Basic Definitions In Accounting And Finance



A financial asset is a legal document representing a claim to income.Stock represents an ownership interest. Bonds represent a debt relationship.Investing involves buying financial assets in the hope of earning income.A mutual fund purchases securities with the pooled resources of many investors.Securities are traded in financial markets like the stock market.A stockbroker is licensed to trade securities on behalf of investors.A real asset is an object that provides a service.Financing means raising money to acquire something.The corporate executive in charge of finance is called the Chief Financial Officer (CFO).The finance department oversees how other departments spend money.The controller is in charge of accounting while the treasurer supervises most other financial functions.In finance, cash is king.Accounting is the language of finance.Assets pledged to guarantee a loan are collateral.A major financial disadvantage of proprietorship is the difficulty encountered in raising money.Double taxation of earnings is the major financial disadvantage of the traditional corporate form.Ease of raising money by selling stock is the most significant financial advantage of the corporate form.Shareholder wealth maximization is a practical goal for corporate management.The ownership of a widely held company is dispersed so no one has enough control to influence.The conflict of interest between stockholders and management is known as the agency problem.An agent is hired by a principal and given decision making authority.Privileges and luxuries provided to executives are called perquisites (or “perks”).A creditor is anyone owed money by a business, including lenders, vendors, employees, or the governmentFinancial statements are numerical representations of a firm’s activities for an accounting period.Depreciation is the proration of an asset’s cost over its service life.A firm’s financial books are a collection of records in which money transactions are recorded.In double entry accounting, every entry has two sides that must balance.Books are closed by updating the period’s transactions in the accounting system and creating financial statementsLeverage is the use of debt financing.Operating profit (EBIT) is a business’s profit before consideration of financing charges.Retained earnings are those not paid out as dividends.A liability is an amount a firm must eventually pay.The ease with which an asset becomes cash is referred to as liquidity.Marketable securities are liquid investments that are held instead of cash.Current assets become cash, within one year.According to the matching principle, recognition of an asset’s cost should match its service life.Accelerated depreciation recognizes more of an asset’s cost in the early years of its life.Vendors extend trade credit when they deliver product without demanding immediate payment.Terms of sale specify when payment is expected for sales made on trade credit.Stretching payables is delaying payment of trade payables.Accruals represent incomplete transactions.Current liabilities require cash within one working capital represents the money required to support day-today activities.A business financed with debt is said to be leveraged.Equity financing is provided by a business’s owners.Retained earnings are profits that have not been distributed to shareholders as dividends.Preferred stock is an equity security that has some of the characteristics of debt.Ordinary income includes wages, business profits, dividends, and interest.Capital gain/loss income arises when an asset that’s held for investment is sold for more/less than was paid for it.The statement of cash flows presents operating, investing, and financing activities separately.Operating activities involve the income statement and current balance sheet accounts.Investing activities typically include purchasing fixed assets.Financing activities deal with the capital accounts, long term debt and equity.A firm that manages cash poorly can go out of business while making an accounting profit.Cash generated beyond Reinvestment needs is free cash flow.For a business, liquidity refers to its ability to pay its bills in the short run.Ratios are typically compared with similar figures from history, the competition, and budget.A common size income statement presents each line item as a percent of revenue.Ratios fall into five categories: liquidity, asset management, debt management, profitability, and market value.Liquidity ratios measure the ability to meet short-term financial obligations.Inventory turnover gives an indication of the quality of inventory as well as how well it is managed.Fixed financial charges like interest increase a firm’s financial risk.A high level of interest coverage implies safety.Lease payments are fixed financial charges similar to interest.ROS measures control of the income statement: revenue, cost and expense.The P/E ratio is an indication of the value the stock market places on a company.A firm’s P/E is primarily a function of its expected growth.The Du Pont equations express relationships between ratios that give insights into successful operation.A business plan is a model of what management expects a business to become in the future expressed in words and financial projections.A firm’s financial plan is a projection of its financial statements into the future.The planning process helps to pull the management team together.Budgets are short-term updates of the annual plan when business conditions change rapidly.Forecasts are very short-term projections of profit and cash flow.The financial plan is an integral part of the overall business plan.Most financial planning involves forecasting changes in ongoing businesses based on planning assumptions.The cash budget is a detailed projection of receipts and disbursements of cash.Capital markets deal in long-term debt and stock. Money markets deal in short-term debt.An investment bank helps companies market their securities.A financial intermediary sells shares in itself and invests the funds collectively on behalf of its investors.The market for initial public offerings (IPOs) is very volatile and risky.The dividend yield gives an indication of the current income an investor can expect.The closing price records the last trade of the day.An employee stock option grants the right to purchase stock at a set price over a limited period.Stock options can motivate executives to act unethically to hold stock price up.A favorable audit result does not guarantee that financial statements are entirely correct.Bonds are the primary vehicle for making debt investments.A debt’s term or maturity is the time until it must be repaid.Interest rates and security prices move in opposite directions.In debt markets lenders represent supply and borrowers represent demand.Interest is the price of money in a debt market.Interest rates include base rates and risk premiums.The base rate is pure interest plus expected inflation.The pure interest rate is the earning power of money.Default risk is the chance the lender won’t pay principal or interest.Liquidity risk is associated with being unable to sell the bond of a little known issuer.The risk-free rate is approximately the yield on short term treasury bills.Expectations theory: Today’s rates rise or fall with term as future rates are expected to rise or fall.Liquidity preference theory: Investors prefer shorter-term securities and must be induced to make longer loans.The present value of a sum at a future time is the amount that must be deposited at interest today to have the sum at that time.The discounted value of a sum is its present value.The future value factor for k and n is the calculated value of (1 _ k)n.The opportunity cost of a resource is the benefit that would have been available from its next best use.The future and present value factors are reciprocals. Either amount equation can be used to solve any amount problem.Perpetuity is a stream of regular payments that goes on forever. Preferred stock dividends are perpetuity.A steady stream of earnings is capitalized at its present value as a perpetuity.An annuity is a finite series of equal payments separated by equal time intervals.In an annuity due payments occur at the beginning of each period.The future value of an annuity is the sum, at its end, of all payments and all interest if each payment is deposited when received.A sinking fund provides cash to pay off a bond’s principal at pounding refers to earning interest on interest.Interest is usually Compounded annually, semiannually, quarterly, or monthly.Interest rates are quoted by stating the nominal rate followed by the compounding period.An amortized loan’s principal is paid off regularly over its life.Loan amortization schedules detail the interest and principal in each loan payment.Convertible bonds are exchangeable for stock at a conversion price. ................
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