FIN 345 1nd EditionExam # 1 Study Guide Lectures: 6 - 9Lecture 71. Reviewa. A proprietorship is an unincorporated business owned by one individual. It is easily and inexpensively formed, it is subject to few government regulations, and it is taxed as an individual not a corporation.b. 3 of 4 Disadvantages of proprietorship: unlimited personal liability for business debts, transferring ownership can be difficult, life is only as long as the person that owns it is alivec. Most significant advantage to corporations: Limited liability d. Most significant disadvantage to corporations: Double taxatione. A Limited Liability Company or S Corporation is a business structure that offers the limited personal liability associated with a corporation, but the company’s income is taxed like a partnership (to the partners as individual income).f. A corporation that has no more than 100 stockholders and only one type of stock outstanding can elect to file taxes as an S Corporation. The income passesthrough the company to the owners so that it is taxed only once.g. Management’s primary goal is stockholder wealth maximization, which translates into maximizing the value of the firm is measured by the price of it’s common stockh. Managerial actions to maximize value/shareholder wealthi. Managers actions must be consistent with the following:ii. The value of any investment, such as a stock, is based on the amount of cash flowiii. Investors prefer to receive an expected cash flow now rather than later.iv. Investors generally are risk averse, which means they are willing to pay more for investments with more certain future cash flows than investments with less certain, or riskier, cash flows, everything else equal.v. Wealth maximization is a long term goali. 2 of 3 mechanisms used by shareholders to get managers to act in shareholder’s best interests:i. Threat of a takeoverii. Incentives tied to manager performance2. New notes:These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.a. Managers’ job: Maximize value of company. Increase in cash flows increases value of company. Need to generate cash flows sooner rather than later. Needs to increase certainty of cash flows. b. External environment same for everybody operating a business: legal restraints, health of the economy (robust or static), tax laws, conditions in financial marketsc. Taxesi. 2 components to US Federal tax system1. Individuals2. Corporationsii. Need to know marginal tax rateLecture 81. Financial Statements and Reportsa. Annual Reporti. A report issued annually by a corporation to its stockholdersii. Management’s opinion of the past year’s operations and the firm’s future prospectsiii. Basic financial statements included in the annual report are:1. Balance sheet: a statement of the firms financial position at a specific point in timea. Cash versus other assetsb. Accounting alternativesi. FIFO (first in first out) LIFO (last in first out)ii. Accelerated or straight-line depreciationc. Breakdown of common equity accounti. Common stock, paid-in capital, retained earningsd. Stock reported at “book values” versus market valuese. The time dimension2. Income statement: a statement summarizing the firm’s revenues and expenses over an accounting period, generally a quarter or ayear3. Statement of retained earnings: a statement reporting changes in the firms retained earnings as a result of the income generated and retained during the yeara. The balance sheet figure for retained earnings is the sum of the earnings retained for each year the firm has been in business (not paid out stockholders)4. Statement of cash flows: a statement reporting the impact of a firm’s operating, investing, and financing activities on cash flows over an accounting period.a. Sources of cashi. Increase liability or equity accountii. Decrease in an asset accountb. Uses of cashi. Decrease in a liability or equity accountii. Increase in an asset accountb. Accounting income versus cash flowi. Cash flows1. The cash receipts and the cash disbursements, as opposed to therevenues and expenses reported for computation of net income, generated by a firm during some specified period2. Accrual accountingii. Accounting profit: a firms net income as reported on its income statementiii. Operating cash flows: those cash flows that arise from normal operations; the difference between cash collections and cash expensesLecture 91. How do investors use financial statements?a. Working/operating capitali. Short term financingii. Short term investingiii. Net working capitalb. Operating cash flows, Free cash flow, economic value added (EVA)2. Ratio Analysisa. Objective is to anticipate future financial conditionsb. Starting point for planning future actionsc. Liquid asseti. An asset that can be easily converted into cash without significant loss of its original valued. Liquidity ratiosi. Ratios that relate the firms cash and other assets to its current liabilitiesii. Indicate how well a firm can meet its current obligationse. Current ratioi. Indicates the extent to which current liabilities are covered by assets expected to be converted into cash in the near future. Current ratio=current assets/current liabilitiesf. Quick ratioi. Deducts inventories from current assets and divides the remainder by current liabilitiesg. Asset management ratiosi. Ratios that measure how effectively a firm is managing its assetsii. Inventory turnover=cost of goods sold/inventory=variable operating costs/inventoryiii. Days sales outstanding = receivables/average sales per day=receivables/(annual sales/360)iv. Fixed assets turnover ratio = sales/net fixed assets (how efficiently is thefirm using fixed assets)v. Total assets turnover ratio=sales/total assetsh. Debt management ratiosi. Analyze the company’s use of debtii. Financial leverage: the use of debt financingiii. Debt ratio: total liabilities/total assetsiv. Times-interest-earned ratio: EBIT/interest chargesv. Fixed charge coverage ratiovi. Profitability ratios:1. Ratios showing the effect of liquidity, asset management, and debt management on operating resultsvii. Net profit margin on sales=net profit/salesviii. Return on total assets: net income/total assetsix. Return on common equity: net income available to common stockholders/total assetsi. Market value ratiosi. Ratios that relate the firms stock price to its earnings and