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YMATHBUSFIN MIDTERMS REVIEWER

MODULE 1 LESSON 1: An Overview of Financial Management
- is concerned with decisions about money (Cash Flows)
- finance decisions deal with how money is raised and used
- everything else being equal:
 More value is preferred to less
 The sooner cash is received the more value it has
Finance  Less risky assets are more valuable than riskier assets
- is defined by Webster’s Dictionary as “the system that includes the circulation of money, the
granting of credit, the making of investments, and the provision of banking facilities.”
- it has many facets, which makes it difficult to provide one concise definition.
- is a study which figures out how people, businesses and groups make and use money. It can mean:
Thinking about money. Thinking about how to control money to make profit. ... As a verb, "to
finance" is to provide money for business.)
- finance prepares students for jobs in banking, investments, insurance, corporations, and
government.
Jobs in Finances
- accounting students need to know marketing, management, and human resources; they also need to
understand finance, for it affects decisions in all those areas.
 Financial Markets and Institutions
 Investments
(4) General Areas of Finance
 Financial Services
 Managerial Finance
- financial institutions, which include banks, insurance companies, savings and loans, and credit
unions, are an integral part of the general financial services marketplace.
- the success of these organizations requires an understanding of the factors that cause interest rates
Financial Markets and Institutions
and other returns in the financial markets to rise and fall, regulations that affect such institutions, and
various types of financial instruments, such as mortgages, auto loans, and certificates of deposit, that
financial institutions offer
- this are of finance focuses on the decisions made by businesses and individuals as they choose
securities for their investment portfolios.
Investments - the major functions in the investments are a.) determining the values, risks, and returns associated
with such financial assets as stocks and bonds and b.) determining the optimal mix of securities that
should be held in a portfolio investment
- financial services refer to functions provided by organizations that deal with the management
money.
- persons who work in these organizations, which include banks, insurance companies, brokerage
Financial Services
firms, and similar companies, provide services that help individuals and companies determine how to
invest money to achieve such goals as home purchase, retirement, financial stability, and
sustainability, budgeting, and so forth
- managerial finance deals with decisions that all firms make concerning their cash flows, including
both inflows and out flows.
- as a consequence, managerial finance is important in all types of businesses, whether they are
public or private, and whether they deal with financial services or the manufacture of products.
Managerial (Business) Finance
- financial managers also have the responsibility for deciding the credit terms under which customers
can buy, how much inventory the firm should carry, how much cash to keep on hand, whether to
acquire other firms (merger analysis), how much of each year’s earnings should be paid out as
dividends versus how much should be reinvested in the firm
1. Proprietorship
2. Partnership
3. Corporation
(3) Alternative Forms of Business Organization

PROPRIETORSHIP
 A proprietorship is an unincorporated business owned by one individual. Starting a proprietorship is fairly easy – just begin business operations.
In many cases, however, even the smallest business must be licensed by the political subdivision (city, county or state) in which it operates.
 A sole proprietorship, also known as the sole trader, individual entrepreneurship, or proprietorship, is a type of enterprise that is owned and run
by one person and in which there is no legal distinction between the owner and the business entity.

Advantages Disadvantages
 Ease of formation  Unlimited personal liability
 Subject to few government regulations  Limited life
 No corporate income taxes  Transferring ownership is difficult
 Difficult to raise capital
PARTNERSHIP
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YMATHBUSFIN MIDTERMS REVIEWER
 A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in
a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations.
 Like a proprietorship, except two or more owners
 A partnership has roughly the same advantages and limitations as a proprietorship
CORPORATION
 A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity and recognized as
such in law for certain purposes. Early incorporated entities were established by charter. Most jurisdictions now allow the creation of new
corporations through registration.
 Corporate charter (GIS) – which provides general information, including the name of the corporation, types of activities it will pursue, amount
of stock that initially will be issued, and so forth, must be filed by the corporate secretary in which the firm incorporates.
 Bylaws – a set of rules drawn up the founders of the corporation that indicates now the company is to be governed; includes procedures for
electing directors, rights of stockholders, and how to change the bylaws when necessary.)

Advantages
 Unlimited life
 Easy transfer of ownership
 Limited liability
 Ease of raising capital
 Limited Liability Partnership (LLP)
 Limited Liability Company (LLC)
 S Corporation
Limited Liability Partnership (LLP)
Limited Liability Company (LLC)
S Corporation
Balancing Shareholder Value and the
Interest of Society
Managerial Actions to Maximize
Shareholder Wealth
Should Earnings per Share (EPS) Be
Maximized?
INTRINSIC VALUES, STOCK PRICE, AND EXECUTIVE COMPENSATION
Intrinsic Value
Stock Price
Executive Compensation
Importance Business Trends
Disadvantages
 Cost of set-up and report filing
 Double taxation
(3) Hybrid Forms of Business
- alternative business forms that include some of the advantages, and avoid some of the
disadvantages, of the three major forms of business have evolved over time. A three popular hybrid
business forms that exist today
- in the earlier discussion of a partnership, we described the form of business that is referred to as a
general partnership, wherein each partner is personally liable for any of the debts of the business.
- a partnership wherein at least one partner is designated as a general partner with unlimited personal
financial liability, and the other partners are limited partners whose liability is limited to amounts
they invest in the firm
- a limited liability company is a relatively new business form that has become popular during the
past couple of decades; it combines features of a corporation and partnership.
- offers the limited personal liability associated with corporation; however, the company’s income is
taxed like that of a partnership
- a corporation with no more than 100 stockholders that elects to be taxed in the same way as
proprietorships and partnerships, so that business income is only taxed once.
- if a corporation elects the S corporation status, then its income is taxed the same as income earned
by proprietorships and partnerships – that is, income “passes through” the company to the owners so
that it is taxed only once
- it focuses primarily on publicly owned companies; hence, we operate on the assumption that
management’s primary financial goal is shareholder wealth maximization.
- at the same time, the managers know that this does not mean maximize shareholder value “at all
costs.” Managers have an obligation to behave ethically, and they must follow the laws and other
society-imposed constraints.
- stockholder wealth maximization. The appropriate goal for management decision; considers the risk
and timing associated with expected cash flows to maximize the price of the firm’s common stock.
- will profit maximization also result in stock price maximization? In answering this question, we
introduce the concept of earnings per share (EPS), which equals net income (NI) divided by the
number of outstanding shares of common stock (shares) – that is, EPS = NI/Shares.
- many investors use EPS to gauge the value of a stock.
- a primary reason EPS receives so much attention is the belief that net income, and thus EPS, can be
used as a barometer for measuring the firm’s potential for generating future cash flows
- an estimate of a stock’s “true” value based on accurate risk and return data. The intrinsic value can
be estimated, but not measured precisely.
- The term stock price refers to the current price that a share of stock is trading for on the market.
Every publicly traded company when its shares are.
- is composed of the financial compensation and other non-financial benefits received by an
executive from their firm for their service to the organization. It is typically a mixture of salary,
bonuses, shares of or call options on the company stock, benefits, and perquisites, ideally configured
to take into account government regulations, tax law, the desires of the organization and the
executive, and rewards for performance.
- business trend awareness as a skill refers to one’s ability to be conscious of the changing ways in
which businesses are developing. For example, the vitality of online presence for having a business
that thrives originated from a mere trend of internet usage. As a result, it is now believed that small
businesses having a website tend to have a 40% faster growth that those that don’t have a website.
- the knowledge of all such trends and the understanding of how they will impact one’s business

YMATHBUSFIN MIDTERMS REVIEWER
Why is business trend awareness
important?
Enhanced forecasting ability
Helps in determining the required changes
for improvement
Business Ethics
Stockholders versus Managers
 Managerial compensation
(incentives)
 Shareholder intervention
 Threat of takeover
Goals of the Corporation
1. Capital Structure Decisions
2. Capital Budgeting Decisions
3. Dividend Policy Decisions
Capital Structure Decisions
Capital Budgeting Decisions
Dividend Policy Decisions
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decisions is what eventually brings success to the individual as well as the company he works for.
- if your business is not amongst those that can instigate a trend, the least your business can do is to
follow such trends. For this reason, people running a business must have business trend awareness
skills and be able to reap the following benefits:
 Enhanced forecasting ability.
 Helps in determining the required changes for improvement.
- if you are able to understand the current trends and predict the future ones surrounding your
business, forecasting the future of your business will be a lot easier for you. It will enable you to
make better strategic decisions, capitalize on good business opportunities, and overcome the fierce
competition that your business might face.
- If you know all about the current and future business trends, you can compare with them your
current strategies. Anything that does not match must be improved. This way the business trends
become a reliable guide for determining the required changes in one’s business or strategies.
- Webster: “A standard of conduct and moral behavior.”
- a company’s attitude and conduct toward its employees, customers, community, and stockholders.
- reputations reflect the extent to which firms and people are ethical.
- Ethics is defined in Webster’s Dictionary as “standards of conduct or moral behavior.”
- Business ethics can be thought of as a company’s attitude and conduct toward its employees,
customers, community, and stockholders.
- a firm’s commitment to business ethics can be measured by the tendency of its employees, from the
top down, to adhere to laws, regulations, and moral standards relating to product safety and quality,
fair employment practices, fair marketing and selling practices, the use of confidential information
for personal gain, community involvement, and the use of illegal payments to obtain business.
- managers are naturally inclined to act in their own best interests.
(3) Mechanisms to motivate managers to act in shareholder’s best interest
1. Primary goal: stockholder wealth maximization — translates to maximizing stock price.
2. Managerial incentives
3. Social responsibility
(3) Managerial Actions to Maximize Stockholder Wealth
- the financial manager makes decisions about the expected cash flows of the firm, which include
decisions about how much and what types of debt and equity should be used to finance the firm.
- what type of assets should be purchased to help generate expected cash flows.
- what to do with net cash flows generated by the firm – reinvest them in the firm or pay dividends.

YMATHBUSFIN MIDTERMS REVIEWER
MODULE 2 LESSON 1: FINANCIAL STATEMENTS, CASH FLOW AND TAXES
Financial Statement Analysis
The Annual Report
1. The Balance Sheet
2. The Income Statement
3. Statement of Cash Flows
4. Statement of Retained Earnings
The Balance Sheet
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- involves evaluation of a firm’s financial position to identify its current strength and weaknesses and
to suggest actions that the firm might pursue to take advantage those strength and correct any
weaknesses to accomplish its goal of wealth maximization.
- is the process of reviewing and analyzing a company's financial statements to make better
economic decisions to earn income in future. These statements include the income statement, balance
sheet, statement of cash flows, notes to accounts and a statement of changes in equity.)
• Discussion of Operations
– Usually a letter from the chairman
• Financial Statements
– The Income Statement
– The Balance Sheet
– Statement of Cash Flows
– Statement of Retained Earnings
- a company’s yearly report to shareholders, documenting its activities and finances in the previous
financial report.
(4) Financial Statements
- a statement of the assets, liabilities, and capital of a business or other organization at a particular
point in time, detailing the balance of income and expenditure over the preceding period.
- represents a picture taken on a specific date that shows a firm’s assets and how those assets are
financed (debt or equity)
 Assets - property owned by a person or company, regarded as having value and available to
meet debts, commitments, or legacies.
 Liabilities - a thing for which someone is responsible, especially a debt or financial
obligation.
 Capital or Equity - can refer to funds raised to support a particular business or project.
And can also represent the accumulated wealth of a business, represented by its assets less
liabilities.
 Stockholders’ Equity - is the total amount of capital given to a company by its
shareholders in exchange for stock, plus any donated capital or retained earnings.
- Cash & equivalents versus other assets - all assets stated in dollars - only cash and equivalents
represent money that can be spent
- Accounting alternatives – e.g., FIFO versus LIFO
- Breakdown of the common equity account - common stock at par, paid-in capital & retained
earnings
- Book values often do not equal market values
- The Time Dimension - a snapshot of the firm’s financial position during a specified period of time
Unilate Textiles: Dec. 31 Balance Sheets
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YMATHBUSFIN MIDTERMS REVIEWER
Additional information: 2012 2011
Net working capital = Current assets – Current liabilities $335.0 $295.0
Net worth = Total assets – Total liabilities 415.0 390.0

Breakdown of net plant and equipment account:

Gross plant and equipment $680.0 $600.0
Less: Accumulated depreciation (300.0) 250.0
Net plant and equipment $380.0 $350.0
- is also referred to as the profit and loss statement, P&L, statement of income, and the statement of
operations. The income statement reports the revenues, gains, expenses, losses, net income and other
totals for the period of time shown in the heading of the statement.
- presents the results of business operations during a specified period of time
- summarizes the revenues generated and the expenses incurred
 Revenues
 Gains
 Expenses
 Losses
 Net Income
Unilate $Textiles:
millions,Income Statements
except per-share for Years Ending Dec. 31
data

The Income Statement

- in financial accounting, a cash flow statement, also known as statement of cash flows, is a financial
statement that shows how changes in balance sheet accounts and income affect cash and cash
equivalents, and breaks the analysis down to operating, investing, and financing activities.
- designed to show how the firm’s operations have affected its cash position
- examines investment decisions (uses of cash)
- examines financing decisions (sources of cash)
Unilate Textiles: Cash Sources and Uses, 2012($ million)

Statement of Cash Flows

Unilate Textiles:
Statement
of Cash Flows for the Period Ending December 31, 2012 ($ million)
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- the statement of retained earnings (retained earnings statement) is a financial statement that outlines
the changes in retained earnings for a company over a specified period.
- changes in the common equity accounts between balance sheet dates
Unilate Textiles: Statement of Retained Earnings for the Period Ending December 31, 2012 ($
million)
Statement of Retained Earnings Balance of retained earnings, December 31, 2011 $260.0
Add: 2011 net income 54.0
Less: 2011 dividends paid to stockholders (29.0)
Balance of retained earnings, December 31, 2012 $285.0
WHAT INFORMATION DO INVESTORS USE FROM FINANCIAL STATEMENTS
• Net Working Capital NWC=Current Assets−Current Liabilites
OCF=NOI ( 1−Tax Rate )+ Depreciaiton∧ Amortization Expense
• Operating Cash Flow
OFC=Net Operating Profit after taxes+ Deprn .∧Amortn . Expense
FCF=Operating Cash Flow−Investments
Free Cash Flow
FCF=Operating Cash Flow−( ∆∈¿ assets+ ∆ NOWC)
Economic Value Added EVA=NOI ( 1−Tax Rate )−[ ( Invested Capital ) × ( after tax cost of capital as a % )]

MODULE 3 LESSON 1: Financial Statement (Ratio) Analysis

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YMATHBUSFIN MIDTERMS REVIEWER
- ratios are accounting numbers translated into relative values
Financial Statement (Ratio) Analysis - ratios are designed to show relationships between financial statement accounts within firms and
between firms
1. Gives an idea of how well the company is doing
The Purpose of Ratio Analysis 2. Standardizes numbers; facilitates comparisons (industry)
3. Used to highlight weaknesses and strengths
1. Liquidity
2. Asset Management
3. Debt Management (5) Five Major Categories of Ratios
4. Profitability
5. Market Values
Liquidity - is the firm able to meet its current obligations
Asset Management - is the firm effectively managing its assets
Debt Management - does the firm have the right mix of debt and equity
Profitability - the combined effects of liquidity, asset and debt management
Market Values - relates the firm’s stock price to its earnings and the book value per share
LIQUIDITY RATIOS
- ratios that show the relationship of a firm’s cash and other current assets to its current liabilities;
Liquidity Ratios
they provide an indication of the firm’s ability to meet its current obligation
1. Current ratio
(2) Liquidity Ratios
2. Quick (Acid test) ratio
Unilate’s Current Ratio
Unilate’s Quick (Acid Test) Ratio
Current Assets Current Assets−Inventories
Current Ratio= Quick Ratio=
Current Liabilities Current Liabilities
$ 456.0 $ 456.0−$ 270.0 $ 195.0
¿ =3.6׿ ¿ = =1.5׿
$ 130.0 $ 130.0 $ 130.0
Industry Average=4.1׿ Industry Average=2.1׿
 A current ratio that is lower than the industry average may indicate a
higher risk of distress or deform
 A current ratio in line or slightly higher than the industry average is
 If the quick ratio is lower than industry average, current assets need
to be increased or reduce the current liabilities
generally considered acceptable
Unilate’s Liquidity Position
Liquidity ratios suggest that Unilate’s liquidity position is fairly poor
ASSET MANAGEMENT RATIOS
Asset Management Ratios - a set of ratios that measure how effectively a firm is managing its assets.
1. Inventory Turnover Ratio
2. Days Sales Outstanding (DSO)
(4) Asset Management Ratios
3. Fixed Assets Turnover Ratio
4. Total Assets Turnover Ratio
Unilate’s Days Sales Outstanding Ratio
Unilate’s Inventory Turnover Ratio Receivables Receivables
DSO= =
Cost of Goods Sold Daily Sales Annual Sales
Inventory Turnover= ( )
Inventory 360
$ 1,230.0 $ 180.0 $ 180.0
¿ =4.6׿ ¿ = =43.2 days
$ 260.0 $ 1,500.0 $ 4.167
( )
Industry Average=7.4׿ 360
Industry Average=32.1׿
 Is the rate that the inventory stock is sold, used, or replaced
 A higher ratio points strong sales and a lower ratio indicates to *if annual sales is given, divide by 360 to get days.
low sales  is a measure of the average of days that it makes a company to
collect payment for a sale

Unilate’s Fixed Assets Turnover Ratio Unilate’s Total Assets Turnover Ratio
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Sales Sales
¿ Assets Turnover= Assets ¿ Total Assets Turnover=
Net ¿ Total Assets
$ 1,500.0 $ 1,500.0
¿ =3.9׿ ¿ =1.8׿
$ 380.0 $ 845.0
Industry Average=4.0׿ Industry Average=2.1׿
 Measures how efficient a company is at generating sales from its
 Measures the efficiency of a company’s asset if it is generating
existing fixed assets
revenue or sales
 Higher ratios implies that management uses its fixed assets more
 Compares the amount of sales/revenue to its total sales as an
effectively (a high FAT ratio does not tell a company’s ability to
annualized percentage
generate solid profits or cash flows)
Debt Management Ratios
- ratios that provide an indication of how much debt the firm has and whether the firm can take on
Debt Management Ratios
more debt.
1. Debt Ratio
2. Times-Interest-Earned Ratio (3) Debt Management Ratios
3. Fixed Charge Coverage Ratio
Unilate’s Fixed Charge Coverage Ratio
Unilate’s Times-Interest-Earned EBIT +( Lease Payments)
Unilate’s Debt Ratio FCC=
Ratio Sinking Fund

Debt Ratio=
Total Liabilities
Total Assets TIE=
EBIT
Interest Charges
( )(
Charges Payments )
Interest + Lease +( Payment )
1−Tax Rate
$ 430.0 $ 130.0+ $ 10.0 $ 140.0
¿ =0.509=50.9 % $ 130.0 ¿ = =2.2׿
$ 845.0 ¿ =3.3׿ $ 8.0 $ 63.0
$ 40.0 $ 40.0+ $ 10.0+( )
Industry Average=42 % 1−0.4
Industry Average=6.5׿
 Measures the extent of a company’s
EBIT – earnings before interest taxes
Industry Average=5.8׿
leverage expressed in decimal or  Measures a firm’s ability to cover its fixed charges such
 Is a measure of a company’s
percentage as debt payments, interest expense, and equipment lease
ability to meet its debt
 In general, investors look for expenses
companies with a DR of 0.3-0.6. obligations based on its current
 It shows how a company’s earnings can cover its fixed
income
 0.4 or lower are considered better expenses
 >2.5 is considered acceptable
while 0.6 or higher is more difficult  A good FCC is ≥1.25:1
to borrow money risk
 1:1 is concerning as it means the business is not making
 <2.5 is considered a much enough money to cover its fixed charges or just scrapping
higher risk for bankruptcy by
Profitability Ratios
- a group of ratios showing the effect of liquidity, asset management, debt management on
Profitability Ratios
operating results.
1. Net Profit Margin
2. Return on Total Assets (3) Profitability Ratios
3. Return on Common Equity
Unilate’s Profit Margin Ratio Unilate’s Return on Total Assets Unilate’s Return on Common Equity
Net Profit
Profit Margin= Net Income Net Income
Sales ROA= ROE=
$ 54.0 Total Assets Common Equity
¿ =0.036=3.6 % $ 54.0 $ 54.0
$ 1,500 ¿ =0.064=6.4 % ¿ −0=0.130=13.0 %
Industry Average=4.9 % $ 845.0 $ 415.0
 Measures how net income is generated as a Industry Average=10.3 % Industry Average=17.7 %
percentage of revenues received  Indicates how well a company’s  A company with higher return is more
 Helps investor assess if the company’s investments generate value making it an successful to generate cash internally
management is generating enough profit important measure of productivity in a  The better benchmark is to compare the
from its sales and whether operating costs certain company company’s ROCE with its industry
and overhead costs are being contained  Lower % return on assets indicates that average
 Includes all the factors that influence the company is not making enough  The higher the ratio than the industry
profitability whether under the income from the use of its assets average, the better the company is
managements control or not  Machinery may be increasing production
 Higher the ratio, the more effective a efficiency or lowering overall production
company is at in cost control costs enough to positively impact the
 Compared to the industry average, it tells the company’s profit margin
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YMATHBUSFIN MIDTERMS REVIEWER
investor how well management and
operations of a company are performing
against the competitors
Market Value Ratios
1. Price/Earnings Ratio
(2) Market Value Ratios
2. Market/Book Ratio
Unilate’s Market/Book Ratio
Unilate’s Price/Earnings Ratio
Market price per share
Price per share Market /Book Ratio=
Price/ Earnings Ratio= Book value per share
Earnings per share $ 23.0
$ 23.0 ¿ =1.4׿
¿ =10.6׿ $ 16.0
$ 2.16 Industry Average=2.5׿
Industry Average=15.0׿
One of the most widely used F. ratios as it compares the company’s
 A higher P/ER shows that the investors are willing to pay a higher market price to its book value
share price today because of growth expectation in the future  Essentially showing the value given by the market for each
 Average P/ER has historically ranged from 13 to 15. company’s net worth
 Stake note for example a company with a current P/ER of 25 means  High growth companies will often show price to book ratio above
that above average it trades an average of 25 times it earnings. 1.0 whereas companies facing severe failure or distress will show
ratios below 1.0
Summary of Ratio Analysis: The DuPont Analysis
ROA=Net Profit Margin × Total Assets Turnover
Net Income Sales
¿ ×
Sales Total Assets
$ 54.0 $ 1,500.0
¿ ×
$ 1,500 $ 845.0
¿ 3.6 % × 1.8=6.4 %
ROE=ROA × Equity Multiplier
Net Income Total Assets
¿ ×
Total Assets Common Equity
$ 845.0
¿ 6.4 % ×
$ 415.0
¿ 6.4 % ×2.036=13.0 %
 Firm’s profitability (measured by ROA)
 Firm’s expense control (measured by
profit margin) (3) DuPont Equation Provides Overview:
 Firm’s asset utilization (measured by
total asset turnover)
Potential Problems and Limitations of Financial Ratio Analysis
 Comparison with industry averages is difficult if the firm operates many different divisions
 Inflation distorts balance sheets
 Seasonal factors can distort ratios
 “Window dressing” can make ratios look better.
 Different operating and accounting practices distort comparisons
 Sometimes hard to tell if a ratio is “good” or “bad”
 Difficult to tell whether company is, on balance, in strong or weak position