Finance I Flashcards
What is the time value of money
The value of money today is worth more than the value of money tomorrow
What is the present value
the current value of future cash flows
what is the future value
the value of a future cash flow at a specific time
Compounding factor and discount factor
the compounding factor = (1+r)ⁿ
the discount factor = 1/compounding factor or (1+ r)⁻ⁿ
Ordinary annuity
In an ordinary annuity payments are made at the end of the payment intervals
Annuity due
In an annuity due payments are made immediately or at the beginning of payment intervals
Deferred annuity
A financial transaction where payments are delayed until a certain period has elapsed
Growing annuity
refers to streams of cashflows where the initial value R grows at constant rate g.
Perpetuity
A perpetuity is an annuity where the payments start at a fixed date and continue forever
Ordinary perpetuity
The holder receives the first payment in the first year PV = R/r
Growing perpetuity
The holder receives the first payment in the first year, and the payment grows at a constant rate PV = R/(r-g)
Net Present Value (NPV)
measures the difference between the PV of all future cashflows PV(in) and the investment outlay I(out).
Probability index (PI)
measures the ratio between the PV of future cash flows and the initial investment
Payback period
The length of time required to retrieve the initial investment ( cover the cost of the investment).
Simple payback
Does not allow for the time value of money and uses future cash flows without discounting
Discounted payback
Discounted cashflows are considered and it uses the time value of money
Average rate of return (ARR)
the ratio of the average annual investment profit to the investment cost.
ARR = [(Total profit/no. of years)/Investment] x 100
Equivalent annual cost (EAC)
The cost per year of owning and maintaining an asset over its lifetime.
EAC is used to compare the cost effectiveness of various assets/ investments with unequal lifespans.
EAC = NPV/An,r
Internal rate of return (IRR)
measures the interest or discount rate that equates the future returns to the present investment outlay.
It is the rate when the NPV of an investment is 0.
Steps for IRR
- Pick a discount rate and fix it into the formula
2.Try with different rates and use two that give a positive NPV and one with a negative NPV - Plot the NPV against the the two discount rates.
- Chose the point in which NPV = 0
Modified internal rate of return (MIRR)
the rate that measures the total future cash flows to the PV of the negative cash flows.
r = ⁿ√(R/PVout) - 1
where R is the FV of all positive cash inflows
n is the number of periods and PVout is the PV of all negative cash flows.
Steps for MIRR
- Calculate R compounded at the reinvestment rate
- Calculate PVout at the financing rate
- Calculate the rate of return for the lifetime n
Sensitivity analysis
Measures the “what if?” and it examines the impact of an individual estimated parameter on the NPV of a project
Scenario analysis
Affects many variables at once. Normally a ‘worst’ and ‘best’ case scenario are included. All ranges of possible outcomes of NPV are considered in all scenarios.
Basic formula of a balance sheet
Assets = Liabilities + shareholders equity
What is an asset
An asset is anything owned by a firm or individual with quantifiable value.
Assets can be Physical, non-physical, current or non-current.
What is a physical asset
A physical asset is a tangible good. such as property or plant and machinery
what is a non physical asset
A non-physical asset is an intangible good such as brands, patents, trademarks and copyrights
what is a current asset
A current asset is an asset which can be converted into cash within one year.
such as cash or cash equivalents (gold), Inventory and accounts payable
what is a non-current asset
A non-current asset is a long term of fixed asset which takes longer to liquify such as property, plant and equipment, intangible assets and long term investments
What is a liability
A liability is anything for which a company owns a debtor.
Liabilities can either be current or non-current.
What is a current liability
Current liabilities are usually due within one year.
ie. accrued expenses, accounts payable, short term debts, wages owned or bank account overdrafts etc.
What is a non-current liability
Non-current liabilities are due after more than one year.
ie. Long term debt or mortgage payable, long-term lease, deferred tax liabilities.
What is the shareholders equity
The net worth of the company. The amount left when all liabilities are paid of and assets are sold.
= Total Assets - Total Liabilities
Components of shareholders equity
Share capital, Retained earnings, Treasury stock and Additional paid-in capital.
How to create a balance sheet
- Determine the reporting date and period
- Identify your assets
- Identify your liabilities
- Identify your shareholders’ equity
- Add ‘total liabilities’ and ‘total shareholders equities’
- If the liabilities + Equities = Assets then the balance sheet is fine.
What is an income statement
An income statement reports a companies financial performance over a period.
The main components are revenue, expenses, gains and losses.
It is also known as the profit loss statement.
What is revenue
Revenue is the value of sold goods and services recognised by a company in a given period.
Revenue can be operating or non-operating
What is operating revenue
Operating revenue refers to revenue the company generates through the companies primary operation. such as the sale of goods or services
What is non-operating revenue
non-operating revenue refers to the revenue not accrued from a companies primary operation such as interest income or investment income.
What is a cash-flow statement
Explains all cash inflows and outflows that a company receives.
Net cash flows = Operating + investing + financing cashflows
What is an operating cashflow
An operating cash flow is the cashflows from a companies primary operation (sale of goods and services)
includes tax payments, rent, wages and salary payments.
What is an investing cashflow
An investing cashflow is derived from purchasing and selling company investment such as PPE ( property, plant and equipment) and other non-current assets
What is a financing cash flow
From debt, dividend and equity financing, payment for stock repurchase.
What is horizontal anaylsis
Horizontal analysis compares financial reports over time, normally from past quarters or years.
HA(%) = (VN - VN-1)/VN-1, where VN and VN-1 are values of periods N and N-1
what is vertical analysis
vertical analysis is a proportional analysis and in each collum a value is chosen to be the base figure.
ie the Revenue in year 1 was 3489 and the COGS was 1000 then the VA for COGS in year 1 would be 1000/3489
what is the current ratio
measures the firms ability to cover its current liabilities with its current assets
current ratio = current assets/ current liabilities
what is the quick or acid ratio
measures the firms ability to cover its liabilities with its most liquid (quick) assets
quick ratio = (current asset - inventory)/current liabilities
what is the cash ratio
measures the firms liquidity or the amount of cash available to pay interest
cash ratio = cash and cash equivalent assets/ current liabilities
what is working capital
The net current assets needed to run the day to day operating activities in a business
calculated as the difference between current assets and current liabilities
what is net working capital
current assets - current liabilities
what is gross working capital
sum of all current assets
What is the inventory
The list of raw material, component parts, semi-finished goods and finished goods of a particular firm.
why do we need to manage inventory
Buying inventory in small quantities can lead to higher cost per unit and potential delays in production
Buying inventory in large quantities can lead to lower cost per unit due to bulk buying however can lead to wasted inventory that spoils and high holding costs
What is accounts recievable
All outstanding invoices that a company has or the money that clients owe the company
why do we need to manage accounts receivable
Promise to pay
Collection policy
How long should the customer be given to pay bills?
How likely are customers to pay?
what is the working capital cycle
the length of time a company takes to convert their aggregate net working capital to cash.
The interval between purchasing raw materials and generating revenue through selling manufactured goods.
