Finance Flashcards
Chapters 15, 16, 17
finance
planning, obtaining, and managing a company’s funds to accomplish its objectives as effectively and efficiently as possible
financial managers
executives who develop and implement their company’s financial plan and determine the most appropriate sources and uses of funds—are among the most vital people within an organization
vice president for financial management or planning
responsible for preparing financial forecasts and analyzing major investment decisions, such as new products, new production facilities, and acquisitions
treasurer
responsible for all of the company’s financing activities, including cash management, tax planning and preparation, and shareholder relations. The treasurer also works on the sale of new security issues to investors.
controller
the chief accounting manager. The controller’s functions include keeping the company’s books, preparing financial statements, and conducting internal audits.
risk-return trade-off
Process of maximizing the wealth of a firm’s shareholders by striking the optimal balance between risk and return. The potential return rises with an increase in risk. Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns.
financial plan
a document that specifies the funds needed by a company for a given period of time, the timing of inflows and outflows, and the most appropriate sources and uses of funds. Based on forecasts of production costs, required purchases, plant and equipment expenditures, and expected sales activities for the period covered.
operating plans
short-term in nature, focusing on projections no more than a year or two in the future.
strategic plans
have a much longer time horizon, perhaps up to 5 or 10 years.
3 Steps to Preparing Financial Plan
1) forecast of sales/revenue over some future time period. Key variable, that can affect other variables.
2) CFO uses the sales forecast to determine the expected level of profits for future periods.
3) CFO needs to estimate how many additional assets the company will need to support projected sales. (“asset intensity”)
financial control
process of comparing actual revenues, costs, and expenses with forecasts.
Short-term/current assets
consist of cash and assets that can be, or are expected to be, converted into cash within a year. The major current assets are cash, marketable securities, accounts receivable, and inventory.
marketable securities
low-risk securities that either have short maturities or can be easily sold in secondary markets.
cash budget
one tool for managing cash and marketable securities because it shows expected cash inflows and outflows for a period of time. The cash budget indicates months when the company will have surplus cash and can invest in marketable securities and months when it will need additional cash.
3 Questions of financial planning
1. What funds will the company require during the planning period?
2. When will it need additional funds?
3. Where will it obtain the necessary funds?
Accounts receivable
yet-to-be-collected credit sales and can represent a significant percentage of a company’s assets. Management of accounts receivable is composed of two functions: determining an overall credit policy and deciding which customers will be offered credit.
Credit Policy
Involves deciding whether the company will offer credit and, if so, on what terms. Often, the overall credit policy is dictated by competitive pressures or general industry practices.
Inventory control
more than just managing items going in and out of a company. It involves managing working capital (current assets minus current liabilities) and making sure that too much cash is not tied up in operations.
Long-lived (fixed) assets
expected to produce economic benefits for more than one year. Often involve substantial amounts of money on fixed assets like a new plant, machinery, equipment, or real estate.
capital investment analysis
process by which decisions are made regarding investments in long-lived assets. Companies make two basic types of capital investment decisions: expansion and replacement.
Asset/Accounting Equation
Assets = Liabilities + Owner’s Equity
Debt capital
consists of funds obtained through borrowing. Choosing more debt increases the fixed costs a company must pay, which in turn makes a company more sensitive to sales revenues. Debt is frequently the least costly method of raising additional financing dollars, one of the reasons it is so frequently used.
Equity capital
consists of funds provided by the company’s owners when they reinvest earnings, make additional contributions, liquidate assets, issue stock to the general public, or raise capital from outside investors.
Capital Structure
mix of company’s debt and equity capital.
Leverage
Raising needed cash by borrowing allows a company to benefit from the principle of leverage, increasing the rate of return on funds invested by borrowing funds. Companies use borrowed capital as funding source when investing to expand asset base and generate returns on risk capital.
Short-term funds
consist of current liabilities, generally less expensive than long-term funds, but they also pose more risk (have to be renewed/rolled-over frequently, and interest rates can be volatile.)
Long-term funds
consist of long-term debt and equity.
Dividends
Dividends are periodic cash payments to shareholders. The most common type of dividend is paid quarterly and is often labeled as a regular dividend. Earnings that are paid in dividends are not reinvested in the firm and don’t contribute additional equity capital.
Trade credit
Trade credit is extended by suppliers when a company receives goods or services and agrees to pay for them at a later date.
Short-term loans: line of credit
A line of credit specifies the maximum amount the company can borrow over a period of time, usually a year. Most lines of credit require the borrower to repay the original amount, plus interest, within one year.
Short-term loans: revolving credit agreements
revolving credit agreement is essentially a guaranteed line of credit—the bank guarantees that the funds will be available when needed. Banks typically charge a fee, on top of interest, for revolving credit agreements.
Commercial Paper
Commercial paper is an unsecured, short-term debt instrument issued by corporations. It’s typically used to the finance short-term liabilities such as payroll, accounts payable, and inventories. 9 months to avoid SEC registration, usually by large, financially strong corporations.
Sources of long-term funds
Organizations acquire long-term funds from three sources. (1) long-term loans obtained from financial institutions such as commercial banks, life insurance companies, and pension funds. (2) bonds—certificates of indebtedness—sold to investors. (3) equity financing that is acquired by selling stock in the company or reinvesting company profits.
Venture capitalists
An important source of private equity financing, especially to small, early-stage emerging firms with high growth potential. Venture capitalists raise money from wealthy individuals and institutional investors. In exchange for the risk taken by investing in early-stage companies, venture capitalists become owners, offering strategic advice—and often, assuming control over decisions.
private equity funds
investment companies that raise funds from wealthy individuals and institutional investors and use those funds to make large investments in both public and privately held companies.
sovereign wealth fund
These companies are owned by governments and invest in a variety of financial and real assets, such as real estate. Generally make investments based on the best risk–return trade-off, political, social, and strategic considerations also play roles in their investment decisions.
Hedge funds
Private investment companies open only to qualified large investors with high minimum investments or net worth. Managed by professional fund managers implementing different strategies.
Merger
Transaction where two or more companies combine into one. Shareholders of both the buyer and target must vote to approve a merger.
Acquisition
Where one company buys out the assets and assumes the obligations of another company. To acquire another company, a company typically offers a higher price than the current market price for the target’s shares - can offer cash, securities, or combo of the two.
Mutual Funds
A financial vehicle that pools assets from shareholders to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.
Secured Bond
A type of investment in debt that is secured by a specific asset owned or revenue stream by the issuer. The asset serves as collateral for the loan. If the issuer defaults on the bond, the title to the asset is transferred to the bondholders.
Synergy
(M&A) The notion that the combined company is worth more than the buyer and the target are individually.
Leveraged buyouts (LBOs)
public shareholders are bought out, and the company reverts to private status. Many of these transactions are financed with high degrees of debt.
Divestiture
The reverse of a merger. That is, a company sells assets such as subsidiaries, product lines, or production facilities. Two types of divestitures exist: sell-offs and spin-offs.
Accounting
the process of measuring, interpreting, and communicating financial information to enable people inside and outside a company to make informed decisions.
open book management
companies share financial information with employees as partners so they become more business literate and understand financial statements.
3 business activities that involve accounting
1. Financing activities provide necessary funds from investors to start a business and expand it after it begins operating.
2. Investing activities provide valuable assets required to run a business.
3. Operating activities focus on selling goods and services, but they also consider expenses as important elements of sound financial management.
Types of Accounting Professionals
Public, management, government, and non-for-profit accountants.
public accountant
provides accounting services to individuals or companies for a fee. Most public accounting firms provide three basic services to clients: (1) auditing, or examining, financial records; (2) tax preparation, planning, and related services; and (3) management consulting.
management accountant
An accountant employed by a business other than a public accounting firm, typically collects and records financial transactions and prepares financial statements used by the company’s managers in decision making. AKA corporate accountants, provide timely, relevant, accurate, and concise information that executives can use to operate their companies more effectively and more profitably than they could without this input.
Government accountant
Government accountants at the federal level manage public funds, investigate white-collar crime, perform audits for government agencies, and stay up-to-date on emerging accounting and regulatory issues. At state and local levels, they manage use of local revenues; investigate fraud; perform financial, performance, and compliance audits; and recommend corrective action where needed. Government accountants work closely on the budget and financial reporting process.
Not-for-Profit Accountant
employed by non-for-profits, and help organizations ensure financial health and stability, maintain standards for financial data, and make decisions based on the fiscal capabilities of the nonprofit.
Generally Accepted Accounting Principles (GAAP)
refer to a common set of accounting rules, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the U.S. must follow GAAP when their accountants compile their financial statements.
Financial Accounting Standards Board (FASB)
primarily responsible for evaluating, setting, or modifying GAAP. Carefully monitors changing business conditions, enacting new rules and modifying existing rules when necessary. It also considers input and requests from all segments of its diverse constituency, including corporations and the SEC.
4 basic GAAP principles
consistency, relevance, reliability, and comparability.
SEC (Securities and Exchange Commission)
chief federal regulator of the financial markets and accounting industry, actually has the statutory authority to establish financial accounting and reporting standards for publicly held companies.
Sarbanes-Oxley Act of 2002
Created the Public Accounting Oversight Board that has the power to set audit standards and to investigate & sanction accounting firms that certify books of publicly traded companies. Board appointed by SEC.
Accounting Cycle
The procedure by which accountants convert data about individual transaction to financial statements.
Recording, Classifying, Summarizing transactions.
asset
anything of value owned or leased by a business (land, buildings, supplies, cash, AR, marketable securities.)
liability
anything owed to creditors - include loans, accounts payable, wages/salaries, mortgages, deferred revenue, bonds, warranties, accrued expenses.
owner’s equity
owner’s initial investment in the business plus profits that were not paid out to owners over time in the form of cash dividends.
double-entry bookkeeping
process by which accounting transactions are entered - each indiv. transaction always has an offsetting transaction.
4 Financial Statements
- balance sheet
- income statement
- statement of owner’s equity
- statement of cash flows
Balance Sheet
Shows company’s financial position on a particular date. On left are assets (shown in descending order of liquidity). On right are claims against assets (liability + owner’s eq.) listed in order in which they’re due.
Liquidity
efficiency/ease with which an asset or security can be converted into ready cash without affecting its market price. Most liquid asset is cash.
Income Statement
indicates the flow of resources that reveals the performance of org. over a specific time period. Profit or loss results. Begins with total sales/revenues, costs are deducted.
Statement of owner’s (shareholder’s) equity
designed to show the components of the change in equity from the end of one fiscal year to the end of the next.
Statement of Cash Flows
statement showing the sources and uses of cash for a comp. from its operating, investing, and financial activities during a period of time.
Leverage Ratio
ratio measuring comp. level of debt relative to another financial metric; extent to which comp. relies on debt financing.
Accrual accounting
recognizes revenues and costs when they occur, not when actual cash changes hands.
Liquidity ratio (current ratio)
info about comp. ability to pay its current debts as they mature.
= current assets / current liabilities
Quick Ratio (acid-test ratio)
measures ability of comp. to meet its debt payments on short notice.
= (current assets - inventory) / current liabilities
Activity ratios
measure effectiveness of management’s use of the company’s resources. inventory receivables, and total asset turnover ratios.
Inventory Turnover Ratio
= cost of goods sold / average inventory
Receivables Turnover Ratio
= credit sales / average accts receivable
Total Asset Turnover Ratio
= sales / avg. total assets
Profitability ratios
measure org. overall financial performance by evaluating its ability to generate revenues in excess of operating costs and expenses.
Debt Ratio
= total liabilities / total assets
4 categories of financial ratios
liquidity, activity, profitability, and leverage ratios
Budget
planning and controlling tool that reflects company’s expected sales revenues, operating expenses, and cash receipts and outlays.
cash budget
prepared monthly, tracks company’s cash inflows and outflows.
Financial System
process by which money flows from savers to users
Securities
aka financial instruments, represent obligations on the part of the issuers—businesses and governments—to provide the purchasers with expected or stated returns on the funds invested or loaned. 3 categories: money market instruments, bonds, and stock.
Money market instruments
short-term debt securities issued by governments, financial institutions, and corporations. All money market instruments mature within one year from the date of issue.
Common stock
shares that give owners voting rights but only residual claims to firm’s assets and income distributions.
capital gain
profit that results from sale of the stock
preferred stock
stock whose holders receive preference in the payment of dividends, which is fixed, and have no voting rights.
Financial markets
markets in which securities are bought and sold - primary and secondary markets
primary market
corp and gov issue securities and sell them initially to the general public
underwriting
financial institution would buy (underwrite) securities issued by the company at discount attempting the IPO and then sell those securities in the market for more. They take on risk.
Investment bankers
assist companies in raising capital and provide merger and acquisition services
secondary market
a collection of financial markets in which previously issued securities are traded among investors
financial institutions
intermediary between savers and borrowers, collecting funds from savers and then lending the funds to individuals, businesses, and governments.
Mutual funds
financial intermediaries that raise money or a pool of funds, from many investors with the purpose of selling shares in those securities—stocks, bonds, or money market instruments—to the general public. Professionally managed diverse portfolios.
Exchange traded funds (ETFs)
type of pooled investment security that operates much like a mutual fund. Typically, ETFs will track a particular index, sector, commodity, or other assets, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can.
