Corporate Finance 101 Final

The Agency Problem

A conflict that occurs if managers focus on their best interests instead of stockholders' best interests.

Possible Solutions to the Agency Problem

Businesses can offer monetary incentives or threaten to fire employees who display it.

Chief Financial Officer (CFO)

A person who guides a company's financial activities and handles capital and investments.

Financial Management Processes: Determination of Capital Structure

Finding out how to acquire money needed by a company, choosing between stocks or bonds.

Corporate Financial Management

The method a company uses to meet organizational goals with capital, focusing on profit maximization.

Limited Liability Partnership

A partnership type often favored by professionals, where partners have limited liability.

General Partnership

A business with multiple owners who work out a partnership agreement without liability protection.

Limited Partnership

A business arrangement with a general partner in control and limited partners with no management rights.

Sole Proprietorship

A business organization where the owner and business are considered the same legally, liable for all debts.

C Corporation

A corporation subject to two levels of taxation: corporate income tax and dividends tax.

Limited Liability Company (LLC): Taxes

An LLC is not responsible for taxes; profits pass through to individual owners' income tax rates.

The Agency Problem: Example

Enron's high-ranking officers used false accounting statements to sell stock at inflated prices.

Limited Liability Company (LLC)

A business structure combining characteristics of corporations and partnerships with liability protection.

Limited Liability Company (LLC): Liability

LLC provides liability protection, keeping personal and business assets separate.

Cash Budget

Estimates inflows and outflows of money for a company to cover operational requirements.

Financial Management Processes: Estimation of Capital Requirements

Determining long-term money needs of a business.

Limited Liability Company (LLC): Registration

Requires registration with state government before starting operations.

Capital Sources

Methods to increase capital, including self-generated revenue or external debt and equity.

Corporation

Large businesses regulated and guided by a board elected by shareholders.

Financial Management Processes: Investment Strategies

Determining strategies to invest and earn money for a company.

Capital Budgeting

Planning the use of capital over time, including payouts and stock repurchases.

S Corporation

A corporation that isn't taxed at the federal level; shareholders are taxed instead.

Uniform Partnership Act

The main law governing partnerships in every state.

Net Cash Flow (NCF)

Measures cash inflows into a company over a period.

Amortization

Deducting costs of an intangible capital asset over a period.

Balance Sheet: Assets

Things of value owned by a company, like equipment or land.

Capital Expenditures

Costs associated with purchasing equipment, machinery, or buildings.

Earnings Before Interest and Taxes (EBIT)

Revenue after production costs and expenses but before taxes and interest.

Depreciation

Deducting costs of tangible capital assets over time.

Revenue

Total money a company acquires during an accounting period.

Free Cash Flow (FCF)

Money a company makes after capital expenditures.

Balance Sheet

Financial statement listing accounts for liabilities, assets, and owner's equity.

Balance Sheet: Liabilities

Amounts a business owes, reported on the balance sheet.

Net Income

Revenue exceeding expenses in an accounting period.

Generally Accepted Accounting Principles (GAAP)

Standards governing the reporting of financial statements.

Balance Sheet Equation / Basic Accounting Equation: Formula

Assets = liabilities + owner's equity.

Negative Cash Flow

Occurs when a business loses more money than it brings in.

Positive Cash Flow

When a business brings in more cash than it loses.

Operating Cash Flow (OCF): Formula

Earnings before taxes and interest + amortization + depreciation - taxes.

Free Cash Flow (FCF): Formula

Operating cash flow - capital expenditures.

Net Cash Flow (NCF): Formula

Operating cash flow + cash from investments + cash from financing.

Operating Cash Flow (OCF)

Measures a company's ability to generate cash from core business activities.

Balance Sheet Equation / Basic Accounting Equation

A company's assets must equal owner's equity plus liabilities.

Permanent Account

Accounts that remain on a company's chart of accounts indefinitely.

Liquidity

The rate at which an asset can be turned into cash.

Return on Equity Ratio

Judges the return from shareholders' investments.

Acid Ratio / Quick Ratio

Measures a company's ability to pay short-term debts with liquid assets.

Current Ratio / Working Capital Ratio

Compares current liabilities to current assets.

Statement of Retained Earnings

Shows how much of a company's earnings are kept and reinvested.

Return on Equity Ratio: Formula

Net income / average stockholder's equity.

Earnings per Share Ratio (EPS)

Indicates net income earned per share of common stock.

Balance Sheet

Lists all company accounts categorized, excluding temporary accounts.

Debt-to-Assets Ratio

Shows assets financed through debt.

Debt-to-Assets Ratio: Formula

Total liabilities / total assets.

Cash Ratio

Liquidity ratio focused solely on cash and cash equivalents.

Acid / Quick Ratio: Formula

(Cash & Cash Equivalents + Accounts Receivable) / Liabilities.

Income Statement

Shows the amount of money a company earned or lost over a period.

Cash Ratio: Formula

(Cash + cash equivalents) / current liabilities.

Financial Statement Ratios

Use information from financial statements to assess productivity and efficiency.

Adjusted Trial Balance

Shows all accounts after financial adjustments for accuracy.

Current Ratio / Working Capital Ratio: Formula

Current assets / current liabilities.

Current Asset

Assets convertible to cash within a year.

Earnings per Share Ratio: Formula

Net income / weighted average shares of outstanding common stock.

Capital Investment

Long-term investments taking time to recover initial costs.

Pro-Forma Balance Sheet

Creates a balance sheet using the percentage of sale method.

Financial Planning Model

Helps assess the impact of business strategies on the future.

Resource Allocation

Determining how to use resources to meet organizational goals.

Financial Planning Model: Economic Assumptions

Focuses on external factors affecting the economy and market.

External Financing Needed (EFN): Formula

Change in Assets - Change in Liabilities - Retained Earnings.

Budget

Used in financial planning to predict revenues and expenses.

Percentage of Sales Method

Forecasts annual sales growth for a business.

Determinants

Factors influencing a company's growth potential.

Financial Planning Model: Sales Forecast

Predicts sales growth percentage for financial planning.

Internal Growth Rate (IGR): Formula

Retained Earnings / Total Assets.

Capital Budget

Used to determine funding for capital investments.

Forecasted Sales Growth: Formula

Current Sales x (1 + Growth Rate/100).

Corporate Balance Sheet

Records a company's assets, liabilities, and owner's equity.

Financial Planning Model: Plug

Backup measure for addressing gaps in financial planning.

External Financing

Funding obtained from sources outside a company.

Natural Resources

Valuable resources found in nature affecting business growth.

Percentage of Retained Earnings: Formula

Retained Earnings / Net Income x 100.

Cash Flow

Movement of money into or out of a business.

Financial Feasibility

Analyzing a business venture's financial viability.

Master Budget

Contains independent budgets that may influence each other.

External Financing Needed (EFN)

Indicates how much financing is needed from outside sources.

Sustainable Growth Rate (SGR)

Maximum growth achievable without borrowing money.

Internal Growth Rate (IGR)

The uppermost amount of growth without external financing.

Financial Control Systems

Controls acquisitions and resource usage in a business plan.

Financial Planning Model: Pro Forma Financial Statement

Forecasts future financial statements within the planning model.

Interest-Only Loan

Initial payments cover only interest; principal payments start later.

Floating-Rate Bond: Coupon

Payments based on a fixed margin plus an index.

Floating-Rate Bond

Has a variable coupon connected to an external variable.

Perpetuity

Payments with no maturity or end date.

Future Value

What an investment is worth in the future based on today's value.

Future Value: Formula

Present value * (1 + interest rate)^number of periods.

Pure Discount Loan

Sold at one price with repayment at face value at maturity.

Bond Yield

Returns from an investment in bonds.

Present Value of a Perpetuity: Formula

Dividend / discount rate.

Bond Yield: Formula

Coupon payment / original price of the bond.

Zero-Growth Valuation Method: Formula

Dividend / rate of return.