WOB – Owners/Investors – Flashcards
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What are the three primary forms of business ownership?
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1) Sole proprietorships 2) Partnerships 3) 'C' Corporations
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What are the hybrid forms of business ownership?
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1) Limited Liability Company (LLC) 2) Benefit Corporation
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What are the 2 key tradeoffs of business forms?
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1) Liability 2) Tax Treatment
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What is a sole proprietorship, and what are it's advantages and disadvantages?
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A sole proprietorship is a business owned and operated by one individual. ADVANTAGES: 1) Taxation (1x) 2) More control of the business 3) Easy and inexpensive to form 4) Secrecy (the sole owner is the only one who knows the secrets of the business) 5) Distribution and use of profits (owner can take salary directly from business profits, no taxes deducted) 6) Minimal government regulation DISADVANTAGES: 1) Unlimited liability (if the business is sued, the owner's personal assets are at risk) 2) Limited source of funding 3) Limited skills
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What is a partnership, and what are it's advantages and disadvantages?
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A partnership is an association of two or more owners who carry on as co-owners of the business. ADVANTAGES: 1) Taxation (1x) 2) Ease of organization 3) Availability of capital and credit 4) Combined knowledge and skills 5) Minimal government regulation DISADVANTAGES: 1) Unlimited liability 2) Distribution of profits (partners can take their salaries directly from business profits, no taxes deducted) 3) Limited sources of funds 4) Life of the partnership/personal challenges
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What is a corporation, and what are it's advantages and disadvantages?
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A corporation is a legal entity whose assets and liabilities are separate from it's owners (corporations are treated as individuals, and they can be public or private). ADVANTAGES: 1) Limited liability 2) Transfer of ownership 3) Perpetual life (the business will continue even if it's directors, shareholders, and officers come and go - it's more stable) 4) External sources of funds 5) Higher potential for expansion DISADVANTAGES 1) Double taxation 2) Difficult to form 3) Disclosure of information (must publish annual reports) 4) Employee-owner separation 5) More government regulation
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What is a Limited Liability Company (LLC) and where is it often seen today?
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A LLC is not a corporation (it's owners are called members), but it has limited liability. It has single taxation, similar to a sole proprietorship or partnership. It has limitations which restrict it's growth (it does not have perpetual life, and there can be difficulties obtaining new equity). Most bars and restaurants are LLCs today.
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What is a Benefit Corporation?
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A benefit corporation is a profit-seeking organization that also wants to pursue social and environmental goals. It possesses most of the attributes of a 'C' Corp.
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What is a 'B' Corp?
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'B' Corps are certified by the nonprofit B Lab. To be certified, a business has to meet certain environmental and social standards, etc. There are 1,000+ 'B' Corps currently. (It's like what Fair Trade certification is to coffee, or USDA Organic certification to milk)
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What is an entrepreneur?
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A person who risks his or her wealth, time, and effort to develop for profit an innovative product or way of doing something.
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What are the characteristics and economic role of a small business?
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- Usually considered to have fewer than 500 employees - Can have any form ownership (corp, partnership, etc.) - Economic role is to provide jobs - Is flexible (can make decisions quickly) - Has a narrow focus (specialized goods/services)
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What is accounting?
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Accounting is measuring, interpreting, and communicating financial information to support internal and external decision-making.
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What is managerial accounting and what are some examples?
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Involves preparing data for managers and other users INSIDE of the organization to be using in planning and directing the course of the organization. Examples: cost estimates, budgets
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What is financial accounting and what are some examples?
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Involves reporting financial information to users OUTSIDE the organization Examples: Financial Statements (Income Statement, Balance Sheet)
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What are GAAP are what are it's principles?
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GAAP (Generally Accepted Accounting Principles) are guidelines governing the form and content of financial reports and are formulated by the Financial Accounting Standards Board. Their principles are: (Red Rocks Community College) 1) Relevant 2) Reliable 3) Consistent 4) Comparable
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Provide some examples on who creates and enforces accounting standards.
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- Securities & Exchange Commission (SEC) - Financial Accounting Standards Board (FASB) - International Accounting Standards Board (IASB)
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What is the Accounting Equation and what does it show?
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Assets = Liabilities + Owner's Equity It shows the relationship between assets, liabilities, and owner's equity. *Must remain balanced
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What are financial statements and what are the 3 types?
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Financial statements are the end result of the accounting process (recording, classifying, and posting information). 1) Balance Sheet 2) Income Statement 3) Statement of Cash Flows
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What is a balance sheet? How are assets, liabilities, and owner's equity listed on a balance sheet?
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A balance sheet is a "snapshot" of an organization's financial position at a specific point in time. It uses the accounting equation. - Assets are listed in descending order of liquidity - Liabilities are listed in the order of how soon they must be paid back
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What is an asset? What are some examples of assets?
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An asset is a resource with economic value that is owned by an individual or company with the expectation that it will provide future benefit (can be tangible or intangible). Examples: Cash, inventory, land, equipment, buildings
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What is a liability? What are some examples of liabilities?
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Debts and obligations that a firm owes to others. Examples: Accounts payable, accrued wages, income taxes payable
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What is owner's/shareholder's equity?
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Owner's/shareholder's equity is money invested in the company for ownership plus accumulated earnings (starting from when the business was formed).
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What are retained earnings?
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Retained earnings are the portions of owner's equity that hasn't been distributed to owner's in the form of dividends.
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What is double-entry bookkeeping?
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Double-entry bookkeeping is a system of recording and classifying business transactions in order to maintain the balance of the accounting equation.
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What is an income statement? What is it's fundamental question?
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A financial record of a company's revenues, expenses, and profits over a given period of time. Revenue - Expenses = Net Income *Also known as a profit and loss statement
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What are the 2 expense categories on an income statement?
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1) Costs of Goods Sold 2) Operating Expenses
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What is depreciation and how is it used in accounting?
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Depreciation is the process of spreading the costs of a long-lived asset such as a building or equipment over the total number of accounting periods in which it is expected to be used. It is used in accounting to try to match the expense of an asset to the income that the asset helps the company earn over the life of that asset.
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How are the balance sheet and income statement related? Why is it important to use both?
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The BS and IS are related because of double-entry bookkeeping and the accounting equation. They are linked through the net income/loss of a period and the owner's equity/networth. The income that a business earns over a period of time (as shown on the IS) is transcribed to the equity portion on the balance sheet. Net income/loss is a category in owner's equity. By analyzing both the IS and the BS, one can see the total financial picture of the company.
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What are financial ratios, and why are they important to analyze?
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Financial ratios compare one thing to another. They simplify complex information and allow us to measure financial performance over time and compare similar businesses.
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What are the 4 categories of financial ratios?
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PLAD 1) Profitability ratios 2) Liquidity ratios 3) Activity ratios 4) Debt ratios
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What do profitability ratios measure? What are some examples?
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Profitability ratios measure how well the business is generating profit. 1) Return on sales, or profit margin (net income/sales) 2) Return on equity (net income/owner's equity) 3) Earnings per share (total earnings/total shares)
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What do liquidity ratios measure? What are some examples?
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Liquidity ratios measure the ability of the business to pay their short-term obligations. 1) Current ratio (current assets/current liabilities) 2) Quick ratio, or acid ratio ((current assets - inventory)/ current liabilities)
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What is the asset utilization ratio and what does it measure?
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The asset utilization ratio measures how well the business is managing it's assets. Inventory Turnover = Cost of Good Sold/Average Inventory OR Inventory Turnover = Sales/Average Inventory
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What is the debt ratio, and what does it measure?
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Debt/leverage ratios measure the level of risk for a business. Debt-to-equity = Total liabilities/Owner's equity Should be less than 1
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What are the 3 concepts of personal finance?
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1) The value of money is constantly changing (for example, inflation reduces purchasing power) 2) Small sacrifices in life can produce big pay-offs 3) Every decision involves trade-offs
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What is debt financing, and what are it's pros and cons?
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Debt financing is when a firm raises money by issuing corporate bonds or taking long-term loans (borrowing money) to meet long-term needs. PROS: - Interest payments are tax deductible - Flexible terms - No loss of ownership - No sharing in profits CONS: - The loan must be repaid - Risky if the firm's cash flow is inadequate to support payments - Interest rates can be high (depending on credit worthiness) - May raise the cost of borrowing in the future
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What is leverage?
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Leverage is the use of debt to increase the potential return of an investment.
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What are credit ratings? What do upgrades and downgrades mean?
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Credit ratings measure the ability to pay back a loan. Upgrades reduces the cost of borrowing and attracts investors. Downgrades increase the cost of borrowing and could trigger repayment terms.
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What is equity financing and what are the pros and cons?
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Equity financing is a method of raising capital by sale of stock or reinvesting earnings. PROS: - No interest or other repayment - Lower risk (doesn't show up as debt on balance sheet) - No legal obligation to pay dividends to Common Stockholders CONS: - Loss of control (Common Stockholders have voting rights) - Loss of ownership (dilution) - Dividends (sharing earnings) paid are not tax deductible - Must keep shareholders happy - Administrative costs
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What are the characteristics of a common stock?
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Regular stock - Most common type of stock - Allows for voting rights - Dividends MAY be paid - Owners expect appreciation (an increase in the value of their stock)
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What are the characteristics of a preferred stock?
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- A preferred stock is a hybrid security - Allows a preference in the distribution of profits (fixed dividends) - Preference over common stock in liquidation - No voting rights - Considered safer than common stock - Generally less opportunity for appreciation (fixed liquidation value)
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What are the trade-offs of debt and equity financing?
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1) Control 2) Risk 3) Cost
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What makes up a firm's capital structure? What structures are considered more/less risky?
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The capital structure is the relative mix of a firm's debt and equity financing. A less risky capital structure is all equity financing, while a more risky capital structure is all debt financing.
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What are the primary and secondary securities markets?
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The primary market is where firms go to raise capital. It involves direct sales to the public and institutions, and is managed by investment bankers. Proceeds go directly to the issuing company. The secondary market is stock exchanges, and is the sale of securities from investor to investor. The proceeds go to investors, not to the company.
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What is Market Cap(itilization)?
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Another measure of the value of a company - Market value of shares outstanding - Equals stock price x number of shares
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How are secondary markets measured?
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Through major indexes, such as: - Dow Jones Industrial Average - NASDAQ - S&P 500 Is referred to as Bull vs. Bear Market
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How are securities markets regulated?
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- Self-regulation by markets (listing requirements, etc.) - Security & Exchanges Commission (SEC), which is a U.S. government agency that measures financial reporting, accounting fraud, and insider trading
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What are considerations for managing investment risk?
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1) Minimize exposure 2) Diversification (mixing a wide variety of investments) 3) Asset Allocation
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What are the two ways of measuring a company's net worth?
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1) Market cap (stock price x number of shares outstanding) (market value) 2) Value of owner's equity (book value)
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What are the categories on a balance sheet?
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Assets = Liability + Owner's Equity
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What are the categories on an income statement?
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Net income = Revenue - (Cost of Goods Sold + Operating Expenses)
