE) (Sales / Sales) ROE = (NI / Sales) (Sales / TA) (TA / TE) ROE = PM * TAT * EM |
Deriving the DuPont Identity
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= PM * TAT * EM
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ROE
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is a measure of the firm’s operating efficiency – how well it controls costs
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Profit Margin
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is a measure of the firm’s asset use efficiency – how well does it manage its assets
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Total Asset turnover
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is a measure of the firm’s financial leverage
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Equity Multiplier
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Used to see how the firm’s performance is changing through time
Internal and external uses |
Time Trend Analysis
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Compare to similar companies or within industries
SIC and NAICS codes |
Peer Group Analysis
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makes ratio analysis much easier than it has been in the past
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Internet
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-earlier money on a time line (today’s value of money)
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present value
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-later money on a time line
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future value
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– “exchange rate” between earlier money and later money
Discount rate Required return |
interest rate
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Suppose you invest $1,000 for one year at 5% per year. What is the future value in one year?
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Interest = 1,000(.05) = 50
Value in one year = principal + interest = 1,000 + 50 = 1,050 Future Value (FV) = 1,000(1 + .05) = 1,050 |
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Suppose you leave the money in for another year. How much will you have two years from now?
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FV = 1,000(1.05)(1.05) = 1,000(1.05)2 = 1,102.50
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Future Value Formula
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FV = PV(1 + r)t
FV = future value PV = present value r = period interest rate, expressed as a decimal t = number of periods Future value interest factor = (1 + r)t |
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How much do I have to invest today to have some amount in the future?
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FV = PV(1 + r)t
Rearrange to solve for PV = FV / (1 + r)t |
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Finding the Number of Periods
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Start with basic equation and solve for t (remember your logs)
FV = PV(1 + r)t t = ln(FV / PV) / ln(1 + r) |
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Your parents set up a trust fund for you 10 years ago that is now worth $19,671.51. If the fund earned 7% per year, how much did your parents invest?
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($19,671.51/1.0710=10,000)
N = 10; I/Y = 7; FV = 19,671.51 CPT PV = -10,000 |
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For a given interest rate – the longer the time period, the lower the present value
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What is the present value of $500 to be received in 5 years? 10 years? The discount rate is 10%
5 years: N = 5; I/Y = 10; FV = 500 CPT PV = -310.46 10 years: N = 10; I/Y = 10; FV = 500 CPT PV = -192.77 |
