Core Concepts of Financial Management
What is the primary goal of financial management in a for-profit organization?
Maximization of firm value
What term describes the difference between the present value of cash inflows and the present value of cash outflows for a project?
Net Present Value / NPV
Which financial statement shows a company’s revenues, expenses, and net income over a period?
Income statement
Name two common sources of external financing for a company.
Debt and equity
Name the term: the total pool of financial resources formed from both equity and debt, used to fund a firm’s operations and investments.
Capital
Name the metric: the discount rate at which a project’s NPV becomes zero.
Internal Rate of Return / IRR
Name the term: total assets minus total liabilities.
Equity
What’s the main difference between short-term and long-term financing?
Short-term financing is typically due within one year; long-term financing is due in more than one year.
Financial managers make decisions in three core areas. What are they?
Investment decisions, financing decisions, and cash flow management / dividend policy)
You are comparing two mutually exclusive investment projects. Project A has a higher NPV, but Project B has a higher IRR. Which metric should generally guide your decision and why?
NPV should be preferred because it measures absolute value creation, whereas IRR can be misleading for non-conventional cash flows or mutually exclusive projects.
What does the current ratio measure, and what is the formula?
It measures short-term liquidity. Formula: Current Assets / Current Liabilities
Name the term: funds borrowed from a bank or investors that must be repaid with interest
Debt financing / Loan / Borrowed capital
What term describes a company’s ability to meet its short-term obligations using current assets?
Liquidity
What investment appraisal method uses a ratio of present value of future cash flows to the initial investment
Profitability Index / PI
What is the formula for Net Profit Margin, and what does it indicate?
Net Income / Revenue. It shows how much profit the company makes per dollar of revenue
What is retained earnings, and why is it considered an internal source of financing?
Retained earnings are profits not distributed as dividends but reinvested into the company; they come from within the business, not external sources
What are three key differences between financial accounting and financial management as disciplines?
1. Financial accounting records historical data; financial management is forward-looking and decision-oriented.
2. Accounting emphasizes accuracy and compliance; financial management emphasizes strategy and performance.
3. Accounting focuses on reporting past performance; financial management focuses on planning for value creation
Name three limitations of the Payback Period method and explain why it is considered a less reliable tool for investment evaluation.
1. Ignores time value of money,
2. Ignores cash flows after payback period,
3. Doesn’t measure profitability or risk
A company has current assets of $200,000 and current liabilities of $100,000. Calculate the current ratio and explain if it suggests good liquidity.
2.0 — Yes, a ratio above 1 indicates the company can cover short-term obligations
Compare two advantages and two disadvantages of using debt instead of equity to finance business growth.
Advantages: 1) No ownership dilution, 2) Interest is tax-deductible.
Disadvantages: 1) Increases financial risk, 2) Requires fixed payments regardless of profits.