Finance Notes and Cheat Sheet, Cheat Sheet of Finance

Download Finance Notes and Cheat Sheet and more Cheat Sheet Finance in PDF only on Docsity! corporate finance- the business function of obtaining funds for a company and managing them to accomplish the company's objectives| investments - types of things you can invest in and how to combine them into a portfolio ex. stocks and bonds| financial institutions - entities that provide financial services, such as taking deposits, managing investments, brokering financial transactions, or making loans, regulations and how they manage risk, ex. banks, insurance companies| corporate finance focuses on 3 questions: 1. What should we invest in? (Capital Budgeting) 2. How do we finance those investments? (Capital Structure) 3. How do we manage the day-to-day operations of the firm? (Short-term cash flow mngt)| balance sheet identity - Assets = Liabilities – Stockholder Equity| Debt is a promise to repay, equity gets everything else, DEBT IS A LEVERAGE. What is Capital Budgeting? Process of planning & managing firms long-term investments. how? 1.estimate cash flows 2.estimate the cost of those cash flows3. discount cash flows | What is Capital Structure? the mix of debt and equity describing how the firm is financed| What does short-term cash flow management entail? Net Working Capital = Current Assets – Current Liabilities, Cash Management = How much cash specifically do we need to have, Credit Management =How much credit do we extend| Cash Flows from firm must exceed cash flows from financial markets, the firm must be a cash generating activity| Primary Market=firms that are selling new securities for cash ex. IPO(initial public offering) sells stock to public, SEO(secondary equity offering) is when company is already publicly traded sells additional shares| Secondary Market= Buying and selling among investors, firm not involved| Sole Proprietorship = a business owned and managed by a single individual pros: easy startup, taxed as personal income cons: unlimited liability life limited to that of owner, equity limited to owner's wealth, difficulty in transferring ownership| Partnership = business in which two or more persons combine their assets and skills pros: easy startup, taxed as personal income cons: unlimited liability, life limited to that of owner, equity limited to owner's wealth, difficulty in transferring ownership| Corporation = a business created as a distinct legal entity composed of one or more individuals or entities pros:, limited liability, easy transfer of ownership, unlimited life, equity is not limited cons: difficult to startup, double taxation of earnings. Separation of ownership and control: Shareholders ( aka owners) Directors(are hired or elected, monitor managers, hire or fire managers) Managers| Goal of the Firm: To maximize shareholder’s wealth| what is a principal-agent relationship? the principal hires an agent to work on their behalf| Agency Problem/Conflict The possibility of conflict of interest between the stockholders (the principal) and management (the agent) of a firm| agency costs = the costs of the conflict of interest between stockholders and management| direct agency costs: actual $ that are spent because of potential COI, includes wasteful spending, monitoring and auditing indirect agency costs: Not actual $ spent, but loss of value, includes missed opportunities| How to control agency conflicts? Managerial Compensation: cash bonus, compensating managers with shares of stock. Control of the Firm: threat of firing. Proxy Fight(attempts by a person or group that wants to take over control of a firm by getting the firms' stockholders to give their voting proxies to the new group, replacing BOD because they won’t fire underperforming managers, very expensive) Hostile Takeover = Shareholders buy extra stock in order to gain control of corp.)| Balance Sheet Identity: Snapshot of firm at single point in time| NWC= CA-CL| Liquidity = how fast we can turn assets into $ without a significant loss in value, items are listed in order of decreasing liquidity pros: allows you to pay obligations quickly, quickly access cash. cons: no rate of return. Accumulated Retained Earnings: money left over after paying stockholders| Balance Sheet: Book Value vs Market Value: Where on the balance sheet can we find the true (market) value of the firm? You can’t!| market value = price you can buy or sell something at today, can’t be found on balance sheet book value = cost - accumulated depreciation| Book value of current assets NWC + CL| Book Value of total assets= net fixed assets + book value of current assets| Market Value of total assets | How to find true market value of stockholders’ equity = price per share X # of shares outstanding| What is the goal of the firm? Increase market value of share| Income Statement = Revenues – Expenses = Income| Income Statement Bottom Line = Net Income or EPS( earnings per share)| GAAP(generally accepted accounting principle) = The timing of cash flows, The matching principle(match expenses to revenues, non- cash items( expenses charged against revenues that do not directly affect cash flow, such as depreciation)| The Statement of Cash Flows(where money is coming or going over time) = Cash Flow from Operating activities(day to day), Cash Flow from Investing Activities(buying & selling long-term-assets), Cash Flow from Financing Activities(to or from debt or equity holders) comes from BOTH the income statement and Balance Sheet| Operating activity: includes net income and changes in most current accounts, changes in assets and liabilities, depreciation, deferred taxes Investment activity: includes changes in fixed assets Financing activity: includes changes in notes payable, long-term debt, and equity accounts, as well as dividends | sources and uses of assets = increase in assets: USE, decrease in assets: SOURCE, sources and uses of liabilities and equity: increase in L/se: SOURCE, decrease in L/se: USE. | Depreciation is not a cash flow, can be found in operating activities Net Income is not a cash flow. Financial Statements are backward looking. Balance Sheet shows book values, not market values| average tax rate = taxes owed / taxable income| marginal tax rate = amount of tax payable on the next dollar earned| Increase in accounts payable is a source of cash| Decrease in inventory is a source of cash| Increase in accounts receivable is a use of cash| Increase in accrued expenses is a source of cash| What does liquidity measure? Explain the trade-off a firm faces between high-liquidity and low-liquidity levels: Liquidity measures how quickly and easily an asset can be converted to cash without significant loss in value. It's desirable for firms to have high liquidity so that they can more safely meet short-term creditor demands. However, liquidity also has an opportunity cost. Firms generally reap higher returns by investing in illiquid, productive assets. It's up to the firm's financial management staff to find a reasonable compromise between these opposing needs.| Why is it that the revenue and cost figures shown on a standard income statement may not be representative of the actual cash inflows and outflows that occurred during a period? The recognition and matching principles in financial accounting call for revenues, and the costs associated with producing those revenues, to be "booked" when the revenue process is essentially complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily correct; it's the way accountants have chosen to do it. common-size statement = allows us to compare companies of different sizes 1. balance sheet items as a percentage of total assets 2. income statement items as a percentage of total sales(revenues) | Shot-term solvency or liquidity ratios(lability to make payments on short-term liabilities| long-term solvency or liquidity ratios(ability to pay long-term)| asset mngt or turnover ratio(how efficiently we’re using assets| profitability ratios (ability to generate profit)| Market Value Ratio( market value of stock) Benchmarking = comparing yourself to competition| Liquidity Ratios: Current Ratio = Current Assets/Current liabilities (greater than 1 means asset liquidity is that many times greater than liabilities liquidity| Quick( acid-test) Ratio = CA – INV/ CL| Cash Ratio = Cash/ CL| Networking Capital to Total Assets = Networking Capital(CA-CL)/ Total Assets| Interval Measure = CA/ avg daily operating costs (how many days will we be able to operate without cash| Financial Leverage Ratios: Total Debt Ratio( for every dollar of debt I have, how much cash do I have) = TL/TA| Debt-equity Ratio: TL/TE| Equity Multiplier: TA/TE, or E + L/E, or 1 + Debt Equity Ratio| Long-term Debt Ratio = Long-term Debt/ LT Debt + Equity| Times Interest Earned (TIE) Ratio = EBIT/ Interest Exp. (Problem with using this is that depreciation isn’t cash flow)| Cash Coverage Ratio = EBIT + Depreciation/ Interest Exp | Asset MNGT (Turnover) Ratio : Inventory Turnover = COGS/Inv| Day’s Sales in Inv = 365/Inv Turnover | Receivables Turnover = Sales(on credit)/Acct Receivable| Day’s sales in receivables = 365/Receivables TO | Networking Capital TO = Sales/ NW Capital | Fixed Asset Turnover = Sales/ Net Fixed Asset | Total Asset TO = Sales/ TA | Profitability Ratios: Profit Margin : Net INC/ Sales | ROA = Net Inc/ TA (should be greater than ROE) | ROE = Net Inc/ SE | Market Value Ratio: EPS (Earning per share) = Net Inc/ # shares | Price-Earning (PE) Ratio = price per share/ EPS | Price-sales Ratio= pps/sales per share | Market-2-Book Ratio = Market Value Per Share/ Book Value Per Share| Tobin’s Q = Market value of assets/ replacement costs of assets | Enterprise Value – EBITDA Ratio = Enterprise Value/ EBITDA| DuPont identity: an expression that shows a company's return on equity (ROE) can be represented as a product of three other ratios: the profit margin, the total asset turnover, and the equity multiplier, ROE = NI/SE, ROE = NI/A x A/SE(ROA x Equity M), ROE = NI/Sales x Sales/A x A/SE(Profit Margin x Total Asset Turnover x Equity M), with leverage ROE is greater than ROA, Breaks ROE down into: Profitability, Asset Use Efficiency, Financial Leverage| Uses of Financial Statements: Ratio Analysis, Common Size Statements, Trend Analysis, Cross-Sectional Analysis, Dupont Identity| Limitations of Financial Statements: Benchmarking, Effects of Inflation, Seasonal Factors, Window Dressing, Big Picture, Differing Operating & ACCT Practices Time Value of Money: Longer we have to wait, less value it has | future value: the amount an investment is worth after one or more periods| simple interest: Interest earned only on the original principal amount invested| compound interest: Interest earned on both the initial principal and the interest reinvested from prior periods| compounding: the process of accumulating interest on an investment over time to earn more interest pros:1. increase with interest rate 2. increase with time 3. increase with the frequency of compounding| ex. R=10%, $100 today: 1 year = 100 + (100 x .10) = $110, 2 yr = 100 x (1.10)^2 = $121, 3 yr = 100 x (1.10)^3 = 133.10, SI is $10 per year, was og interest on og 100, Compound Int is 33.10 | FV Calcu: FV = PV x (1+r)^t | Effects of Compounding: Increase with Int Rate, Increase with time, Increase with frequency of compounding| present value: the current value of future cash flows discounted at the appropriate discount rate| discount: calculate the present value of some future amount| discount rate: the rate used to calculate the present value of future cash flows | PV Calc: PV = FV/(1+r)^t | As t goes up, PV goes down and FV goes up| As r goes up, PV goes down and FV goes up| Profit margin is: A measure of the firm's operating efficiency (how well it controls costs) Total asset turnover is:A measure of the firm's asset use efficiency (how well foes it manage its assets Equity multiplier is: A measure of the firm's financial leverage| Investments: Work with financial assets such as stocks and bonds; value of financial assets, risk versus return, and asset allocation ex) stockbrokers, financial advisors, etc.| Working Capital A firms short term assets and liabilities; focus on how to manage day to day finances of the firm ex) short term asset would be inventory while a short term liability would be money owed to shareholders| Stakeholder: Someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm| Primary Market: Company directly involved; corporation is the seller and the transaction raises money for the corporation| Secondary Markets: Involves one owner or creditor selling to another, and provides means for transferring ownership or corporate securities; Dealer Markets or Auction Markets| Dealer Markets "over the counter securities" transactions are handled through a dealer; dealers do not have a physical location or own any of commodity; buy and sell for themselves at their own risk ex) NASDAQ is typically high tech and growth co's.; less value with stock ex) car dealership buying and selling vehicles | Auction Markets: Physical location with agents. Buyers and sellers trade physically by comparing prices; match those wishing to sell with those wishing to buy ex) NYSE (New York Stock Exchange); typically fortune 500, blue chip, and industrials ex) Wall Street is an auction market | Assets on the Balance Sheet: Listed in order of decreasing liquidity (brings ease of conversion of cash and no significant loss of value)| What do liquid assets do?: Typically earn a lower return| What do you do to find a balance between liquid and illiquid assets? Trade-off| Is market or book value more important to the decision making process? market values are generally more important for the decision making process because they are more reflective of the cash flows that would occur today| Matching Principle: GAAP says to show revenue when it accrues and match the expenses required to generate the revenue| Cash Flow from Assets (Free Cash Flow): The total of cash flow to creditors and stockholders, consisting of the following: operating cash flow, capital spending, and change in networking capital| Operating Cash Flow: Cash generated from a firm's normal business activities| Cash Flow to Creditors: A firm's interest payments to creditors less net new borrowing| Cash Flow to Stockholders: Dividends paid out by a firm less net new equity raised| Sources: A firm's activities that generate cash; cash inflow, occurs when we "sell" something| Sources affect on Assets, Liabilities, and Equity: Decrease in asset account (accounts receivable, inventory, and net fixed assets) Increases in liabilities and equity account (accounts payable, other current liabilities, and common stock) | Uses (applications of cash): A firm's activities in which cash is spent; cash outflow, occurs when we "buy" something| Uses affect on Assets, Liabilities, and Equity: Increases in asset account (cash and other current assets) Decreases in liability or equity account (notes payable and long-term debt)| Standardized financial statements: Make it easier to compare financial information, particularly as the company grows; they are usually for comparing companies of different sizes usually in the same industry (common sized balance sheet or common sized income statement)| Common sized balance sheets: Compute all accounts as a percentage of total assets, Common sized income statements, Compute all line items as a percentage of sales| Du Pont Identity: ROE=PMxTATxEM| Internal uses for evaluating financial statements: Performance evaluation (compensation and comparison between divisions) and planning for the future (guide in estimating future cash flows)| External uses for evaluating financial statements: Creditors, suppliers, customers, and stockholders| OCF (Operating Cash Flow) = EBIT - Taxes + Depreciation| OCF = CFFA(cash flow from assets) + NCS + change in NWC| NCS (Net Capital Spending) = Ending Fixed Assets - Beginning Fixed Assets + Depreciation OR Increase in net fixed assets + Depreciation| Change in NWC (Net working Capital) = Ending WC - Beginning WC | 1. You are looking to purchase a home automation system when you graduate in two years. You plan to deposit the money in an investment account earning 8 percent annually. The anticipated cost of the system in two years is $2,500. How much must you deposit today? 2. When you were born 21 years ago, your Aunt Burtha put $2,000 into a saving account for you. The account has earned an average annual return of 4 percent per year, and nothing else has been deposited or withdrawn from the account. How much is there today? 3. Aunt Burtha also put $2,000 into a different savings account for your brother when he was born 18 years ago. If his account has $4,813.24 in it today, what rate of return did his account earn? 4. You decide to borrow money from Cousin Vinnie and he has agreed to a 20 percent interest rate per year. If you borrowed $200 last year, and know you have to pay him in full exactly $716.64 (and make no other payments to him), how long from now until you must pay him back? 5. Five years ago, you bought a piece of art at auction for $1.2 million. Yesterday, you sold that piece at auction for $2,630,937.64. You also purchased a new piece yesterday for $300,000. If the piece you just bought earns the same rate of return as the first one, how much will you be able to sell it for in 8 years? 6. You plan to save for a Caribbean cruise. You deposit $500 today, $250 in two years, and $1,000 in three years. If your investment account earns 9 percent per year, how much will you have in five years? 7. Which do you prefer: (1) receiving $1,000 in five years when the interest rate is 3 percent per quarter or (2) receiving $1,500 in six years when the interest rate is 6 percent every six months? 8. You have won a lawsuit and the court has arranged for the defendant to pay you $7,500 per year for the next three years. If the appropriate discount rate is 8 percent, what is the value of your settlement today? 9. Last year, you borrowed money from Cousin Vinnie and he agreed to a 25 percent interest rate per year. If you borrowed $250, and know you have to pay him in full exactly $488.28 (and make no other payments to him), what will be the total length of the loan? 10. An investment offers a return of 1 percent every month if you deposit a minimum of $20,000. If you make the minimum deposit today and do not make any additional deposits, how much will you have in your account in 20 years? 11. Which of the following actions are likely to reduce the agency problem between stockholders and managers? A manager receives a lower salary but receives additional shares of the company’s stock and The board of directors has become more vigilant in its oversight of the company’s management. 12. Information on the Statement of Cash Flows comes from… Both the income statement and balance sheet 13. Which of the following statements is most correct? a. Many large firms operate different divisions in different industries, and this makes it hard to develop a meaningful set of industry benchmarks for these types of firms. b. Financial ratios should be interpreted with caution because there exist seasonal and accounting differences that can reduce their comparability. c. Financial ratios should be interpreted with caution because it may be difficult to say with certainty what is a “good” value. For example, in the case of the current ratio, a “good” value is neither high nor low. d. Ratio analysis facilitates comparisons by standardizing numbers e. all are correct 14. Other things equal, present value… increases as future value increases 15. On the Statement of Cash Flows, depreciation will be found in the section entitled… Cash Flow from Operating Activities. 16. Which of the following statements is most correct? A firm with financial leverage has a larger equity multiplier than an otherwise identical firm with no debt in its capital structure . 17. Your dentist mentions that if you earn 15% for two years, you will have more money than if you earn 10% for one year and 20% for the other year. What do you think about your dentist’s statement? The dentist is correct. 18. The current Federal income tax system gives corporate financial managers the incentive to use ____ financial leverage and to ____ a higher proportion of corporate earnings. more; retain 19. You observe that a firm’s profit margin is below the industry average, its debt ratio is below the industry average, and its return on equity exceeds the industry average. What can you conclude? Total assets TO is above industry avg.