CHAPTER 1: INTRODUCTION TO FINANCIAL MANAGEMENT

Sarbanes–Oxley Act​ – A law passed by Congress that requires the CEO and CFO to certify
that their firm’s financial statements are accurate.

Proprietorship​ – An unincorporated business owned by one individual.

Partnership​ – An unincorporated business owned by two or more persons.

Corporation​ – A legal entity created by a state, separate and distinct from its owners and
managers, having unlimited life, easy transferability of ownership, and limited liability.

S Corporations​ – A special designation that allows small businesses that meet qualifications to
be taxed as if they were a proprietorship or a partnership rather than a corporation.

Limited Liability Company (LLC)​ – A popular type of organization that is a hybrid between a
partnership and a corporation.

Limited Liability Partnership (LLP)​ – Similar to an LLC but used for professional firms in the
fields of accounting, law, and architecture. It provides personal asset protection from business
debts and liabilities but is taxed as a partnership.

Intrinsic Value​ – An estimate of a stock’s “true” value based on accurate risk and return data.
The intrinsic value can be estimated, but not measured precisely.

Market Price​ – The stock value based on perceived but possibly incorrect information as seen
by the marginal investor.

Marginal Investor​ – An investor whose views determine the actual stock price.

Equilibrium​ – The situation in which the actual market price equals the intrinsic value, so
investors are indifferent between buying and selling a stock.

Corporate Raiders​ – Individuals who target corporations for takeover because they are
undervalued.

Hostile Takeover​ – The acquisition of a company over the opposition of its management.
Shareholder Wealth Maximization – The primary financial goal for managers of publicly owned
companies implies that decisions should be made to maximize the long-run value of the firm’s
common stock.

Derivative​ – Any financial asset whose value is derived from the value of some other
“underlying” asset.
CHAPTER 2: FINANCIAL MARKETS AND INSTITUTIONS

Spot Markets​ – The markets in which assets are bought or sold for “on-the-spot” delivery.

Future Markets​ – The markets in which participants agree today to buy or sell an asset at some
future date.

Money Markets​ – The financial markets in which funds are borrowed or loaned for short
periods (less than 1 year)

Capital Markets​ – The financial markets for stocks and for intermediate– or long-term debt (one
year or more)

Primary Markets ​– Markets in which corporations raise capital by issuing new securities.

Secondary Markets​ – Markets in which securities and other financial assets are traded among
investors after they have been issued by corporations.

Private Markets​ – Markets in which transactions are worked out directly between two parties.

Public Markets​ – Markets in which standardized contracts are traded on organized exchanges.

Investment Bank​ – An organization that underwrites and distributes new investment securities
and helps businesses obtain financing.

Commercial Bank​ – The traditional department store of finance serving a variety of savers and
borrowers.

Financial Services Corporations​ – A firm that offers a wide range of financial services,
including investment banking, brokerage operations, insurance, and commercial banking.

Mutual Funds​ – Organizations that pool investor funds to purchase financial instruments and
thus reduce risks through diversification.

Money Market Funds​ – Mutual funds that invest in short-term, low-risk securities, and allow
investors to write checks against their accounts.

Over-the-Counter (OTC) Market​ – A large collection of brokers and dealers, connected

electronically by telephones and computers, that provides for trading in unlisted securities.

Dealer Markets​ – Includes all facilities that are needed to conduct security transactions not
conducted on the physical location exchanges.
Physical Location Exchanges​ – Formal organizations having tangible physical locations that
conduct auction markets in designated (“listed”) securities.

Closely Held Corporation​ – A corporation that is owned by a few individuals who are typically
associated with the firm’s management.

Publicly Owned Corporation​ – A corporation that is owned by a relatively large number of

individuals who are not actively involved in the firm’s management.

Going Public​ – The act of selling stock to the public at large by a closely held corporation or its
principal stockholders.

Initial Public Offering (IPO) Market ​– The market for stocks of companies that are in the
process of going public.

CHAPTER 3: FINANCIAL STATEMENTS, CASH FLOWS, AND TAXES

Annual Report​ – A report issued annually by a corporation to its stockholders. It contains basic
financial statements as well as management’s analysis of the firm’s past operations and future
prospects.

Balance Sheet​ – A statement of a firm’s financial position at a specific point in time.

Stockholders’ Equity​ – It represents the amount that stockholders paid the company when
shares were purchased and the amount of earnings the company has retained since origination.

Retained Earnings​ – They represent that cumulative total of all earnings kept by the company
during its life.

Income Statements​ – A report summarizing a firm’s revenues, expenses, and profits during a
reporting period, generally a quarter or a year.

Operating Income​ – Earnings from operations before interest and taxes.

Depreciation​ – The charge to reflect the cost of assets depleted in the production process.
Depreciation is not a cash outlay.

Amortization​ – A noncash charge similar to depreciation except that it represents a decline in

value of intangible assets.

EBITDA​ – Earnings before interest taxes, depreciation, and amortization.

Statement of Stockholders’ Equity​ – A statement that shows by how much a firm’s equity
changed during the year and why this change occurred.

Free Cash Flow (FCF)​ – The amount of cash that could be withdrawn without harming a firm’s
ability to operate and to produce future cash flows.
Net Operating Profit After Taxes (NOPAT)​ – The profit a company would generate if it had no
debt and held only operating assets.

Market Value Added (MVA)​ – The excess of the market value of equity over its book value.

Economic Value Added (EVA)​ – Excess of NOPAT over capital costs.

Progressive​ – A tax system where the tax rate is higher on higher incomes. The personal
income tax in the United States which ranges from 0% on the lowest incomes to 39.6% on the
highest incomes, is progressive.

Marginal Tax Rate –​ The tax rate applicable to the last unit of a person’s income.

Average Tax Rate ​– Taxes paid divided by taxable income.

Capital Gain or Loss ​– The profit (loss) from the sale of a capital asset for more (less) than its
purchase price.

Alternative Minimum Tax (AMT)​ – Created by Congress to make it more difficult for wealthy
individuals to avoid paying taxes through the use of various deductions.

Tax Loss Carry-Back or Carry-Forward ​– Ordinary corporate operating losses can be carried
backward for 2 years and carried forward for 20 years to offset taxable income in a given year.

Net Working Capital-​ current assets minus current liabilities

Net Operating Working Capital (NOWC)​- current assets minus non-interest bearing current
liabilities

CHAPTER 4: AN ANALYSIS OF FINANCIAL STATEMENTS

Liquid asset​- an asset that can be converted to cash quickly without having to reduce the
asset’s price very much

Liquidity ratio​- ratios that show the relationship of a firm’s cash and other current assets to its
current liabilities
Current ratio​- this ratio is calculated by dividing current assets by current liabilities. It indicates
the extent to which current liabilities are covered by those assets expected to be converted to
cash to cash in the near future.

Quick (acid test) ratio​- this ratio is calculated by deducting inventories from current assets and
then dividing the remainder by current liabilities

Asset management ratios​- a set of ratios that measure how effectively a firm is managing its
assets

Inventory turnover ratio​- this ratio is calculated by dividing sales by inventory

Day Sales Outstanding (DSO)​- this ratio is calculated by dividing accounts receivable by
average sales per day. It indicates the average length of time the firm must wait after making a
sale before it receives cash.

Fixed assets turnover ratio​- the ratio of sales to net fixed

Total assets turnover ratio​- this ratio is calculated by dividing sales by total assets

Debt management ratios​- a set of ratios that measure how effectively a firm manages its debt

Total debt to total capital​- the ratio of total debt to total capital

Times-Interest-Earned (TIE)​ ratio- the ratio of earnings before interest and taxes (EBIT) to
interest charges; a measure of the firm’s ability to meet its annual interest payments

Profitability ratios​- a group of ratios that show the combined effects on liquidity, asset
management, and debt on operating results

Operating margin​- this ratio measures operating income, or EBIT, per dollar of sales; it is
calculated by dividing operating income by sales

Profit margin​- this ratio measures net income per dollar of sales and net is calculated by
dividing net income by sales

Return on Total Assets (ROA)​- this ratio of net income to total assets

Return on Common Equity (ROE)-​ this ratio of net income to common equity; measures the
rate of return on common stockholders’ investment

Return on Invested Capital (ROIC)- ​this ratio of after-tax operating income to total invested
capital; it measures the total return that the company has provided for its investors
Basic Earning Power (BEP) ratio-​ this ratio indicates the ability of the firm’s assets to generate
operating income; it is calculated by dividing EBIT by total assets

Market value ratios​- ratios that relate the firm’s stock price to its earnings and book value per
share
Price/Earnings (P/E) ratio- ​the ratio of the price per share to earnings per share; shows the
dollar amount investors will pay for $1 of current earnings

Market/Book (M/B) Ratio-​ the ratio of a stock’s market price to its book value

DuPont Equation-​ a formula that shows that the rate of return on equity can be found as the
product of profit margin, total assets turnover, and the equity multiplier. It shows the
relationships among asset management, debt management, and profitability ratios.

Benchmarking-​ the process of comparing a particular company with a subset of top

competitors in its industry

Trend Analysis-​ an analysis of a firm’s financial ratios over time; used to estimate the likelihood
of improvement or deterioration in its financial condition.

Window dressing techniques-​ techniques employed by firms to make their financial

statements look better than they really are

Time Line-​ an important tool used in time value analysis; it is a graphical representation used to
show the timing of cash flows

CHAPTER 5: TIME VALUE OF MONEY

Future Value (FV)-​ the amount to which a cash flow or series of cash flows will grow over a
given period of time when compounded at a given interest rate

Present value (PV)-​ the value today a future cash flow or series of cash flows

Compounding-​ the arithmetic process of determining the final value of a cash flow or series of
cash flows when compound interest is applied

Compound interest- ​occurs when interest is earned on prior period’s interest

Simple interest- ​occurs when interest is not earned on interest

Opportunity cost-​ the rate of return you could earn on alternative investment of similar risk
Discounting- ​the process of finding the present value of a cash flow or series of cash flows;
discounting is the reverse of compounding

Annuity-​ a series of equal payments at fixed intervals for a specified number of periods

Ordinary (Deferred) annuity-​ an annuity whose payments occur at the end of each period
Annuity Due-​ an annuity whose payments occur at the beginning of each period

FVAn-​ the future value of annuity over N periods

PVAn​- the present value of an annuity of N periods

Uneven (Nonconstant) cash flows-​ a series of cash flows where the amount varies from one
period to the next.

Payment (PMT)-​ this term designates equal cash flows coming at regular intervals

Cash flow- ​this term designates of cash flow that’s not part of an annuity

Annual compounding- ​the arithmetic process of determining the final value of a cash flow or
series of cash flows when interest in added once a year

Semiannual compounding-​ the arithmetic process of determining the final value of a cash flow
or series of cash flows when interest is added twice a year

Nominal (Quoted or Stated) Interest Rate-​ the contracted interest rate

Annual Percentage Rate (APR)-​ the periodic rate times the number of periods per year

Effective (equivalent) annual rate (EFF% or EAR)-​ the annual rate of interest actually being
earned, as opposed to the quote rate

Amortized Loan-​ a loan that is repaid in equal payments over its life

Amortization schedule- ​a table showing precisely how a loan will be repaid. It gives the
required payment on each payment date and a breakdown of a payment, showing how much is
interest and how much is repayment of principal.

Perpetuity- ​a stream of equal payments at a fixed intervals expected to continue forever