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Financial Accounting Key Concepts and Formulas

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  • The Goal of the Firm
    Maximize shareholder wealth by increasing the firm's stock price over time.
  • Five Principles of Finance (Principles 1-3)
    Principle 1: Cash flow is what matters.
    Principle 2: Money has a time value.
    Principle 3: Risk requires a reward.
  • Efficient Market Principle
    Market prices fully reflect all available information, making it impossible to consistently achieve higher returns without additional risk.
  • Agency Problem
    Conflict of interest between managers (agents) and shareholders (principals) where managers may not act in shareholders' best interests.
  • Legal Forms of Business Organization
    Includes sole proprietorship, partnership, and corporation, each with distinct advantages and disadvantages regarding liability, taxation, and control.
  • Capital Markets
    Markets where long-term securities such as stocks and bonds are issued and traded.
  • Primary vs Secondary Market
    Primary market involves new securities issuance; secondary market involves trading existing securities among investors.
  • Sarbanes-Oxley Act
    U.S. law enacted to protect investors by improving the accuracy and reliability of corporate disclosures.
  • Nominal vs Real Interest Rate
    Nominal rate includes inflation; real rate is adjusted for inflation, reflecting true purchasing power.
  • Term Structure of Interest Rates
    Relationship between interest rates and maturities; upward sloping is normal, indicating long-term rates > short-term rates.
  • Income Statement
    Financial statement showing revenues, expenses, and profits over a period.
  • Earnings Per Share (EPS)
    Net income available to common shareholders divided by the number of outstanding shares.
  • Balance Sheet
    Snapshot of a company's assets, liabilities, and equity at a specific point in time.
  • Working Capital
    Current assets minus current liabilities; measures short-term liquidity.
  • Statement of Cash Flows
    Reports cash inflows and outflows from operating, investing, and financing activities.
  • Liquidity Ratios
    Ratios that measure a firm's ability to meet short-term obligations, e.g., current ratio and quick ratio.
  • Return on Equity (ROE)
    Net income divided by shareholder's equity; measures profitability relative to equity.
  • Price Earnings (P/E) Ratio
    Market price per share divided by earnings per share; indicates market expectations of growth.
  • Time Value of Money
    A dollar today is worth more than a dollar received in the future due to earning potential.
  • Compound Interest vs Simple Interest
    Compound interest earns interest on interest; simple interest earns interest only on principal.
  • Ordinary Annuity vs Annuity Due
    Ordinary annuity payments occur at period end; annuity due payments occur at period start.
  • Perpetuity
    A stream of equal payments that continues indefinitely.
  • Expected Return
    Weighted average of possible returns, based on their probabilities.
  • Risk
    The uncertainty regarding the return on an investment.
  • Systematic vs Unsystematic Risk
    Systematic risk affects the entire market; unsystematic risk is specific to a company or industry.
  • Beta
    Measure of a stock's volatility relative to the market; beta > 1 means more volatile.
  • Bond Yield to Maturity (YTM)
    The total return anticipated on a bond if held until maturity.
  • Preferred Stock
    Stock with fixed dividends and priority over common stock in asset claims.
  • Dividend Growth Model
    Valuation model for common stock assuming dividends grow at a constant rate.
  • Weighted Average Cost of Capital (WACC)
    Average rate of return a company must pay to finance its assets, weighted by capital structure.
  • Capital Budgeting
    Process of evaluating and selecting long-term investments.