Finance

Question 1

Finance

Answer 1

Finance, or corporate finance, is the business function of obtaining funds for a company and managing them to accomplish the company’s objectives

Question 2

Financial management

Answer 2

The job of acquiring and managing funds is called financial management.

Question 3

Questions asked in corporate finance

Answer 3

Does the company have enough money?
- For its day to day operations?
• To cover payroll?
• To pay our suppliers?
• To cover maintenance?
- For new projects?
• To purchase short term assets (computers)?
• To purchase long term assets (machinery or buildings)?
• To invest in new products/markets (R&D, promotion)?

Question 4

Use of financial assets

Answer 4

How does the company use the money it holds?
• Leave it in a bank account?
• Invest in all sorts of stuff?
• Invest in new products (R&D, design, tests)?
• Invest in new markets? (trade shows…)?
• Purchase better equipment (modernise, expand)?
• Return some to the owners (dividends)?
• All or some of the above?

Question 5

Efficient use of financial assets

Answer 5

• How does management decide?
  • By chance?
  • Past information? (financial statements & management reports)
  • Future projections & estimates (what ifs)?
  • Financial analysis? (ratios & comparative tools)
• How do the shareholders determine goals?

Question 6

Financial plan and its three parts

Answer 6

• A financial plan is a firm’s strategy for reaching its financial goals.

It has three parts:
1. forecasting
2. budgeting
3. financial controls

Question 7

Planning tools : forecasting

Answer 7

Forecasting is predicting revenues, costs, and expenses for a certain period of time.

Question 8

Planning tools : budget

Answer 8

A budget is defined as a detailed financial plan showing estimated revenues and expenses for a particular future period, usually on year.

Question 9

4 types of budget and their definition

Answer 9

1. Operating Budgets: For Predicting Sales and Production Goals and the Costs Required to Meet Them.
2. Capital Budgets: For Predicting Purchase of Long-Term Assets.
3. Cash Budgets: For Predicting Cash Shortages or Surpluses During the Year.
4. Master Budgets: For Pulling Together the Other Budgets into an Overall Plan of Action.

Question 10

Planning tools : financial control

Answer 10

Financial Control is the process in which a company from time to time compares its actual revenues and expenses with those predicted in its budget.

Question 11

Borrowing (4 reasons for borrowing)

Answer 11

• There are four reasons why companies, large and small, often wish to obtain financing.
• They need funds for:
1. managing everyday business activities
2. extending credit to their customers
3. keeping enough product (inventory) available
4. making major investments.

Question 12

Debt versus equity financing (questions asked)

Answer 12

Financial decisions
- Does the company borrow money?
• From a bank?
> At what terms & conditions?
• Otherwise?
> Bonds & complicated stuff?
- Do the shareholders sell a part of the company?
• What are our shares worth? Now and in the future?
• Existing shareholders will own less of the company
> They may even lose control

Question 13

Capital structure

Answer 13

how a firm finances its overall operations and growth using debt and equity financing

Question 14

Debt financing

Answer 14

creditors (banks, other)

Question 15

Equity financing

Answer 15

Owners/shareholders

Question 16

Sources of debt financing

Answer 16

• Long-term loans
• Issuing notes or bonds (promise to pay with interest)
Bonds will be covered in the Market Securities section.

Question 17

Sources of equity financing

Answer 17

• Equity financing involves direct contributions by owners and future shareholders
• Corporations can fund investments by:
• Gaining equity capital by issuing stock to owners and/or future shareholders
• Using retained earnings accumulated during past years or the current year (net income)

Question 18

Five characteristics of money

Answer 18

• Portability: “I Can Carry It in My Pocket”
• Divisibility: “I Can Easily Break Big Bills Down into Smaller Ones”
• Durability: “The Material Won’t Deteriorate Quickly”
• Uniqueness: “This Can’t Be Easily Copied or Counterfeited”
• Stability: “This Has the Same Value to Everyone”

Question 19

Currency

Answer 19

Currency: government-issued coins and paper money

Question 20

Money supply

Answer 20

Money supply: the amount of money Central Banks make available for people to buy goods and services.

Question 21

The three functions of money

Answer 21

Medium of exchange: it makes economic transactions easier and eliminates the need to barter
Store of wealth: people can save it until they need to make new purchases
Standard of value: or unit of account, meaning that it can be used as a common standard to measure the values of goods and services

Question 22

4 types of financial ratios

Answer 22

Four common types of financial ratios are :
1. liquidity ratios;
> to determine how well a firm can pay its liabilities as they come due

2. activity ratios
   > to see how well the firm manages its assets to generate revenue
3. debt to owners’ equity ratios
   > to determine how much the firm relies on borrowing to finance its operations
4. profitability ratios
   > to see how good the firm’s profits are in relation to its sales, assets, or owners’ equity.

Question 23

Liquidity ratio information

Answer 23

Liquidity ratios measure a firm’s ability to meet its short term obligations when they become due
Two important liquidity ratios are:
- the current ratio : current assets/current liabilities
- the acid-test (or quick) ratio : the current ratio where inventory is not included in current assets

Most companies aim to have a current ratio above 1 and often up to 2 or higher, depending on the industry
Banks favour companies with a higher current ratio

Question 24

Activity ratios information

Answer 24

Activity ratios: also called efficiency ratios, this group of ratios measures the efficiency of the company
- inventory turnover : COGS/average inventory
- accounts receivable turnover : net credit sales/average accounts receivable
- accounts payable turnover : total purchases/average accounts payable

These ratios are used by management to help improve the company as well as outside investors and creditors looking at the operations of profitability of the company

Question 25

Debt to owners equity ratios

Answer 25

Measures the extent to which the company relies on debt (liabilities) to acquire its assets
- debt to equity ratio = liabilities/owner’s equity
- debt to assets ratio = liabilities/assets

The higher it is, the more the company is “leveraged” which means it is using borrowed money to increase its value.
Banks will favor companies with a low debt-to-equity ratio when considering loans.

Question 26

Profit
(Profitability ratios)

Answer 26

• Profitability ratios compare income statement accounts and categories to show a company’s ability to generate profits from its operations
• Gross profit is sales less Cost of goods sold
• Net profit is Gross profit less selling, administrative and other (such as taxes) expenses.
• Earnings per share

Gross profit margin = gross profit as a % of sales
Profit margin = net profit as a % of sales
Margin habitually signifies a percentage, so the word ratio is not common in the business world, though it may be useful for students.
Cost of goods sold is commonly expressed as a % of sales

Question 27

Two types of financial analysis and their definition

Answer 27

Horizontal : compares information in a firm’s financial statements over a period of 2 years or more.
Vertical : expresses items on the balance sheet and income statement as a percentage of a key value like sales, assets, etc.

Question 28

Personal finance (questions)

Answer 28

• Personal finance
• Goal = have assets, not debts
  • Mortgage free home
  • Real estate (condo?, cottage, land)
  • Cash
  • Stocks and bonds?
  • Income tax planning