Financial Management Functions and Formulas

1. "What is the corporate governance function? - CORRECT ANSWER Making sure that managerial behavior is ethical and in the business owners' best interests." 2. "What is the risk-management function? - CORRECT ANSWER Identifying and managing the business's various kinds of risks." 3. "What does it mean to manage working capital? - CORRECT ANSWER Making sure the business has net short-term assets available to meet short-term obligations. This includes managing inventory and receivables." 4. "What is the working capital ratio? - CORRECT ANSWER Current assets minus current liabilities." 5. "What is the current ratio? - CORRECT ANSWER Current assets divided by current liabilities." 6. What are the five main functions of financial management? - CORRECT ANSWER 1. Financing function. 2. Capital budgeting function. 3. Financial management function. 4. Corporate governance function. 5. Risk-management function." 7. "What is the financing function? - CORRECT ANSWER Raising the capital necessary to fund a business." 8. "What is the capital budgeting function? - CORRECT ANSWER Choosing the best long-term projects based on the projects' expected risks and returns." 9. "What is the financial management function? - CORRECT ANSWER Managing the business's internal cash flows and capital structure to minimize financing costs and ensure liabilities are paid when due. This includes managing investments." 10."What is the quick ratio? - CORRECT ANSWER Quick assets divided by current liabilities." 11. "What are quick assets? - CORRECT ANSWER Cash, marketable securities, and accounts receivable. So not inventory." 12."What is the inventory conversion period formula? - CORRECT ANSWER Average inventory divided by cost of goods sold per day." 13. "What is the accounts receivable collection period formula? - CORRECT ANSWER Average accounts receivable divided by average credit sales per day." 14. "How can you profit from float? - CORRECT ANSWER Maximize float on payments and minimize float on receipts." 15. "What are the methods of managing float? - CORRECT ANSWER 1. Pay by draft or check. 2. Zero-balance accounts. 3. Concentration banking. 4. Lock-box system. 5. Electronic funds transfers." 16. "What is the benefit of a zero-balance account? - CORRECT ANSWER You can keep your money where you want it and only transfer money to the bank when the bank tells you there are checks you need to pay." 17. "What is the benefit of concentration banking? - CORRECT ANSWER You can get receivables quicker through a local branch." 18. "List 9 investments in order of lowest to highest risk. - CORRECT ANSWER 1. Treasury bills under a year. 2. Treasury notes between 1 and 10 years. 3. Treasury bonds over 10 years. 4. Treasury inflated-indexed securities. 5. Federal agency securities. 6. Certificates of deposit. 7. Commercial paper 9 months. 8. Bankers' acceptances 30-90days. 9. Money market mutual funds under 1 year. 10. Short-term bond mutual funds under 5 years. 11. Individual stocks and bonds." 19."How do you manage receivables? - CORRECT ANSWER Through credit approval and monitoring receivables." 20. "What are 4 key credit policies? - CORRECT ANSWER 1. Credit period. 2. Discounts. 3. Credit criteria such as financial requirements. 4. Collection policies such as Guido." 21. "What is the accounts payable deferral period? - CORRECT ANSWER Average payables divided by purchases per day." 22. "What is the cash conversion cycle? - CORRECT ANSWER Inventory conversion period plus accounts receivable collection period minus accounts payable deferral period." 23. "What is the purpose of the cash conversion cycle? - CORRECT ANSWER It measures the number of days between paying for inputs and collecting cash from finished goods. A shorter CCC improves profitability." 24. "What are some reasons businesses keep cash balances? - CORRECT ANSWER Operations, compensating balances, trade discounts, speculative balances, & precautionary balances." 25. "What are compensating balances? - CORRECT ANSWER A minimum checking account balance required by banks in compensation for loans." 26. "What are speculative and precautionary balances? - CORRECT ANSWER Money saved for unexpected business opportunities or emergencies." 27. "What is float? - CORRECT ANSWER The time it takes for check to be mailed, processed and cleared." 28."What is a seasonal dating credit period? - CORRECT ANSWER Seasonal customers who buy out of season pay when their selling season begins." 29."How can a company generate immediate cash with receivables? 3 ways. - CORRECT ANSWER 1. Pledging as collateral. 2. Assigning A/R to someone else as part of lending. 3. Factoring without recourse by selling to a financing company." 30."How does factoring affect A/R turnover? - CORRECT ANSWER It improves it." 31."What is the formula for A/R turnover? - CORRECT ANSWER Net credit sales divided by average A/R." 32."What is the formula for number of days of sales in average receivables? - CORRECT ANSWER 360 divided by A/R turnover." 33."What computerized systems uses demand forecasts to monitor inventory? - CORRECT ANSWER Material requirements planning." 34."What is the time when you need to order? - CORRECT ANSWER Reorder point." 35."How do you calculate the reorder point? - CORRECT ANSWER Average daily demand times average lead time. Add in safety stock as needed." 36."What is the inventory turnover ratio? - CORRECT ANSWER Cost of Goods Sold divided by average inventory." 37."What is the number of days of supply in average inventory? - CORRECT ANSWER 360 divided by inventory turnover." 38."What is present value? - CORRECT ANSWER The value today of a single cash flow in the future. Or how much you need to invest today to get a specific amount in the future." 39."What is the present value of an ordinary annuity? Or an annuity in arrears. - CORRECT ANSWER " 40."What are 4 capital budgeting techniques? - CORRECT ANSWER 1. Payback period. 2. Internal rate of return. 3. Accounting rate of return. 4. Net present value." 41."What is the payback period formula? - CORRECT ANSWER Initial investment divided by after tax annual net cash inflows equals number of years." 42."What are 2 disadvantages o the payback method? - CORRECT ANSWER It does not account for either profitability or time value of money?" 33."How do you know how much to order? - CORRECT ANSWER Use the economic order quantity which factors in costs of storage and costs of placing orders." 44."What is the calculation of economic order quantity? - CORRECT ANSWER Square root of 2 times annual usage of inventory times cost of placing order all divided by cost of storing. (Square root (2 x A x P)/S)" 45."What is another term for storage cost? - CORRECT ANSWER Obsolescence cost." 46."When is just in time effective for businesses? - CORRECT ANSWER 1. The costs of storage are high. 2. Lead times are low. 3. Safety stock needs are low due to good relationships with reliable suppliers. 4. Costs per purchase order are low." 47. "How do you keep track of Cost of Goods Sold for just in time businesses? - CORRECT ANSWER Use the backflush approach?" 48. "What is the backflush approach & it's journal entries? - CORRECT ANSWER It charges all manufacturing costs to cost of goods sold instead of inventory and back into remaining inventory at the end of the year. cost of goods sold debit. cash credit. Inventory debit. cost of goods sold credit." 49."What payback method accounts for the time value of money? - CORRECT ANSWER The discounted payback method." 50."What is the internal rate of return formula? - CORRECT ANSWER Investment divided by annual cash flows equals the present value factor. Find the present value factor in the present value table at the given years of life." 51."What are 3 advantages of IRR and 2 disadvantages of IRR? - CORRECT ANSWER 1. Accounts for the time value of money. 2. Hurdle rates create a comparison. 3. Understandable. Disadvantages: 1. Multiple IRRs using the same cash flow. 2. No IRR for net present values of zero." 52."What is the formula for accounting rate of return? - CORRECT ANSWER Accounting income divided by average or initial investment." 53."What is accounting income? - CORRECT ANSWER Income net of all expenses including depreciation and income taxes." 54."What are 3 disadvantages of accounting rate of return? - CORRECT ANSWER 1. No time value of money. 2. No projected risk. 3. Different depreciation methods equal different ARR." 55."What is public debt? - CORRECT ANSWER Obligations easily resold to the public and has fixed interest." 56."What are Eurobonds? - CORRECT ANSWER Bonds state in U.S. dollars that are sold abroad." 57."What are positive debt covenants? - CORRECT ANSWER Providing annual audited financial statements. Maintaining financial ratios. Maintaining life insurance policies for officers." 58."What is the net present value formula? - CORRECT ANSWER Present value of inflows minus present value of outflows." 59."What are 4 advantages to using net present value? - CORRECT ANSWER 1. Accounts for time value of money. 2. Accounts for risk. 3. Includes total profitability. 4. Results are in dollars." 60."What are 3 disadvantages of net present value? - CORRECT ANSWER 1. Complex computations. 2. Harder to comprehend. 3. Managers may not follow scheduled investments and expenses." 61. "What is forecasting? - CORRECT ANSWER Projecting for the future environment." 62."How do businesses manage short-term financing? - CORRECT ANSWER By purchasing goods on trade credit." 63."What is the formula for annual financing costs of not taking a trade discount? - CORRECT ANSWER Discount percent divided by remainder of 100 times 360 divided by total pay period minus discount period. (discount %/remaining% x 360/(total pay period - discount period))." 64."What is the formula for the cost of a loan with a compensating balance? - CORRECT ANSWER Interest paid divided by principal minus compensating balance." 65."What is private debt? - CORRECT ANSWER Business obligations that are not easily resold to the general public." 66."What is the prime rate? - CORRECT ANSWER Rate that each lender charges its most creditworthy customer." 67."What are 4 negative debt covenants? - CORRECT ANSWER 1. Not borrowing from other lenders. 2. Not selling specific assets. 3. Not paying dividends to shareholders. 4. Limiting compensation for executives." 68."What are five securitized bonds? - CORRECT ANSWER 1. Mortgage bonds. 2. Collateral trust bonds. 3. Debentures. 4. Subordinated debentures. 5. Income bonds." 69."What are unsecured bonds? - CORRECT ANSWER Debentures" 70."What is the stated rate? - CORRECT ANSWER Fixed payment given on face value of the bond. Also known as coupon, face or nominal rate." 71."What is the current yield formula? - CORRECT ANSWER Annual interest paid divided by bond market price." 72."What is the yield to maturity? - CORRECT ANSWER Interest rate at which the present value of the cash flows of interest and principal equal the current selling price of a bond. AKA market or effective rate." 73."What is the present value of the face value of a bond? - CORRECT ANSWER Face value times present value of a lump sum using the effective interest rate." 74."What is the present value of the interest payments? - CORRECT ANSWER Face value times stated rate times time equals interest times present present value of an ordinary annuity at the effective interest rate." 3. Usually no down payment. 4. Leasors have less rights in bankruptcy. 5. Lessees do not recognize the lease as a liability." 75."What are 3 advantages to funding your company with common stock? - CORRECT ANSWER 1. Flexibility of payments. 2. Does not increase future debt borrowing costs. 3. Attractive to investors." 76."What are 4 disadvantages to funding your company with common stock? - CORRECT ANSWER 1. Costs of issuing stock are larger than borrowing costs. 2. Reduced ownership and control for current owners. 3. Distributions are not tax deductible. 4. Higher costs of capital if business is successful." 77."What are six possible features of preferred stock? - CORRECT ANSWER I. I.Cumulative dividends. II.Redeemabilitiy. III.Callability. IV.Convertability. V.Participation. VI.Floating rate." 78."What is Floating rate? - CORRECT ANSWER Dividends vary based on an index." 79."Explain Degree of Operating Leverage. - CORRECT ANSWER It is a measure of how fixed costs affect performance as revenues change. As revenues increase high fixed costs and low variable costs means increases in profits." 80."What is the degree of operating leverage formula? - CORRECT ANSWER Percent change in earnings before interest and taxes divided by percent change in sales volume." 81."Explain the degree of financial leverage. - CORRECT ANSWER Measures how increased debt increases risks and future debt financing costs." 82."What is the formula for degree of financial leverage? - CORRECT ANSWER Percent change in earnings per share divided by percent change in EBIT." 83."What are zero-coupon bonds? - CORRECT ANSWER Bonds that only pay the face value, so your profit is based on the discount." 84."What is a floating rate bond? - CORRECT ANSWER Interest payments based on a fluctuating index." 85."What are registered bonds? - CORRECT ANSWER Bonds paid directly to the bondholder instead of a broker." 86."What are 5 advantages to debt financing? - CORRECT ANSWER 1. Interest is tax-deductible. 2. It's a fixed obligation. 3. Don't lose control of the company. 4. Earnings accrue to the owners. 5. Debt is less costly than equity." 87."What are 3 disadvantages of debt financing? - CORRECT ANSWER 1. Repayment is not based on profitability. 2. Covenant obligations cause restrictions. 3. High debt increases risk." 88."What are two types of leases? - CORRECT ANSWER Operating and capital." 89."What are 6 benefits of leasing? - CORRECT ANSWER 1. Doesn't require good credit. 2. Terms are less strict. 90."What is the cost of debt financing formula? - CORRECT ANSWER Yield to maturity times net of 1 minus the effective tax rate. (YTM x (1-effective tax rate))." 91."What is the business goal when looking at weighted average cost of capital? - CORRECT ANSWER Have a lower WACC for lower interest rates." 92."How do you calculate weighted average cost of capital? - CORRECT ANSWER Take the weighted percent times the percent of cost. Remember to do the after tax effect for bonds. (YTM - (1-effective tax rate))." 93."What are the 3 approaches to valuation? - CORRECT ANSWER 1. Actual prices for identical assets traded in liquid markets. 2. Prices of similar assets traded in liquid markets. 3. Valuation models." 94."What are 3 types of mergers? - CORRECT ANSWER Horizontal, vertical, & conglomerate." 95."What is a conglomerate merger? - CORRECT ANSWER A business acquiring another in an unrelated market." 96."What is residual income? - CORRECT ANSWER Operating profit minus interest on investment." 97."What is the formula for economic value added? - CORRECT ANSWER Net operating profit after taxes minus cost of financing." 98."What is cost of financing? - CORRECT ANSWER Total assets minus current liabilities then times weighted average cost of capital." 91."What is the cost of preferred stock financing formula? - CORRECT ANSWER Dividend divided by net issue price." 99."What is the Capital Asset Pricing Model calculation for return on existing common stock? - CORRECT ANSWER Beta times excess of normal market return over risk free investments plus return on risk free investments. (risk free rate + ((expected market rate - risk free rate) x Beta))." 100."Explain the arbitrage pricing model. - CORRECT ANSWER A capital asset pricing model that uses separate returns and betas for various factors." 101."Describe the bond yield plus method. - CORRECT ANSWER Uses the historical relationship of equity and debt." 102."What is the formula for the dividend yield plus growth rate for existing common stock? - CORRECT ANSWER Next expected dividend divided by current stock price then add expected growth in earnings." 103."What is the cost of new common stock? - CORRECT ANSWER Next expected dividend divided by sum of current stock price less flotation costs, then add expected growth in earnings."