Principles of Finance – C708 - QA study guide PDF

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Course Overview Finance can be defined as the art and science of managing money. All organizations, from large multinational corporations to small family-owned businesses, need to understand finance to survive in an economic world; it is the lifeblood of business. Throughout this course, you will be presented with business cases and scenarios that emphasize financial concepts and rules and their application to a wide variety of real-world situations. These topics include financial forecasting, valuation of stocks and bonds, financial risk, and capital budgeting. This course is designed to take approximately 60 hours to complete. There are 4 Units (2-5) to work through. Each Unit is broken down into 3 modules. As you work through this course, you will want to reference the provided formula sheet and have a financial calculator.

UNIT 2: 24% (3/4) Upon completion of Module 1, you should be able to answer the following questions : 1. Define finance and subspecialties in finance Finance: Study of fund management and asset allocation over time  The three main areas of finance are financial Institutions, financial markets, and financial management  two main drivers of finance are the time value of money and risk.  Underlying driver behind all finance: Time (forward looking) 2. Describe the function of finance in various management roles within an organization  Financial managers perform data analysis and advise senior managers on profit -maximizing ideas  Value profitability of multiple projects and choosing one to invest in  Preparing corps budget for next fiscal year  Determining whether to pay a dividend to shareholders  Also prepare and interpret financial statements (Income Statement)  Types of financial managers include controllers, treasurers, credit managers, cash managers, risk managers and insurance managers. - Controllers: direct the preparation of financial reports that summarize and forecast the organization's financial position; income statements, balance sheets, and analyses of future earnings or expenses, preparing special reports required by governmental agencies that regulate businesses, typically oversee the accounting, audit and budget department - Credit Managers: oversee the firm's credit business. They set credit-rating criteria, determine credit ceilings, and monitor the collections of past-due accounts - Treasures: direct their organization's budgets to meet its financial goals and oversee the investment of funds. They carry out strategies to raise capital and also develop financial plans for mergers and acquisitions. - Cash managers: monitor and control the flow of cash that comes in and goes out of the company to meet the company's business and investment needs - Risk managers: control financial risk by using hedging and other strategies to limit or offset the probability of a financial loss or a company's exposure to financial uncertainty - Insurance managers: how best to limit a company's losses by obtaining insurance against risks such as the need to make disability payments for an employee who gets hurt on the job or costs imposed by a lawsuit against the company

3. Describe the function of finance in various business scenarios  Maximize shareholder value  Ensure money is at the right place at the right time  Choose between potential investments (or projects)  Nearly every job has to be able to manage a budget and make a business case that it should get funding for a project  managers, directors, and vice presidents need to be able to articulate why their departments should get financial support from the company 4. Identify underlying financial principles that affect business decisions  CSR, ethics  personal (on a micro scale), professional (on an intermediate scale), and corporate (on a macro scale)

Upon completion of Module 2, you should be able to answer the following questions : 1. Explain the different forms of business organization: Sole Proprietorship, Partnership, Corporation  Sole Proprietorship: a type of business structure open to businesses run and owned by one entrepreneur - One person, files business expenses on personal taxes, flexibility but has all of the liability, no separation between business and entrepreneur  Partnership: simplest structure open to collaborative ownership. It’s structure has the benefit of simplicity and control, but the drawback of personal liability for the partnership's activities - Partnership is not separate from owners, but has ease in terms of filing and tax treatment  Corporation (LLC): a business structure in the United States whereby the owners are not personally liable for the company's debts or liabilities, harder tax filings but separated from individuals and less liability 2. Define the principal agent problem concerns the difficulties in motivating one party (the "agent"), to act on behalf of another (the "principal"). The two parties have different interests and asymmetric information. Moral hazard and conflict of interest may thus arise - Shareholders generally want the company to pursue riskier projects; bondholders do not. - shareholders have a vote in how the company conducts its business; bondholders generally do not. - Shareholders are only paid if the company makes a profit, bondholders are paid regardless.

Upon completion of Module 3, you should be able to answer the following questions : 1. Describe the US Financial System  Financial system functions include accumulating savings and lending funds.  One of the most significant functions of the financial system is the creation of money, which serves as a medium of exchange. 2. Define Financial Institutions  Central Banks: financial institutions responsible for the oversight and management of all other banks. In the United States, the central bank is the Federal Reserve Bank, which is responsible for conducting monetary policy and supervision and regulation of financial institutions  Retail and commercial banks: the majority of large banks offer deposit accounts, lending, and limited financial advice to both demographics (individuals and businesses)

Internet banks: offer the same products and services as conventional banks, but they do so through online platforms instead of brick and mortar locations  Credit unions: serve a specific demographic per their field of membership, such as teachers or members of the military. While the products offered resemble retail bank offerings, credit unions are owned by their members and operate for their benefit  Savings and loan associations: Individual consumers use savings and loan associations for deposit accounts, personal loans, and mortgage lending - provide no more than 20% of total lending to businesses  Investments banks: do not take deposits; instead, they help individuals, businesses and governments raise capital through the issuance of securities. Investment companies, traditionally known as mutual fund companies, pool funds from individuals and institutional investors to provide them access to the broader securities market  Brokerage firms: assist individuals and institutions in buying and selling securities among available investors. Customers of brokerage firms can place trades of stocks, bonds, mutual funds, exchange-traded funds (ETFs)  Insurance companies: help individuals transfer the risk of loss  Mortgage companies: originate or fund mortgage loans 3. Identify Types of Financial Market  Financial Markets are an aggregate of possible buyers and sellers of financial securities, commodities, and other fungible items, as well as the transactions between them.  One of the main functions of financial markets is to allocate capital.  Capital Markets: for long-term finance, capital markets are used - primary market is the part of the capital market that deals with the creation and sale of equity-backed securities to investors directly by the issuer - Includes bond markets and stock market  Money Markets: for short-term finance (maturity up to one year)  Derivatives market: is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets  Examples of financial markets include capital markets, derivative markets, money markets, and currency markets  Financial Markets also provide additional information to management 

4. What is the role of Financial Markets in capital allocation?  One of the main functions of financial markets is to allocate capital, matching those who have capital to those who need it.  Capital markets especially facilitate the raising of capital while money markets facilitate the transfer of liquidity  attract funds from investors and channel them to enterprises that use that capital to finance their operations and achieve growth, from start-up phases to expansion--even much later in the firm's life 5. What is the Securities Exchange Acts of 1933 and 1934  1933: The first federal legislation used to regulate the stock market. Primary purpose is to ensure that buyers of securities receive complete and accurate info before they invest  1944: a law governing the secondary trading of securities, financial markets and their participants. - amended by the Maloney Act, which authorized the formation and registration of national securities associations to supervise the conduct of their members subject to the oversight of the SEC. 6. What is the Sarbanes-Oxley Act of 2002  law that aims to protect investors by making corporate disclosures more reliable and accurate

requires all financial reports to include an Internal Controls Report. This shows that a company's financial data accurate and adequate controls are in place to safeguard financial data 7. Explain types of economic impacts 

UNIT 3: 27% (2/4) This is the first of two Units where you will find some of the math that you’ll see on the PA/OA. Pay particular attention to these modules: Financial Statements (Module 4) – be sure you are VERY comfortable with the Balance Sheet and Income Statement. You should know the components of each part of both statements. Read and watch embedded videos on pages 50-66 Complete Financial Statements quiz

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You should be able to answer the following questions after reviewing this module: 1. Identify the components of an income statement, balance sheet, and statement of cash flows  An income statement reports on a company's expenses and profits to show whether the company made or lost money. - Net income/bottom line

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The balance sheet reports a point-in-time snapshot of the assets, liabilities and equity of the entity

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cash flow statement reports the flow of cash in and out of the business, dividing cash into operating, investing and financing activities. Total Assets = total liabilities + owners equity Explain how financial statements are used to make business decisions Owners and managers use financial statements to make important long-term business decisions. For example: whether or not to continue or discontinue part of its business, to make or purchase certain materials, or to acquire or rent/lease certain equipment in the production of its goods. Prospective investors use financial statements to perform financial analysis, which is a key component in making investment decisions. A lending institution will examine the financial health of a person or organization and use the financial statement to decide whether or not to lend funds.

3. Explain accounting principles: accrual-based accounting and historical cost  The accrual principle is an accounting concept that requires transactions to be recorded in the time period in which they occur, regardless of when the actual cash flows for the transaction are received - ensures there’s an asset for every deduction  he historical cost of an asset refers to its purchase price or its original monetary value. the transactions of a business tend to be recorded at their historical costs. 4. Recognize the difference between cash and non-cash items on a financial statement  Noncash items such as depreciation and amortization, will affect differences between the income statement and cash flow statement  Noncash items should be added back in when analyzing income statements to determine cash flow because they do not contribute to the inflow or outflow of cash like other gains and expenses eventually do  Common noncash items are related to the investing and financing of assets and liabilities, and depreciation and amortization. When analyzing income statements to determine the true cash flow of a business, these items should be added back in because they do not contribute to inflow or outflow of cash like other gains and expenses.

Module 5 Ratio Calculations and Analysis – this is the first quantitative Module in the text. Understand the 5 ratio categories and what they mean. The calculations you will see are focused on the DuPont Equation so understand how that formula works. Understand what are the limitations of the Return on Equity and what are the relationships between ROE, ROA and Growth. Complete the following activities: You should be able to answer the following questions after reviewing this module:

1. Describe the three main approaches to using ratios, including the purpose of each  Ratio analysis involves the comparison of financial data to gain insight on business performance  Typically comes from info from income statement or balance sheet  Looks at: why is one business more profitable than another, what returns on investment are there, how does a busi stay solvent, and how effectively is a busi using its assets  Benchmarking, trend, 2. Define the types of financial ratios (30:00) 1. Profitability Ratios: measure comps use of assets and expenses to generate a return that’s acceptable to its shareholders  Operating Margin: ratio that determines how much money a company is actually making in profit - Operating income / Revenue - Operating income = revenue – operating expenses (no tax or depreciation)  Profit margin: most used. measure the amount of profit a comp earns from sales - Profit/sales (net or gross) * 100 - Net profit = gross revenue – all expenses - Gross profit = diff between net sales and COGS  ROA (return on assets): measures how well assets are being used to make profit - Net Income/ total assets - Net income = gross profit – operating expenses and taxes - Product of 2 ratios: profit margin and asset turnover -

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ROE (return on equity): measures how effective a company is at using its equity to generate income - Dupoint calculation: Net Income Margin x Total Asset turnover x Leverage Multiplier - ONLY use on test if the problem specifically mentions net income margin, total asset turnover or leverage multiplier otherwise use basic calculation - ROE BASIC: Net Income / Total Equity - Formulas for these will be provided on test, just no name - Net income Margin = Net Income / Sales - Total Asset Turnover = Sales / Total Assets - Leverage Multiplier = Total Assets / Total Equity - What shows on test:

2. Liquidity ratios: measure how much cash is available to pay debt  Current ratio Can a comp pay its short term debts (liabilities) using short term assets? - current assets/current liabilities  Quick Ratio (aka acid test) Can a comp pay its short term debts using short term assets excluding inventory? - Cash & cash equivalents + marketable securities + accounts receivable / current liabilities 3. Debt ratios: measure ability to pay long term debt – virtually every ratio is higher the better, except debt. 4. Market Ratios (not as important for class): relative value of company in its market  Price/Earnings Ratio: used as a guide to the relative values of comp. higher P/E means the investor is paying more per dollar of net income

 Price to book ratio: how much value is management creating from its assets 5. Efficiency ratios: measure how effective comp is in using its assets to generate sales/income  Dividends Ratios: Dividend Payout Ratio (b) = Dividends / Net Income - Retention Ratio (RR) = 1 – b (Dividend Payout Ratio) 3. Dupoint Equation: NSG Corp. has sales of $35 mil, net income of 2.5 mill. Total assets of $44 mill and leverage multiplier of .95. what is return on equity?  ROE = Net income margin x total asset turnover x leverage multiplier     

Net income margin: Net income = $2.5 mill / Sales = $35 mill x - 0.0714 > move dec over 2 for percentage > 7.14% (or can do at the end with the answer) Total asset turnover: Sales = $35 mill / total assets = $44 mill x - 0.80 Leverage multiplier = .95 7.14% x 0.80 x .95 = 5.4264 > rounded up > 5.43%

4. NSG Corp has a Return on Equity of 15.2%, Net income margin of 7.2% and total asset turnover of 1.5. what is the leverage multiplier? Given ROE? Multiply the two ratios that are not the ROE, then divide the ROE by the total of the two ratios  ROE: X = Net Income Margin * Total Asset Turnover * Leverage Multiplier  15.2% = 7.2% * 1.5 * X  7.2% * 1.5 = 0.1080 > 15.2% = 0.1080 * X  15.2% / 0.1080 (opposite to cancel out) = 1.4074 > 1.41

5. What are dividends?  Payments made by the company to its shareholders to give them a portion of the firms net income  A company can only do 2 things with their net income: pay shareholders dividends and retain them into the company (retained earnings) 6. What are the relationships between ROE, ROA and Growth?  Higher of the two numbers relative to each other, historical, and others in their industry shows growth. ROE is what the company’s sustainable growth rate (SGR) is based on.

Financial Forecasting (Module 6) You should be able to answer the following questions after reviewing this module: 1. Describe the role of financial markets in capital allocation  One of the main functions of financial markets is to allocate capital. Capital markets especially facilitate the raising of capital while money markets facilitate the transfer of liquidity, matching those who have capital to those who need it 2. Describe the Securities Exchange acts of 1933/34  1933: two basic objectives: require that investors receive financial and other significant information concerning securities being offered for public sale; and. prohibit deceit, misrepresentations, and other fraud in the sale of securities. controls the registration of securities with SEC and national stock markets

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1944: controls trading of those securities

3. Describe the Sarbanes-Oxley Act of 2002  Act put in place to stop/prevent major fraudulent accounting practices  Means that senior officers have to validate the books themselves 4. Describe the difference between Spontaneous and Non-Spontaneous Accounts  Spontaneous Account: any account that is affected by a change in sales (Income statement accounts like revenue, taxes, operating expenses and Balance sheet accounts like accounts receivables, inventory, etc.) 5. Describe the process of Financial Forecasting  the process of estimating or predicting how a business will perform in the future  Most commonly used is the Income Statement, but in a complete model all financial statements are eventually used  % of sales is most common 6. Explain the percent of sales forecasting method  Method of forecasting used by many companies to make forecasted Income Statements and Balance Sheets.  Uses the % of growth forecasted in Sales and applies that growth rate to forecast any account that changes as sales changes (aka spontaneous account)  Management also uses it to forecast the cash needed to finance future sales growth 7. What is Sales Growth Rate?  Whats used to forecast the income statement and balance sheet using the Percent of Sales method of forecasting - Sales Growth Rate = Forecasted Sales / Last Years Sales – 1  Example: 2017 sales were 50 mill & forecasted 2018 to be 60 mill. What is the Sales growth rate? > 60/50 = 1.2 > 1.2 – 1 = 0.2 = 20% Calculator function: 2nd 5 (triangle%) computes sales growth rate enter old (enter) down arrow, new (enter) then cpt (compute) 8. What is Discretionary Financing Needed?  Estimate of...