Module 1 Flashcards
Intro & Financial Statements, Taxes, and Cash Flow
Usually associated with a top officer of the firm, such as VP of Finance or CFO
Financial Management
Coordinates the activities of the treasurer and controller
VP of Finance
The office that handles cost & financial accounting, tax payments, and management information systems
Controller’s Office
The office that is responsible for managing the firm’s cash and credit, its financial planning, and its capital expenditures
Treasurer’s Office
The process of planning and managing a firm’s long-term investments
Capital Budgeting
A Firm’s short term assets and its short term liabilities; Current Assets - (minus) Current Liabilities
Working Capital
Cash, Accounts Receivable, Inventory, Prepaid Assets
Current Assets
Accounts Payable, Notes Payable, Wages Payable, Interest Payable, Taxes Payable
Current Liabilities
What are the three different legal forms of business organizations?
Sole Proprietorship, Partnership, & Corporation
A business owned by one person who keeps all the profits and has unlimited liability for business debts
Sole Proprietorship
Describe the length of a Sole Proprietorship
It is limited to the owner’s life span
Describe the limits to the amount of equity that can be raised in a Sole Proprietorship
The amount of equity that can be raised is limited to the amount of the proprietor’s personal wealth
Describe the transfer of a Sole Proprietorship
May be difficult to transfer because it requires the sale of the entire business to a new owner
A business organization that has two or more owners
Partnership
What are the two types of partnerships?
General Partnership & Limited Partnership
A partnership where all the partners share in gains and losses, and all have unlimited liability for all partnership debts
General Partnership
How are the gains and losses divided in a general partnership
They are described in the Partnership Agreement
A partnership where one or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who will not actively participate in the business and have limited liability up to the amount contributed to the partnership
Limited Partnership
Describe the length of a partnership
The partnership terminates when a general partner wishes to sell out or dies
Describe the limits to the amount of equity that can be raised in a partnership
It is limited to the partners’ combined wealth
Describe the transfer of a partnership
It is not easy because it requires that a new partnership be formed; a limited partner’s interest can be sold without dissolving the partnership, but finding a buyer may be difficult
The most important business organization in the US that can borrow money and own property, can sue and be sued, can even be a general partner or a limited partner in a partnership, and can own stock in another business organization like it
Corporation
How is a corporation formed?
It involves preparing articles of incorporation or charter and a set of bylaws
It must contain the corporation’s name, its intended life, its business purpose, and the number of shares that can be issued
Articles of Incorporation
Where must the articles of incorporation be filed?
The state in which the firm will be incorporated
The rules describing how the corporation regulates its existence. They may be simple or quite extensive. They may be amended or extended from time to time by shareholders
Bylaws
Who elects the board of directors of a corporation?
The Stockholders
Who selects the managers of a corporation?
The Board of Directors
Who is charged with running the corporation’s affairs in the stockholders’ interests?
The Managers
How is the ownership of a corporation represented?
Shares of Stock
Describe the transfer and lifespan of a corporation
It can be readily transferred, and life is therefore not limited
What is the significant disadvantage of a corporation?
Double Taxation
What is double taxation?
Corporate profits are taxed twice; at the corporate level when they are earned and then again at the personal level when they are paid out
What business organization operates and is taxed like a partnership, but retains limited liability for owners?
Limited Liability Company
What is the goal of financial management?
To maximize the market value of the existing owner’s equity
What is the intended goal of the Sarbanes-Oxley Act of 2002?
To protect investors for corporate abuses in response to corporate scandals
What are the requirements of Sarbanes-Oxley?
Officers of the corporation must review and explicitly declare that the annual report does not contain any false statements or material omissions, that the financial statements fairly represent the financial results, and that they are responsible for all internal controls
What are the unintended effects of Sarbanes-Oxley?
Because of the extensive reporting requirements, compliance can be very costly; since its implementation hundreds of public firms have chosen to no longer trade on major stock exchanges
What is the relationship between stockholders and management?
Agency Relationship
What is the possibility of conflict of interest between principal and agent?
Agency Problem
Who is the principal?
The stockholders
Who is the agent?
Someone hired to represent the the interest of the stockholders
What are the costs of conflict of interest between stockholders and management?
Agency Costs
What is an indirect agency cost?
Lost opportunity
What are direct agency costs?
Corporate expenditures (benefit management) and expenses that arise from the need to monitor management actions
What are the two factors that determine whether managers will act in the best interest of stockholders?
How closely management goals are aligned with stockholder goals & Whether or not managers can be replaced if they do not pursue stockholder goals
What is the authority to vote someone else’s stock?
Proxy
What is a proxy fight?
When a group solicits proxies in order to replace the existing board and thereby replace the existing management
Why would a takeover give management incentive to act in shareholders’ interests?
Firms that are poorly managed are more attractive as acquisitions because a greater profit potential exists; thus avoiding a takeover would allow them to keep their jobs
Who are stakeholders of a firm?
Someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm; i.e. employees, customers, suppliers, etc.
Describe Cash Flows to and from the Firm
- Firm issues securities to raise cash
- Firm invests in assets
- Firm’s operations generate cash flow
- Cash is paid to gov. as taxes/Other stakeholders may receive cash
- Reinvested cash flows are plowed back into firm
- Cash is paid out to investors in the form of interest or dividends
What is a primary market?
The original sale of securities by governments and corporations
What is a secondary market?
Those markets in which securities are bought and sold after the original sale
Describe the Balance Sheet
A convenient means of organizing and summarizing what a firm owns (assets), what a firm owes (liabilities), and the difference between the two (firm’s equity) at a given point in time
Current Assets
Assets that will convert to cash within 12 months
Fixed Assets
A tangible or intangible ass that has a relatively long life
Current Liabilities
Liabilities that must be paid within the year
Long-term Liabilities
A debt that is not due in the coming year
Shareholders’ Equity
The difference between the total value of the assets and the total value of the liabilities
Balance Sheet Equation
Assets = Liabilities + Equity
Net Working Capital (NWC)
= Current Assets - Current Liabilities
Liquidity
The speed and ease with which an asset can be converted to cash
Shareholders’ Equity
= Assets - Liabilities
Financial Leverage
The use of debt in a firm’s capital structure; the more debt a firm has (as a percentage of assets) the greater is it’s degree of financial leverage
Book Value
Values shown on the balance sheet for a firm’s assets
Generally Accepted Accounting Principles (GAAP)
The common set of standards and procedures by which audited financial statements are prepared
Market Value
What an asset COULD be sold for
Income Statement
Measures the firm’s performance over some period of time, usually quarterly or annually
Income Statement Equation
Revenues - Expenses = Income
What are the three things that a financial manager needs to keep in mind when looking at income statements?
GAAP, cash vs. non-cash items, and time & costs
GAAP & the income statement
Will show revenue when it accrues (recognition principle) and expenses are matched to those revenues at the time they occur (matching principle)
Non-cash Items
Expenses charged against revenues that do not directly affect cash flow; i.e. depreciation
Product Costs
Such things as raw materials, direct labor expense, and manufacturing overhead (CoGS)
Period Costs
Costs incurred during a particular time period and might be reported as selling, general, and administrative expenses
What can be one of the largest cash outflows that a firm experiences?
Corporate Taxes
What is the Average Tax Rate?
The firm’s tax bill divided by the taxable income; the percentage of income that goes to pay taxes
What is the Marginal Tax Rate?
The rate of the extra tax you would pay if you earned one more dollar
Flat-Rate Tax
There is only one tax rate, so the rate is the same for all income levels
Describe Cash Flow
The difference between the number of dollars that came in and the number that went out
Cash Flow Identity
Cash Flow from Assets = Cash Flow from Creditors + Cash Flow to Stockholders
What are the three components of Cash Flow from Assets?
Operating Cash Flow, Capital Spending, and Change in Net Working Capital
Operating Cash Flow
Refers to the cash flow that results form the firm’s day-to-day activities of producing and selling
Capital Spending
Refers to net spending on fixed assets (purchases of fixed assets less sales of fixed assets)
Change in Net Working Capital (NWC)
Measured as the net change in current assets relative to current liabilities for the period being examined
“Free” Cash Flow
Cash that the firm is free to distribute to creditors and stockholders because it is not needed for working capital or fixed asset investments
Cash Flow to Creditors
= Interest Paid less Net New Borrowing
Cash Flow to Stockholders
= Dividends Paid less New Equity Raised
