Finance Flashcards
Finance
Finance, or corporate finance, is the business function of obtaining funds for a company and managing them to accomplish the company’s objectives
Financial management
The job of acquiring and managing funds is called financial management.
Questions asked in corporate finance
Does the company have enough money?
- For its day to day operations?
• To cover payroll?
• To pay our suppliers?
• To cover maintenance?
- For new projects?
• To purchase short term assets (computers)?
• To purchase long term assets (machinery or buildings)?
• To invest in new products/markets (R&D, promotion)?
Use of financial assets
How does the company use the money it holds?
• Leave it in a bank account?
• Invest in all sorts of stuff?
• Invest in new products (R&D, design, tests)?
• Invest in new markets? (trade shows…)?
• Purchase better equipment (modernise, expand)?
• Return some to the owners (dividends)?
• All or some of the above?
Efficient use of financial assets
- How does management decide?
• By chance?
• Past information? (financial statements & management reports)
• Future projections & estimates (what ifs)?
• Financial analysis? (ratios & comparative tools) - How do the shareholders determine goals?
Financial plan and its three parts
• A financial plan is a firm’s strategy for reaching its financial goals.
It has three parts:
1. forecasting
2. budgeting
3. financial controls
Planning tools : forecasting
Forecasting is predicting revenues, costs, and expenses for a certain period of time.
Planning tools : budget
A budget is defined as a detailed financial plan showing estimated revenues and expenses for a particular future period, usually on year.
4 types of budget and their definition
- Operating Budgets: For Predicting Sales and Production Goals and the Costs Required to Meet Them.
- Capital Budgets: For Predicting Purchase of Long-Term Assets.
- Cash Budgets: For Predicting Cash Shortages or Surpluses During the Year.
- Master Budgets: For Pulling Together the Other Budgets into an Overall Plan of Action.
Planning tools : financial control
Financial Control is the process in which a company from time to time compares its actual revenues and expenses with those predicted in its budget.
Borrowing (4 reasons for borrowing)
• There are four reasons why companies, large and small, often wish to obtain financing.
• They need funds for:
1. managing everyday business activities
2. extending credit to their customers
3. keeping enough product (inventory) available
4. making major investments.
Debt versus equity financing (questions asked)
Financial decisions
- Does the company borrow money?
• From a bank?
> At what terms & conditions?
• Otherwise?
> Bonds & complicated stuff?
- Do the shareholders sell a part of the company?
• What are our shares worth? Now and in the future?
• Existing shareholders will own less of the company
> They may even lose control
Capital structure
how a firm finances its overall operations and growth using debt and equity financing
Debt financing
creditors (banks, other)
Equity financing
Owners/shareholders
Sources of debt financing
• Long-term loans
• Issuing notes or bonds (promise to pay with interest)
Bonds will be covered in the Market Securities section.
Sources of equity financing
• Equity financing involves direct contributions by owners and future shareholders
• Corporations can fund investments by:
• Gaining equity capital by issuing stock to owners and/or future shareholders
• Using retained earnings accumulated during past years or the current year (net income)
Five characteristics of money
• Portability: “I Can Carry It in My Pocket”
• Divisibility: “I Can Easily Break Big Bills Down into Smaller Ones”
• Durability: “The Material Won’t Deteriorate Quickly”
• Uniqueness: “This Can’t Be Easily Copied or Counterfeited”
• Stability: “This Has the Same Value to Everyone”
Currency
Currency: government-issued coins and paper money
Money supply
Money supply: the amount of money Central Banks make available for people to buy goods and services.
The three functions of money
Medium of exchange: it makes economic transactions easier and eliminates the need to barter
Store of wealth: people can save it until they need to make new purchases
Standard of value: or unit of account, meaning that it can be used as a common standard to measure the values of goods and services
4 types of financial ratios
Four common types of financial ratios are :
1. liquidity ratios;
> to determine how well a firm can pay its liabilities as they come due
- activity ratios
> to see how well the firm manages its assets to generate revenue - debt to owners’ equity ratios
> to determine how much the firm relies on borrowing to finance its operations - profitability ratios
> to see how good the firm’s profits are in relation to its sales, assets, or owners’ equity.
Liquidity ratio information
Liquidity ratios measure a firm’s ability to meet its short term obligations when they become due
Two important liquidity ratios are:
- the current ratio : current assets/current liabilities
- the acid-test (or quick) ratio : the current ratio where inventory is not included in current assets
Most companies aim to have a current ratio above 1 and often up to 2 or higher, depending on the industry
Banks favour companies with a higher current ratio
Activity ratios information
Activity ratios: also called efficiency ratios, this group of ratios measures the efficiency of the company
- inventory turnover : COGS/average inventory
- accounts receivable turnover : net credit sales/average accounts receivable
- accounts payable turnover : total purchases/average accounts payable
These ratios are used by management to help improve the company as well as outside investors and creditors looking at the operations of profitability of the company
