Module 3: Finance & Accounting (Lecture Slides 1-4) Flashcards
1
Q
This module is about helping you develop…
A
financial literacy. “Financial” pertains to finance and economics. “Literacy” is the ability to read and write.
2
Q
Why do you want financial literacy? (2 answers, with 2 subanswers each)
A
- Make decisions on your own finances that try to maximize opportunities (such as a sensible attitude to investments and a suitable use of debt)
- Participate in conversations (understand business and government activities in the media, advise and share knowledge with friends and family)
3
Q
How does the National Financial Educators Council define a financial literate person?
A
A person that “possess[es] the skills and knowledge on financial matters to confidently take effective action that best fulfills an individual’s personal, family, and global community goals.”
4
Q
What is Economic (GDP) Growth?
A
The rate at which a nation’s GDP (market value of all goods and services produced in a country in a particular time period) changes/grows from one year to another.
5
Q
What is inflation?
A
A general increase in prices and fall in the purchasing value of money.
6
Q
What are unemployment rates? What kind of rate does an economy experience in recessions?
A
Measure of the prevalence of unemployment and it is calculated as a percentage by dividing the number of unemployed individuals by all individuals currently in the labor force. During periods of recession, an economy experiences a relatively high unemployment rate.
7
Q
What are bond rates?
A
Tells the purchaser of the bond how much interest they will be paid in return for investing the bond being issued.
8
Q
What are equity markets?
A
Also known as the stock market, an equity market is a market in which shares are issued and traded, either through exchanges or over-the-counter markets.
9
Q
Equity market averages are important but…
A
should not be overemphasized, because current averages are close to all-time highs. ???
10
Q
Get curious about what ___ and ___ are doing in the economy.
A
government, business
11
Q
Costs are made up of ___ and ___ costs.
A
variable, fixed
12
Q
What is the difference between a variable cost and a fixed cost?
A
Variable costs go as you sell more, but fixed costs are the same no matter how much you sell.
13
Q
What are examples of variable costs?
A
Ingredients, supplies, product, hourly labor, commissions
14
Q
What are examples of fixed costs?
A
Rent, fixed salaries
15
Q
How do you calculate profit?
A
Profit = Sales - Costs
16
Q
How do you calculate costs?
A
Costs = Fixed Costs + Variable Costs
17
Q
Suppose we have a product that sells for $p and costs $v variable costs each unit. We have total fixed costs of $F and we sell n units. Using these variables, what is the formula for Profit?
A
Profit = np - nv - F
18
Q
What is the contribution margin?
A
Contribution Margin = Price - Variable Costs
19
Q
Consider Pippa’s Lemonade Stand. Glasses and table rental is $2 per day (to Mommy) and the cost of lemon and sugar is $0.40. Pippa is selling each glass of lemonade for $0.60.
How many glasses would Pippa need to sell to break-even? (Hint: Find the contribution margin first.)
A
Pippa’s contribution margin is $0.20 per unit. She needs to cover the $2 glasses and table rental. She has to sell 10 glasses to break even.
20
Q
Consider Pippa’s Lemonade Stand. Glasses and table rental is $2 per day (to Mommy) and the cost of lemon and sugar is $0.65. Pippa is selling each glass of lemonade for $0.60.
How many glasses would Pippa need to sell to break-even?
A
Pippa will never break even; with every glass she sells, she is losing $0.05.
21
Q
Tell me about the Study.net reading “Delivery Start-Ups are Back Like It’s 1999.”
A
- Tech crash in the early 2000s: on-demand delivery services failed. Web-enabled delivery was not a good business because it cost too much to build warehouses, manage and inventory, and pay drivers.
- There is a resurgence of these services, pitches for an “Uber for x,” like Caviar and DoorDash.
- The biggest change: Companies improve same-day delivery with software and have distanced themselves from physical supply chains. Now, they’re middle men, connecting customers with couriers.
- Challenge: Small ticket orders to far-away houses. The solution, investors and entrepreneurs claim, is in algorithms that minimize the amount of time it takes couriers to pick up orders and maximize the number of deliveries they can make.
- The Network Effect: This market crashed in the early 2000s when not even half of American households had Internet connection. Now, 98% of Americans have access to Internet.
- Instacart vs. Webvan: Webvan had several distribution centers, whereas Instacart has 70 employees in a small office in SF, all engineers and administrators who never touch the food – they contract with “personal shoppers!”
- Delivery start-ups are trying to bridge the digital and physical worlds - the most complicated part is getting the product to the customers.
- Boils down to one question: How much are people willing to pay to be lazy?
22
Q
Think about Instacart (Study.net reading). What are the costs, and what is the estimated contribution margin per order?
A
They charge a $4 delivery charge, pay shoppers $20 an hour, and the shoppers deliver it to you. The estimated contribution margin per order is between -$6 and -$16 (depending on the speed of picking).
23
Q
What is Instacart’s secret?
A
Instacart has now applied a 20-30% mark-up. Instacart gets 1/4 of the order price plus a $4 delivery fee. They pay the picker $10.
For an order of $40, Instacart’s contribution margin is $4.
24
Q
The ease of setting up ___ has contributed to US prosperity.
A
businesses
25
The US economy has exhibited __-__% annual growth rate over the last few decades. Is this good for a developed country?
2-4%, Yes
26
The United States accounts for about __% of world economic activity (IMF) while having less than __% of the world's population. The U.S. has __% more GDP than its closest competitor.
24, 5, 60
27
What is a planned economy?
Relies on a centralized government to control all or most factors of production and to make all or most production and allocation decisions
28
What is a market economy?
Individual producers and consumers control production and allocation by balancing supply and demand mediated by price
29
What type of economy do most countries follow?
Mixed Market Economy - a mix of planned and market economies
30
What is demand?
The willingness and ability of buyers to purchase a product (a good or a service)
31
What is supply?
The willingness and ability of producers to offer a good or service for sale
32
The demand curve shows that when price decreases and the quantity demanded...
increases. At the lower price, more people "demand" the product.
33
The supply curve shows that when price increases, the quantity supplied...
increases. Only when price goes up will pizza makers be willing and able to increase supply.
34
What is the market price?
The equilibrium price. This is the point at which the price that suppliers can charge is the same as the price that a maximum number of customers is willing to pay.
The equilibrium point is the point at which profits can be maximized.
35
Describe a Perfect Competition setting.
Example: Local farmer
Number of competitors: Many
Ease of Entry into industry: Relatively easy
Similarity of goods or services offered by competing firms: Identical
Level of control over price by individual firms: None
36
Describe a Monopolistic Competition setting.
Example: Stationary Store
Number of competitors: Many, but fewer than in perfect competition
Ease of Entry into industry: Fairly easy
Similarity of goods or services offered by competing firms: Similar
Level of control over price by individual firms: Some
37
Describe an Oligopoly.
Example: Steel industry
Number of competitors: Few
Ease of Entry into industry: Difficult
Similarity of goods or services offered by competing firms: Can be similar or different
Level of control over price by individual firms: Some
38
Describe a Monopoly.
Example: Public utility
Number of competitors: None
Ease of Entry into industry: Regulated by government
Similarity of goods or services offered by competing firms: No directly competing goods or services
Level of control over price by individual firms: Considerable
39
What is GDP?
A key economic indicator, GDP is the total value of all goods and services produced within a given period by a national economy through domestic factors of production. A measure of aggregate output.
40
What are factors of production? (definition + 5 categories)
The resources that a country's businesses use to produce goods and services. This includes land and physical resources, labor, entrepreneurship, capital and machinery, information resources
41
What does GNP include?
GNP includes domestic and international factors of production owned by US entities.
42
What does GDP per capita mean?
"GDP per person." This is a better measure of economic well-being of the average person.
43
What does the current difference between GDP and GDP per capita mean?
This reflects the increase in the rate of population growth, particularly from 1947 to 1966.
44
What is the balance of trade?
The economic value of all the products that a country exports minus the economic value of its imported products. Positive or negative balance.
45
What is the national debt?
The amount of money the government owes its creditors
46
Inflation occurs when the price of goods in an economy...
increases.
47
How is inflation measured?
By calculating the price of a "basket" of goods and comparing with a year ago
48
The U.S. has inflation of total ___% since 1983, an average annual rate of __%.
153, 2.7
49
What are the levers by which government tries to manage the economy? (2)
- Fiscal Policies
| - Monetary Policies
50
What are fiscal policies?
Policies used by a government regarding how it collects and spends revenue
51
What are monetary policies?
Policies used by a government to control the size of its money supply (i.e. Government can directly or indirectly control the number of dollars in circulation)
52
What is the current economic (GDP) growth?
2.5% 4Q (www.bea.gov)
53
What is the current inflation rate?
2.2% / 1.8% excluding food/energy (data.bls.gov)
54
What is the current unemployment rate?
4.1% (data.bls.gov)
55
What is the current bond rate? Is this low or high?
2.84% (10 year) -- quite low (markets.wsj.com/us)
56
Where can you find equity market averages?
DOW30 - most discussed
S&P500 - most broad-based
NASDAQ - emphasizing tech
57
Equity prices are a function of... (2 things)
- Expected future earnings and cash flows
| - Traders' perception of risks in the market
58
You can "look under the hood" of individual companies using your knowledge of... (3 things)
- Accounting
- Finance
- Financial Statement Analysis
59
Don't forget the debt markets! What's so special about them?
- They're huge.
- They have an outsize effect on some industries (like real estate).
- They help you buy stuff like houses and cars.
60
What are the five economic indicators?
GDP growth, inflation rates, unemployment rates, bond rates, equity market averages
61
Companies finance their assets by issuing stockholders' ___ and ___.
equity, debt
62
Stockholders' equity (SE) is the issuance of ___ ___.
common stock
63
There must be at least __ share of stock issued by a company.
one
64
Stockholders are the ___ of the company.
owners
65
Debt is ___ by the company.
borrowing
66
All assets must be financed by either stockholders' ___ or ___.
equity, liabilities (debt)
67
What is the accounting equation?
Assets = Liabilities + Stockholders' Equity
or A = L + SE
68
Assets are economic resources that can be useful to the company. What are examples of assets?
Buildings, equipment, inventory to sell to customers, cash to fund future growth and expansion
69
What is financial seniority?
The order in which claims on the company's assets are paid if the company is liquidated.
70
What are claims comprised of?
Liabilities and stockholders' equity (assets)
71
What is liquidation?
The sale of all assets for cash and the payment of the cash to the investors who hold claims
72
What is the basic rule of financial seniority?
Liabilities (debt) are paid first.
73
In the event there is any cash remaining after debt is paid, that residual amount is paid to...
stockholders.
74
Customarily, liquidation only takes place when a company is in...
bad shape. Usually there is little left for stockholders, and sometimes, debt holders do not get paid in full!
75
What's good about being residual?
This means that things are going well and the company is worth A LOT.
76
Why is equity attractive as a long-term investment?
Debt is a fixed claim: when debt is repaid, companies pay back the amount borrowed. Equity is the remaining value.
77
What are the main differences between debt and equity? (4)
- Debt has high seniority, equity has no seniority.
- Debt has a legal right to be repaid and to get interest before that, but equity has no legal right to be repaid - just gets receives the "residual."
- A lender sees debt has a low risk, low reward venture. A stock investor sees equity as a high risk, high reward venture.
- With debt, the company has a risk of going bankrupt if they can't pay back the interest, there's a low cost of capital, and there's no voting power for bank (???). From the company's point of view, equity can never cause bankruptcy, you only have to pay dividends if you can, there is a high cost of capital, you can "lose" voting power (???).
78
What is a secured loan?
An asset-backed loan. Loan to finance an asset, backed by the borrower pledging the asset as collateral to the lender.
79
What is collateral?
Asset pledged for the fulfillment of repaying a loan.
80
What are examples of collateral?
Land, property (fixed assets), accounts receivable (financial asset), royalties from David Bowie's music (intangible asset)
81
What is an unsecured loan?
Loan for which collateral is not required.
82
What is a loan principal?
Amount of money that is loaned and must be repaid.
83
What is interest?
Periodic payments that must be made on a loan or bond.
84
What is a corporate bond?
Formal pledge obligating the issuer (the company) to pay interest periodically (usually every 6 months) and repay the principal at maturity
85
What is a bond indenture (bond contract)?
Legal document containing complete details of a bond issue.
86
What is the maturity date (due date)?
Future date when repayment of a bond principal is due from the bond issuer (borrower)
87
What is the face value (par value)?
Amount of money that the bond buyer (lender) will receive on the maturity date
88
What is the default?
Failure of a borrower to make payment (of interest or principal) when due to a lender
89
What is a bondholders' claim?
Request for court enforcement of a bond's terms of payment
90
What are angel investors? How much do they invest in comparison to venture capitalists?
Outside investors who provide new capital for firms in return for a share of equity ownership. In general, "angels" tend to invest smaller sums than venture capitalists.
91
What is venture capital?
Private funds from wealthy individuals seeking investment opportunities in new growth companies. May be managed by professional investors as a VC fund.
92
What is an initial public offering (IPO)?
First sale of a company's stock to the general public
93
Stock is valued based on...
future earnings expectations. If profit margins or growth in profits is expected to be high, a company's stock will be more valuable. Dividend yield is also a contributor.
94
What is market capitalization (market cap)? How is it calculated?
The total dollar value of all the company's outstanding shares.
Market cap = share price * number of shares outstanding
95
How is earnings per share calculated?
Net Income / Number of Shares Outstanding
96
What is a dividend?
Cash payment paid by company to the stockholder for each share they hold
97
How do you calculate dividend yield?
Annual Dividend Paid / Stock Price
98
How do you calculate a price earnings ratio?
Stock Price / EPS
99
Similar companies usually have a similar...
PE ratio
100
What is the range of capitalization for the Micro-Cap capitalization category?
below $250 million
101
What is the range of capitalization for the Small-Cap capitalization category?
$250 million - $2 billion
102
What is the range of capitalization for the Mid-Cap capitalization category?
$2 billion - $10 billion
103
What is the range of capitalization for the Large-Cap capitalization category?
over $10 billion
104
Under which capitalization category do most "household name" stocks fall under?
Large-Cap
105
What are outstanding shares?
Outstanding shares refer to a company's stock currently held by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company's officers and insiders. (Shown on a company's balance sheet under "Capital Stock.")
106
What is accounting?
A comprehensive system for collecting, analyzing, and communicating financial information.
107
Accounting is ___ relevant.
decision
108
Accounting is distinct from bookkeeping. What is the difference?
Bookkeeping is the recording of accounting transactions - no analysis or communication involved! Bookkeeping contributes to the accounting record on which teh system is based, but accounting is more skilled and requiring of judgment.
109
Who are the users of accounting information? (2 subsets)
1. Internal decision makers (managers within a firm)
| 2. External Decision markets (Investors, Workforce and Unions, Governmental Bodies)
110
What are the four types of documents/information in a financial statement?
1. Income Statement
2. Balance Sheet
3. Statement of Cash Flows
4. Statement of Sockholders' Equity
(Don't worry, we're not going to be talking about #4 very much.)
111
Although financial statements of large companies are audited by independent CPAs, the statements must be...
prepared under the direction of the company's management, often by private accountants within the firm.
112
What is a CPA? What are the two ways a CPA can offer service?
A Certified Public Accountant. An accountant licensed by the state who may offer services to the public as an independent CPA (only independent CPAs can perform audits) or work for a company as a management accountant.
113
A GPA is licensed by the...
state.
114
Only ___ CPAs can perform audits.
independent
115
What is an audit?
Systematic examination of a company's accounting system to determine whether its financial reports are in accordance with GAAP, including reliably representing its operations.
An audit only provides "reasonable assurance" that there are no material (i.e. large) errors.
116
An audit only provides ___ ___ that there are no ___ errors.
reasonable assurance, material
117
What is GAAP?
Generally Accepted Accounting Principles. Accounting guidelines that govern the content and form of financial reports.
118
What is the accounting equation used for by accountants?
To balance data for the firm's financial transactions at various points in the year
119
What is the basis of the balance sheet?
The Accounting Equation
120
The Accounting Equation is the basis of...
the balance sheet.
121
What is a balance sheet?
A financial statement that supplies detailed information about a firm's assets, liabilities, and owners' equity
122
What is a liability?
A debt owed to an outside party
123
What is owners' equity or stockholders' equity?
The amount of money left over if you were to sell the assets and then pay of all the liabilities. This is also known as the residual claim.
124
Owners' equity and stockholders' equity are the same thing. True or false?
True
125
Owners' equity and the residual claim are the same thing. True or false?
True
126
Stockholders' equity and the residual claim are the same thing. True or false?
True
127
What is a current asset?
An asset that can or will be converted into cash within a year.
128
What is a fixed asset?
An asset with long-term use or value, such as land, buildings, and equipment
129
What is liquidity?
Ease with which an asset can be converted into cash
130
What is depreciation?
Accounting method for distributing the cost of an asset over its useful life
131
What is an intangible asset?
A nonphysical asset, such as a patent or trademark, that has economic value in the form of expected benefit
132
What is goodwill?
Goodwill is an intangible asset that arises when one company purchases another for a premium value (over its fair market value). The value of a company's brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent goodwill.
133
What is a current liability?
Debt that must be paid within one year
134
What are accounts payable (also known as payables)?
Current liability consisting of bills owed to suppliers
135
What is long-term liability?
Debt that is not due for at least one year
136
What is paid in capital?
Money the stockholders invested in teh firm
137
What are retained earnings?
Earnings retained by a firm for its use rather than paid out as dividends
138
How Shareholders' Equity Works: Tell me about additions to equity. (2)
See Page 49.
- New investments from stockholders increase shareholders equity as paid in capital.
- Income generated by the company increases shareholders equity.
139
How Shareholders' Equity Works: Tell me about deductions from equity. (2)
See Page 49.
- Payment of cash dividends decreases shareholders equity (return on investment)
- Losses by the company decrease shareholders equity
140
What is on the balance sheet?
- Breakdown of assets and how they are financed
| - Calculation of useful ratios such as current ratio (current assets / current liabilities)
141
What is the current ratio?
Current Assets / Current Liabilities
142
Why is the current ratio important?
It's an indicator of liquidity.
143
What is the "rule of thumb" regarding the current ratio?
See page 55.
The ratio should be greater than 2:1.
144
Some large companies have a current ratio of <1. True or false?
True
145
The current ratio for Coke and Walmart shows a lower level of liquidity below 2. How do they "get away" with it?
...
146
What are the two other names for income statement?
profit-and-loss statement, statement fo operations
147
What is an income statement?
A financial statement listing a firm's annual or quarterly revenues and expenses so that the bottom line shows the period's profit or lss
148
What are the two other words for profit?
Income, earnings
149
What is the equation for profit?
Profit (or Loss) = Revenues - Expenses
150
What is the guiding concept for the income statement
The profit equation! PRofit = Revenues - Expenses
151
What are expenses?
Costs of serving customers
152
What is the statement of cash flows?
Financial statement describing a firm's yearly or quarterly cash receipts and cash payments.
153
What is a statement of cash flows made up of? (3)
- Operating cash flows from earnings (usually positive)
- Investing cash flows to buy new assets (usually negative)
- Financing cash flows from/to the investors (varies)
154
Earnings is not the same as...
cash.
155
What is the equation for earnings or income?
Earnings or Income = Revenues - Expenses
156
What is revenue?
- Funds or net assets that flow into a company from selling goods or services.
- Funds can be cash or accounts receivable.
- Revenues are also called sales or turnover.
157
Consider this: A company borrows money - cash is received. Is this an example of revenue?
No, because the company did not sell goods or services.
158
Consider this: A company performs consulting services in January, but agrees to be paid at the end of the quarter in March. Is this a revenue in January or March?
January, because the flow of value is a receivable
159
When is revenue recorded? (2)
- When goods are supplied or delivered to the customer
| - When the service is performed
160
When is revenue NOT recorded?
When the customer pays (customer might pay in advance or pay later)
161
How do you find revenue in dollars?
Use the price the customer has paid or will pay.
162
What are expenses?
The using up of value that the company needs to sell goods and services
163
Consider: A company buys chocolate to sell after New Years. Is there an expense?
No expense yet, because the value is not used. Chocolate is on the balance sheet as inventory.
164
Consider: It is after New Years, and a company sells the chocolate. What is the revenue, the expense, and the income?
The revenue is the sale price to the customer. The expense is the purchase price of the chocolate. The income or earnings is the difference between the revenue and the expense.
165
What is the cost of goods sold?
Also known as the cost of sales or cost of revenues, these are the costs of the products sold by a firm during the year (paid to suppliers by Tesla for materials and parts)
The cost of acquiring or manufacturing the products that a company sells during a period. Therefore, the only costs included in the measure are those that are directly tied to the production of the products, such as the cost of labor, materials, and manufacturing overhead.
166
What are Tesla's operating expenses?
Costs, other than the cost of sales, incurred by Tesla in designing and marketing its cars
167
What is gross profit?
Preliminary, quick-to-calculate profit figure calculated from the firm's revenues minus its cost of revenues (the direct costs of getting the revenues)
168
What is Tesla's gross profit?
+19%
169
What is operating income?
Gross profit minus operated expenses
170
What is the equation for gross profit?
Revenues - Cost of Revenues
171
What is the equation for net income?
Gross Profit - Operating Expenses and Income Taxes
172
What is the profit margin ratio?
Annual net income / Annual revenues
173
What is Tesla's profit margin ratio?
-19%
174
What is Google's profit margin?
21 to 22%
175
The HBS Paper does not concentrate on...
liquidity.
176
What is the HBS Paper's starting point?
Return on equity or RoE = Annual net income / stockholders' equity
177
How do you calculate return on equity?
Annual net income / stockholders' equity
178
What does return on equity mean?
For every dollar invested in equity, how many cents on the dollar does the equity investor get, per year. For example, Google makes $14.4 billion, and stockholders have invested $104.5 billion. So, they receive 13.8% of their investment each year.
179
The HBS framework emphasizes...
efficiency and maximum profit per dollar invested.
180
What is the DuPont Formula?
RoE = Net PRofit Margin * Asset Turnover * Financial Leverage
181
How do you calculate net profit margin?
Net Income / Net Sales
182
How do you calculate asset turnover?
Net Sales / Average Total Assets
183
How do you calculate financial leverage?
Average Total Assets / Average Stockholders Equity
184
This analysis combines what two things?
The income statement and balance sheet data.
185
How do you calculate RoE? (2)
1: Net Income / Average Stockholders Equity
2: Net PRofit Margin * Asset Turnover * Financial Leverage
186
The DuPont Formula gets at the ___ ___ of good or bad performance.
root causes
187
What does a good profit margin indicate?
Profitability
188
What does a good asset turnover indicate?
Investment efficiency
189
What does a good financial leverage indicate?
Smart Financing Strategy
190
The DuPont Formula can can tell us what is the source of the return on equity. What are the three possible sources?
Profitability, Investment Efficiency, Financial Leverage
191
What tells you if there are any liquidity issues?
Current ratio and/or Quick Ratio
192
What tells you if there are any solvency issues?
Net debt and/or Equity
193
Why is financial leverage beneficial for a company?
- Actually, it depends on the interest rate!
- A company that borrows cheaply, compared to the returns it gets, does well to increase debt.
- For every dollar of assets funded cheaply, additional return goes to the stockholder. This increases or "levels up" the stockholders' return.
194
Ratios, and the DuPont analysis in particular, provide an analytical framework for explaining...
differences between companies' performance.
195
Ratios provide a ___ ___ to discuss company performance and characteristics with fellow professionals.
common language
196
Who has the higher RoE: Tesla or Ford? What are their respective values?
Ford (22% > -43%)
197
What other factors (not RoE) are playing into the Tesla vs. Ford competition? (2)
- An important element of stock price performance is expected FUTURE profits
- The growht part of the picture is not captured by the DuPont ratio
198
How do you calculate revenue growth?
Rev(t) / Rev(t-1) - 1
199
How much did Tesla grow during 2017?
68%
200
How much did Ford grow during 2017?
3%
201
What is the super best case for Tesla with regards to its competition with Ford?
If Tesla can grow as big as Ford and maintain current SG&A costs (as fixed costs)
202
What does SG&A mean?
Selling, General and Administrative Expenses
203
The idea of keeping Tesla's SG&A constant is... (optimistic or likely, but even if...)
very optimistic, but additional SG&A could be offset by emission credit sales and/or income from power storage.
204
What is the present value formula?
Future Value / (1+r)^t
| where r is the expected rate of return
205
Higher risk must provide a ___(lower/higher)___ expected return.
Higher
206
What is the Future Value formula?
Present Value * (1+r)^t
| where r is the expected rate of return
