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corporate finance, investments, institutions

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main line finance disciplines

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process of determining what capital assets to buy

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capital budgeting analysis

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own money (equity) or the bank's money (debt).

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finance your company with ...

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Amount of owners' portion of a business.

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Equity

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Money lent by a creditor to provide financing to the borrower

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debt

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someone who invests funds in an attempt to earn positive returns (old term - money manager)

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Asset manager

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Portfolio of assets professionally managed for others to invest in - your stock

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Mutual funds

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Professionally managed investment capital that typically invests in very young new ventures - Private companies

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Venture capital

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process of valuing assets

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asset pricing

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what someone would pay right now for an asset

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current market value

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the investor will either buy the asset (if the analysis indicates the asset is underpriced) or sell the asset (if overpriced)

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If there is a big enough difference between the estimated price and the current market price,

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buying

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Longing

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selling

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shorting

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investing without active management

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passive investing strategy

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acceptable return on a passive investment

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fair return

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where the investor invests a set amount each month in a no-load mutual (or index) fund.

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Dollar cost averaging

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retirement plan individuals can use to avoid taxes, such as a 401K or Roth IRA.

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tax sheltered plan

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chose which assets to invest in

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investments

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banks - commercial; insurance companies; pension funds

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institutions

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the finance function of the business

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corporate finance

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buy stocks or bonds with investor money. The managers attempt to find under-valued or growth stocks (or bonds) and buy low, sell high

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Mutual Fund managers

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earn a strong return for their investors. However, managers are not restricted to buy (long) positions only. They can also sell stocks and bonds (short) and can buy and sell financial derivatives (stock options, for example).

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Hedge fund managers

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1) company/industry analysis, 2) mergers and acquisitions, 3) raising capital via corporate offerings, 4) sales and trading, 5) private client services, and 6) back office support

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I-bankers primary roles

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1.Commercial banking 2.Corporate finance 3.Financial planning 4.Insurance 5.Investment banking 6.Money management 7.Real estate 8.Hedge funds 9.Private equity

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Nine Career Tracks within Finance

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Assets = Liabilities + Owners' Equity

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Balance Sheet Equation includes

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cash, marketable securities, accounts receivable, and inventory.

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Common current assets

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shows the total dollar amount we have sold to our customers but not yet collected (usually within 30-60 days).

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Accounts receivable (AR)

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(Last In, First Out) (First In, First Out)

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LIFO - FIFO

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money that the company owes to another company as a result of purchases made on credit

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Accounts payable (AP)

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obligations that a company has incurred in the current period but has not yet paid.

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Accruals

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involve an explicit interest-bearing lending arrangement between the company and a lending institution

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notes payable

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the operations of the company that is plowed back (or retained) in the business.

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Retained earnings (RE) is generated from

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Net Income - Dividends

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Change in RE = (Retained earnings)

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Assets on the balance sheet with a life span greater than one year

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Fixed Asset

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obligations that are going to require cash in the next year. These liabilities are listed in order of maturity, with the shortest maturity listed first

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current liabilities

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describes the revenues and expenses associated with a company's operations for a given period of time (that is why it is dated "for the period ended"). Due to the many possible accounting assumptions and vagaries surrounding each line item on the income statement, it is far more susceptible to misinterpretation than is the balance sheet

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Income Statement

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a snapshot of the firm's assets and the financing of those assets at a given point in time (that's why it's dated "as of" a particular date). It is a listing of all of the assets, liabilities, and equity of the firm

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balance sheet

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require that production costs be recognized with the associated revenue

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the accounting rules (the matching principle) governing cost recognition

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Earnings Before Interest and Taxes,

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EBIT means

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Dividends + Change in Retained Earnings

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Net income is created by ( it can pay it out as dividends to shareholders or retain it within the firm.) =

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this year's retained earnings equal the sum of last year's retained earnings balance plus the change in retained earnings from the current year

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New RE = Old RE + Change in RE

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Net Income - dividends = change in RE

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New RE = Old RE + Net Income - Dividends

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Watch the inventories Beware of rising receivables Uncover extraordinary expenses Investigate asset sales Who's skimping on research? When is revenue really not? Spot out-of-balance growth

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Red Flags in Earnings

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the sources and uses of cash for the company—it shows cash in and cash out of the company for a given year.

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cash flow statement

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cash flows from operations (CFO), cash flows from investing (CFI), and cash flows from financing (CFF). The sum of all of these cash flow sources should equal the company's change in cash for the year.

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cash flows are divided into three groups:

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both the balance sheet and income statement

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constructing the statement of cash flows requires

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obligations that will require cash within the next year. and items that will generate cash within the next year

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Current liabilities and current assets are

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cash, marketable securities, accounts receivable, and inventory acknowledges this difference in liquidity by subtracting inventory from current assets (leaving only the three most liquid current asset types in the numerator)

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Quick Ratio =(current assets-liquid inventory) - current liabilities - involves what?

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Average Collection Period = AR / Daily Credit Sales

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Daily credit sales, or credit sales per day, is simply annual credit sales divided by 365.

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AR Turnover = Credit Sales / AR

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It is simply credit sales divided by AR. An AR turnover ratio of 12 means that the company collects its entire accounts receivable

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Inventory Turnover

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the number of times it turns (or sells) its inventory annually. Inventory turnover is calculated as cost of goods sold divided by inventory

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how many dollars in sales the firm generates per dollar of assets it owns.

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Total Asset Turnover calculates

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sales / total assets

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Total Asset turnover =

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calculates sales generated per dollar of fixed assets. Fixed assets include all non-current assets, or total assets minus current assets.

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Fixed asset turnover

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sales / fixed assets

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Fixed Asset turnover =

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operating income / total assets

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OIROI (Operating Income Return on Investment)

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how much pre-tax, pre-financing profit the company generates per dollar of assets.

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OIROI (also be classified as a profitability ratio) is

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to bring something off the truck and put it directly into the assembly line. The product is shipped out immediately after it is made

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theory of JIT

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Total Debt / Total Assets

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Debt Ratio

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EBIT / Interest Expense

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Times Interest Earned =

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how many times a company covers (or could pay) its interest expense given its earnings.

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times interest earned

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compares the firm's annual net income to the total asset base used to generate that income. It shows how profitable the firm is given its asset investment

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Return on assets, or ROA,

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compares annual net income to total equity

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the return on equity (ROE) ratio

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To calculate gross, operating, and net margin, we simply take each of these three primary profitability measures and divide it by sales

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Gross Margin, Operating Margin, Net Margin

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Return on Equity = Net Profit Margin × Asset Turnover × Leverage Multiplier

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DuPont Equation

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Net Profit Margin equals Net Income/Sales

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Net Profit Margin.

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Sales/Assets

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Asset Turnover

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Assets/Equity

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Leverage Multiplier

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Return on Invested Capital = where NOPAT is equal to net operating profit after taxes and is defined as EBIT (1 - t) and Costly Capital equals all interest bearing debt plus total equity

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ROIC = NOPAT / (Costly Capital)

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Free cash flow to the firm

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FCFF means

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Total tax payments from the income statement

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Cash Tax Payments means

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Depreciation from the income statement (or two balance sheets

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Depreciation means

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Earnings before interest and taxes (from the income statement)

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EBIT means

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Capital expenditure (gross property, plant, and equipment) changes from two balance sheets

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CAPEX means

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Net working capital (current assets - current liabilities) changes from two balance sheets

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NWC means

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FCFF = EBIT - Cash Tax Payments + Depreciation - CAPEX - Increases in NWC

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base equation for measuring Free Cash Flow to the Firm is

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FCFE = NI + Depreciation - CAPEX - Increases in NWC + Increases in Net Long-Term Debt

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We want to measure the cash flows that are left over for equity holders after all company operations and after paying the creditors (interest and debt due).

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looks at a firm's financial ratios over time; generally looks backwards five years and forecasts forward three years.

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Trend analysis

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compares a firm's financial ratios with those of some peer group. its competitors, its industry, or even the market in general, and thus tells the analyst something about the target firm's relative strength (or weakness) and performance.

answer

cross-sectional analysis

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trend analysis; cross sectional analysis and measure progress and achieve goals

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three main comparison methods used in ratio analysis

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EBIT - Cash Tax Payments + Depreciation - CAPEX (capital expenditure) - Increases in NWC (Net working capital)

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FCFF =

question

Current Assets / Current Liabilities

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Current Ratio =

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(Current Assets - Inventory) / Current Liabilities

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Quick Ratio =

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COGS (cost of goods sold) / Inventory

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Inventory Turnover =

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This additional financing : a number of assumptions about the future increase in sales, the current relationship between sales and assets, and the firm's profitability: how much more financing we will need to sustain future expected growth

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Discretionary Financing Needed or DFN

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to understand the impact of decisions we make today on our reported results tomorrow, as well as to avoid making dumb mistakes in the future

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The goal of financial forecasting

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estimated

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pro forma

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1.Project sales revenues and expenses 2.Forecast change in spontaneous balance sheet accounts 3.Deal with discretionary accounts 4.Calculate retained earnings 5.Determine total financing needs/assets 6.Calculate DFN

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Percent of Sales Method - Sales forecast

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accounts on the income statement and balance sheet that change automatically in proportion with sales - current assets; accruals - wages and tax; accts payable

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Spontaneous accounts

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discretionary accounts. - These accounts do not increase automatically with sales but are left to the discretion of management

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non-spontaneous accounts

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note payables; long term financing; common stock

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discretionary accounts constant

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added to the balance sheet to ensure both sides equal

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plug figure

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an infinite stream of equally spaced, equal cash flows.

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Perpetuity

question

annuity that pays at the end of each period End Mode -searching for End pay

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ordinary annuity

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annuity that pays at the beginning of each period time zero plus future payments = total annuity due Begin Mode in calculator

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annuity due

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how much spending power money has at a point in the future

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future value

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cash flow stream falls in the broad category we have to discount or compound each individual flow separately using the present/future value approach that we used for single sums and then add them together

answer

uneven cash flows

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a standard annuity whose first payment is deferred to some point in the future

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deferred annuity

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earning available to common stockholders divided by the number of common stocks shared outstanding

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earning by share

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Total assets = Total debt + Total equity

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Debit to total assets ratio

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common stock w no growth in dividends

answer

dividend n preferred stock

EZC1 – Finance WGU

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