uNit 3

Generally Accepted Accounting Principles (GAAP)

A set of accounting standards that is used in the preparation of financial statements.

Financial Accounting

The branch of accounting that prepares financial statements for use by owners, creditors, suppliers, and other external stakeholders.

Accounting

A system for recognizing, organizing, analyzing, and reporting information about the financial transactions that affect an organization.

Financial Accounting Standards Board (FASB)

The private board that establishes the generally accepted accounting principles used in the practice of financial accounting.

Accounting Equation

Assets = Liabilities + Owners’ Equity.

Owners’ (or Stockholders’) Equity

The claims a firm’s owners have against their company’s assets.

Balance Sheet

A financial statement that reports the financial position of a firm by identifying and reporting the value of the firm’s assets, liabilities, and owners’ equity.

Liabilities

Claims that outsiders have against a firm’s assets.

Assets

Resources owned by a firm.

Income Statement

The financial statement that reports the revenues, expenses, and net income that resulted from a firm’s operations over an accounting period.

Accrual-Basis Accounting

The method of accounting that recognizes revenue when it is earned and matches expenses to the revenues they helped produce.

Expenses

Resources that are used up as the result of business operations.

Revenue

Increases in a firm’s assets that result from the sale of goods, provision of services, or other activities intended to earn income.

Net Income

The difference between the revenue a firm earns and the expenses it incurs in a given time period.

Statement of Cash Flows

The financial statement that identifies a firm’s sources and uses of cash in a given accounting period.

Horizontal Analysis

Analysis of financial statements that compares account values reported on these statements over two or more years to identify changes and trends.

Budgeting

A management tool that explicitly shows how a firm will acquire and use the resources needed to achieve its goals over a specific time period.

Operating Budgets

Budgets that communicate an organization’s sales and production goals and the resources needed to achieve these goals.

Financial Budgets

Budgets that focus on the firm’s financial goals and identify the resources needed to achieve these goals.

Master Budget

A presentation of an organization’s operational and financial budgets that represents the firm’s overall plan of action for a specified time period.

Managerial (or Management) Accounting

The branch of accounting that provides reports and analysis to managers to help them make informed business decisions.

Fixed Costs

Costs that remain the same when the level of production changes within some relevant range.

Implicit Costs

The opportunity cost that arises when a firm uses owner-supplied resources.

Cost

The value of what is given up in exchange for something.

Out-of-Pocket Costs

A cost that involves the payment of money or other resources.

Variable Costs

Costs that vary directly with the level of production.

Direct Costs

Costs that are incurred directly as the result of some specific cost object.

Indirect Costs

Costs that are the result of a firm’s general operations and are not directly tied to any specific cost object.

Activity-Based Costing (ABC)

A technique to assign product costs based on links between activities that drive costs and the production of specific products.

Owners’ Equity

The claims a firm’s owners have against their company’s assets.

Direct Cost

Costs that are incurred directly as the result of some specific cost object.

Implicit Cost

The opportunity cost that arises when a firm uses owner-supplied resources.

Out-of-Pocket Cost

A cost that involves the payment of money or other resources.

Financial Capital

The funds a firm uses to acquire its assets and finance its operations.

Risk

The degree of uncertainty regarding the outcome of a decision.

Finance

The functional area of business that is concerned with finding the best sources and uses of financial capital.

Financial Ratio Analysis

Computing ratios that compare values of key accounts listed on a firm’s financial statements.

Risk-Return Trade-Off

The observation that financial opportunities that offer high rates of return are generally riskier than opportunities that offer lower rates of return.

Liquid Asset

An asset that can quickly be converted into cash with little risk of loss.

Liquidity Ratios

Financial ratios that measure the ability of a firm to obtain the cash it needs to pay its short-term debt obligations as they come due.

Financial Leverage

The use of debt in a firm’s capital structure.

Leverage Ratios

Ratios that measure the extent to which a firm relies on debt financing in its capital structure.

Asset Management Ratios

Financial ratios that measure how effectively a firm is using its assets to generate revenues or cash.

Profitability Ratios

Ratios that measure the rate of return a firm is earning on various measures of investment.

Budgeted Income Statement

A projection showing how a firm’s budgeted sales and costs will affect expected net income.

Budgeted Balance Sheet

A projected financial statement that forecasts the types and amounts of assets a firm will need to implement its future plans and how the firm will finance those assets.

Trade Credit

Spontaneous financing granted by sellers when they deliver goods and services to customers without requiring immediate payment.

Cash Budget

A detailed forecast of future cash flows that helps financial managers identify when their firm is likely to experience temporary shortages or surpluses of cash.

Spontaneous Financing

Financing that arises during the natural course of business without the need for special arrangements.

Factor

A company that provides short-term financing to firms by purchasing their accounts receivables at a discount.

Revolving Credit Agreement

A guaranteed line of credit in which a bank makes a binding commitment to provide a business with funds up to a specified credit limit at any time during the term of the agreement.

Commercial Paper

Short-term (and usually unsecured) promissory notes issued by large corporations.

Retained Earnings

The part of a firm’s net income it reinvests.

Line of Credit

A financial arrangement between a firm and a bank in which the bank preapproves credit up to a specified limit, provided that the firm maintains an acceptable credit rating.

Covenant

A restriction lenders impose on borrowers as a condition of providing long-term debt financing.

Equity

Funds provided by the owners of a company.

Capital Structure

The mix of equity and debt financing a firm uses to meet its permanent financing needs.

Cash Equivalents

Safe and highly liquid assets that many firms list with their cash holdings on their balance sheet.

Dodd-Frank Act

A law enacted in the aftermath of the financial crisis of 2008–2009 that strengthened government oversight of financial markets.

Debt Financing

Funds provided by lenders (creditors).

U.S. Treasury Bills (T-bills)

Short-term marketable IOUs issued by the U.S. federal government.

Capital Budgeting

The process a firm uses to evaluate long-term investment proposals.

Money Market Mutual Funds

A mutual fund that pools funds from many investors and uses these funds to purchase very safe, highly liquid securities.

Time Value of Money

The principle that a dollar received today is worth more than a dollar received in the future.

Certificate of Deposit (CD)

An interest-earning deposit that requires the funds to remain deposited for a fixed term.

Present Value

The amount of money that, if invested today at a given rate of interest, would grow to become some future amount.

Equity Financing

Funds provided by the owners of a company.

Net Present Value (NPV)

The sum of the present values of expected future cash flows from an investment, minus the cost of that investment.

Financial Markets

Markets that transfer funds from savers to borrowers.

Depository Institutions

A financial intermediary that obtains funds by accepting checking and savings deposits and then lending those funds to borrowers.

Credit Unions

A depository institution that is organized as a cooperative, meaning that it is owned by its depositors.

Savings and Loan Associations

A depository institution that has traditionally obtained most of its funds by accepting savings deposits, primarily for making mortgage loans.

Securities Brokers

A financial intermediary who acts as an agent for investors who want to buy and sell financial securities.

Investment Banks

A financial intermediary that specializes in helping firms raise financial capital by issuing securities.

Securities Dealers

A financial intermediary who participates directly in securities markets by buying and selling stocks and other securities.

Securities Exchange Act of 1934

A federal law that established the Securities and Exchange Commission to regulate and oversee the securities industry.

Securities Act of 1933

The first major federal law regulating the securities industry, requiring firms issuing new stock to file registration statements.

Banking Act of 1933

The law that established the FDIC to insure bank deposits and prohibited commercial banks from selling insurance.

Federal Reserve Act of 1913

The law that established the Federal Reserve System as the central bank of the United States.

Securities and Exchange Commission (SEC)

The federal agency with primary responsibility for regulating the securities industry.

Common Stock

The basic form of ownership in a corporation.

Preferred Stock

A type of stock that gives its holder preference over common stockholders in terms of dividends.

Capital Gain

The return on an asset resulting when its market price rises above the price the investor paid for it.

Financial Services Modernization Act of 1999

An act that overturned parts of the Banking Act of 1933, allowing commercial banks to sell insurance.

Bond

A formal debt instrument issued by a corporation or government.

Coupon Rate

The interest paid on a bond, expressed as a percentage of the bond’s par value.

Maturity Date

The date when a bond will come due.

Par Value

The value of a bond at maturity, promised to be paid to the bondholder.

Current Yield

The amount of interest earned on a bond, expressed as a percentage of the bond’s current market price.

Convertible Securities

Bonds or shares of preferred stock that can be exchanged for common stock.

Financial Diversification

Investing in a wide variety of securities to reduce risk.

Mutual Funds

An institutional investor that raises funds by selling shares and uses them to buy a portfolio of securities.

Exchange-Traded Fund (ETF)

Shares traded that represent ownership over part of a basket of individual stocks.

Net Asset Value Per Share

The value of a mutual fund’s holdings minus liabilities, divided by outstanding shares.

Primary Securities Market

The market where newly issued securities are traded.

Secondary Securities Market

The market where previously issued securities are traded.

Public Offering

A primary market issue offered to any willing investors.

Underwrites

An investment banker agrees to purchase all shares of a public offering at an agreed price.

Initial Public Offering (IPO)

The first time a company issues stock that can be bought by the public.

Private Placement

A primary market issue negotiated between the issuing corporation and a small group of accredited investors.