BUS101 Study Guide

Unit 4: Accounting, Finance, and Banking

4a. Describe the role of accounting and finance in the business process

A. While businesses focus on more than their profit margin and bottom line, financial management and the financial well-being of a business are important to many stakeholders. Different stakeholders are interested in managerial or financial accounting.

  • List the stakeholders interested in the financial well-being of a business.
  • Define and explain the difference between managerial accounting or financial accounting.
  • Explain why the different stakeholders in your list are interested in managerial or financial accounting.
  • Define generally accepted accounting principles (GAAP).

Review The Role of Accounting.


4b. Describe and analyze components of the income statement and balance sheet

A. Business managers prepare two financial statements to present information to their stakeholders: the income statement and balance sheet.

  • Define assetcashaccounts receivableinventoryfixed asset.
  • Define liabilityaccounts payabledebtequity.
  • Define fiscal year and calendar year.
  • Define and describe the difference between an income statement and a balance sheet.

Review Understanding Financial Statements.

B. Business managers also need to generate a statement of cash flows and statement of owner's equity.

  • Define cash flow and liquidity.
  • Define statement of cash flows and statement of owner's equity.

Review "Accounting" on pages 207–214 of Introduction to Business and Understanding Financial Statements.


4c. Differentiate among key financial ratios for making business decisions, including profit margin, return on equity, and debt to equity ratio

A. Financial analysts use ratios to understand how well a business is doing financially. For example, the profit margin tells an analyst how much profit a business makes for every dollar it receives in sales or revenue. This ratio takes into account the percentage of sales revenue the business receives, as compared to the amount of money it spends on materials and for operating the business. Analysts want to know how much money is left over to invest in the future of the business and to pay dividends to shareholders after expenses are paid.

  • Define profit margin (for example, what does it mean if the profit margin is 0.4?).
  • Define operating margin.
  • Describe the formula analysts use to calculate the profit margin.
  • Which financial statement should an analyst review to collect this information?

B. The return on equity tells an analyst whether management is choosing its assets wisely.

  • Define and describe the difference between equity and assets.
  • Define return on equity (for example, what does it mean if the return on equity is 0.4?).
  • Describe the formula analysts use to calculate the return on equity.
  • Which financial statement should an analyst review to collect this information?

C. The debt-to-equity ratio indicates the relationship between the amount a company owes, as compared to what it owns. This ratio helps potential lenders and investors decide whether a business can afford to borrow any more money.

  • Define debt-to-equity ratio (for example, what does it mean if the debt-to-equity ratio is .49?).
  • Describe the formula analysts use to calculate the debt-to-equity ratio?
  • Which financial statement should an analyst review to collect this information?

Review Financial Statement Analysis and "Accounting" on pages 214–220 of Introduction to Business.


4d. Assess the implications of financial ratios for the future performance of a company

A. Stakeholders often use financial ratios to predict how a company will do in the future, based on their past performance. Analysts put these ratios into specific categories based on the information they provide. These categories include profit margin ratios, management efficiency ratios, management effectiveness ratios, and financial condition ratios.

  • Define profit margin ratiosmanagement efficiency ratiosmanagement effectiveness ratios, and financial condition ratios.
  • Which category do the three ratios (profit margin, return on equity, and debt-to-equity ratio) we discussed above belong to?

Review Financial Statement Analysis.

A. In the television show Shark Tank, entrepreneurs try to convince a panel of industry veterans (sharks) to invest in their idea. They talk a lot about valuation, which are estimates about what a company is worth financially. These potential investors determine the financial value of the potential company when they decide whether they would obtain a good return on their investment.

Sharks often think entrepreneurs put too much value on their business. This makes sense because the entrepreneurs often have a close emotional attachment to the product or service they want to sell and feel consumers would pay a lot of money for it. In terms of the numbers, an entrepreneur who asks an investor to pay $500,000 for a 10 percent share of the company, believes their product, company, or idea is worth $5 million (100 percent of the shares). However, the entrepreneur needs to convince the sharks (and other potential investors) that they can really generate sufficient revenues: they need to prove the company is really worth that much.

  • Calculate the valuation of a company if an entrepreneur asks investors to pay $35,000 for a 20 percent share.
  • What is the most common valuation ratio financial analysts use?

Review valuation ratios in "Accounting" on pages 214–220 of Introduction to Business.


4e. Describe the roles of the Federal Reserve, banks, interest rates, and credit analysis in respect to decisions of financial lending

A. We have a variety of options for investing our money, whether in a savings account, a checking account, a money market account, or under our mattress. Businesses have the same options.

  • Define six types of financial institutions: commercial banksavings bank, credit unionfinance companyinsurance company, and brokerage firm.
  • Define interest rate and mortgage.
  • How do banks expand the money supply?
  • Define a credit analysis.
  • Explain the five C's of credit analysis: capacitycapitalcollateralconditions, and character.

Review financial institutions and their impact on the money supply in Financial Institutions. Review credit analysis in "Credit Analysis and Lending" on pages 224–227 of Introduction to Business.

B. American financial institutions turn to the U.S. Federal Reserve (the Fed) for guidance on making their own financial investments.

  • What is the U.S. Federal Reserve? Name its primary three goals.
  • Define Federal Reserve discount rate and prime rate.
  • Define and explain the difference between monetary policy and fiscal policy.

Review The Federal Reserve System.


4f. Describe different options for financing

A. Businesses often need an influx of capital (money) to help expand their business or cover a temporary deficit in their cash flow. They have two options for getting some extra money into their coffers: equity financing and debt financing.

Businesses do not need to repay the money they obtain through equity financing. The business owner may provide the money themselves (from their savings account), or the business could sell shares of ownership in the business to an investor.

  • Define equity financing.
  • Define a stock and the U.S. Stock Market.
  • Define an angel investorventure capitalistpublicly-traded companyinitial public offering (IPO).
  • Name the two most common market indexes investors use to buy and sell stocks.
  • Define a primary and secondary market when buying or selling stock.

B. Businesses must repay the money they borrow through debt financing. The repayment usually involves a fee (usually in the form of interest).

  • Define debt financing.
  • Define a bond and the U.S. Bond Market.
  • Explain the difference between collateralized or secured loans, and non-collateralized or unsecured loans?
  • What types of assets can a business use for collateral for a loan?
  • Can you think of the types of businesses that would require a seasonal loan?

Review Understanding Securities Markets and equity financing options in Financing the Going Concern. Review debt financing in "Credit Analysis and Lending" on pages 224–225 of Introduction to Business.


4g. List and explain the tools available to the Federal Reserve during financial crises

A. Review outcome 4e, above, which explored the U.S. Federal Reserve system.

  • Define open market operations.
  • How does the U.S. Federal Reserve use open market operations to control the money supply in the United States, via monetary policy?

Review The Federal Reserve System and "Monetary Policy" on page 79 of Introduction to Business.


4h. Analyze the causes and implications of the 2008 financial meltdown

A. Remember the old adage "those who don't understand history are doomed to repeat it"?

  • Define a subprime loan and foreclosure.
  • Explain the role banks had in the 2008 financial crisis.
  • Explain the role the housing industry had in the 2008 financial crisis.
  • Explain the role the U.S. Federal Reserve had in the 2008 financial crisis, especially with respect to the low-interest rates it offered Americans before and after the financial fallout occurred.

See this explanation in Financial Crisis of 2007–2008.


4i. Calculate the time value of money

A. Business owners must determine the opportunity cost for investing the profits they make. In other words, they need to calculate what they will earn from an investment and whether it would be more profitable to invest in something else. The time value of money says the dollar you receive today is worth more than a dollar you could receive in the future.

  • Define compound interest.
  • Describe the formula used to calculate the future value of money.
  • Calculate the money you would earn if you invest $1,000 in an account that earns five percent for 10 years? How will this number compare if you withdraw the amount of interest earned every year?

Review Time Is Money and "The Time Value of Money" on pages 228–230 of Introduction to Business.


Unit 4 Vocabulary List

Be sure you understand these terms as you study for the final exam. Try to think of the reason why each term is included.

  • Accounts payable
  • Accounts receivable
  • Angel investor
  • Asset
  • Balance sheet
  • Bond
  • Brokerage firm
  • Capital
  • Cash
  • Cash flow
  • Collateral
  • Commercial bank
  • Compound interest
  • Credit analysis
  • Credit union
  • Debt financing
  • Debt to equity ratio
  • Emergency Economic Stabilization Act
  • Equity
  • Federal funds rate
  • Federal Reserve Discount Rate
  • Finance company
  • Financial accounting
  • Financial condition ratio
  • Fiscal policy
  • Fiscal year (vs. calendar year)
  • Fixed asset
  • Foreclosure
  • Future value
  • Generally accepted accounting principles (GAAP)
  • Income statement
  • Insurance company
  • Initial public offering (IPO)
  • Interest rate
  • Inventory
  • Liability
  • Liquidity
  • Management efficiency ratio
  • Management effectiveness ratios
  • Managerial accounting
  • Monetary policy
  • Money supply
  • Mortgage
  • Open market operations
  • Owner's equity
  • Present value
  • Prime rate
  • Profit margin ratio
  • Publicly-traded company
  • Return on equity
  • Savings bank
  • Savings and loan
  • Secured loan
  • Securities
  • Stakeholder
  • Statement of cash flows
  • Statement of owner's equity
  • Stocks
  • Subprime loan
  • Time value of money
  • U.S. Bond Market
  • U.S. Federal Reserve
  • U.S. Stock Market
  • Valuation ratios
  • Venture capitalist