State the three-component DuPont Analysis decomposition of Return on Equity (ROE).

ROE = Net Profit Margin * Asset Turnover * Financial Leverage = (Net Income / Revenue) * (Revenue / Total Assets) * (Total Assets / Shareholders' Equity).

State the Present Value (PV) formula for a single future sum.

PV = FV / (1 + r)^n = FV * (1 + r)^(-n).

What is Free Cash Flow to the Firm (FCFF) and what are its standard formulas?

The cash flow available to all capital providers (debt and equity) after operating expenses, taxes, and reinvestment. Starting from US GAAP CFO (where interest paid was deducted): FCFF = CFO + Interest Expense × (1 − Tax Rate) − CapEx. Equivalently, from EBIT: FCFF = EBIT × (1 − Tax Rate) + D&A − CapEx − ΔOperating NWC.

How do changes in operating Current Assets and Current Liabilities affect Cash Flow from Operations (CFO)?

In the indirect method, an increase in a non-cash operating current asset (e.g., Accounts Receivable, Inventory, Prepaids) is subtracted as a cash outflow, while an increase in a non-debt operating current liability (e.g., Accounts Payable, Accrued Expenses) is added as a cash inflow.

What are the three core sections of the Statement of Cash Flows?

Cash Flow from Operating Activities (CFO), Cash Flow from Investing Activities (CFI), and Cash Flow from Financing Activities (CFF). Under US GAAP (ASC 230), interest paid, interest received, and dividends received are classified in CFO while dividends paid are in CFF; IFRS allows differing classifications depending on entity policy and IFRS 18/IAS 7 rules.

How is ending Retained Earnings calculated on the statement of retained earnings?

Ending Retained Earnings = Beginning Retained Earnings + Net Income (or − Net Loss) − Dividends Declared (common and preferred), adjusted for any prior-period accounting changes.

State the fundamental balance sheet accounting equation.

Assets = Liabilities + Shareholders' Equity.

What does the Debt-to-Equity (D/E) Ratio measure, and how is it calculated?

D/E = Total Debt / Total Shareholders' Equity (where corporate finance typically defines Total Debt as short-term plus long-term interest-bearing debt, while some accounting texts use Total Liabilities). It measures financial leverage and the relative mix of debt versus equity financing.

What is EBITDA and why do financial analysts utilize it?

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBIT + D&A). Analysts use this non-GAAP metric to compare core operating profitability across firms with different capital structures, tax rates, and depreciation policies; however, it is not operating or free cash flow because it ignores working-capital changes, CapEx, and cash taxes.

Why must Sunk Costs be excluded from capital budgeting cash flow analyses?

Sunk costs are past, irreversible outlays that cannot be recovered regardless of whether a project is accepted or rejected. Capital budgeting includes only incremental prospective cash flows (including opportunity costs and cannibalization/synergy side effects).

What is the timing difference between an Ordinary Annuity and an Annuity Due?

An Ordinary Annuity pays cash flows at the end of each period (PV = C × [1 − (1 + r)^(−n)] / r), whereas an Annuity Due pays at the beginning of each period, shifting every payment one period earlier and multiplying both PV and FV by (1 + r).

How is straight-line depreciation calculated for a fixed capital asset?

Annual Depreciation Expense = (Historical Asset Cost - Estimated Salvage Value) / Useful Economic Life (in years).

What is the Payback Period, and what are its primary analytical limitations?

The time required for cumulative project cash inflows to recover the initial investment outlay. It relies on an arbitrary cutoff date, ignores the time value of money (unless Discounted Payback is used), and ignores all cash flows occurring after the payback cutoff.

What is Working Capital (Net Working Capital) and why is it monitored?

In financial accounting, Working Capital = Current Assets − Current Liabilities, measuring short-term liquidity. In corporate finance and valuation, Operating Net Working Capital excludes cash and short-term debt: (Non-Cash Current Assets) − (Non-Debt Current Liabilities).

What is the Interest Coverage Ratio (Times Interest Earned) formula?

Interest Coverage Ratio = EBIT / Interest Expense; it indicates how many times a company's operating profits can cover its annual contractual interest payments.

What is the Current Ratio formula and what does a ratio below 1.0 signify?

Current Ratio = Current Assets / Current Liabilities. A value below 1.0 means obligations due within one year (or the operating cycle) exceed total current assets (negative accounting working capital), which can signal potential liquidity stress.

Define Internal Rate of Return (IRR) and its standard acceptance criterion.

IRR is the discount rate that sets a project's Net Present Value to zero (∑_{t=0}^n CF_t / (1 + IRR)^t = 0). For a conventional investment project (an initial cash outflow followed by net inflows, giving a single sign change), accept the project if IRR > Opportunity Cost of Capital (hurdle rate); projects with multiple cash-flow sign changes can have multiple IRRs.

What is the Quick Ratio (Acid-Test Ratio) formula, and why does it exclude inventory and prepaids?

Quick Ratio = (Cash & Equivalents + Short-Term Marketable Securities + Net Accounts Receivable) / Current Liabilities. It excludes inventory (which may take time or discounting to sell) and prepaid expenses (which cannot be converted back into cash).

State the compound interest formula for Future Value (FV).

FV = PV * (1 + r)^n, where PV is present value, r is interest rate per period, and n is total compounding periods.

Why is Net Present Value (NPV) theoretically superior to IRR when evaluating mutually exclusive projects?

IRR is a percentage rate that ignores project scale (a higher percentage return on a small project can create less dollar wealth than a lower percentage return on a large project), can rank projects differently from NPV when cash-flow timing differs across discount rates (crossover rate), and can fail when non-conventional cash flows produce multiple IRRs. NPV directly measures additive dollar wealth created at the opportunity cost of capital.

How does accrual accounting differ from cash accounting?

Accrual accounting records revenues when earned and expenses when incurred regardless of when cash changes hands; cash accounting records transactions only when cash is received or paid.

What is the Cash Ratio formula?

Cash Ratio = (Cash and Cash Equivalents + Marketable Securities) / Current Liabilities, providing the most stringent and conservative test of immediate liquidity.

Distinguish between Return on Assets (ROA) and Return on Equity (ROE).

ROA = Net Income / Average Total Assets (measuring profitability relative to the total asset base); ROE = Net Income / Average Shareholders' Equity (measuring net profit generated per dollar of book equity).

How is Cash Flow from Operations calculated using the indirect method?

Start with Net Income, add back non-cash expenses (Depreciation & Amortization), add non-operating losses (or subtract gains), and adjust for net changes in operating working capital.

What is the Present Value formula for a perpetual, constant stream of cash flows (Perpetuity)?

PV = C / r (for r > 0), where C is the constant periodic cash flow starting one period from today (t = 1) and r is the per-period discount rate.

What does the Revenue Recognition Principle dictate under US GAAP (ASC 606) and IFRS (IFRS 15)?

Under the converged five-step model (ASC 606 / IFRS 15), revenue is recognized when (or as) an entity satisfies a performance obligation by transferring control of a promised good or service to a customer, in the amount of consideration to which the entity expects to be entitled—regardless of when cash is collected.

List the sequential income statement line items from Net Sales down to Net Income.

Net Sales/Revenues → Cost of Goods Sold (COGS) → Gross Profit → Operating Expenses (SG&A, R&D, D&A) → Operating Income (equals EBIT when there is no non-operating income/expense) → Net Interest & Non-Operating Items → Pre-Tax Income (EBT) → Income Tax Expense → Net Income.

What is the Matching (Expense Recognition) Principle in financial accounting?

Costs directly associated with generating specific revenues (such as Cost of Goods Sold) are recognized as expenses in the same accounting period as those revenues, whereas period costs lacking a direct cause-and-effect link (such as general administrative overhead) are expensed in the period incurred.

What is the formula for the Present Value of a Growing Perpetuity?

PV = C_1 / (r - g), where C_1 is next period's cash flow, r is discount rate, and g is perpetual growth rate (valid only when r > g).

Define Net Present Value (NPV) and its investment decision rule.

NPV is the present value of future net cash flows minus the initial investment outlay: NPV = ∑_{t=1}^n [CF_t / (1 + r)^t] − Outlay_0 (or ∑_{t=0}^n CF_t / (1 + r)^t with signed CF_0 0 and reject if NPV < 0.

What is the difference between Annual Percentage Rate (APR) and Effective Annual Rate (EAR)?

APR is the nominal stated annual rate ignoring intra-year compounding; EAR accounts for intra-year compounding: EAR = (1 + APR / m)^m - 1, where m is compounding frequency per year.

What does Asset Turnover measure and how is it calculated?

Asset Turnover = Revenue / Average Total Assets; it measures operational efficiency by evaluating how many dollars of top-line revenue are generated per dollar of asset investment.

Financial Accounting, Statements & Time Value of Money

Financial accounting and valuation foundations for tax and business law: accrual vs. cash accounting, revenue and expense recognition (ASC 606 / IFRS 15), balance sheet, income statement, and cash flow mechanics, depreciation, financial ratios, and time value of money.

Level: basic
Languages: en → en
Cards: 32
Markdown: Financial Accounting, Statements & Time Value of Money (.md)

Flashcards (32)

#	Front (Term / Question)	Back (Definition / Answer)
1	State the three-component DuPont Analysis decomposition of Return on Equity (ROE).	ROE = Net Profit Margin * Asset Turnover * Financial Leverage = (Net Income / Revenue) * (Revenue / Total Assets) * (Total Assets / Shareholders' Equity).
2	State the Present Value (PV) formula for a single future sum.	PV = FV / (1 + r)^n = FV * (1 + r)^(-n).
3	What is Free Cash Flow to the Firm (FCFF) and what are its standard formulas?	The cash flow available to all capital providers (debt and equity) after operating expenses, taxes, and reinvestment. Starting from US GAAP CFO (where interest paid was deducted): FCFF = CFO + Interest Expense × (1 − Tax Rate) − CapEx. Equivalently, from EBIT: FCFF = EBIT × (1 − Tax Rate) + D&A − CapEx − ΔOperating NWC.
4	How do changes in operating Current Assets and Current Liabilities affect Cash Flow from Operations (CFO)?	In the indirect method, an increase in a non-cash operating current asset (e.g., Accounts Receivable, Inventory, Prepaids) is subtracted as a cash outflow, while an increase in a non-debt operating current liability (e.g., Accounts Payable, Accrued Expenses) is added as a cash inflow.
5	What are the three core sections of the Statement of Cash Flows?	Cash Flow from Operating Activities (CFO), Cash Flow from Investing Activities (CFI), and Cash Flow from Financing Activities (CFF). Under US GAAP (ASC 230), interest paid, interest received, and dividends received are classified in CFO while dividends paid are in CFF; IFRS allows differing classifications depending on entity policy and IFRS 18/IAS 7 rules.
6	How is ending Retained Earnings calculated on the statement of retained earnings?	Ending Retained Earnings = Beginning Retained Earnings + Net Income (or − Net Loss) − Dividends Declared (common and preferred), adjusted for any prior-period accounting changes.
7	State the fundamental balance sheet accounting equation.	Assets = Liabilities + Shareholders' Equity.
8	What does the Debt-to-Equity (D/E) Ratio measure, and how is it calculated?	D/E = Total Debt / Total Shareholders' Equity (where corporate finance typically defines Total Debt as short-term plus long-term interest-bearing debt, while some accounting texts use Total Liabilities). It measures financial leverage and the relative mix of debt versus equity financing.
9	What is EBITDA and why do financial analysts utilize it?	Earnings Before Interest, Taxes, Depreciation, and Amortization (EBIT + D&A). Analysts use this non-GAAP metric to compare core operating profitability across firms with different capital structures, tax rates, and depreciation policies; however, it is not operating or free cash flow because it ignores working-capital changes, CapEx, and cash taxes.
10	Why must Sunk Costs be excluded from capital budgeting cash flow analyses?	Sunk costs are past, irreversible outlays that cannot be recovered regardless of whether a project is accepted or rejected. Capital budgeting includes only incremental prospective cash flows (including opportunity costs and cannibalization/synergy side effects).
11	What is the timing difference between an Ordinary Annuity and an Annuity Due?	An Ordinary Annuity pays cash flows at the end of each period (PV = C × [1 − (1 + r)^(−n)] / r), whereas an Annuity Due pays at the beginning of each period, shifting every payment one period earlier and multiplying both PV and FV by (1 + r).
12	How is straight-line depreciation calculated for a fixed capital asset?	Annual Depreciation Expense = (Historical Asset Cost - Estimated Salvage Value) / Useful Economic Life (in years).
13	What is the Payback Period, and what are its primary analytical limitations?	The time required for cumulative project cash inflows to recover the initial investment outlay. It relies on an arbitrary cutoff date, ignores the time value of money (unless Discounted Payback is used), and ignores all cash flows occurring after the payback cutoff.
14	What is Working Capital (Net Working Capital) and why is it monitored?	In financial accounting, Working Capital = Current Assets − Current Liabilities, measuring short-term liquidity. In corporate finance and valuation, Operating Net Working Capital excludes cash and short-term debt: (Non-Cash Current Assets) − (Non-Debt Current Liabilities).
15	What is the Interest Coverage Ratio (Times Interest Earned) formula?	Interest Coverage Ratio = EBIT / Interest Expense; it indicates how many times a company's operating profits can cover its annual contractual interest payments.
16	What is the Current Ratio formula and what does a ratio below 1.0 signify?	Current Ratio = Current Assets / Current Liabilities. A value below 1.0 means obligations due within one year (or the operating cycle) exceed total current assets (negative accounting working capital), which can signal potential liquidity stress.
17	Define Internal Rate of Return (IRR) and its standard acceptance criterion.	IRR is the discount rate that sets a project's Net Present Value to zero (∑_{t=0}^n CF_t / (1 + IRR)^t = 0). For a conventional investment project (an initial cash outflow followed by net inflows, giving a single sign change), accept the project if IRR > Opportunity Cost of Capital (hurdle rate); projects with multiple cash-flow sign changes can have multiple IRRs.
18	What is the Quick Ratio (Acid-Test Ratio) formula, and why does it exclude inventory and prepaids?	Quick Ratio = (Cash & Equivalents + Short-Term Marketable Securities + Net Accounts Receivable) / Current Liabilities. It excludes inventory (which may take time or discounting to sell) and prepaid expenses (which cannot be converted back into cash).
19	State the compound interest formula for Future Value (FV).	FV = PV * (1 + r)^n, where PV is present value, r is interest rate per period, and n is total compounding periods.
20	Why is Net Present Value (NPV) theoretically superior to IRR when evaluating mutually exclusive projects?	IRR is a percentage rate that ignores project scale (a higher percentage return on a small project can create less dollar wealth than a lower percentage return on a large project), can rank projects differently from NPV when cash-flow timing differs across discount rates (crossover rate), and can fail when non-conventional cash flows produce multiple IRRs. NPV directly measures additive dollar wealth created at the opportunity cost of capital.
21	How does accrual accounting differ from cash accounting?	Accrual accounting records revenues when earned and expenses when incurred regardless of when cash changes hands; cash accounting records transactions only when cash is received or paid.
22	What is the Cash Ratio formula?	Cash Ratio = (Cash and Cash Equivalents + Marketable Securities) / Current Liabilities, providing the most stringent and conservative test of immediate liquidity.
23	Distinguish between Return on Assets (ROA) and Return on Equity (ROE).	ROA = Net Income / Average Total Assets (measuring profitability relative to the total asset base); ROE = Net Income / Average Shareholders' Equity (measuring net profit generated per dollar of book equity).
24	How is Cash Flow from Operations calculated using the indirect method?	Start with Net Income, add back non-cash expenses (Depreciation & Amortization), add non-operating losses (or subtract gains), and adjust for net changes in operating working capital.
25	What is the Present Value formula for a perpetual, constant stream of cash flows (Perpetuity)?	PV = C / r (for r > 0), where C is the constant periodic cash flow starting one period from today (t = 1) and r is the per-period discount rate.
26	What does the Revenue Recognition Principle dictate under US GAAP (ASC 606) and IFRS (IFRS 15)?	Under the converged five-step model (ASC 606 / IFRS 15), revenue is recognized when (or as) an entity satisfies a performance obligation by transferring control of a promised good or service to a customer, in the amount of consideration to which the entity expects to be entitled—regardless of when cash is collected.
27	List the sequential income statement line items from Net Sales down to Net Income.	Net Sales/Revenues → Cost of Goods Sold (COGS) → Gross Profit → Operating Expenses (SG&A, R&D, D&A) → Operating Income (equals EBIT when there is no non-operating income/expense) → Net Interest & Non-Operating Items → Pre-Tax Income (EBT) → Income Tax Expense → Net Income.
28	What is the Matching (Expense Recognition) Principle in financial accounting?	Costs directly associated with generating specific revenues (such as Cost of Goods Sold) are recognized as expenses in the same accounting period as those revenues, whereas period costs lacking a direct cause-and-effect link (such as general administrative overhead) are expensed in the period incurred.
29	What is the formula for the Present Value of a Growing Perpetuity?	PV = C_1 / (r - g), where C_1 is next period's cash flow, r is discount rate, and g is perpetual growth rate (valid only when r > g).
30	Define Net Present Value (NPV) and its investment decision rule.	NPV is the present value of future net cash flows minus the initial investment outlay: NPV = ∑_{t=1}^n [CF_t / (1 + r)^t] − Outlay_0 (or ∑_{t=0}^n CF_t / (1 + r)^t with signed CF_0 < 0). For independent projects, accept if NPV > 0 and reject if NPV < 0.
31	What is the difference between Annual Percentage Rate (APR) and Effective Annual Rate (EAR)?	APR is the nominal stated annual rate ignoring intra-year compounding; EAR accounts for intra-year compounding: EAR = (1 + APR / m)^m - 1, where m is compounding frequency per year.
32	What does Asset Turnover measure and how is it calculated?	Asset Turnover = Revenue / Average Total Assets; it measures operational efficiency by evaluating how many dollars of top-line revenue are generated per dollar of asset investment.