Test 2 Flashcards
What is a sole proprietorship?
A business that is owned, and usually managed, by a single individual.
What are the advantages of a sole proprietorship?
- You get all the money.
- You get to make all the decisions.
- You’re your own boss.
- Ease of establishment - little paperwork to start.
- Income is taxed as personal income.
What are the disadvantages of a sole proprietorship?
- If it goes bad it’s all on you.
- Unlimited liability (personal assets at risk)
- Lack of performance.
- Limited financial resources (only your worth is considered in a bank loan)
What is a partnership?
A voluntary agreement under which two or more people act as co-owners of a business for profit.
What is a general partnership?
Each partner has the right to participate in the company’s management and share in profits - but also has unlimited liability for any debts the company incurs.
What are the advantages of a general partnership?
- Bigger talent pool - share resources.
- Ease of establishment.
- Share responsibility.
- Income taxed as personal income.
What are the disadvantages of a general partnership?
- Potential for disagreements.
- Unlimited liability.
- Lack of continuity.
- Difficulty in withdrawing from a partnership.
What is a limited partnership?
A partnership arrangement that includes at least one general partner and at least one limited partner.
What is a limited liability partnership (LLP)?
A form of partnership in which all partners have the right to participate in management and have limited liability for company debts.
What are the characteristics of a limited partnership and LLP?
- Money invested.
- Ran by general partner.
- Only held accountable for your own investment.
- Responsible for your own work.
- Doctors/Lawyers offices.
What is a corporation?
A form of business ownership in which the business is considered a legal entity that is separate and distinct form its owners.
What are the advantages of a corporation?
- Limited liability.
- Permanence.
- Easy to transfer ownership.
- Ability to raise large amounts of money.
- Ability to make use of specialized management.
What are the disadvantages of a corporation?
- Difficult to establish and regulate.
- Double taxation (Corp is taxed on profit & personal tax)
- Conflicts - 51% ownership.
- More paperwork, less secrecy.
What is a limited liability company (LLC)?
Formed like corporations but treated like partnerships.
What are the advantages of LLCs?
- Limited liability.
- Flexible ownership.
- Income taxed as personal income.
What are the disadvantages of LLCs?
- Recognized in a single state.
- State franchise tax.
- Limits on types of firms that can form LLCs.
What are 3 types of mergers?
- Horizontal - in the same business.
- Vertical - in the same supply chain.
- Conglomerate - completely unrelated businesses.
What is a franchise?
A licensing agreement under which a franchisor allows franchisees to use its name, trademark, products, business methods, and other property in exchange for monetary payments and other considerations.
What are the advantages of a franchise?
- Name recognition.
- Business plan mapped out for you (less risk)
- Training and support.
- Easier access to funding.
What are the disadvantages of a franchise?
- Cost.
- Lack of control.
- Negative halo effect.
- Growth challenges.
- Restrictions on sale.
- Poor execution.
What is financial accounting?
The branch of accounting that prepares financial statements for use by owners, creditors, suppliers, and other external stakeholders.
What is managerial accounting?
The branch of accounting that provides reports and analysis to managers to help them make informed business decisions.
What are 3 basic financial statements?
- Balance Sheet
- Income Statement
- Statement of cash flows
What does the Balance Sheet report?
Reports the financial position of a firm by identifying and reporting the value of the firm’s assets, liabilities, and owner’s equity.
What does the Income Statement report?
Reports the revenues, expenses, and net income that resulted from a firm’s operations over an accounting period.
What does the Statement of cash flows report?
Identifies the firm’s sources and uses of cash in a given accounting period.
What is the fundamental accounting equation?
Assets = Liabilities + Owner’s Equity
What are the characteristics of a Balance Sheet?
Has the following accounts:
- Assets
- Liabilities
- Owner’s Equity
What are the characteristics of the Income Statement?
Has the following accounts:
- Revenue
- Costs and Expenses
- Net Income
What are the characteristics of the Statement of cash flows?
Has the following accounts:
- Operating cash flows
- Investing cash flows
- Financing cash flows
What is the difference between gross profit and net income?
Gross profit is the total profit BEFORE costs and expenses is taken out. Net income is total income AFTER costs and expenses is taken out.
How do you calculate cost of goods sold?
accural-basis accounting: method of accounting that recognizes revenue when it is earned and matches expenses to the revenues they helped produce.
What is an operating budget?
Budgets that communicate an organization’s sales and production goals and the resources needed to achieve these goals.
What is a financial budget?
Budgets that focus on the firm’s financial goals and identify the resources needed to achieve these goals.
Define GAAP
Generally Accepted Accounting Principles (GAAP): A set of accounting standards that is used in the preparation of financial statements.
Define FASB
Financial Accounting Standards Board (FASB): The private board that establishes the generally accepted accounting principles used in the practice of financial accounting.
Define owner’s equity
The claims a firm’s owners have against their company’s assets (often called “stockholder’s equity”)
Define retained earnings
The accumulated earnings reinvested in the company (rather than paid to owners).
Define revenue
Increases in a firm’s assets that result from the sale of goods, provision of services, or other activities intended to earn income.
Define cash flow
The flow of cash in and out of the following accounts: operating activities, investing activities, financing activities.
Define operating expenses
Costs the firm incurs in the regular operation of its business.
Define assets
Resources owned by a firm.
Define horizontal analysis
Analysis of financial statements that compares account values reported on these statements over two or more years to identify changes and trends.
Define financial ratios
Comparing one financial indicator in light of another.
What are the 3 types of financial ratios?
- Liquidity ratio: Current ratio
- Leverage ratio: debt-to-equity or debt-to-assets
- Profitability ratio: return on equity or return on assets
What is a current ratio?
A firm’s ability to pay short-term debts.
Current Assets/Current Liabilities
What is a debt-to-equity ratio?
Measures the extent to which a firm relies on debt to meet its financing needs.
Liabilities/Equity
What is a debt-to-assets ratio?
Measure the extent to which a firm relies on debt to meet its financing needs.
Liabilities/Assets
What is a return on equity ratio?
Compares profit to resources invested.
Income/Equity
What is a return on assets ratio?
Compares profit to resources invested.
Income/Assets
What is an earnings per share ratio?
Compares profit to resources invested.
Income/# of shares
What are sources of short term operating funds?
Trade credit, factoring, short-term bank loans, commercial paper
Define trade credit
Spontaneous financing granted by sellers when they deliver goods and services to customers without requiring immediate payment.
Define factor
A company that provides short-term financing to firms by purchasing their accounts receivables at a discount.
What are short-term bank loans?
Loans through the bank that are usually due within 30-90 days. Two types: line of credit, revolving credit agreement
Define line of credit
A financial arrangement between a firm and a bank in which the bank pre-approves credit up to a specified limit, provided that the firm maintains an acceptable credit rating.
Define revolving credit agreement
A guaranteed line of credit in which a bank makes a binding commitment to provide a business with funds up to a specified credit limit at any tie during the term of the agreement.
Define commercial paper
Short-term (and usually unsecured) promissory notes issued by large corporations.
What are sources of long-term operating funds?
Direct investments from owners, long-term debt, term loans, corporate bonds
Define covenant
A restriction lenders impose on borrowers as a condition of providing long-term debt financing.
Define time value of money
The principle that a dollar received today is worth more than a dollar received in the future.
Define net present value
The sum of the values of expected future cash flows from an investment, minus the cost of that investment.
Define collateral
Owned assets that are used as assured payment if funds are not collected on a loan.
Define pro forma balance sheet
Forecasts the types and amounts of assets a firm will need to implement its future plans. Also helps determine the amount of additional financing the firm must arrange to acquire those assets.
Define pro forma income statement
Uses information from the sales budget and various cost budgets to develop a forecast of net income for the planning period.
Define cash budget
A detailed forecast of future cash flows that helps financial managers identify when their firm is likely to experience temporary shortages or surpluses of cash.
Define leverage
How much a firm relies on debt.
Define bond
A formal debt instrument issued by a corporation or government entity.
What are the characteristics of a bond?
- Long-term debt
- No ownership
- Obligation to repay
- Secured
terms: coupon rate, maturity date, par value, callable, convertible
Define coupon rate
The interest paid on a bond, expressed as a percentage of the bond’s par value.
Define maturity date
The date when a bond will come due.
Define par value (of a bond)
The value of a bond at its maturity; what the issuer promises to pay the bondholder when the bond matures.
Define callable
special circumstance Can pay back early (decided by bond holder)
Define convertible
Can convert value of bond into stock.
What are the characteristics of a stock?
- Ownership - people bought into the company
- Voting rights
- No obligation to repay
- Residual claim on assets
- Tax consequences - double taxation
terms: common stock, preferred stock, dividends
Define common stock
Basic form of ownership in a corporation. - Get to vote
Define preferred stock
A type of stock that gives its holder preference over common stockholders in terms of dividends and claims on assets. - No voting rights.
Define dividends
Quarterly profits paid out to shareholders per stock.
Define capital gain
If the price of the stock rises above the amount paid for it.
What is a primary securities market?
Where corporations raise additional financial capital by selling newly issued securities.
What is a secondary securities market?
Where previously issued securities are traded.
What are 5 investment strategies?
- Investing for income
- Market timing
- Value investing
- Investing for growth
- Buying and holding
Explain “investing for income”
Focus on buying bonds and preferred stocks to generate a steady, predictable flow of income.
Explain “market timing”
Try to make quick gains by buying low and selling high over a relatively short time horizon.
Explain “value investing”
Try to find stocks that are undervalued in the market. - competitive.
Explain “investing for growth”
Look for companies that have the potential to grow much faster than average for a sustained time, which they believe will lead to a stead rise in the stock’s price.
Explain “buying and holding”
Involves purchasing a diversified set of securities and holding them for a long period of time.
Define Dow Jones
An index that tracks stock prices of thirty large, well-known US corporations.
Define IPO
initial public offering (IPO): The first time a company issues stock that may be bought by the general public.
Define market order
An order telling a broker to buy or sell a specific security at the best currently available price.
Define limit order
An order to a broker to buy a specific stock only if its price is below a certain level, or to sell a specific stock only if its price is above a certain level.
Define mutual funds
An institutional investor that raises funds by selling shares to investors and uses the accumulated funds to buy a portfolio of many different securities.
