Principles of Finance

Finance

The study of the management, movement, and raising of money.

Business Finance

Looks at how managers can apply financial principles to maximize the value of a firm in a risky environment.

Working Capital Management

Study and management of short-term assets and liabilities.

Capital Budgeting

Process of determining the long-term or fixed assets to acquire in an effort to maximize shareholder value

Capital structure

Process by which managers focus more specifically on long-term debt and increasing shareholder wealth.

Investments

Products and processes used to create and grow wealth.

Balance Sheet

Show assets, liabilities, and equity at a specified date

Cash Flow

Identify actual receipt and use of cash over a period

Income Statement (P&L)

Summarizes flow of revenues and expenses over a specified period

Risk Vs. Return

As risk increases, exp. return increases

Default Risk

Risk that issuer will fail to make required payment

Inflation Risk

Risk that investors will have less purchasing power in the future

Diversifiable (Unsystematic) Risk

occurs when investors hold small and non-diversified assets. Larger, well-rounded portfolios can eliminate this.

Non-diversifiable (Systematic) Risk

What remains after portfolio diversification has eliminated diversifiable risk.

Politcal Risk

Risk associated with macroeconomics and political systems

Primary Market

Market for new securities

Secondary Market

Market for non-new securities

Money Market

Market for short-term, low-risk, highly liquid securities

Money market securities

Maturity of less than one year

Capital Market

Market for long-term financial instruments. Liquidity is less certain, default risk varies more, maturities are longer.

Sole Proprietorships

• An unincorporated business owned by a single person
• No divide between the business and the person
• Unlimited liability

Partnerships

• Business structure that involves a legal arrangement
between two or more people who decide to go business
together

General Partnership

General partners have full operational control of a business
and unlimited liability in the business sense.

Limited Partners

Limited partners have less liability (limited to the extent of their investment) and often do not take part in day-to-day business operations.

Corporation

A legal entity that is separate and distinct from its owners.

C Corp

• Separate Legal Entity
• Articles of Incorporation
• Single or Multiple Owner Business
• Limited Liability Provided to Investors
• Double Taxation
• Capital Raised Through Sale of Stock

S Corp

• Limited to no more than 100 shareholders.
• All shareholders must have U.S. legal residence.
• Income flows to stockholders, avoiding double taxation
at the federal level.
• Limited liability is provided to investors.

What is the default tax treatment for a single-member LLC.

Sole Proprietorship

What is the default tax treatment for a multiple-member LLC.

General Partnership.

Articles of Organization (LLC)

Charter to organize an LLC

Articles of Incorporation

Corporate charter, filed to start a corporation

Secretaries of State

Host to state- level corporate paperwork (such as articles)

Stakeholder

Any person or group that has an interest in the outcomes of an organization’s actions (i.e.: employees, customers, shareholders, suppliers, communities, and governments)

Common shareholder

Any person who owns a common stock, have voting rights

Preferred shareholder

Own a share of company’s preferred stock, have no voting rights – but, they do receive a fixed dividend before common shareholders.

Main difference between Shareholders and Stockholders

Shareholder – partial owner of a company; stakeholders
do not have to have ownership

Shareholder

Person, company, or organization that holds stock in a company.

What roles do shareholders have?

Voting, appointing directors, deciding on director compensation, monitoring and approving financial statements, etc.

SEC: Securities and Exchange Commission

A regulatory agency in the United States responsible for overseeing and enforcing federal securities laws.

What is the SEC’s primary mission?

Protect investors, maintain fair and efficient markets, and facilitate capital formation.

IFRS: International Financial Reporting Standards

Sets forth, alongside the SEC, regulations for Investor Relations
• Coordinate live shareholder meetings and press conferences
• Disseminate financial information to the investment community
• Conduct briefings to the financial analyst community
• Publish quarterly and annual reports
• Address any issues that arise as a result of financial disclosure

Quarterly Report

Financial reporting 4x/year

Annual Report

Financial reporting 1x/year

Interest Rate

An interest rate is the cost of borrowing money or the return on investment for
lending or investing money.
• It represents the percentage at which interest is either earned or paid on a principal amount (the initial sum of money).

Nominal Interest Rate

Stated or quoted interest rate

Real Interest Rate

The true determinant of the cost of borrowing and the reward for lending.

Real Interest Rate = Nominal Interest Rate – Inflation Rate

Risk Premium

Lenders want to be rewarded for taking on risk, so they charge a risk premium to borrowers who are higher risk

Credit Risk

The risk that the lender may not be able to collect all of the money due

How are interest rates determined?

Interest rates are determined by the demand and supply of loanable funds.

Spot Exchange Rate

The currency exchange rate at any given time

Currency Appreciation

The appreciation of a currency in relation to another; in this case, it costs more to purchase a currency than it did before

Currency Depreciation

The depreciation of a currency in relation to another; in this case, it costs less to purchase a currency than it did before

Exchange Rate Risk (currency risk or foreign exchange risk)

Refers to the potential financial loss that can occur due to fluctuations in exchange rates when dealing with foreign currencies. It is the risk that the value of one currency relative to another may change unfavorably, impacting the value of assets, liabilities, revenues, or expenses denominated in different currencies.

Long Term Asset

Any asset that is not expected to be used by the business for more than a year

Short Term Asset

Any asset that is expected to be used by the business within a year

Tangible Asset

An asset that has a physical substance, as it can be seen or touched. Can be short-term (inventory, supplies) or long-term (land, buildings, equipment, etc).

Fixed Asset

Refers to a long-term, physical asset held by a company or individual for productive use in business operations. These assets are not intended for resale and are expected to provide economic benefits over an extended period.

What do fixed assets typically include?

Buildings, land, machinery, vehicles, and equipment.

Depreciation

Process of allocating the cost of a tangible asset over its useful life or the period that the business believes it will use the asset to help generate revenue.

Depreciation Expense

(Cost of Asset - Salvage Value) / Estimated Useful Life

Cost of Asset

Initial purchase price of the asset.

Salvage Value

Estimated residual value of the asset at the end of its useful life.

Estimated Useful Life

The expected number of years the asset will provide value.

Net Income

The total amount of profit a company earns after deducting all its expenses, including operating costs, taxes, interest, and depreciation, from its total revenue. It represents the company's bottom-line profitability and is a key indicator of its financial performance

Net Loss

The total amount of money a company loses after deducting all its expenses from its total revenue when the expenses exceed the revenue. It indicates that the company incurred more costs than it generated in income, resulting in a negative bottom-line financial result.

Income Statement (Profit and Loss)

Shows the firm’s performance over a specific period of time; helps get a view of sales and expenses.

Expenses

Costs incurred by individuals, businesses, or organizations in the process of generating revenue or conducting their operations.

Revenue

Total sales generated by selling a product or service to a customer

Gains

Income from items that aren’t common to the firm’s day-to-day business operations

Losses

Negatives that do not stem from the firm’s day-to-day operations

Net Income

The bottom line, net income/loss reflects the net impact of all financial transactions for the firm, including those that are caused by events outside the normal course of business.

Total Revenue

Represents all the income a company earns from its various sources, including sales of goods or services, interest income, and other revenue streams.

Total Expenses

Encompass all the costs incurred by the company, including operating expenses, interest expenses, taxes, and any other costs associated with its operations.

EBITDA

Earnings before interest, taxes, depreciation, and amortization

Depreciation

Depreciation is a non-cash expense that reflects the allocation of the cost of tangible assets (like buildings or machinery) over their useful lives. It's added back to EBITDA to account for the fact that it's a non-operating expense.

Amortization

Amortization is also a non-cash expense that represents the gradual allocation of the cost of intangible assets (like patents or trademarks) over their useful lives. It's added back to EBITDA for the same reason as depreciation.