Financial Management Vocabulary: TVM and Ratio Analysis

Comprehensive vocabulary flashcards covering key definitions, mathematical equations, and ratios for Time Value of Money (Chapter 5) and Financial Statement Ratio Analysis (Chapter 4).

Compounding

The process of determining the future value ($FV$) of a single cash amount growing over $N$ periods at an interest rate $I$, calculated as $FV = PV \times (1 + I)^N$.

Discounting

The process of finding the present value ($PV$) of a future cash amount, which is the reverse of compounding, calculated using the formula $PV = \frac{FV}{(1 + I)^N}$.

Annuity

A stream of equal cash flows occurring at regular intervals for a specified number of periods.

Ordinary Annuity

An annuity whose equal cash flow payments occur at the end of each period (at $t = 1, 2, 3...$).

Annuity Due

An annuity whose equal cash flow payments occur at the beginning of each period (at $t = 0, 1, 2...$), earning one additional period of interest compared to an ordinary annuity.

Uneven Cash Flow Stream

A series of cash flows where payments are not equal across periods, requiring each individual cash flow to be valued separately.

Nominal Interest Rate ($I_{NOM}$)

The quoted or stated annual interest rate written in contracts that ignores compounding and must always state the compounding period.

Periodic Interest Rate ($I_{PER}$)

The interest rate charged each compounding period, calculated as $I_{PER} = \frac{I_{NOM}}{M}$ where $M$ is the number of compounding periods per year.

Effective Annual Rate (EAR)

The actual interest rate earned or paid in a year once compounding is accounted for, calculated as $EAR = \left(1 + \frac{I_{NOM}}{M}\right)^M - 1$.

Amortized Loan

A loan paid off with equal periodic payments over time, where each payment is split between interest expense and principal reduction.

Balance Sheet

A financial statement providing a snapshot of a firm's assets, liabilities, and equity at a single specific date.

Income Statement

A financial statement showing a firm's revenues and expenses over a specific period of time to measure profitability.

Statement of Cash Flows

A financial statement summarizing the cash impact of a firm's operating, investing, and financing activities over a period.

Statement of Stockholders' Equity

A financial statement displaying the portion of profit retained versus paid out as dividends and showing how ownership equity changed over a period.

Current Ratio

A liquidity ratio measuring a firm's short-term solvency, calculated as $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$.

Quick Ratio

A stringent liquidity ratio that measures short-term debt-paying capability excluding less liquid inventory, calculated as $\text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}$.

Days Sales Outstanding (DSO)

An asset management ratio measuring the average length of time a firm waits to collect cash after making a sale, calculated as $\text{DSO} = \frac{\text{Accounts Receivable}}{\frac{\text{Sales}}{365}}$.

Inventory Turnover

An asset management ratio indicating how efficiently inventory is converted into sales, calculated as $\text{Inventory Turnover} = \frac{\text{Sales}}{\text{Inventory}}$.

Times Interest Earned (TIE)

A debt management ratio measuring a firm's ability to pay its annual interest obligations out of operating income, calculated as $\text{TIE} = \frac{\text{EBIT}}{\text{Interest Expense}}$.

Basic Earning Power (BEP)

A profitability ratio evaluating raw operating performance before taxes and leverage, calculated as $\text{BEP} = \frac{\text{EBIT}}{\text{Total Assets}}$.

Return on Equity (ROE)

The key profitability ratio under management's control measuring return earned on common stockholders' investment, calculated as $\text{ROE} = \frac{\text{Net Income}}{\text{Total Equity}}$.

DuPont Equation

A diagnostic framework dissecting ROE into three operational levers: $\text{ROE} = \text{Profit Margin} \times \text{Total Assets Turnover} \times \text{Equity Multiplier}$.

Trend Analysis

A ratio analysis method comparing a firm's financial ratios across consecutive years to evaluate whether performance is improving, declining, or remaining stable.

Benchmarking

The process of comparing a firm's financial ratios against industry averages or specific key competitors to assess relative peer performance.