Essential Financial Terms and Formulas
Business Structures
Sole Proprietorship
A business owned by a single individual.
Partnership
An association of two or more individuals joining together as co-owners to operate a business for profit.
General Partnership
A partnership in which all partners are fully liable for the indebtedness incurred by the partnership.
Limited Partnership
A partnership in which one or more of the partners have limited liability, restricted to the amount of capital he or she invested in the partnership.
Corporation
An entity that legally functions separate and apart from its owners.
S-Corporation
A corporation that, because of specific qualifications, is taxed as though it were a partnership.
Limited Liability Company (LLC)
A cross between a partnership and a corporation under which the owners retain limited liability but the company is run and is taxed like a partnership.
Key Financial Terms
Incremental Cash Flow
The difference between the cash flows a company will produce both with and without the investment it is thinking about making.
Opportunity Cost
The cost of making a choice in terms of the next best alternative that must be forgone.
Agency Problem
Problems and conflicts resulting from the separation of the management and ownership of the firm.
Fixed Cost
Costs that remain constant, regardless of any change in a firm’s activity.
Semi-Variable Costs
Costs composed of a mixture of fixed and variable components.
Cash
Cash on hand, demand deposits, and short-term marketable securities that can quickly be converted to cash.
Other Current Assets
Other short-term assets that will benefit future time periods, such as prepaid expenses.
Fixed Assets
Assets such as equipment, buildings, and land.
Liquidity
A firm’s ability to pay its bills on time. Liquidity is related to the ease and speed with which a firm can convert its noncash assets into cash, as well as to the size of the firm’s investments in noncash assets relative to its short-term liabilities.
Asset Management
How efficiently management is using the firm’s assets to generate sales.
Investable Assets
Financial instruments and business assets.
Financial Markets
Efficient Market
A market in which the prices of securities at any instant in time fully reflect all publicly available information about the securities and their actual public value.
Financial Markets
Those institutions and procedures that facilitate transactions in all types of financial claims.
Capital Markets
All institutions and procedures that facilitate transactions in long-term financial instruments.
Spot Market
Cash market.
Primary Market
A market in which securities are offered for the first time for sale to potential investors.
Futures Market
Markets where you can buy or sell something at a future date.
Investment & Funding
Capital Budgeting
The decision-making process with respect to investment in fixed assets.
Capital Structure
The decision-making process with funding choices and the mix of long-term sources of funds.
Working Capital Management
The management of the firm’s current assets and short-term financing.
Angel Investor
A wealthy private investor who provides capital for a business start-up.
Venture Capital
An investment firm (or individual) that provides money to business start-ups.
Time Value of Money (TVM)
Time Value of Money
A substantial amount of money is produced each year from individual and corporate savings. Those funds can be invested in the thousands of investable assets that are generally available.
Annuity
A series of equal dollar payments made for a specified number of years.
Ordinary Annuity
An annuity where the cash flows occur at the end of each period.
Compound Annuity
Depositing an equal sum of money at the end of each year for a certain number of years and allowing it to grow.
Annuity Due
An annuity in which the payments occur at the beginning of each period.
Amortized Loan
A loan that is paid off in equal periodic payments.
Effective Annual Rate (EAR)
The annual compound rate that produces the same return as the nominal, or quoted, rate when something is compounded on a nonannual basis. In effect, the EAR provides the true rate of return.
TVM Formulas
Single Cash Flow Future Value
N = # of future time periods investment return is paid
I = Investment return
PV = Present Value / Initial investment asset
FV = Future value of investment asset
FV = PV * FVF
or 
Annuity Present Value
PVA = PMT x PVFAI,n
PVFAI,n = [
]
PVFAI,n = PVA / PMT
Perpetuity Present Value
PV = PMT / I
I = PMT / PV
Growing Perpetuity Present Value
PV = PMT1 / (I – g)
(I – g) = PMT1 / PV
Unequal Future Cash Flows Present Value (Limited N)
PV = CF1 / (1+I)1 + CF2 / (1+I)2 + CF3 / (1+I)3 + … + CFn / (1+I)n
Unequal Future Cash Flows Present Value (Unlimited N)
PV = CF1 / (1+I)1 + CF2 / (1+I)2 + CF3 / (1+I)3 + … + CFn / (1+I)n + CFn+1 / (I – g)
Financial Statement Concepts & Formulas
FCF vs WACC
Free Cash Flow Return on Assets > Weighted Average Cost of Capital (FCF > WACC)
Asset & Liability Impact on Cash Flow
Assets: Increase = Use of Cash (to buy items). Decrease = Source of Cash.
Liabilities/Equity: Increase = Source of Cash. Decrease = Use of Cash.
ROE (Risk-Based)
ROE = Rate of return on a risk-free investment + Appropriate risk premium
Total Assets Formula
Total assets = Total liabilities (debt) + Total shareholders’ equity
Ending Retained Earnings Formula
Beginning retained earnings + Net income for the year – Dividends paid during the year = Ending retained earnings
Common Equity Formula
Common equity = Common shareholders’ investment + Cumulative profits – Cumulative dividends paid to common stockholders
Net Working Capital Formula
Net working Capital = Current assets – Current liabilities
Cash Collections from Sales Formula
Cash collections from sales = Sales – Change in accounts receivables
Free Cash Flow Formula
Free cash flow = [After-tax cash flows from operations] – [Change in net operating working capital] – [Change in long-term assets]
Key Financial Ratios
Current Ratio
Current ratio = Current assets / Current liabilities
Acid Test Ratio
Acid test ratio = (Cash + Accounts receivables) / Current liabilities
Days in Receivables
Days in receivables = Accounts receivable / Daily credit sales = Accounts receivables / (Annual credit sales / 365)
Accounts Receivable Turnover
Accounts receivable turnover = Annual credit sales / Accounts receivables
Days in Inventory
Days in inventory = Inventory / Daily cost of goods sold = Inventory / (Annual cost of goods sold / 365)
Inventory Turnover
Inventory turnover = Cost of goods sold / Inventory
Operating Return on Assets
Operating return on assets = Operating profits / Total assets
Operating Return on Assets (Alternative)
Operating return on assets = Operating profit margin x Total asset turnover
Operating Return on Assets (Expanded)
Operating return on assets = (Operating profits / Sales) x (Sales / Total assets)
Operating Profit Margin
Operating profit margin = Operating profits / Sales
Total Asset Turnover
Total asset turnover = Sales / Total assets
Fixed Asset Turnover
Fixed asset turnover = Sales / Net fixed assets
Debt Ratio
Debt ratio = Total debt / Total assets
Times Interest Earned
Times interest earned = Operating profits / Interest expense
ROE (Net Income Based)
ROE = Net income / Total common equity
Price/Earnings Ratio
Price/Earnings ratio = Market price per share / Earnings per share
Price/Book Ratio
Price/Book ratio = Market price per share / Equity book value per share
EVA
EVA = (Operating return on assets – Cost of capital) x Total assets
Net Profit Margin
Net profit margin = Net income / Sales
Operating Profit Margin (EBIT)
Operating profit margin = EBIT / Sales