Detailed summary of chapter 3-4-5-10-15 for the Financial Management 2 exam in year 2 - summary has all equations needed during the exam and mentions in the chapters listed in red. All concepts are easily found by searching the word in the search bar.
3.1 the stockholders’ report page 4- 12
Generally accepted accounting principles (GAAP) – The practice and procedure guidelines
used to prepare and maintain financial records by the Financial Accounting Standard Board
(FASB) – The accounting profession’s rule-setting body, which authorizes generally accepted
accounting principles (GAAP).
Public Company Accounting Oversight Board (PCAOB) – A not-for-profit corporation
established by the Sarbanes-Oxley Act of 2002 to protect the interest of investors and
further the public interest in the preparation of informative, fair, and independent audit
reports.
Security and Exchange Commission (SEC) –
Stockholder’s report – Annual report that publicly owned corporations must provide to
stockholders; it summarizes and documents the firm’s financial activities during the year.
Letter to stockholders – Typically, the first elements of the annual stockholders’ report and
the primary communication from management.
The four key financial statements
Page 5 -
Income statement – Provides a financial summary of the firm’s operating results during a
specified period (one quarter or a year)
Dividend per share (DPS) – The dollar amount of cash distributed during the period on
behalf of each outstanding share of common stock.
Balance sheet – summary statement of the firm’s financial position at a given point in time.
Current assets/ liabilities – short-term assets/ liabilities, expected to be converted into cash
or paid within 1 year.
An item on the balance sheet is called liquid when the item is easy to convert into cash
without loss of value. The assets are list from most liquid-cash-down to the least liquid.
- A/R represents the total monies owed to the firm by its customers on credit sales,
not as liquid as cash because of uncertainty of the customer will pay the bills.
- Inventory includes raw material, work in progress (partially finished goods) and
finished goods held by the firm. Are less liquid because the firm has to sell and then
collect on the sales.
- Gross fixed assets are the original cost of all the fixed (long-term) assets owned by
the firm.
- Net fixed assets represent the difference between gross fixed assets and
accumulated depreciation which is the total expense recorded for the depreciation
of fixed assets.
The value of any item listed is called its book value
, - Current liabilities include accounts payable, amounts owed for credit purchases by
firm, notes payable, outstanding short-term loans (commercial banks, accruals,
amounts owed for services (bill may not will not be received)
Long-term debt – Debt for which payment is not due in the current year.
Stockholders’ equity – the owners’ claims on the firm
Preferred stock entry – shows the historical proceeds from the sales of preferred stock
Paid-in capital in excess of par – The amount of proceeds in excess of the par value received
from the original sale of common stock
Par value is an arbitrary number assigned to shares of stock when they first are created
The sum of the common stock and paid-in capital accounts divided by the number of shares
outstanding represents the original price per share received by the firm on a single issue of
common stock – (common stock + Paid-in capital) / outstanding shares = original price per
share
Retained earnings – the cumulative total of all earnings, net of dividends, that have been
retained and reinvested in the firm since its inception
Retained earnings do not represent a pool of cash that the firm can draw upon – they are
funds already reinvested in the business
Net worth is the difference between total assets and total liabilities = TA-TL
Statement of stockholders’ equity shows all equity account transactions that occurred
during a given year.
Statement of retained earnings – reconciles the net income earned during a given year, and
any cash dividends paid, with the change in retained earnings between the start and the end
of that year. And shortened form of the ‘statement of stockholders’ equity’
Statement of cash flows a summary of the firm’s operating, investment, and financing cash
flows and reconciles them with changes in its cash and marketable securities during the
period.
Interest-bearing debt = notes payable +long-term debt
Notes to the financial statements – Explanatory notes keyed to relevant accounts in the
statements; they provide detailed information on the accounting policies, procedures,
calculations and transactions underlying entries in the financial statements.
Financial accounting standards board (FASB) standard No. 52 – Mandates that U.S.-based
companies translate their foreign currency-denominated assets and liabilities into U.S.
dollars, for consolidation with the parent company’s financial statements. This process is
done by using the current rate (translation) method.
- Professional securities analysts use the data in the statements and notes to develop
estimates of the value of securities that the firm issues, these influence the actions
of investors and therefore the firm’s share value.
, Current rate (translation) method – technique used by US-based companies to translate
their foreign-currency-denominated assets and liabilities into US dollars, for consolidation
with the parent company’s financial statements using the year-end (current year).
- Equity accounts, are translated into dollars by using the exchange year that is
prevailed when the parent’s equity investment was made (historical rate)
- Retained earnings are adjusted to reflect each year’s operating profit or loss
3.2 Using Financial Ratios page 13-17
Ratio analysis – Involves methods of calculation and interpreting financial ratios to analyze
and monitor the firm’s performance
- Needs the income statement and balance sheet
- Is of interest to shareholders (present and prospective) because it could affect the
share price, creditors because – primarily the short-term liquidity and ability to make
interest and principal payment – secondary they want to ensure profitability and the
firm’s management because of the financial situation and uses ratios to monitor
performance from period to period.
Types of ratio comparisons
Looking at ratios over time or in comparison to other firms in the same industry allows users
of financial ratios to make more refined judgements about a company’s performance.
Cross-sectional analysis – Comparison of different firms’ financial ratios at the same point in
time; involves comparing the firm’s ratios with those of other firms in its industry or with
industry average.
Benchmarking – A type of cross-sectional analysis in which the firm’s ratio values are
compared with those of a key competitor or a group of competitors that it wishes to
emulate.
- Ratio analysis on its own is most useful in highlighting areas for further research
- Ratios may be above or below the industry norm for both positive and negative
reasons, it is necessary to determine why it differs from others
Time-series analysis – evaluates financial performance over time using financial ratio
analysis.
- Compares the current to the past performance
- Enables analysts to assess the firm’s progress and to spot trends
- Year to year change could indicate a problem – especially if the same trend is not
industry-wide known.
Combined analysis – combination of cross-sectional and rime-series analysis. Makes it
possible to assess the trend in the behavior of the ration in relation to the trend for the
industry
Cautions about using ration analysis READ PAGE 16!!
Financial ratio falls under five categories based on performance they are designed to assess:
liquidity, activity, debt, profitability and market ratios
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