MANAGERIAL FINANCE REVIEWER (PRELIMS)

Finance art and science of managing money

Financial Services - the area of finance concerned
with the design and delivery of advice and
financial products to individuals, business, and
government
Managerial Finance - concerned with the duties of
the financial manager in the business firm
Financial Managers - manage the financial affairs
of any type of businesses; perform such varied
financial tasks as planning, extending credit to
customers, evaluating proposed large
expenditures, and raising money to fund the
firms operations
Sole Proprietorship - business owned by one
person and operated for his or her own profit; has
unlimited liability - condition of a sole
proprietorship (or general partnership) allowing
the owners total wealth to be taken to satisfy
creditors.
Partnership - business owned by two or more
people and operated for profit.
Articles of Partnership - written contract
used to formally establish a business partnership.
Corporation artificial being created by law (often
called a legal entity).
* For many small corporations, as well as small
proprietorships and partner- ships, there is no
access to financial markets. In addition, whenever
the owners take out a loan, they usually must
personally cosign the loan.
Stockholders - owners of a corporation,
whose ownership, or equity, is evidenced by
either common stock or preferred stock
Common Stock - purest and most basic
form of corporate ownership; units of ownership,
or equity, in a corporation
Dividends - periodic distributions of
earnings to the stockholders of a firm.
Board of Directors - group elected by the
firms stockholders and having ultimate authority
to guide corporate affairs and make general
policy
* Some corporations do not have stockholders but
rather have members who often have rights
similar to those of stockholdersthat is, they are
entitled to vote and receive dividends. Examples
include mutual savings banks, credit unions,

mutual insurance companies, and a whole host of

charitable organizations
President or CEO - responsible for managing the
firms day-to-day operations and carrying out the
policies established by the board of directors
Other Limited Liability Organizations:
Limited partnership (LP) - one or more partners
have limited liability as long as at least one
partner (the general partner) has unlimited
liability; limited partners cannot take an active
role in the firms management; they are passive
investors.
S corporation (S corp) - tax-reporting entity that
allows certain corporations with 75 or fewer
stockholders to choose to be taxed as
partnerships; receive the organizational benefits
of a corporation and the tax advantages of a
partnership
Limited liability Corporation (LLC) - permitted in
most states, the LLC gives its owners, like those
of S corps, limited liability and taxation as a
partnership; can own more than 80% of another
corporation, and corporations, partnerships, or
non-U.S. residents can own LLC shares; work well
for corporate joint ventures or projects developed
through a subsidiary.
Limited Liability Partnership (LLP) permitted in
many states; governing statutes vary by state;
partners have limited liability. They are liable for
their own acts of malpractice, not for those of
other partners. The LLP is taxed as a partnership;
frequently used by legal and accounting
professional
*In recent years this organizational form has
begun to replace professional corporations or
associationscorporations formed by groups of
professionals such as attorneys and accountants
that provide limited liability except for that
related to malpracticebecause of the tax
advantages it offers.
Financial Analyst - prepares the firms financial
plans and budgets. Other duties include financial
fore- casting, performing financial comparisons,
and working closely with accounting.
Capital Expenditures Manager - evaluates and
recommends proposed asset investments. May
be involved in the financial aspects of
implementing approved investments.
Project Finance Manager - in large firms, arranges
financing for approved asset investments.

Coordinates consultants, investment bankers, and

legal counsel.

to share price; most popular incentive plan

involves the grant of stock options.

Cash Manager - maintains and controls the firms

daily cash balances. Frequently manages the
firms cash col- lection and disbursement
activities and short-term investments;
coordinates short-term borrowing and banking
relationships.

Stock Options - incentive allowing managers to

purchase stock at the market price set at the
time of the grant.

Credit Analyst/Manager - administers the firms

credit policy by evaluating credit applications,
extending credit, and monitoring and collecting
accounts receivable.
Pension Fund Manager - in large companies,
oversees or manages the assets and liabilities of
the employees pension fund.
Foreign Exchange Manager - manages specific
foreign operations and the firms exposure to
fluctuations in exchange rates
Treasurer -firms chief financial manager, who is
responsible for the firms financial activities, such
as financial planning and fund raising, making
capital expenditure decisions, and managing
cash, credit, the pension fund, and foreign
exchange; external
Controller - firms chief accountant, who is
responsible for the firms accounting activities,
such as corporate accounting, tax management,
financial accounting, and cost accounting;
internal
Foreign Exchange Manager - responsible for
monitoring and managing the firms exposure to
loss from currency fluctuations
Earnings Per Share (EPS) - amount earned during
the period on behalf of each outstanding share of
common stock, calculated by dividing the
periods total earnings available for the firms
common stockholders by the number of shares of
common stock outstanding
Stakeholders - employees, customers, suppliers,
creditors, owners, and others who have a direct
economic link to the firm
Risk - chance that actual outcomes may differ
from those expected
Agency Problem - likelihood that managers may
place personal goals ahead of corporate goals

Performance Plans - plans that tie management

compensation to measures such as EPS, growth
in EPS, and other ratios of return. Performance
shares and/or cash bonuses are used as
compensation under these plans.
Performance Shares - shares of stock given to
management for meeting stated performance
goals.
Cash Bonuses - cash paid to management for
achieving certain performance goals.
Financial Institution - an intermediary that
channels the savings of individuals, businesses,
and governments into loans or investments;
directly or indirectly pay savers interest on
deposited funds; others provide services for a fee
*Individuals not only supply funds to financial
institutions but also demand funds from them in
the form of loans they are net suppliers - save
more money than they borrow
*Business Firms also deposit some of their funds
in financial institutions, primarily in checking
accounts with various commercial banks they are
net demanders - borrow more money than they
save
* Governments maintain deposits of temporarily
idle funds, certain tax payments; do not borrow
funds directly from financial institutions, although
by selling their debt securities to various
institutions, governments indirectly borrow from
them; net demanders
Financial Markets - forums in which suppliers of
funds and demanders of funds can transact
business directly
Money Market - transactions in short-term
debt instruments, or marketable securities;
financial relationship created between suppliers
and demanders of short-term funds
Capital Market - long-term securities
bonds and stocks

Agency Costs - costs borne by stockholders to

minimize agency problems

Private Placement - sale of a new security issue,

typically bonds or preferred stock, directly to an
investor or group of investors

Incentive Plans - management compensation

plans that tend to tie management compensation

Public Offering - nonexclusive sale of either bonds

or stocks to the general public

Primary Market - financial market in which

securities are initially issued; the only market in
which the issuer is directly involved in the
transaction; receives the proceeds from the sale
of securities
Secondary Market - financial market in which preowned securities (those that are not new issues)
are traded
Marketable Securities - short-term debt
instruments, Sisuch as treasury bills, commercial
paper, and negotiable certificates of deposit
issued by government, business, and financial
institutions, respectively.
* In the money market, businesses and
governments demand short-term funds (borrow)
by issuing a money market instrument. Parties
who supply short-term funds (invest) purchase
the money market instruments.
Capital Market - enables suppliers and demanders
of long-term funds to make transactions;
backbone is formed by the various securities
exchanges that provide a forum for bond and
stock transactions
Bonds - long-term debt instrument used by
business and government to raise large sums of
money, generally from a diverse group of lenders;
key capital market securities
Corporate Bonds - pay interest semiannually at a
stated coupon interest rate
Preferred Stock - special form of ownership
having a fixed periodic dividend that must be
paid prior to payment of any common stock
dividends
International Equity Market - market that allows
corporations to sell blocks of shares to investors
in a number of different countries simultaneously
Efficient Market - allocates funds to their most
productive uses as a result of competition among
wealth-maximizing investors that determines and
publicizes prices that are believed to be close to
their true value
Capital Gain - amount by which the sale price of
an asset exceeds the assets initial purchase
price
Time Value of Money - an important tool that
financial managers and other market participants
use to assess the impact of proposed actions;
enable financial managers to evaluate cash flows
occurring at different times in order to combine,

compare, and evaluate them and link them to the

firms overall goal of share price maximization
Time Line - horizontal line on which time zero
appears at the leftmost end and future periods
are marked from left to right; can be used to
depict investment cash flows
Financial Tables - include various future and
present value interest factors that simplify time
value calculations
Single Amount - lump-sum amount either
currently held or expected at some future date
Annuity - level periodic stream of cash flow;
annual cash flows
Mixed Stream - stream of cash flow that is not an
annuity; a stream of unequal periodic cash flows
that reflect no particular pattern
* Although future value is more intuitively
appealing, present value is more useful in
financial decision making
Compound Interest - interest that is earned on a
given deposit and has become part of the
principal at the end of a specified period
Principal - amount of money on which interest is
paid
Future Value - value of a present amount at a
future date, found by applying compound interest
over a specified period of time
Future Value Interest Factor - multiplier used to
calculate, at a specified interest rate, the future
value of a present amount as of a given time
Present Value - current dollar value of a future
amountthe amount of money that would have
to be invested today at a given interest rate over
a specified period to equal the future amount
Discounting Cash Flows - process of finding
present values; the inverse of compounding
interest
Present Value Interest Factor - multiplier used to
calculate, at a specified discount rate, the
present value of an amount to be received in a
future period
Annuity - stream of equal periodic cash flows,
over a specified time period. These cash flows
can be inflows of returns earned on investments
or outflows of funds invested to earn future
returns

Ordinary Annuity - annuity for which the cash flow

occurs at the end of each period

Quarterly Compounding - compounding of

interest over four periods within the year

Annuity Due - annuity for which the cash flow

occurs at the beginning of each period

Continuous Compounding - compounding of

interest an infinite number of times per year at
intervals of microseconds

Future Value Interest Factor for an Ordinary

Annuity - multiplier used to calculate the future
value of an ordinary annuity at a specified
interest rate over a given period of time
Present Value Interest Factor for an Ordinary
Annuity multiplier used to calculate the present
value of an ordinary annuity at a specified
discount rate over a given period of time
* The future value of an annuity due is always
greater than the future value of an otherwise
identical ordinary annuity.

Nominal (stated) Annual Rate - contractual

annual rate of interest charged by a lender or
promised by a borrower.
Effective (true) Annual Rate (EAR) - annual rate of
interest actually paid or earned
Loan Amortization - determination of the equal
periodic loan payments necessary to provide a
lender with a specified interest return and to
repay the loan principal over a specified period.

Perpetuity - annuity with an infinite life, providing

continual annual cash flow.

Loan Amortization Schedule - schedule of equal

payments to repay a loan. It shows the allocation
of each loan payment to interest and principal

Semiannual Compounding - compounding of

interest over two periods within the year

*Amortizing a loan actually involves creating an

annuity out of a present amount