BFIN 330 - Midterm Review

Goal of Financial Management

Maximize the current value per share of the existing stock, maximize shareholder wealth

What is capital budgeting?

The process of planning long-term investments, including mergers and equipment purchases.

What does capital structure refer to?

The mix of debt and equity used to finance a firm's asset base.

What is working capital management?

The management of short-term assets and liabilities to ensure a company can continue its operations.

What are short-term assets?

Assets that are expected to be converted into cash within one year, such as accounts receivable.

What is the primary goal of corporate finance?

To maximize the value of the business and its shares.

What are the key questions corporate finance seeks to answer?

What long-term investments to undertake, what lines of business to pursue, and how to manage daily financial activities.

What is the role of a CEO?

The highest-ranking executive responsible for setting overall strategy and managing operations.

What responsibilities does a CFO have?

Making decisions regarding the company's finances and projects.

What does a treasurer do?

Handles cost accounting, taxes, cash management, and financial planning.

What is a sole proprietorship?

A business owned and run by one person, with unlimited liability for debts and legal issues.

What is a partnership?

A business owned by two or more individuals who share responsibilities and profits.

What is a partnership agreement?

A legally binding document that outlines the rules and responsibilities of partners.

What distinguishes a general partner from a limited partner?

General partners manage the business and have personal liability, while limited partners invest without personal liability.

What is a corporation?

A legal entity separate from its owners, providing personal liability protection and requiring formal incorporation.

What are the advantages of a corporation?

Personal liability protection, easier access to capital, and transferable ownership.

What is double taxation in corporations?

Corporations pay taxes on earnings, and shareholders pay taxes on dividends received.

What is a proxy fight?

A situation where a disillusioned shareholder gives authority to another to vote on their behalf, often to influence management decisions.

What is an LLC?

A limited liability company that combines the benefits of a partnership and a corporation, protecting owners from personal liability.

What is the primary market?

The market for the first trade of a stock, known as an initial public offering (IPO).

What is the secondary market?

A market where existing shares of stock are traded between owners or creditors.

What is an auction market?

A market with a physical location where buyers and sellers meet to trade securities, such as the NY Stock Exchange.

What is a dealer market?

A market where dealers buy and sell securities for their own accounts, often referred to as over-the-counter (OTC) markets.

What is the role of a broker?

An agent who buys or sells securities on behalf of clients, matching buyers and sellers.

What are the two main concerns of a financial manager regarding capital structure?

1. How much should the firm borrow? 2. What are the least expensive sources of funds?

What is the Sarbanes-Oxley Act?

A law enacted by Congress requiring publicly listed companies to assess their financial reporting and hire independent auditors.

What is the agency problem?

A conflict of interest that arises when managers act on behalf of shareholders but may not prioritize their interests.

Who are stakeholders?

Individuals or groups, other than stockholders or creditors, who have a potential claim on a firm's cash flows.

What are the three main financial statements?

Balance Sheet, Income Statement, and Cash Flow Statement.

What is the formula for calculating net income?

Revenue - Expenses = Income.

What distinguishes current assets from fixed assets?

Current assets are short-term (less than 1 year), while fixed assets are long-term.

What is goodwill in financial terms?

The excess purchase price over the stated equity value of a company.

What is liquidity?

The ease with which an asset can be converted into cash.

What is the difference between market value and book value?

Market value reflects the asset's current worth based on risk and cash flows, while book value is the total assets minus total liabilities.

What does the cash flow statement indicate?

It shows the money coming in and going out of a business.

What is free cash flow?

The cash that a business redistributes to creditors and shareholders because it's not needed for working capital.

What is a common-size statement?

A financial statement that expresses each line item as a percentage of a base figure, making it easier to compare companies.

What do liquidity ratios measure?

A company's ability to pay its short-term obligations.

What is the DuPont identity?

A formula that breaks down return on equity (ROE) into three components: profit margin, asset use efficiency, and financial leverage. ROE can be improved with leverage, but interest expense reduces profit margins.

What is the matching principle in accounting?

Revenues are recorded when earned, not when cash is received, matching costs with associated revenues.

What are tangible vs. intangible assets?

Tangible assets can be physically touched (e.g., equipment), while intangible assets have intrinsic value (e.g., patents).

What is working capital?

The difference between short-term assets and short-term liabilities.

What is leverage in financial terms?

The use of debt in a company's financial structure to amplify earnings.

What are profitability ratios intended to measure?

How efficiently a business uses cash and manages its operations.

What is the significance of the income statement's bottom line?

It represents the net income of the company.

What are the challenges associated with financial statements?

Accounting inconsistencies, human error, and the lack of a magic formula to identify key quantities.

What does the cash coverage ratio indicate?

It provides a better look at cash flow by adding back non-cash expenses.

What is the purpose of ratio analysis?

To determine relationships, compare performance, and examine financial health.

What do liquidity ratios measure?

Intended to give information on firm liquidity and to measure the company’s ability to pay.

What are the key liquidity ratios?

Current, Quick, Cash and Net Working Capital/Assets

What are financial leverage ratios?

Intended to address a company’s ability to meet its financial obligations

What are the key financial leverage ratios?

Total debt, long-term debt, times interest earned and cash coverage ratio.

What are turnover ratios?

They’re intended to describe how efficiently a company uses its assets to generate sales

What are the key turnover ratios?

Inventory turnover, inventory days, receivables turnover, receivable days, fixed asset turnover and asset turnover

What are profitability ratios?

Intended to measure how efficiently a business uses cash and manages operations

What are the key profitability ratios?

Profit margin, Return on Asset and Return on Equity 

What are market-based ratios?

They’re intended to measure how much an investor is willing to pay for something

What are the key market-based ratios?

P/E, Price/Sales, P/BV, Enterprise Value and EBITDA Ratio

What are problems with analyzing financial statements?

Conglomerates, establishing benchmarks, peer groups, accounting inconsistency, different FYES, and one-time events.