BUS202: Principles of Finance

Read this introductory article, which will help you understand what the field of finance encompasses. What do you learn in a course in finance that you do not learn in financial accounting? How does finance build on what you learned? What does a financial manager do?

In this chapter, we will explain the goal of financial management. It is essential to always know the end goal when contemplating various strategies and making financial decisions. If a company focuses only on quality and makes a great product but does not make money, can they stay in business? If managers act to improve their own wealth, what happens to the future value of the corporation?

It is important to examine the ethical considerations involved in finance. You will want to be able to differentiate between ethics and morals. Why is it essential for individuals working in the financial sector to keep organizational, professional, and personal ethical behavior front-and-center?

This chapter will review the various ethical considerations that managers in a business face and explain the concept of fiduciary duty. It also examines unique ethical concerns that arise from globalization.

It is essential to understand the various ways companies can exist in the US and the impact that company structures have on taxes, regulations, liability, and decision-making. In these sections, you will learn the difference between sole proprietors, partnerships and corporations, and how you decide which form is best for your business.

This video will explain the main forms of business organization. Use this to supplement the section you read, and reinforce critical concepts you will need throughout the course.

Corporate governance refers to the system by which companies are governed and controlled. Many different stakeholders have a role in overseeing corporate performance. Financial fraud also can occur when conflicts of interest arise. Many high-profile corporate fraud cases have cost investors and employees billions of dollars and resulted in increased regulations, including the Sarbanes-Oxley Act. If you've heard of companies like Enron, World-com, Adelphia Cable, and investors like Bernie Madoff, you've heard of examples of ineffective Corporate Governance Systems. These large-scale frauds can all be traced back to breakdowns in governance. Everyone working in a business must understand the checks and balances that should exist to protect employees, investors, and the public.

Conflicts naturally occur between owners and managers, and companies must have policies to ensure that employees are working for the benefit of the owners.

This article discusses the financial intermediary as an institution that facilitates the flow of funds between individuals or other economic entities. By the end of this article, you will be able to discuss the purpose and types of financial institutions and identify the role that financial intermediaries play in the economy.

Financial markets function to transfer capital between buyers and sellers and provide corporations and individuals with sources of investing and raising funds. In this section, you will get to know the types of financial markets in the US economy and their role in corporate governance.

Complete these exercises and problems and then check your work.

This lesson will introduce you to financial statements, their uses, and their limitations. This broad overview will help frame the upcoming lessons on each individual statement.

This lesson focuses on the elements and limitations of the income statement and the effects of GAAP on the income statement. It will also discuss noncash items.

This video introduces income statements. An income statement is an account of a company's revenues (net sales), costs, expenses, and taxes during a given period. The goal of an income statement is to compute a company's net profits.

This lesson will introduce the balance sheet, a representation of a firm's financial position at a single point in time. The balance sheet is one of the four major financial statements. You will be able to identify assets, liability, and shareholder's equity, and learn how to compute the balance sheet equation. You will also be able to create a balance sheet.

This video introduces balance sheets. A balance sheet statement is an account of the value of assets, liabilities, and net worth of a company. It records these values on a certain date, and as such, it is a snapshot of a company's financial position at a single point in time. Assets are things that a company owns, while liabilities are things that a company owes. Assets minus liabilities results in the net worth of a company.

This video describes more about balance sheets and equity.

This video discusses the relationship between balance sheets and income statements.

This lesson exposes you to the impact of taxes on firms. You will learn how different forms of corporate organization affect the tax obligations for the firm and the individual owners. You will be able to compute tax liability using the tax rate. This section defines the various types of taxes and discusses the impact of depreciation on taxable income. It also compares a tax credit with a tax deduction, and demonstrates multiple methods of computing depreciation.

This video introduces cash accounting. While most businesses use accrual accounting, some small companies may use cash accounting. Even companies that use accrual accounting must also account for all of their cash flows through the cash flow statement. Thus, all businesses need to understand cash accounting.

This video introduces the accrual basis of accounting.

This video compares accrual and cash accounting.

This section exposes you to one of the four major financial statements, the "Statement of Cash Flows". It explains how to create and interpret the statement and discusses the three major activities that produce cash for a firm – operating, investing, and financing.

This video introduces cash flow statements.

In this section, you will learn about less commonly used financial statements such as the Statement of Equity and the Free Cash Flow Statement (which is different from The Statement of Cash Flows) and their uses in finance. It also explains the difference between economic value and market value.

This section provides more insight into the standard elements included in all balance sheets and income statements. It provides a listing of common accounts on each statement and the order in which those accounts are listed.

This section provides a general overview of what a financial ratio is, how they are used, and the relevant categories of financial ratios.

An overview of the financial ratios is presented in this section. The manager or student may well ask the question, "Why are financial ratios important to understanding the activities of the business?" This question is addressed in this section. Pay particular attention to the following topics: (1) Sources of financial ratios, (2) Purpose and types of ratios, (3) Accounting methods and principles, (4) Abbreviations and terminology, and (5) A summary of all ratios used to analyze financial statements. Try to remember some of the basic formulas presented in this section.

After reading this section, you will have been exposed to the different types of profitability ratios, their formulas, how to compute them, and which financial statements contain the information needed to calculate the ratios. You will also learn how to interpret the ratios and apply those interpretations to understanding the firm's activities.

After reading this section, you will have been exposed to the different types of asset management ratios, their formulas, how to compute them, and which financial statements contain the information needed to calculate the ratios. You will also learn how to interpret the ratios and apply those interpretations to understanding the firm's activities.

After reading this section, you will have been exposed to the different types of liquidity ratios, their formulas, how to compute them, and which financial statements contain the information needed to calculate the ratios. You will also learn how to interpret the ratios and apply those interpretations to understanding the firm's activities.

After reading this section, you will have been exposed to the different types of market value ratios, their formulas, how to compute them, and which financial statements contain the information needed to calculate the ratios. You will also learn how to interpret the ratios and apply those interpretations to understanding the firm's activities.

These three videos discuss how to compute the P/E ratio and its significance.

As you read this section, you will learn about special ratios that address dividend growth, return on assets, and equity. You will be exposed to their formulas, how to compute them, and which financial statements contain the information needed to calculate the ratios. You will read about the DuPont Equation (also known as the strategic profit model), which comprises multiple financial ratios. You will also learn how to interpret the ratios and apply those interpretations to understanding the firm's activities.

An overview of how financial ratios are used to aid in company analysis is presented in this lesson. Financial ratios are used for industry comparisons, benchmarking, and trend analysis. This section also presents some limitations of financial ratio analysis to consider when evaluating firms.

This section presents financial ratios and their analysis. Why are financial ratios and their analysis important? To answer this question, you should pay particular attention to the firm's profitability, and allow comparisons between the firm and its industry. By the end of this section, you will be able to summarize how an interested party would use financial ratios to analyze a company's financial statement.

This lesson describes what inflation is and the various categories of inflation. It discusses the effect that inflation in an economy has on a firm's earnings and financial statements.

This section mentions other items that can distort the true value or representation of information on financial statements. It provides information about two primary examples of distortions – accounting errors and unusual one-time gains or losses.

After reading this section, you will understand how to create a forecast of the income statement, using assumptions for the future growth of expenses and sales by category. A forecasted financial statement is called a "pro forma" statement. Pro Forma financial statements help value a firm in preparation for its sale, comparing the impacts of proposed financial transactions, or estimating future costs and expenses under specific business scenarios. By the end of this section, you will be able to draft a pro forma income statement. Businesses in all industries use Pro Forma income statements to make managerial decisions that affect their sustainability.

This section discusses the Pro Forma balance sheet. The question "why should the Pro Forma balance sheet be used in a business?" is relevant as the economy changes. Possible uses of the Pro Forma balance sheet include mergers and acquisitions, warranties, and negotiating a commercial lending relationship to support growth. A pro forma balance sheet summarizes the projected future status of a company after a planned transaction, based on the current financial statements. By the end of this section, you will be able to prepare a pro forma balance sheet.

This section emphasizes the importance of cash and good cash management to a business. You will learn how to analyze cash inflows and outflows to better forecast a firm's cash budget. When you have completed this section, you will be able to describe the direct and indirect methods of cash flow forecasting. Cash flow is often used as a determinant providing financing to firms. A cash budget is used along with pro forma financial statements to assess the result of financial transactions.

When you have completed this section, you will be able to use ratio analysis to assess a firm's performance to compare its performance to itself, its competitors, its industry, and across time. You will learn the categories of ratios, how to compute ratios and how to interpret the numeric values of a ratio as a comment on the firm's performance. Ratio analysis is used to consider the impact of certain financial transactions on a firm.

Read this section and pay close attention to the summary of pro- forma financial statements as follows: (1) the Pro-forma income statement, (2) the Pro-forma balance sheet, (3) assessment of Pro-forma statements, (4) the bigger picture, and (5) end of chapter problems. Attempt the practical exercises at the end of this section to check your understanding of the uses of Pro-forma financial statements. Note that the images in this resource are broken.

This section discusses financial modeling and pro forma analysis. The five key takeaways include: (1) Introduction - financial goals and long-term planning, (2) Percent of sales method, (3) Forecasting a planned expansion, (4) The planned expansions value, and (5) Growth and firm value. Managers and executives use these financial tools regularly to make internal decisions and present them to external partners such as banks and investors.

Complete these exercises and problems and then check your work.

This very brief video introduces the concept of working capital and how it is calculated.

This chapter presents an overview of working capital: how a company manages its current assets and current liabilities. Working capital decisions are the day-to-day decisions all companies must make to keep their operations running. While they may not seem as critical as stock issues and capital budgeting, the reality is that poor short-term management is a leading reason why businesses fail. Understanding these concepts is essential for everyone in an organization.

Management of cash is the primary concern of most entrepreneurs when they start a business. How will they ensure they collect funds in time to pay their bills? Cash management is also a key concern for most households. For example, I may know that I make enough money to pay all my bills, but if the timing of when the cash hits my bank versus when my bills are due isn't in sync, I run the risk of penalties or worse.

Manufacturing companies take raw materials and turn them into finished products. Merchandising companies buy product and resell it. Both types of companies must manage their inventory. If you order too much, you risk obsolescence, spoilage, or inability to sell. If you order too little, you may lose sales you could have made and risk upsetting your customers. This section will help you understand how companies manage their inventory to minimize overall costs.

In this section, you will learn the options companies have when they need to borrow for a short period. Imagine if you are a caterer who just got your first big corporate job. You need to buy ingredients and hire workers before the event. The company will pay you when you invoice them after the event. Where do you get the cash to allow you to accept the job before getting paid? What are your options for financing if your business is seasonal?

Complete these exercises. Pay attention to the conceptual questions.

This video discusses the difference between present value and future value. The time value of money assumes that individuals face either an increase in prices in the economy as time passes in the form of an inflation rate, such as a 4% annual inflation rate, or an opportunity to put their savings in an investment account offering an interest rate, such as 5% per year. Therefore, under the "time value of money" concept, you can see that the $1,000 that you can receive in two years from today does not have the same value as $1,000 today. In fact, it will have a lesser value today. Likewise, if you receive $1,000 today and have the opportunity to put this money in an investment account earning 5% per year, in two years, you will have more than $1,000.

This video discusses how interest rates are applied. Note that a rate of return is usually expressed as a percentage (such as 4%), but when you need to apply it in a calculation, use it in decimal form (0.04 is the decimal form of 4%, and 0.10 is the decimal form of 10%). The same applies to the numerical expressions of interest rates.

This video discusses how interest rates are applied. When you need to calculate the future value of an amount using a simple interest rate, you apply the interest rate only to the initial amount. On the contrary, when you calculate the future value of an amount using the compound interest rate, you apply the interest rate not only to the initial amount but also to amounts of interest earned. Compounding means you earn interest on interest. It is compounding that allows your savings to grow so much over time.

Read this section that discusses the time value of money. "Why is the time value of money important?". The answer to this question lies in the concepts presented in this section. In finance, a dollar is more valuable today than it is one year or ten years from now. To explain why this is the case, we will give formulas and examples to demonstrate how money is used. As part of this discussion, we will also address why a dollar is worth more today than in the future. Pay particular attention to the definitions and problems presented related to interest rate, future value, and present value.

Read this section that discusses four separate but related concepts. They include: (1) multi-period investment, (2) approaches to calculating future value, and (3) single-period investment. How are these topics used in the business world? Applying these concepts is helpful when comparing alternative investments and when scarce capital resources are available. Often in a business setting, limited capital resources are available. Therefore, deciding which investment is best depends on comparing which investments will bring the highest returns to the business.

Read this section. You will learn how to calculate the future value of multiple annuities.

This video gives an easy-to-understand demonstration of the power of compounding and why it is so essential that you start saving early.

This video discusses the basic use of the Present Value (PV) formula when only one period is considered.

This video applies the PV formula when different cash flows are considered in different periods.

This video discusses how to re-calculate the PV amounts when the interest rate changes.

This section discusses how to calculate the present value of a future single-period payment, the return on a multi-period investment over time, and what real-world costs to the investor comprise an investment’s interest rate. It also addresses what a period is in terms of present value calculations and distinguishes between the formula for present value with simple interest and compound interest.

Read this section to see how to use present value to determine the best financing option and calculate the present value of an investment portfolio that has multiple cash flows.

This section gives more detail on computing present and future values. It shows you how to compute more complex problems involving future and present values when there are multiple compounding periods and when the time duration of those problems are longer or are less than one year.

After reading this section, you will know how to identify, define, and calculate an annuity's present and future value. An annuity is the structure of a financial instrument that is a finite series of level payments that have a definite end. When you are finished, you will be able to recognize the two types of annuities: an ordinary annuity and an annuity due, and explain how they are different. You will also be able to calculate each of these types of annuities and contrast them to their opposites: perpetuities. Annuities are key to understanding because they mimic the payment structure of a bond's coupon payment. This section is foundational for being able to calculate bond prices.

Read about ordinary annuities in this section. The business executive may ask how annuities are used in the real world of business? Pay close attention to how the present value of an ordinary annuity is calculated. Then, the future value of an ordinary annuity is discussed. This is followed by a discussion about when annuities are due. Examples of how and when annuities are used include investments and retirement planning for a regular future payment.

This section discusses calculating perpetuities, a special type of annuity where the stream of payments never ends.

This lesson shows you how to determine the yield (or return) on an investment. It also describes the differences between the effective annual rate and the annual percentage rate.

This section discusses calculating the yield of an annuity, which is the total return received stated as a percent. There are two major methods used to calculate the yield.

This section discusses how to value a series of cash flows and offers a few exercises related to mortgage loans that illustrate how annuities pertain to everyday situations.

These videos will help you learn to use Excel to solve the Practice and Assessment, rather than purchasing a financial calculator or using the formulas. You may also use calculating apps on your phone. Try practicing doing the homework problems with Excel.

Complete these exercises and problems and then check your work.

The first video here explains the definition of a stock and what individual investors obtain when they buy a share of a company's stock. The next video explains the definition of a bond and what individual investors obtain when they buy a corporate bond. The final video explains the difference between a stock and a bond.

A company's stock represents the original capital paid into the business by its founders and can be purchased as shares. Shareholders have the right of preemption, meaning they have the first chance to buy newly issued shares of stock before the general public. By the end of this section, you will be able to explain what it means to own stock and describe some of the rights of shareholders.

By the end of this article, you will be able to define common stock and preferred stock and differentiate between these two types of stock.

This article explains the rights of shareholders, depending on what kind of stock they own, including the right to claim income in the case of bankruptcy, voting rights, and the right to buy newly created shares. This section further differentiates preferred stock and common stock.

The actors in the stock market include individual retail investors, mutual funds, banks, insurance companies, hedge funds, and corporations. The world's largest stock exchange market is the New York Stock Exchange (NYSE), and the NASDAQ is an American dealer-based stock market in which dealers sell electronically to investors or firms. By the end of this section, you will be able to differentiate among these stock markets and explain the purpose and function of a market index.

Valuations rely heavily on the expected growth rate of a company; the past growth rate of sales and income provide insight into future growth. A no-growth company would be expected to return high dividends under traditional finance theory. Ideally, the portion of the earnings not paid to investors is left for investment to provide for future earnings growth. By the end of this section, you will be able to explain how a stock is valued and describe the limitations of valuing a company with dividends that have a non-constant growth rate.

The cost of money is the opportunity cost of holding cash instead of investing it, depending on the interest rate. An interest rate is the rate at which a borrower pays interest for using money that they borrow from a lender. Market interest rates are driven mainly by inflationary expectations, alternative investments, risk of investment, and liquidity preference. The term structure of interest rates describes how interest rates change over time.

A yield curve shows the relationship between interest rate levels (or cost of borrowing) and the time to maturity. It also tells what investors' expectations for interest rates are and whether they believe the economy will expand or contract. Three variables determine interest rates: inflation rate, GDP growth, and the real interest rate.

Par value is the amount of money a holder will get back once a bond matures; a bond can be sold at par, at a premium, or at a discount. The coupon rate is the amount of interest that the bondholder will receive per payment, expressed as a percentage of the par value. Maturity date refers to the final payment date of a loan or other financial instrument. A callable bond allows the issuer to redeem the bond before the maturity date; this is likely to happen when interest rates go down. A sinking fund is a method by which an organization sets aside money to retire debts. Other important features of bonds include the yield, market price, and putability of a bond.

Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.

A bond is an instrument of indebtedness of the bond issuer to the holders. Duration is the weighted average of the times until fixed cash flows of a financial asset are received. A bond indenture is a legal contract issued to lenders that defines the commitments and responsibilities of the seller and buyer. Bond credit rating agencies assess and report the creditworthiness of a corporation's or government's debt issues.

A government bond is a bond issued by a national government denominated in the country's domestic currency. A zero-coupon bond is a bond with no coupon payments, bought at a price lower than its face value, with the face value repaid at the time of maturity. Floating rate bonds have a variable coupon equal to a money market reference rate (such as LIBOR), plus a quoted spread. Other bonds include register vs. bearer bonds, convertible bonds, exchangeable bonds, asset-backed securities, and foreign currency bonds.

Most individuals purchase bonds via a broker or through bond funds. By the end of this section, you will be able to describe the process for purchasing a bond and explain why bond markets may not have price transparency.

The value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate. Yield to maturity is the discount rate at which the sum of all future cash flows from the bond is equal to the price of the bond. "Time to maturity" refers to the length of time before the par value of a bond must be returned to the bondholder. This section will show you how to calculate a bond's yield to maturity and calculate the price of a bond.

Bondholders face several types of risk, including price risk, reinvestment risk, and default risk. Credit rating agencies assign a bond's credit rating as a financial indicator; bond ratings below BBB-/Baa are considered junk bonds.

This article will introduce stock market transactions, including IPOs, secondary market offerings, private placement, and stock repurchase. By the end of this section, you will be able to differentiate between the different types of market organizations that facilitate trading securities: auction market, brokered market, and dealer market.

This article will help you define and distinguish realized returns from unrealized returns. By the end of this section, you will be able to calculate an investment's dollar return and percentage return. You will also be able to describe how to use historical and average returns to predict future performance.

This article explains why transparent financial markets provide efficient information about financial instruments, and aid in the discovery of financial information by interested parties. There are three ways to categorize markets based on the information available in the market. After reading, you will be able to identify all three market conditions called "efficiencies". When markets provide the most efficient form of readily available information, no one party can benefit unfairly from the price changes in a market.

This section discusses some of the most important legislation meant to regulate finance and protect stakeholders.

Convertible securities are convertible bonds or preferred stocks that pay regular interest and can be converted into shares of common stock. By the end of this section, you will be able to identify the different features of convertible bonds and discuss the advantages and disadvantages of convertible bonds.

A warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiration date.

A derivative is a financial instrument whose value is based on one or more underlying assets. By the end of this section, you will be able to identify the uses of derivatives and differentiate between the different types of derivatives.

Derivatives allow risk related to the price of underlying assets, such as commodities, to be transferred from one party to another.

Complete these exercises and problems and then check your work.

Complete these exercises and problems and then check your work.

Read this section about making capital budgeting decisions. The discussion discusses the goals of capital budgeting, how to rank investment proposals, assumptions about reinvestment, long- and short-term financing, Payback Method (PM), Internal Rate of Return (IRR), Net Present Value (NPV), and cash flow analysis. When managers and executives make financial decisions to invest limited resources, they use this information to invest more wisely.

Read this section, which discusses capital budgeting and decision-making, net present values, annuity tables, and internal rate of return. Large corporations use capital budgeting techniques when investing in real estate projects or large equipment projects.

Read this section that discusses Net Present Values (NPV), calculating and interpreting NP, and the advantages and disadvantages of using NPV. It also gives examples of how these concepts are implemented in practical applications.

Read this section about the Internal Rate of Return (IRR). Pay attention to calculating IRR, the advantages and disadvantages of using IRR, calculating multiple Internal Rates of Return, and calculating Modified Internal Rates of Return. Try the problems in this section and check your solutions.

Read this section about capital budgeting and ranking investment proposals. These are important when businesses are comparing similar real estates investments with the intent of picking the investment that yields the highest return. This section presents several methods that are commonly used to rank investment proposals, including net present value (NPV), internal rate of return (IRR), profitability index (PI), and accounting rate of return (ARR). It also gives formulas and examples that demonstrate how to apply these formulas in the real world.

Read this section that discusses methods of evaluating capital budgeting and calculating the profitability index and modified internal rate of return (MIRR). Comparing these gives a manager a broad view of assessing the best decision for investing limited or scarce financial resources. Corporations use these capital budgeting methods when comparing and contrasting competing real estate investments that will yield variable returns.

Read this section on the Payback Method of investing and review the examples of how this method is used.

Watch this video, which gives an example of the relationship between risk and reward.

Read this section, which discusses uncertainty, expected value, fair games, and mathematical preliminaries. These form the basis for the analysis of individual decision-making in uncertain situations.

This section introduces risk and return, discusses how to understand return, and considers portfolio concerns such as diversification and weighting. It also discusses the expectations for expected returns, implications across portfolios, diversification, and understanding security lines. Risk considerations include the types of risk and measuring risk. Why are these topics of risk and return essential to consider?

Read this section and pay attention to the risks associated with capital budgeting. Why is it important to understand and apply risk in capital budgeting? Risks can include operational risks, financial risks, and market risks. The process of capital budgeting must consider the different risks faced by corporations and their managers.

Read this chapter and learn more about risk and return. When and how are risk and return used in business?

Read this section that discusses portfolio diversification and weighting, implications for expected returns, and implications for variance.

This section discusses diversification and the impact of diversification on risk and return. Unsystematic risk addresses the impact of diversification on risk and return. Systematic risk evaluates the effect of diversification on risk and return. These concepts are used as corporations manage their investment portfolios and seek to achieve the best returns possible, given existing market conditions.

This section discusses what factors affect a stock's return. How do individual company news items, and changes that affect the entire economy, impact a stock's return?

Read this section and learn more about risk and return, implications across portfolios, and the beta coefficient for portfolios. Why are these topics important to businesses? The answer is contained in this section. This section discusses how a beta coefficient compares how much a particular stock fluctuates in value daily.

Read this section that discusses expected risk and risk premium, defining the security market line, and the impact of the SML on the cost of capital.

This video will introduce you to CAPM, the model that quantifies the relationship between risk and return for stocks.

This section discusses how to price risky securities to determine if a business should undertake an investment. Why is this important? When you finish this section, you should understand unsystematic risk, systematic risk, and beta.

Complete these exercises and problems and then check your work.

This section discusses capital structure, optimal capital structure, debt and equity, and cost of capital considerations. Why are these concepts important when managing a business? Application and examples are presented in this section so the student and manager will understand how to use the optimal capital structure effectively.

This video gives you an example of two similar businesses with different capital structures. This video will help reinforce and explain concepts concerning capital structure that you read earlier.

This video explains the difference between market value and book value for defining firm value.

This video explains how to calculate the market value of a firm by concentrating on its assets.

This video explains the relationship between choosing a particular cost of debt and the return on capital.

How do businesses benefit from using capital structure, optimal capital structure, debt and equity, and return on investment? Businesses have the opportunity to earn more return from their investments and their blend of debt and equity capital structure. This section gives examples of how these concepts are used.

This section provides an overview of the cost of capital, flotation costs, debt cost, preferred stock cost, and common stock cost. It also gives examples that show why WACC is important.

This section presents the WACC in more detail. Why is the WACC so important?

Complete these exercises and problems and then check your work.