chapter 8

Question 1

financial management

Answer 1

deals with two activites; (1) raising money, and (2) managing a company’s finances in a way that achieves the highest rate of return.

Question 2

profitability

Answer 2

the ability to earn a profit. many start-ups are not profitable during their first 1 to 3 years, but a firm must become profitable to remain viable and provide a return to its owners.

Question 3

liquidity

Answer 3

a company’s ability to meet its short-term financial obligations. the firm needs to keep enough money in the bank to meet its routine obligations in a timely manner. to do so, a firm must keep a close watch on accounts receivable and inventories.

Question 4

accounts receivable

Answer 4

money owed to the firm by its customers.

Question 5

inventory

Answer 5

a firm’s merchandise, raw materials, and products waiting to be sold. if levels of these get too high, the firm may not be able to keep sufficient cash to meet its short-term obligations.

Question 6

efficiency

Answer 6

how productively a firm utilises its assets relative to its revenue and its profits.

Question 7

stability

Answer 7

the strength and vigour of the firm’s overall financial posture. for a firm to be stable, it must only earn a profit and remain liquid but also keep its debt in check. if a firm continues to borrow from lenders and its debt-to-equity ratio gets too high, it may have trouble meeting its obligations and securing the level of financing needed to fuel its growth.

Question 8

buying groups or co-ops

Answer 8

where business band together to attain volume discounts on products and services.

Question 9

financial statement

Answer 9

a written report that quantitatively describes a firm’s financial health. the income statement, balance sheet, and the statement of cash flows are the financial statements entrepreneurs use most commonly.

Question 10

forecasts

Answer 10

estimates of a firm’s future sales, expenses, income, and capital expenditures, based on its past performance, its current circumstances, and its future plans.

Question 11

budgets

Answer 11

itemised forecasts of a company’s income, expenses, and capital needs and are also an important tool for financing planning and control.

Question 12

financial ratios

Answer 12

depict relationships between items on a firm’s financial statements and are used to discern whether a firm is meeting its financial objectives and how it stacks up against its industry peers.

Question 13

historical financial statements

Answer 13

reflect past performance and are usually prepared on a quarterly and annual basis. they include the income statement, balance sheet, and statement of cash flows. they are usually prepared in this order because information flows logically from one to the next.

Question 14

10-K

Answer 14

the most comprehensive filing, which is a report similar to the annual report except that it contains more detailed information about the company’s business.

Question 15

pro forma financial statements

Answer 15

projections for future periods based on forecasts and are typically completed for two to three years in the future. they are not required (most companies consider them as confidential).

Question 16

income statement

Answer 16

reflects the results of the operations of a firm over a specified period of time. it records all revenues and expenses for the given period and shows whether a firm is making a profit or a loss. three numbers are most important; net sales, cost of sales, and operating expenses. one of the most valuable things to do with income statements is to compare the ratios of cost of sales and operating expenses to net sales for different periods.

Question 17

net sales

Answer 17

total sales minus allowances for returned goods and discounts.

Question 18

cost of sales/cost of goods sold

Answer 18

includes all direct costs associated with producing or delivering a product or service, including material costs and direct labour.

Question 19

operating expenses

Answer 19

includes marketing, administrative costs, and other expenses not directly related to producing a product or service.

Question 20

profit margin/return on sales

Answer 20

a ratio that is of particular importance when evaluating the firm’s income statements. it is computed by dividing net income by net sales.

Question 21

price-to-earnings (P/E) ratio

Answer 21

a simple ratio that measures the price of a company’s stock against its earnings. generally, the higher, the greater the market thinks it will grow.

Question 22

balance sheet

Answer 22

a snapshot of a company’s assets, liabilities, and owner’s equity at a specific point in time.

Question 23

current assets

Answer 23

include cash plus items that are readily convertible to cash.

Question 24

fixed assets

Answer 24

assets used over a longer time frame.

Question 25

current liabilities

Answer 25

obligations that are payable within a year.

Question 26

long-term liabilities

Answer 26

include notes or loans that are repayable beyond one year.

Question 27

owners’ equity

Answer 27

equity invested in the business by its owners plus the accumulated earnings retained by the business after paying dividends.

Question 28

working capital

Answer 28

represents the amount of liquid assets the firm has available.

Question 29

current ratio

Answer 29

equals the firm’s current assets divided by its current liabilities. it provides another picture of the relationship between a firm’s current assets and current liabilities and can tell us more about a firm’s ability to pay its short-term debt.

Question 30

statement of cash flows

Answer 30

summarises the changes in a firm’s cash position for a specified period of time and details why the change occurred.

Question 31

operating activities

Answer 31

include net income, depreciation, and changes in current assets and liabilties other than cash and short-term debt.

Question 32

investing activities

Answer 32

include purchase, sale, or investment in fixed assets.

Question 33

financing activities

Answer 33

include cash raised during the period by borrowing money or selling stock and/or cash used during the period by paying dividends, buying back outstanding stock, or buying back outstanding bonds.

Question 34

ratio analysis

Answer 34

the most practical way to interpret or make sense of a firm’s historical financial statements.

Question 35

assumptions sheet

Answer 35

an explanation of the sources of the numbers for the forecast and the assumptions used to generate them.

Question 36

sales forecast

Answer 36

a projection of a firm’s sales for a specified period, though most firms forecast their sales for 2 to 5 years into the future. for an existing firm, it is based on (1) its record of past sales, (2) its current production capacity and product demand, and (3) any factor or factors that will affect its future production capacity and product demand. there are sophisticated tools available to project future sales, eg. regression analysis.

Question 37

regression analysis

Answer 37

a statistical technique used to find relationships between variables for the purpose of predicting future values.

Question 38

percent-of-sales method

Answer 38

a method for expressing each expense item as a percentage of sales. once a firm completes it, it usually goes through its income statement on an item-by-item basis to see if there are opportunities to make more precise forecasts. if a firm determines it can use this method, the net result is that each expense on its income statement will grow at the same rate as sales, called constant ratio method of forecasting.

Question 39

constant ratio method of forecasting

Answer 39

an approach that results in each expense item on the income statement to grow at the same rate as sales.

Question 40

break-even point

Answer 40

lets the entrepreneur know if the proposed initiative is feasible. for a new product, it is the point where total revenue received equals total costs associated with the output of the sale of the product.

Question 41

pro forma income statement

Answer 41

once a firm forecasts its future income and expenses, it is merely a matter of plugging in the numbers. the constant ratio method of forecasting is used to forecast the cost of sales and general and administrative expenses.

Question 42

pro forma balance sheet

Answer 42

provides a firm a sense of how its activities will affect its ability to meet its short-term liabilities and how its finances will evolve over time. it can also quickly show how much a firm’s money will be tied up in accounts receivable, inventory, and equipment. it is also used to project the overall financial soundness of a company.

Question 43

pro forma statement of cash flows

Answer 43

shows the projected flow of cash into and out of the company during a specified period. the most important function is to project whether the firm will have sufficient cash to meet its needs. it is broken intro three activities; operating, investing, and financing activities. close attention is typically paid to operating activities since it shows how changes in the company’s accounts receivable, payable, and inventory levels affect the cash that is has available for investing and financing activities. if any of these items increase at a rate faster than the company’s annual increase in sales, it typically raises a red flag.

Question 44

profitability ratios

Answer 44

return on assets, return on equity, profit margin.

Question 45

liquidity ratios

Answer 45

current, quick.

Question 46

overall financial stability ratios

Answer 46

debt, debt to equity.