Ch.3: Theoretical Issues Flashcards
Why is it important to understand which stage of a life cycle a firm is in?
Helps us to understand its capital needs and allows us to better predict its future.
Describe the life cycle stage of an new firm just starting.
CFO is typically negative because it takes time to identify a customer base, establish a presence, etc
CFI is usually negative as CapEx is used to buy equipment, infrastructure, etc
CFF is usually positive since CFO and CFI are negative; hence, it needs outside sources of capital. Cash is, of course, coming from lenders and investors.
Describe the growth phase for a company.
CFO moves from being negative to postive as sales increase.
CFI remains negative as the company continues to invest.
CFF continues to remain positive as the company still needs external financing to sustain its operations.
Describe the mature phase of a company.
CFO remains positive and starts to flatten.
CFI flattens and moves towards neutral territory.
CFF moves to 0/negative as the company pays off debt.
Describe the decline phase of a company.
CFO starts to decline.
CFI, remains flat or starts to increase to deter falling CFO.
CFF may turn positive if CFO isn’t enough to sustain operations.
What are the 3 most important predictions one should make about a company?
Can the company generate enough cash to support its daily operation, to invest in activities to support its growth, and to satisfy the demands of lenders and investors?
What is the term for forecasted financial statements?
Pro-forma financial statements
Explain the difference between soft vs hard financing.
Soft financing is equity financing, because stock does not have to be repurchased. If investors want to sell their shares, they do so to other investors. The only tangible expense directly involved is payment of dividends.
Hard financing is debt financing, since that requires the payment of interest and repayment of principal.
Why is debt generally cheaper than equity?
It is typically a lower risk since lenders can require collateral and other agreements that reduce risk. Lenders also have a higher claim to assets than do equity holders. Furthermore, interest is tax deductible, whereas dividend payments are not deductible.
Explain how returns are different for equity and debt holders. Explain the different returns in different economic environments.
Debt holders receive payment based on the interest rate %. The execess returns flow to the stockholders. In high return situations, the stockholders benefit more. Conversely, in declining situations, creditors typically receive their expected return, whereas stockholders will have negative returns.
What is the 10-K, 10-Q, 8-K, and Proxy?
10-K: Annual filing including financial statements
10-Q: Quarterly filing including financial statements
8-K: Filing after a significant event occurs, such as M&A or a change in management, directors, accountants, etc
Proxy: Request for voting rights to be exercised at the next annual shareholder’s meetings
What are the two main principals of accrual accounting?
Revenue and matching principals.
What is the revenue principal?
What is the matching principal?
Book revenue when it is earned and is realized/realizable. The two points are that you EARNED the revenue by performing a serivce, etc. And, the payment MUST be realizable, meaning you are likely to get paid.
Matching Principal: book the expense when the benefit is received
What is the cost principal? What is another term for that?
Assets are recorded on the balance sheet at their cost, which means cash value or cash equivalent value (PV).
Another term: Historical cost
Balance sheet Asset line items are listed in order of ____?
List the order of 7 assets.
Liquidity
Cash, AR, Short Term Investments, Inventory, Pre-Paid expenses, PPE, Intangible assets
