EDITION Entrepreneurial Finance Philip J Adelman DeVry University Alan M Marks DeVry University Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Editorial Director: Vernon R Anthony Acquisitions Editor: Sara Eilert Editor, Digital Projects: Nichole Caldwell Editorial Assistant: Doug Greive Director of Marketing: David Gesell Marketing Manager: Stacey Martinez Senior Marketing Manager: Alicia Wozniak Marketing Assistant: Les Roberts Associate Managing Editor: Alexandrina Benedicto Wolf Production Editor: Alicia Ritchey Inhouse Production Liasion: Debbie Ryan Art Director: Jayne Conte Cover Designer: Bruce Kenselaar Cover Art: Fotolia Full-Service Project Management: Integra Software Services, Ltd Printer/Binder: Edward Brothers/Jackson Road Cover Printer: Lehigh Text Font: Bembo Std, 12/14 Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on the appropriate page within text Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A and other countries Screen shots and icons reprinted with permission from the Microsoft Corporation This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation Copyright © 2014, 2009, 2007, 2004, 2001 by Pearson Education, Inc., publishing as Prentice Hall All rights reserved Manufactured in the United States of America This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Permissions Department, One Lake Street, Upper Saddle River, New Jersey 07458, or you may fax your request to 201-236-3290 Many of the designations by manufacturers and sellers to distinguish their products are claimed as trademarks Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps Library of Congress Cataloging-in-Publication Data Adelman, Philip J Entrepreneurial finance / Philip J Adelman, DeVry University, Alan M Marks, DeVry University.—6 Edition pages cm ISBN-13: 978-0-13-314051-4 (alk paper) ISBN-10: 0-13-314051-2 (alk paper) Small business—Finance I Marks, Alan M II Title HG4027.7.A338 2013 658.15’92—dc23 2012050973 10 ISBN 10: 0-13-314051-2 ISBN 13: 978-0-13-314051-4 T o my wife, Hannah B Adelman, for her support and continued belief in my abilities; and to my children, Eddie, Danny, and Tova; my daughters-in-law, Connie and Cherie; my son-in-law, Jason Gilbert; and my wonderful grandchildren, Ellie, Jed, Erin, Joey, Emily, Abby, and Naomi, for being my cheerleaders Philip J Adelman T o my loving and supportive family—my wife, Cheryl; my children, Jamie and Jared; my daughter-in-law Jessica; and my wonderful grandchildren, Kellen, Spencer, Preston, and Beckett, who gave me the encouragement to realize that my goal is achievable Alan M Marks T o DeVry University, who gave us the opportunity to use our creative talents to teach In memory of Philip Pomerantz whose story gave us the inspiration to pursue small business case studies This page intentionally left blank Contents Preface ix Chapter Financial and Economic Concepts Basic Financial Concepts ● Importance of Finance ● Economic Concepts of Finance ● Scarce Resources ● Opportunity Costs ● Savings, Income, Expenditures, and Taxes Policy 18 ● Supply of Money Saved 11 Inflation 18 ● Risk 20 ● Demand for Borrowed Funds 15 ● Federal Reserve ● ● Conclusion 23 ● Review and Discussion Questions 24 ● Exercises and Problems 24 ● Recommended Team Assignment 25 ● Case Study: Macy’s Housewares, Incorporated 25 Chapter Financial Management and Planning 29 Management Functions 30 ● Planning 30 ● Organizing 31 ● Staffing 32 ● Directing 32 Controlling 33 ● Business Organizations and Ownership 33 ● Sole Proprietorship 34 ● Partnership 36 ● Corporation 38 ● Limited Liability Company 41 ● Franchise 43 ● Nonprofit Organizations 43 ● Starting a Business 44 ● Development of a Business Plan 46 ● Executive Summary 46 ● General Company Description 47 ● Business Ownership Succession Plans 52 ● Financing a Business or Raising Capital 52 ● Sources of Financing 54 ● ● ● Conclusion 56 ● Review and Discussion Questions 57 ● Exercises and Problems 57 Suggested Group Project 58 ● Case Study: Introduction to Entrepreneurship 59 Chapter Financial Statements 63 Personal Cash Flow Statement 66 ● Income Statement 67 ● Statement of Financial Position 72 ● Balance Sheet 74 ● ● Chart of Accounts 67 Sole Proprietorship 78 ● Partnership 78 ● Public Corporations 79 ● Owner’s Equity 82 ● Statement of Cash Flows 82 ● Problems with Financial Statements 85 ● Conclusion 87 ● Review and Discussion Questions 88 ● Exercises and Problems 88 ● Recommended Team Assignments 89 ● Case Study: DPSystems, LLC 90 Chapter Analysis of Financial Statements 95 Vertical Analysis 97 ● Horizontal Analysis 99 ● Ratio Analysis 101 ● Types of Business Ratios 101 ● Liquidity Ratios 101 ● Current Ratio 102 ● Quick (Acid Test) Ratio 102 ● ● ● Activity Ratios 103 ● Inventory Turnover Ratio 103 ● Accounts Receivable Turnover Ratio 104 Fixed Asset Turnover Ratio 105 ● Total Asset Turnover Ratio 105 ● Leverage Ratios 106 Debt-to-Equity Ratio 106 ● Debt-to-Total-Assets Ratio 107 ● Times-Interest-Earned Ratio 107 v vi Contents Profitability Ratios 108 ● Gross Profit Margin Ratio 108 ● Operating Profit Margin Ratio 109 Net Profit Margin Ratio 109 ● Operating Return on Assets Ratio 110 ● Net Return on Assets Ratio 110 ● Return on Equity Ratio 110 ● Market Ratios 111 ● Earnings per Share Ratio 111 ● Price Earnings Ratio 112 ● Operating Cash Flow per Share Ratio 113 ● Free Cash Flow per Share 114 ● ● ● Sources of Comparative Ratios 116 ● Conclusion 116 ● Review and Discussion Questions 117 ● Exercises and Problems 118 ● Recommended Team Assignment 122 ● Case Study: Mosbacher Insurance Agency 122 ● Background 122 ● Gaining Experience 123 ● Mosbacher Insurance Company 124 ● Entrepreneurship at Work 124 ● The result 125 Chapter Profit, Profitability, and Break-Even Analysis 127 Efficiency and Effectiveness 128 ● Profit 129 ● Profitability 129 ● Earning Power 130 Break-Even Analysis 131 ● Break-Even Quantity 132 ● Break-Even Dollars 136 ● BreakEven Charts 137 ● Leverage 138 ● Operating Leverage 139 ● Financial Leverage 140 ● Bankruptcy 143 ● Conclusion 146 ● Review and Discussion Questions 147 Exercises and Problems 147 ● Recommended Team Assignment 150 ● Case Study: Mark Wheeler Craftsman, Inc 150 ● ● Chapter Forecasting and Pro Forma Financial Statements 153 Forecasting 154 ● Types of Forecasting Models 156 ● Mean Absolute Deviation 161 ● Practical Sales Forecasting for Start-Up Businesses 175 ● Pro Forma Financial Statements 178 ● Pro Forma Income Statement 178 ● Pro Forma Cash Budget 180 ● Pro Forma Balance Sheet 184 ● Monitoring and Controlling the Business 188 ● Start-Up Business Costs Revisited 188 Gantt Chart 189 ● Conclusion 191 ● Review and Discussion Questions 191 ● ● Exercises and Problems 192 ● Recommended Team Assignment 195 ● Case Study: Hannah’s Donut Shop 196 ● Historical Background 197 ● Environmental Changes 198 ● Changes in Measurement Systems 198 ● Changes in Strategy 199 ● Implementing the Five-Step Process and Drum Buffer Rope 202 ● Step 202 ● Step 202 ● Step 203 The Change Process 203 ● Step 204 Constraints 205 ● Summary 206 ● ● Step 204 ● Results 204 ● Shifting Chapter Working Capital Management 207 Working Capital 208 ● Working Capital Management 208 ● Current Asset Management 210 ● Cash Management 210 ● Marketable Securities Management 213 ● Accounts Receivable Management 214 ● Inventory Management 219 ● Economic Order Quantity Formula 219 ● Types of Inventories 224 ● Current Liabilities Management 228 ● ShortTerm Debt Management 228 ● Accrued Liabilities Management 230 ● Accounts Payable Management 231 ● Conclusion 236 ● Review and Discussion Questions 237 ● Exercises and Problems 238 ● Recommended Team Assignment 240 Steel Trading, LLC 240 ● Background 240 ● Case Study: Associated Chapter Time Value of Money—Part I: Future and Present Value of Lump Sums 243 Simple Interest 245 ● Fixed Principal Commercial Loans 246 ● Bridge Loans 249 ● Bank Discount 250 ● Compound Interest 254 ● Financial Calculators 255 ● Rounding Errors 256 ● Effective Rate 257 ● Time-Value-of-Money Methods 259 ● Future Value of a Lump Sum 260 ● Present Value of a Future Lump Sum 263 ● Internal Rate of Return 268 Conclusion 271 ● Review and Discussion Questions 272 ● Exercises and Problems 272 ● Recommended Team Assignment 274 ● Case Study: Blue Bonnet Café 275 ● Contents vii Chapter Time Value of Money—Part II: Annuities 279 Future Value of an Ordinary Annuity 280 ● Future Value of an Annuity Due 286 ● Present Value of an Ordinary Annuity 291 ● Present Value of an Annuity Due 294 ● Present Value and Amortization 298 ● Amortization 300 ● Combining Lump Sum and Annuities into the Same Problem 304 ● Conclusion 308 ● Review and Discussion Questions 308 ● Exercises and Problems 309 ● Recommended Team Assignment 311 ● Case Study: Entrepreneurial Spirit 311 Chapter 10 Capital Budgeting 315 Capital Budgeting 316 ● Factors Affecting Capital Budgeting 317 ● Changes in Government Research and Development 318 ● Changes in Business Strategy 318 ● Formulating a Proposal 319 ● Costs in Capital Budgeting 319 ● Benefits in Capital Budgeting 320 ● Evaluating the Data (Techniques of Capital Budgeting) 323 ● Payback 324 ● Net Present Value 324 ● Profitability Index 330 ● Internal Rate of Return 331 ● Accounting Rate of Return 335 ● Lowest Total Cost 336 ● Making the Decision 338 ● Following Up 339 ● Taking Regulations 317 ● Corrective Action 339 ● Conclusion 340 ● Review and Discussion Questions 341 Exercises and Problems 342 ● Recommended Group Activity 345 ● Case Study: SWAN Rehabilitation Company: A Great Success Story 345 ● Chapter 11 Personal Finance 349 Risk 350 ● Identification of Risk Exposure 351 ● Risk Management 351 ● Life, Health, Disability, Property, and Liability Insurance 353 ● Financial Planning Goals 358 ● Investments 358 ● Cash Equivalents 358 ● Certificates of Deposit 359 ● Bonds 360 ● Stock 364 ● Mutual Funds 370 ● Real Estate 373 ● Precious Metals 375 ● Collectibles 375 ● Investment Strategies 376 ● Short-Term Investment Strategies 376 ● Long-Term Investment Strategies 377 ● Pension Planning 377 ● Retirement Plans 378 ● Retirement Strategies 383 ● Retirement Strategy Examples 384 ● Estate Planning 387 ● Conclusion 391 ● Review and Discussion Questions 391 ● Exercises and Problems 392 ● Recommended Group Activities 395 ● Case Study: The Gilberts: An Entrepreneurial Family 396 Appendix A Working with Spreadsheets Spreadsheet Basics 399 ● Formula Entry 403 Interest or Future Value of a Lump Sum 403 ● ● Future Value of an Ordinary Annuity 406 ● ● Present Value of an Ordinary Annuity 409 ● ● Working with Calculators 412 Appendix B and Calculators 399 ● Simple Interest 403 ● Compound Present Value of a Future Lump Sum 405 Future Value of an Annuity Due 408 Present Value of an Annuity Due 411 Time-Value-of-Money Tables 417 Appendix C Answers to Even-Numbered Exercises and Problems 425 Chapter 425 ● Chapter 425 ● Chapter 426 ● Chapter 427 ● Chapter 430 ● Chapter 431 ● Chapter 435 ● Chapter 435 ● Chapter 438 ● Chapter 10 442 ● Chapter 11 444 Case Studies 447 Glossary 463 Index 477 This page intentionally left blank Preface NEW TO THE SIXTH EDITION In this edition, we include short case studies of small businesses at the end of each chapter We have also added some additional case studies at the end of the textbook Chapter has updated material on the Small Business Administration (SBA), with a discussion of new programs including loans and grants that have been developed to assist veterans and severely disabled veterans We also added updated sources of financing, the requirements for obtaining federal contracts, and the need for businesses to develop succession plans Chapter has updated financial ratios that include averaging information from two balance sheets when data for the ratio is taken from both the income statement and balance sheet (statement of financial position) Chapter introduces fixed interest loans to include both fixed principal commercial loans and bridge loans New to this edition are examples of Time Value of Money problems using both Microsoft Excel and the TI (Texas Instruments) BA II Plus calculator We include step-by-step diagrams for the solution to TVM problems Chapter includes a discussion of adjustable rate mortgages (ARMs) and illustrates the problem with an upside-down mortgage when real estate values decline We also include step-by-step diagrams for the solution to TVM annuity problems using the TI BA II Plus calculator Chapter 11 is updated to show changes in retirement programs and now includes a discussion of Medicare insurance and an explanation of the new Medicare Prescription Drug Plan and income replacement insurance policies Chapter 11 also includes the requirements for an annual financial tuneup Appendix A has been updated to show solutions to typical financial problems using both Microsoft Excel and the TI BA II plus calculator We include screenshots of Microsoft Excel spreadsheets We also include screenshots of how to enter time-value-of-money formulas using the function wizard fx Appendix A also includes step-by-step solutions to sample problems using the TI BA II Plus financial calculator We have written this textbook for the more than 99 percent of business owners and managers in the United States who manage sole proprietorships, partnerships, ix www.downloadslide.net Glossary cannot be used for loans Reserve requirements are established by the Fed These reserves must be kept in the bank’s vault or kept on deposit with the Fed Retained earnings The amount of a corporation’s profit not distributed to the owners but is retained by a corporation for future investment Retirement plans (pension) The establishment of an investment structure to accumulate wealth for use upon retirement Under current law, most plans require that money may be withdrawn after age 59 and 1/2, and money must be withdrawn after age 70 and 1/2 Retirement plans, benefit-oriented A defined benefit plan to the retiree based on employment longevity and compensation Retirement plans, combined A plan designed by individuals and the employer based on tax-deferred salary contributions and employer contributions Retirement plans, contribution-oriented A plan in which benefits to the retiree are based on an account balance that has been accumulated during the employee’s tenure Returns and allowances A method of accounting that provides the customer with an avenue to return unwanted items as well as providing discounts to the customer for taking advantage of special promotions Return on equity (ROE) A ratio that indicates to the stockholder or individual owner what each dollar of his or her investment is generating in net income The formula is Return on Equity = Net Income (Profit) , Average Owner’s Equity Return on investment (ROI) See Net return on assets (ROA) Revenues The money generated as a result of sales of a product and services for a company Revocable trusts A trust in which the trustor has the right to cancel the trust during his or her lifetime Risk The probability that an expected outcome will occur, and the variability in that expected outcome In financial terms, the probability that the actual return on an investment will be different from the desired return Risk assumption When you believe that the loss you might incur is less than the cost of risk avoidance or risk transfer Risk avoidance A method of managing a business by distancing yourself from a hazard that may cause a loss Example: Dealing in only cash to avoid credit risk Risk exposure The placement of a business in a situation in which there is uncertainty of outcome Smoking cigarettes for an individual is risk exposure, some but not all smokers get cancer Introducing a new product for a business is risk exposure, some but not all products succeed Risk management involves performing the management planning function in a manner that reduces uncertainty Risk premium An interest rate added onto the real rate of return that takes into consideration the risk of a project 473 Risk, pure Pure risk involves only the chance of loss, and it is therefore insurable Example: Having your house catch on fire is pure risk Risk reduction A program used by a business or individual to lessen the severity of an outcome as the result of risk Fastening your seat belt or having air bags in a car are methods of risk reduction Risk, speculative The risk in which there may be a possible gain or loss that is uninsurable Example: Buying a lottery ticket is speculative risk.You can either gain a dollar or more or lose a dollar Risk transfer Having another party assume the risk and agreeing to pay you for your loss as long as you pay the fee (or premium) charged by the agency assuming the risk Example: A fire insurance policy on your house Roth 401(k) An after-tax elective contribution to a 401(k) plan funded with after-tax dollars and not taxed on distribution Roth Individual Retirement Account (Roth IRA) An individual retirement account that allows you to contribute up to $5,000 of after-tax dollars ($6,000 if age 50 or older as of 2008) The earnings on this account are tax-free and will be indexed beginning in 2009 Rule of 72 An approximation of the amount of time that it takes for a present sum of money to double by dividing 72 by the annual interest rate Safety stock (ss) The quantity of stock held to satisfy variations in demand Salvage (residual) value The value of an asset after it has been depreciated over its useful life Savings Incentive Match Plan for Employees (SIMPLE) An IRA established after 1996 by an employer with fewer than 100 employees The company must match dollar for dollar the employees’ contribution up to percent of salary Scarcity A condition that exists because human beings want more than they currently have Seasonal variation The variation that exists in company sales based on predictable differences in climate, holidays, and buyer behavior Secondary securities market A market in which stock is bought and sold by the existing owners of individual shares Secured debt Debt of a company or individual backed by specific assets, which are pledged to guarantee the debt Securities and Exchange Commission (SEC) An agency that regulates the sale and exchange of publicly traded securities The SEC is an independent, nonpartisan, quasi-judicial regulatory agency with responsibility for administering the federal securities laws Sensitivity analysis Also known as what-if analysis It uses a mathematical spreadsheet program or other computer www.downloadslide.net 474 Glossary program that allows us to change some variable to determine what would happen with a decision when the variable is changed Example: What is the result of loan payments on a loan at various interest rates? Service Corporation of Retired Executives (SCORE) A consulting service provided by the Small Business Administration (SBA) that consists of a group of retired business owners and managers who have years of experience in various businesses Set-asides are federal government and state programs that identify specific business groups who are underrepresented in obtaining contracts Businesses owned by members of these groups are given preference when contracts are awarded Short-term debt The obligations of a business that will be paid during the current accounting period, usually 1 year or less Simple interest The amount of money earned on the principal amount stated Simplified Employee Pension (SEP) plans IRAs funded by employers SEPs are common for the self-employed; the participating employee makes no contribution Single equivalent discount A discount equal to 100 percent of the list price minus the actual percentage of the list price paid (net cost rate factor) Slope Rise of a line (change in y) divided by the run of a line (change in x) In the formula y = a + bx, b is the slope of the line Smoothing constant A value (alpha a) assigned by the forecaster to adjust the forecast based on the forecaster’s assumption of the relationship of sales in one time period and sales in the next time period Used in the exponential smoothing forecasting model Social Security See Federal Insurance Contribution Act Sole proprietorship A business operated by an individual for his or her own profit Speculative risk See Risk, speculative Staffing Obtaining the most capable personnel in order to implement business plans Start-up costs All the money a business spends to get a project under way Start-up costs usually include acquisition costs, training costs, and maintenance costs State employment taxes usually consist of income, unemployment, and workmen’s compensation taxes Municipal employment taxes usually are only income tax Stated (quoted) rate The rate of interest that is listed, usually on an annual basis, and it disregards compounding Statement of cash flows A financial statement that determines what has happened to the working capital account (the amount of cash available) of a company between the beginning and end of an accounting period Statement of financial position On a personal balance sheet, it indicates all items owned and all items owed by an individual or family at a specific point in time Stock Ownership in a corporation divided into shares The individual shares are referred to as stock Stock bonus plans A retirement plan in which the employer contributes shares of stock rather than money into a retirement account Strategic planning Establishing an overall long-range plan for a business Strategic plans The long-range overall plans for a business Strengths The core competencies of a business Subchapter S corporation One that is privately held, has more than owner but not more than 100, and is granted Subchapter S status by the Internal Revenue Service Subchapter S corporations have favorable tax status Subprime loan (mortgage) Offered to people who have poor credit ratings and are considered to be high risk Supply curve A curve generated from a supply table by horizontally summing the total product or service provided at various prices in the marketplace The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds Supply table A table generated by determining how much of a product or service people and business are willing and able to provide to the market at various prices Surveys of customers are effective for virtually all firms, but particularly for the company that has a few large customers Examples include firms that manufacture parts for a few large national chains, original equipment manufacturers, and unique specialty shops Surveys of sales forces are conducted by managers to determine future sales within the company’s sales territories SWOT An acronym that stands for Strengths, Weaknesses, Opportunities, and Threats that pertain to both the internal workings (strengths, weaknesses) and external factors (opportunities, threats) of a company See also Individual entries Systematic risk Risk that is associated with economic, political, and sociological changes that affect all participants on an equal basis Tax factor benefits In capital budgeting, the benefits that current tax law allows a business to deduct or write off once a new investment is made Tax factor costs In capital budgeting, the calculation of the costs that result in additional taxes that must be paid by a firm Tax-sheltered annuities (TSAs) Retirement plans that allow employees of not-for-profit organizations to establish a retirement fund purchased and approved by the employer Taxes Payments to government for goods and services provided by government Taxes payable The accrued taxes owed by a business, but not actually paid as of the date of the business balance sheet Example: Sales taxes collected in December that www.downloadslide.net Glossary are not paid to the state until January of the following year T-bill U.S Treasury bond that matures in less than year, typically and months T-bond U.S Treasury bond that has a maturity greater than 10 years Testamentary trust A trust established at the death of the trustor Theory of constraints (TOC) A theory developed by Eliyahu M Goldratt used to find business’s primary problem(s)/(constraints), generate a simple solution to the problem, and provide an implementation strategy Threats Factors in the environment that may impede the growth of a business, directly or indirectly Time series forecasting models Forecasting models that use historical records that are readily available within a firm or industry to predict future sales Times-interest-earned A ratio that shows the relationship between operating income and the amount of interest in dollars the company must pay to its creditors on an annual basis The formula is Time-Interest-Earned = Operating Income , Interest Time value of money The loss of purchasing power that occurs over time as a result of inflation T-note U.S Treasury bonds that mature in 10 years or less Total asset turnover A ratio that indicates how efficiently total assets are being used to generate revenue for the firm The formula is Total Asset Turnover = Net Sales , Average Total Assets Total assets The sum of current and fixed assets Total current liabilities are nothing more than the sum of all current liabilities for a company, as depicted on the balance sheet Total liabilities The sum of current liabilities and longterm debt Trade discount These are amounts deducted from the list price of items when specific services are performed by the customer Usually given by manufacturers to wholesalers or retailers U.S Treasury bonds Bonds issued by the government of the United States Trend variation The change in sales over time, represented by a straight line that depicts changes in sales over time The trend line uses least square regression to eliminate seasonal variation, cyclical variation, and noise Trusts A legal entity similar to a corporation that has a legal persona of its own Property placed in a trust is separate from that of its owner A trust is created by a trustor or grantor and beneficiaries or trustees are named by the trustor Unsystematic risk Risk that is unique to an individual, firm, or industry Use assets See Fixed assets U.S Small Business Administration (SBA) is a government agency founded in 1953 for the purpose of 475 helping Americans start, build and grow business The SBA runs several program which can be found on their home page at www.sba.gov Variable costs Costs driven directly by the volume of product flow Variable expenses Pertains to a personal cash flow statement Expenses over which we have some control, such as food, clothing, and automobile expenses Variance A deviation from the norm If a company establishes a personnel budget of $250,000, and actual spending is $260,000, then the variance is a negative $10,000 Venture capitalists Investors who provide financing at the expansion and later stages of business development Vertical analysis A process of using a single variable on a financial statement as a constant and determining how all of the other variables relate as a percentage of the single variable Warranty The guarantee that a product or service will perform under certain terms and conditions Usually lists the remedy the purchaser may pursue if the warranty is not carried out Weaknesses The areas in which a company definitely needs improvement Weighted average cost of capital (WACC) The method of determining a company’s cost of capital when it takes into consideration the rate charged by the lender(s) and the opportunity cost foregone by the borrower(s) The WACC is calculated using these rates and the proportion of total financing funded by the lender and borrower Weighted moving average forecasting model A model that assumes that some recent time periods are a more accurate predictor of sales than previous time periods, but that the predictive ability of the time periods used is not equal Whole-life insurance or permanent Which allocates part of the premium to building equity, or cash value, that can be used on retirement or borrowed against in case of an emergency Will A document that directs others as to how you want your wishes carried out after death with regard to disposition of property Work-in-process The inventories that a firm uses while in the assembly or transformation process Working capital The current assets and current liabilities of a business Working capital commitment costs In capital budgeting, the costs of maintaining a specific level of working capital that are required by lending institutions Example: Inventory and accounts receivable costs committed to back up a loan Working capital management The ability to effectively and efficiently control current assets and current liabilities in a manner that provides the firm with maximum return on its assets and minimizes payments for its liabilities www.downloadslide.net This page intentionally left blank www.downloadslide.net Index ABC inventory analysis, 225–228 Absolute deviation, 161, 463 Absolute value, 161, 463 Accelerated cost recovery system (ACRS) depreciation, 75, 463 Accounting accrual method of, 71, 86, 463 cash method of, 86 Accounting profit, 129, 463 Accounting rate of return (ARR), 335–336, 463 Accounts, chart of, 67–72 Accounts payable, 76, 463 Accounts payable management cash discounts, 233–235, 464 cumulative discounts, 236, 465 overview of, 231 quantity discounts, 235–236, 472 single equivalent discount, 232, 474 trade discounts, 231–233, 475 Accounts receivable, 75, 463 Accounts receivable management aging, 217–218 analyzing, 216–217 credit evaluation, 215–216, 465 factoring, 214–215, 323, 467 overview of, 214 Accounts receivable turnover ratio, 104–105, 463 Accrual method of accounting, 71, 86, 463 Accrued liabilities, 463 management of, 230–231 Accumulated depreciation, 76, 82–83, 463 Accumulated retained earnings, 81 Acid test (quick) ratio, 101, 102–103, 463, 472 Activity ratios accounts receivable turnover ratio, 103, 463 defined, 104, 463 fixed asset turnover ratio, 105, 475 inventory turnover ratio, 103–104, 468 total asset turnover ratio, 105, 129, 476 Additional paid in capital, 365, 463 Adjustable rate mortgages (ARMs), 23, 303 Aging, of accounts receivable, 217–218 Aloha Airlines, 369 Amortization defined, 300, 463 overview of, 300–304 present value and, 298–300 Analogy, historical, 157, 468 Angel investors, 55, 463 Annuity(ies) combining lump sum and annuities into same problem, 304–308 defined, 279, 463 ordinary, 279–285, 291–293, 386, 408, 409–410, tax-sheltered (TSAs, 403b plans), 381, 474 Annuity due defined, 280, 463 future value of, 286–291, 406–408 present value of, 294–298, 409–411 Annuity paid, 279 Annuity received, 279 Appreciation, 108 Asset(s) capital, 2, 464 defined, 72, 463 financial, 2, 467 fixed, 6, 72–76, 105, 467 invested, 72, 469 personal, 53 total, 73, 75, 76, 105, 131, 475 Assets, current See Working capital (current assets); Working capital management ATA, 369 Average collection period, 104, 463 The baker, 202, 464 Balanced (growth and income) funds, 371, 464 Balance sheet contents of, 74–82 defined, 74, 463 percentage of sales method, 186–187, 471 pro forma, 184–187, 472 Bank accounts, 211–213 Bank discount, 250–253, 464 Bankers, difference between investors and, 52–53 Bankruptcy Bankruptcy Abuse Prevention and Consumer Protection Act, 145–146, 464 Chapter 7, 144–146, 464, 465 Chapter 11, 144, 145, 464, 465 Chapter 13, 144–146, 464, 465 defined, 143, 464 overview of, 143–146 477 www.downloadslide.net 478 Index Basic accounting equation, 75 Basis point, 10, 252 Beneficiary, 355 Benefit-oriented retirement plans, 378, 464 Bonds corporate, 361–362, 465 defined, 360, 464 junk (high-income-yielding), 363, 469 municipal, 360–361, 470 par value of, 361, 471 U.S Treasury, 360 Book value in a financial statement, 78, 85–86, 464 of stock, 365, 366, 464 Break-even analysis calculators, working with, 413 charts, break-even, 137–138, 464 defined, 131, 464 dollars (BE$), break-even, 136–137, 413, 464 quantity (BEQ), break-even, 132–136, 413, 464 Bridge loans, 249, 464 Budget cash, pro forma, 180–184, 188, 472 deficit, 360 Budgeting, capital See Capital budgeting Buildings, 76 Business, starting a, 44–46 See also Start-up business Business organizations/ownership corporation, 38–41, 71, 79–81, 465 franchise, 43, 467 limited liability company (LLC), 41–42, 70, 469 non-profit (not-for-profit) organization, 43–44 overview of, 33–34 partnership, 36–38, 71, 78–79, 82, 381, 387, 471 sole proprietorship, 34–36, 70, 74, 78, 474 succession plan, 52 Business philosophy, 47 Business plan appendices, 51 executive summary, 46–47 financial plan, 51 financial statements, personal, 50 general company description, 47–51 management and organization, 50 marketing plan, 48–49 operational plan, 50 products and services, 47 start-up expenses, 50 Business strategy changes, capital budgeting and, 318–319 Buy and hold, 377, 464 Buy-sell agreement, 36 Calculators, working with break-even dollars (BE$), 413 break-even quantity (BEQ), 413 economic order quantity (EOQ), 414 future value of annuity due, 288, 289, 409 future value of lump sum, 261, 262, 405 future value of ordinary annuity, 281, 283, 408 overview of, 412–413 present value of an annuity annuity, 295, 412 present value of an ordinary annuity, 293, 411 present value of a future lump sum, 265, 267, 406 time-value of money, 255–256 total cost (TC), 414 Callable preferred stock, 369, 464 Call premium, 369 Capacity, credit evaluation and, 215, 464 Capital additional paid in, 365, 463 assets, 2, 464 expenditures, 85, 115, 464 financial, 6, 467 resources, 6, 464 start-up, 50, 53, 55 structure, 35 weighted average cost of (WACC), 325–326, 334, 475 See also Financing; Working capital management Capital budgeting accounting rate of return (ARR), 335–336, 463 benefits in, 320–323 business strategy changes and, 318–319 corrective action, taking, 339–340 costs in, 319–320, 325–330 data evaluation and, 323–338 defined, 243–244, 464 factors affecting, 317–319 following up, 339 government regulations changes and, 317 internal rate of return (IRR) and, 331–335 lowest total cost (LTC), 336–338, 469 making the decision, 338–339 net present value (NPV), 324–330, 470 overview of, 243–245, 316–317 payback, 324, 471 profitability index (PI), 330, 472 proposal, formulating a, 319–323 research and development and, 318 steps involved in, 319–340 taxes and, 319–323 Capital intensive, 102, 464 Capital rationing, 339, 464 Carrying cost, 219–220 Case studies, 447–462 on analysis of financial statements, 122–126 on annuities, 311–313 on capital budgeting, 345–348 on financial and economic concepts, 25–28 on financial management and planning, 59–60 on financial statements, 90–91 on forecasting and pro forma financial statements, 190–206 on personal finance, 396–397 on profit, profitability, and break-even analysis, 150–151 on time value of money, 275–277 on working capital management, 240–242 Cash budget, pro forma, 180–184, 472 Cash discounts, 233–235, 464 Cash equivalents, 358–359, 464 Cash flow defined, 317 from financing activities, 84, 464 free, 84 free cash flow per share ratio, 114–116, 467 from investing activities, 84, 464 from operating activities, 82–84, 87, 113, 464 Cash flow statement business, 82–85 personal, 66–67, 471 Cash management, 210–213 Cash method of accounting, 86 Cash-on-delivery (COD), 144 Cash on hand, 211 Cash surrender value (CSV), 353 Causal (external or exogenous) models, 174, 464 Cause-and-effect methods, 156 C corporation See Corporation www.downloadslide.net Index CDs (certificates of deposit), 359–360, 464 Central Contractor Registration (CCR), 49 Certified public accountant (CPA), 64, 465 Ceteris paribus, defined, 11, 465 Character, credit evaluation and, 215, 465 Checking accounts, 211–213 Collateral, credit evaluation and, 215, 465 Collectibles, 375–376, 465 Collections float, 212, 465 Combined leverage, degree of (DCL), 142, 466 Combined retirement plans, 378, 473 Commercial real estate, 374, 465 Commodities basic, precious metals, investing in, 375, 471 Common stock, 364–366, 465 Company goals, 47, 465 Company objectives, 47, 465 Compound interest, 254–255 defined, 254, 465 examples, 254–255 rounding errors, 256–257 using spreadsheet to calculate, 403–405 Condition, credit evaluation, 215, 465 Consumer price index (CPI), 18, 465 Contribution margin, 134–135, 465 Contribution-oriented retirement plans, 378, 465 Controlling, 33, 339, 465 Convertible preferred stock, 368–369, 465 Corporate bonds defined, 361, 465 mechanics of financing, 361–364 secured versus unsecured, 361 Corporation advantages of, 39 defined, 38, 465 disadvantages of, 39–40 owner’s equity for, 79–82, 471 private, 40, 472 professional, 40 public, 38, 64, 79–81, 472 Subchapter S, 38, 40, 41, 70, 71, 474 taxes and, 38, 40–42, 70 Corrective action, taking, 339–340 Cost(s) in capital budgeting, 319–320, 325–330 carrying, 219–220 fixed, 70, 132, 467 (see also operating expenses) of goods sold (COGS), 69–70, 465 marginal, opportunity, 6–8, 471 tax-factor, 320, 474 total (TC), 221–222 variable, 70, 132, 475 working capital commitment, 320, 475 See also Expense(s) Coupon rate 361, 465 See also Stated (coupon, nominal, quoted) rate Coverage gap, 356n2 Coverdell Education Savings accounts, 380 Credit decision, 215–216, 465 Credit evaluation, 215–216, 465 Creditor, 143, 465 Credit terms, 216, 465 Cumulative discounts, 236, 465 Cumulative preferred stock, 368, 465 Current assets, 465 See also Accounts receivable; Working capital (current assets); Working capital management Current liabilities, 76, 208, 465 See also Current liabilities management; Liabilities, financial; Working capital management Current liabilities management of accounts payable, 231–236, 463 of accrued liabilities, 230–231 overview of, 228 of short-term debt, 228–230, 474 Current market interest rates, 465 See also Market interest rates Current ratio, 102, 465 Customers, surveys of, 157 Cutoff (hurdle) rate, 334 Cyclical variation, 168, 466 Daily demand, inventory, 222, 466 Data evaluation, capital budgeting and, 323–338 Debenture (unsecured debt), 361, 466 Debt national, 360 secured, 361, 473 unsecured (debenture), 361, 466 See also Liabilities, financial Debt financing, 141 Debt ratios See Leverage (debt) ratios Debt-to-equity ratio, 106–107, 466 479 Debt-to-total-assets ratio, 107, 466 Deductible IRAs, 379 Deficit budget, 360 Deflation, 19 Degree of combined leverage (DCL), 142–143, 466, 469 Degree of financial leverage (DFL), 141–142, 466 Degree of operating leverage (DOL), 139–140, 466 Delegate, 32 Delphi method, 158, 466 Demand, law of, 15–18, 469 Demand curve, 16–17, 466 Demand for borrowed funds, 15–18, 466 Demand table, 16, 466 Dependent variable, 168, 466 Depreciation accelerated cost recovery system (ACRS), 75, 463 accumulated, 76, 82–83, 463 calculating, 322–323 defined, 75–76, 466 modified accelerated cost recovery system (MACRS), 75, 322, 470 straight-line, 321–322 Directing, 32–33, 466 Disability insurance, 356, 468 income replacement, 356–357 Disbursement float, 212, 466 Discount(s) bank, 250–253, 464 bond, 362 cash, 233–235, 464 cumulative, 236, 465 quantity, 235–236, 472 single equivalent, 232, 474 trade, 231–233, 475 Discount rate, 20, 250, 252, 466 Discretionary income, 11, 466 Disposable income, 10, 466 Dividend(s) defined, 3, 466 preferred stock, 367–370 Dollar cost averaging, 377, 466 Dow Jones Industrial Average, 21–22, 367 Dun & Bradstreet, 215 Dun’s Review, 116 Earning power, 130–131, 466 Earnings (inflows) accumulated retained, 81 before taxes, 70, 466 www.downloadslide.net 480 Index Earnings (inflows) (continued) per share, 71–72, 466 personal, 66 retained, 72, 473 Earnings per share ratio, 111–112, 466 Ebbers, Bernard, 86 Economic capital, 6, 466 See also Fixed assets Economic order quantity (EOQ) formula calculating, 219–221, 414 defined, 219, 466 EDGAR (Electronic Data Gathering and Retrieval System), 38, 97, 177, 466 Effective rate (effective annual interest rate), 251–252, 257–259, 466 Efficiency, difference between effectiveness and, 128, 466 Electronic funds transfer (EFT), 213, 466 Enron, 86, 113, 114 Entrepreneur defined, 6, 466 investor’s question, 127 non-financial factors, 52 overview, Entrepreneurial profit, 129, 466 Entrepreneurial resources, Equilibrium/equilibrium point, 17, 466 Equipment, 76, 467 Equity, owner’s See Owner’s equity Equity financing, 54, 467 Estate planning defined, 467 gifting, 388, 389 joint ownership with right of survivorship, 388–389 overview of, 387–391 probate, 388, 472 trusts, 389, 475 wills, 388, 475 Executive summary, 46, 467 Exogenous (causal or external) models, 174, 464 Expense(s) capital expenditures, 85, 115, 464 fixed, 66, 177, 467 interest, 70, 468 operating, 70, 471 start-up, 50–51, 177, 188–189, 319–320, 474 variable, 66, 177, 475 See also Cost(s) Exponential smoothing forecasting model, 165–167, 467 External (causal or exogenous) models, 174, 464 Face value, 361, 467 See also Par (face, principal) value Factoring, 214–215, 352, 467 Fair Labor Standards Act (FLSA), FDA (Food and Drug Administration), 86, 376 Federal Acquisition Regulation (FAR), 49 Federal bonds, 360–361, 467 See also U.S Treasury bonds Federal Deposit Insurance Corporation (FDIC), 359 Federal employment taxes, 230, 467 Federal funds rate, 19–20, 272, 467 effective, 19 Federal Reserve defined, 18, 467 monetary policy, 18, 20, 470 Federal Treasury bills, 251–253, 467 FICA (Federal Insurance Contribution Act) taxes, 77, 467 Fidelity, 372 Finance basic concepts, 2–3 defined, 2, 467 economic concepts of, 3–11 importance of, Financial Accounting Standards Board (FASB), 64, 467 Financial asset, 2, 33, 467 Financial capital, 6, 467 Financial leverage, 140–143, 467 degree of (DFL), 141–142, 466 Financial market, Financial planning in business plan, 51 defined, 30, 467 estate planning, 387–391 goals, 358 investments, 251–252, 358–376 retirement planning, 378–383 Financial position, statement of, 72–74, 474 Financial statements, analysis of, 96–97 horizontal, 99–100, 430 ratio, 101–116 vertical, 97–99 Financial statements, business balance sheet, 74–82, 184–187, 463 cash budget, 180–184, 464 cash flow statement, 82–85 income statement, 67–72, 178–180, 468 monitoring and controlling process, 188 problems with, 85–87 pro forma, 68, 178–187, 472 Financial statements, personal in business plan, 50 cash flow statement, 66–67, 464 defined, 64, 467 financial position, statement of, 72–74, 474 Financial tune-ups, components, 389–391 Financing cash flow from, 84, 464 corporation and, 38–41 debt, 131 difference between bankers and investors, 52–53 equity, 54 sole proprietorship and, 34–36 sources of, 54–56 Finished goods inventories, 225, 467 The finisher, 202, 467 403b plan, 381, 463 Fixed assets economic capital, physical capital, use assets, 2, 75–76, 466 turnover ratio, 105, 467 Fixed costs (business), 70, 132, 467 Fixed expenses, 467 business, 177 personal, 66 Flat-tax proposals, 10–11 Float collections, 212–213, 465 disbursement, 212, 466 Following up, 339 Forecasting causal (external or exogenous) models, 174–175 defined, 154, 467 judgmental models, 156–157, 469 for start-up businesses, 175–177 steps in, 154–156 time series models, 158–174, 475 Form 10-K (SEC), 38, 39, 97, 116, 463 401(k) Keogh profit sharing, 145 401(k) plans, combined, 382, 463 defined, 467 retirement plans, 382 www.downloadslide.net Index Roth, 382–383, 437 SIMPLE, 381 traditional, 382–383 403b plans (tax-sheltered annuities), 381 Franchise, 43, 467 Free cash flow, 84 free cash flow per share ratio, 114–116, 467 The fryer, 202, 467 FTC (Federal Trade Commission), 116 Functional planning, 30, 468 Future lump sum, present value of, 263–268, 405–406, 419 Future value of annuity due, 286–290, 408–409, 411–412 of lump sum, 260–263, 405–406, 418, 419 of ordinary annuity, 282–285, 406–407, 420, 422 Gantt chart, 189–191, 320, 468 General (nominal) ledger, 67 Generally accepted accounting principles (GAAP), 75, 113, 468 General Motors, 369 General obligation bonds, 360, 468 General partner/partnership, 36, 468, 471 General revenue (obligation) bonds, 360, 468 Gifting, 388 Global funds, 371, 468 Goals defined, 468 difference between objectives and, 31, 47 financial planning, 358 Goal setting, 30–31 Government regulations changes, capital budgeting and, 317 Grants, 56, 468 Gross income, 8, 468 Gross profit, 70, 468 margin ratio, 108–109, 468 Gross working capital, 208, 468 Growth and income (balanced) funds, 371, 377 Growth funds, 371, 468 Health insurance defined, 354, 468 disability insurance, 356–357, 468 long-term care insurance, 357, 468 Medicare, 354–356 (see also FICA [Federal Insurance Contribution Act] taxes) Health Maintenance Organization (HMO), 354, 355 High contact, 50 High-income-yielding (junk) bonds, 363, 371 Historical analogy, 157, 468 Horizontal analysis, 99–100, 468 Human resources, 4–5, 468 Hurdle (cutoff) rate, 334 Income discretionary, 11, 466 disposable, 10, 466 gross, 8, 468 net, 68, 71, 470 operating, 70, 471 Income funds, 370–371, 468 Income statement, 67–72, 468 pro forma, 68, 178–180, 472 Income taxes, 70, 76, 79, 230, 361, 468 Independent variable, 168, 468 Individual Retirement Accounts See IRAs (Individual Retirement Accounts) Industry Norms and Key Business Ratios (Dun & Bradstreet), 116 Inflation, 18–20, 244, 468 premium for, 325 Inflows See Earnings (inflows) Initial Public Offering (IPO), 365 Insurance defined, 468 disability, 356–357, 468 health, 353–358, 468 liability, 357–358, 468 life, 353–354, 468 long-term care, 357, 468 property, 468 Intermediaries, 362 Internal rate of return (IRR), 268–271, 468 capital budgeting and, 331–335 time-value-of-money methods, 268–271 Interest compound, 254–255, 403–405, 465 defined, 468 simple, 245–254, 403, 474 Interest expense, 70, 468 481 Interest rate(s) bonds and, 360–364 CDs (certificates of deposit) and, 359–360 discount rate, 20, 250, 251, 466 effective, 251, 257–259, 466 federal funds rate, 19–20, 467 forecasting future, 324–325 market, 16, 362–363 money market funds and, 371, 372 prime, 3, 22, 247–248, 253, 325, 472 stated (nominal, quoted, coupon), 254, 257–258, 361, 474 Internal/intrinsic forecasting models See Time series (internal or intrinsic) forecasting models International funds, 371, 468 Interpolation, 332, 468 Inventory/inventory management, 75, 468 ABC analysis, 225–228 defined, 468 economic order quantity (EOQ) formula, 219–224, 414, 466 finished goods, 225, 467 just-in-time (JIT), 223–224 maintenance, repair, and operating (MRO), 225, 469 overview of, 219 raw materials, 224–225, 472 reorder point (ROP) calculations, 222 turnover ratio, 103–104 work-in-process, 225, 475 Invested assets, 72, 469 Investing activities, cash flow from, 84, 464 Investments bonds, 360–364, 464 cash equivalents, 358–359, 464 CDs (certificates of deposit), 359–360, 464 collectibles, 375–376 defined, 358, 469 long-term strategies, 377 mutual funds, 370–373, 470 precious metals, 375, 471 real estate, 373–375, 472 short-term strategies, 376–377 stock, 364–370, 474 Investors angel, 55, 463 difference between bankers and, 52–53 Investment vehicle, 358, 469 www.downloadslide.net 482 Index IRAs (Individual Retirement Accounts) Coverdell Education Savings accounts, 380 deductible, 379 defined, 468 nondeductible, 379 Roth, 379, 382–383, 473 Section 529 plans, 380 SEP (simplified employee pension), 380, 474 SIMPLE (Savings Incentive Match Plan for Employees), 381, 473 Irrevocable grantor (Rabbi) trusts, 389, 469 Irrevocable trusts, 389, 469 IRS (Internal Revenue Service), 40, 41, 43, 49, 212, 230, 378, 474 checklist for starting a business, 51 Janus, 372 Job requirements, 32 Joint ownership with right of survivorship, 388 Judgmental forecasting models defined, 156–157, 469 Delphi method, 158, 466 historical analogy, 157, 468 market research, 157–158 surveys of customers, 157 surveys of sales forces, 156–157 Junk (high-income-yielding) bonds, 363, 469 Just-in-time (JIT) inventory, 223–224 Keogh plans combined 401k Keogh profit sharing, 381–382, 464 defined, 469 traditional, 383 Labor, Labor intensive, 138, 469 Land, 4, 76, 469 See also Natural resources Law of demand, 15–18, 469 Law of supply, 11–14, 469 Lead time, inventory, 222, 469 Least squared regression, 167, 469 Ledger, general (nominal), 67 Leverage combined, 142, 466, 469 defined, 138–139, 469 financial, 140–143, 467, 469 operating, 139–140, 469, 471 Leverage (debt) ratios debt-to-equity ratio, 106–107, 466 debt-to-total-assets ratio, 107, 466 defined, 106, 469 times-interest-earned ratio, 107–108, 475 Liabilities, financial current, 77, 208, 465 defined, 73, 469 long-term, 77, 469 total, 73, 77, 475 See also Current liabilities management Liability corporation and, 39, 41 limited, 37, 39, 41, 42 partnership and, 36, 37 personal, 36, 37 sole proprietorship and, 35 unlimited, 35, 39 Liability insurance, 357–358, 468 Life insurance defined, 353–354, 468 term, 353 universal, 354 variable, 354 whole- (permanent), 353–354 Limited (company), 369 Limited liability, 37, 39, 4142 Limited liability company (LLC), 41–42, 70, 469 Limited liability partnership (LLP), 37, 469 Limited partner/partnership, 37, 469 master, 37–38, 4470 Linear regression model, 167–174, 469 Line of credit, 228–229, 469 Liquidity, 72, 469 Liquidity ratios current ratio, 102, 465 defined, 101, 469 quick (acid test) ratio, 102–103, 472 Living trusts, 389, 469 Load funds, 372, 469 Loan(s) bridge, 249, 464 defined, 11 fixed principal commercial, 246–248 See also Mortgages Lockbox, 212–213, 469 Long-term care insurance, 357, 468 Long-term liabilities, 77, 469 Low contact, 50 Lowest total cost (LTC), 336–338, 469 Lump sum combining lump sum and annuities into same problem, 304–308 future value of, 260–263, 405–406, 418, 419 present value of future, 263–268, 405–406, 419 Maintenance, repair, and operating (MRO) inventories, 225, 469 Management business plan, described in, 46 defined, 29, 470 functions of, 30–33 Marginal cost, 4, 470 defined, 4, 470 physical product, 4, 470 revenue product, 4, 470 Market, 3, 470 Marketable securities defined, 470 management of, 213–214 Market economy, Marketing mix, 48 Marketing plan, 48–49, 470 Market interest rates, 16, 363–364, 373 Market ratios defined, 111, 470 earnings per share ratio, 111, 466 free cash flow per share ratio, 114–116, 467 operating cash flow per share ratio, 113–114, 471 price earnings (P/E) ratio, 112–113, 472 price earnings to growth (PEG) ratio, 112–113, 472 Market research, 157–158, 470 Market value, 366, 470 Master limited partnership, 37–38, 470 Maturity, 361 Maturity value, See also Par (face, principal) value MCI, 86 Mean absolute deviation (MAD), 161–163, 470 Medicare benefits Part A, 355 Part B, 355 Part C, 355 Part D, 355–357 See also FICA [Federal Insurance Contribution Act] taxes www.downloadslide.net Index Medicare prescription drug coverage, 355–357 Medicare taxes, 9–10, 77, 230 Mission statement, 47, 470 Modified accelerated cost recovery system (MACRS) depreciation, 75, 322, 470 Monetary policy, 18, 20, 470 Money market account, 359, 470 Money market funds, 354, 371, 470 Money purchase plans, 383, 470 Money supply L, 14 M1, 14, 469, 470 M2, 14, 469, 470 M3, 14 Monitoring, 339 Mortgages adjustable rate (ARMs), 23, 303–304 amortization of, 300–302, 463 defined, 470 near prime (Alt A), 302, 470 prime, 302–303, 472 subprime, 303, 470, 474 Moving average model, 159–161, 470 Municipal bonds defined, 360–361, 470 general obligation, 360–361, 468 general revenue, 360, 468 Mutual funds defined, 370, 470 families of, 372–373, 470 global, 371, 468 growth, 370, 468 growth and income (balanced), 371, 377 income, 370–371, 468 international, 371, 468 load, 372, 469 money market, 359, 371, 470 no-load, 372, 471 specialized, 371 Mutually exclusive versus non-mutually exclusive, 338–339, 470 NASDAQ, 87, 367 National debt, 360 Natural resources, 4, 470 Near prime (Alt A) mortgages, 302, 470 Net asset value (NAV), 370, 470 Net cost rate factor, 231–232, 470 Net income after taxes, 71, 470 before taxes, 70 defined, 470 personal, 68 Net present value (NPV), 324–330, 470 Net profit margin ratio, 109–110, 470–471 Net return on assets (ROA) ratio (net return on investment [ROI] ratio), 110, 130, 471 Net sales, 69, 471 Net working capital, 208, 471 Net worth, 73, 471 Noise (random variation), 168, 471 No-load funds, 372, 471 Nominal (general) ledger, 67 Nominal rate See Stated rate Nondeductible IRAs, 379 Non-mutually exclusive versus mutually exclusive, 338–339 Non-owner-occupied residential real estate, 374, 471 Non-profit (not-for-profit) organization, 43–44 Notes payable, 76, 471 Objectives, difference between goals and, 31, 47 Open market operations, 19, 471 Operating activities, cash flow from, 82–85, 87, 464 operating cash flow per share ratio, 113–114, 471 Operating expenses, 70, 471 Operating income, 70, 471 Operating leverage, 139–140, 471 degree of (DOL), 139, 466, 469 Operating profit margin ratio, 109, 471 Operating return on assets ratio, 110, 471 Operational plan, 50 Opportunities (in SWOT analysis), 45, 471 Opportunity costs, 6–7, 471 Ordinary annuity defined, 280, 281, 471 future value of, 280–285, 406–408, 420, 422 present value of, 291–293, 409–411 Organizing defined, 31–32, 471 management and organization, described in business plan 50 questions to ask, 31 OSHA (Occupational Safety and Health Administration), 41 483 Outflows See Expenses Owner-occupied residential real estate, 373–374, 471 Owner’s equity, 77 for corporation, 79, 471 for partnership, 79, 82 for sole proprietorship, 78, 82 Pareto’s Law (20–80 rule), 227 Partner/partnership defined, 36, 471 general, 36, 468 liability and, 37 limited, 37, 469 limited liability (LLP), 37, 469 master limited, 37–38, 470 owner’s equity for, 78–79, 81 taxes and, 70 Par (face, principal) value of a bond, 361, 471 of a stock, 365, 471 Payback, 324, 471 Payroll taxes, 230, 383 Pension planning See Retirement planning Percentage change, formula for, 99–100, 471 Percentage of sales method for calculating a pro forma balance sheet, 186–187, 471 for determining new financing, 187, 471 Personal assets, 54, 471 Personal cash flow statement, 471 Personal liability, 37 Petty cash, 211, 471 Physical capital See Fixed assets Plan/planning business, 46–51 defined, 30, 471 financial see (Financial planning) functional, 30, 468 goal setting, 30–31 marketing, 48–50, 470 operational, 50 strategic, 30, 474 succession, 52 Positioning statement, 48 Post-audit, 339, 471 Precious metals, 375, 471 Preferred Provider Organization (PPO), 354, 355 Preferred stock callable, 369, 464 convertible, 368–369, 465 www.downloadslide.net 484 Index Preferred stock (continued) cumulative, 368, 465 defined, 471 dividends of, 367–370 Premium bond, 362 call, 369 insurance, 329 risk, 325, 473 Present value amortization and, 298–300 of annuity due, 294–298, 409–411 of future lump sum, 263–268, 405–406, 419 of ordinary annuity, 291–294, 411–412 Present value factor (PVF), 264 Price, 11, 132, 472 Price earnings (P/E) ratio, 112–113, 472 Price earnings to growth (PEG) ratio, 112–113, 472 Primary data/data models, 158 Primary research, 48 Primary securities market, 365, 472 Prime mortgages, 302–303, 472 Prime rate, 3, 22, 246–248, 253, 330, 472 Principal amount stated, 245, 472 Principal value See Par (face, principal) value Private corporation, 40, 472 Probate, 388, 472 Proceeds, 472 Professional corporation, 40 Profit accounting, 129, 463 defined, 6, 129, 472 entrepreneurial, 129, 466 gross, 70, 468 Profitability defined, 129–130, 472 earning power, 130–131 Profitability index (PI), 330, 472 Profitability ratios defined, 108, 472 gross profit margin ratio, 108–109, 468 net profit margin ratio, 109–110, 130, 470 net return on assets (ROA) ratio (net return on investment [ROI] ratio), 110, 130, 471 operating profit margin ratio, 109, 471 operating return on assets ratio, 110, 471 return on equity (ROE) ratio, 110–111, 473 pro forma, 68, 180–183, 184–187 Profit sharing plans combined 401k Keough, 381–382 defined, 472 traditional, 379 Pro forma financial analysis, 472 Pro forma financial statements balance sheet, 184–187, 472 cash budget, 180–184, 472 income statement, 68, 178–180, 472 monitoring and controlling process, 188 Progressive taxes, 8, 472 Promissory note, 2, Property insurance, 468 Proportional taxes, 9, 472 Provision for income taxes, 472 Public corporation, 38, 64, 79–81, 472 Pure risk, 350, 472 Qualitative methods, 156 Quantitative methods, 156 Quantity discounts, 235–236, 472 Quarterly Financial Report for Manufacturing, Mining, and Trade Corporations (FTC), 116 Quick (acid test) ratio, 102–103, 472 Quoted rate See Stated (coupon, nominal, quoted) rate Rabbi (Irrevocable grantor) trusts, 389, 469 Random variation (noise), 168, 472 Ratio, defined, 472 Ratio analysis accounts receivable turnover ratio, 104–105, 463 activity ratios, 103, 108, 463 current ratio, 102, 465 debt-to-equity ratio, 106–107, 466 debt-to-total-assets ratio, 107, 466 defined, 472 earnings per share ratio, 111–112 fixed asset turnover ratio, 105, 467 free cash flow per share ratio, 114–116, 471 gross profit margin ratio, 108, 430 inventory turnover ratio, 103–104, 468 leverage ratios, 106–108, 469 liquidity ratios, 101–103, 427, 432, 436 market ratios, 111–113, 470 net profit margin ratio, 109–110, 130, 470–471 net return on assets (ROA) ratio (net return on investment [ROI] ratio), 110, 130, 471 operating cash flow per share ratio, 113–114, 471 operating profit margin ratio, 109, 471 operating return on assets ratio, 110, 471 overview of, 97 price earnings (P/E) ratio, 112–113, 472 price earnings to growth (PEG) ratio, 112–113, 472 profitability ratios, 108–111, 472 quick (acid test) ratio, 102–103, 472 return on equity (ROE) ratio, 110–111, 473 sources of comparative ratios, 116 times-interest-earned ratio, 107–108, 475 total asset turnover ratio, 105, 129, 475 Rationing, capital, 339, 464 Raw materials inventories, 224–225, 472 Real estate commercial, 374, 465 defined, 472 non-owner-occupied residential, 374, 471, 472 owner-occupied residential, 373–374, 471, 472 Real estate investment trusts (REITs), See REITs (real estate investment trusts), Real rate of return, 325 Receivables See Accounts receivable; Accounts receivable management Regression See Linear regression model Regressive taxes, 9, 472 REITs (real estate investment trusts), 374–375, 472 Reorder point (ROP) calculations, 222–223, 472 Research market, 157–158 primary, 48 secondary, 48 Research and development, capital budgeting and, 318 Reserve requirement, 19–20, 472–473 Residential real estate non-owner-occupied, 374, 471 owner-occupied, 373–374, 471 Residual (salvage) value, 328, 473 Resources, scarce capital, 6, 464 www.downloadslide.net Index entrepreneurial, 6, 466 human, 4–5, 468 natural, 4, 470 Retained earnings, 72, 473 Retirement Contribution Policy (RCP), 357 Retirement planning benefit-oriented plans, 378, 464, 473 combined plans, 378, 473 contribution-oriented plans, 378, 465, 473 401k plans, 382, 463 IRAs (Individual Retirement Accounts), 378–383, 468 Keogh plans, 383, 469 money purchase plans, 383, 470 overview of, 378, 473 profit sharing plans, 381–382, 472 stock bonus plans, 383, 474 strategies, 383–387 taxes and, 378–383 tax-sheltered annuities (TSAs, 403b plans), 381, 474 TI BA II Plus calculator, 399–411 Return on equity (ROE) ratio, 110–111, 473 Return on investment (ROI) See net return on assets (ROA) ratio (net return on investment [ROI] ratio) Returns and allowances, 68, 473 Revenues, 68, 473 Revocable trusts, 389, 473 Risk assumption of, 352–353, 473 avoidance of, 352, 473 defined, 20–22, 350, 473 exposure, 351, 473 insurance, 353–358 management of, 351–353, 473 overview of, 350–351 premium for, 350, 473 pure, 350, 473 reduction of, 352, 473 speculative, 350, 473 systematic, 21 transfer of, 352, 473 unsystematic, 21–22, 475 Robert Morris Associates, 116 Roth defined, 473 401k plans, 382, 463, 473 IRAs, 378–383, 468 Rule of 72, 270–271, 473 Safety stock, inventory, 222, 473 Sales, net, 69, 471 Sales forces, surveys of, 156–157 Sales taxes, 9, 75–76, 230–231 Salvage (residual) value, 328, 473 Sarbanes-Oxley Act, 86 Savings, accounts, 211–212 supply of money saved, 11–15 Scarce resources See Resources, scarce Scarcity, defined, 473 SCORE (Service Core of Retired Executives) business plan requirements, 46–51, 54 defined, 474 training, 175 Seasonal variation, 167, 473 SEC (Securities and Exchange Commission), 64 EDGAR (Electronic Data Gathering and Retrieval System), 38, 97, 177, 466 Form 10-K, 38, 39, 97, 116, 463 defined, 473 Secondary data, 158 Secondary research, 48 Secondary securities market, 365, 473 Section 529 plans, 380 Secured debt, 361, 473 Securities Investment Protection Corporation (SIPC), 359 Securities market primary, 365, 472 secondary, 365, 473 Sensitivity (what-if) analysis, 330, 473–474 SEP (simplified employee pension) IRAs, 380–381, 474 Set-asides, 49, 474 Short-term debt management, 228–230, 474 SIMPLE (Savings Incentive Match Plan for Employees) defined, 473 401k plans, 382, 463 IRAs, 378–383, 468 Simple interest bank discount, 252–256, 464 bridge loans, 249, 464 defined, 245–246, 474 examples, 245–246 fixed principal commercial loans, 246–248 485 Treasury bills, 251–252 using spreadsheet to calculate, 403 Single equivalent discount, 232, 474 Sinking fund, 280 Slope, 168, 474 Small Business Administration (SBA), 46, 49, 68, 247 loan programs described, 54 Smoothing constant, 165, 474 Social Security benefits, 355, 356, 377 taxes, 9, 77, 230, 474 Sole proprietorship advantages of, 34–35 defined, 34, 474 disadvantages of, 35–36 owner’s equity for, 78, 82 taxes and, 35, 70 Speculative risk, 350, 473 Spreadsheets, working with basics of, 399–402 compound interest, 403–405 future value of annuity due, 421 future value of lump sum, 418 future value of ordinary annuity, 420 present value of annuity due, 422 present value of future lump sum, 405–406 future value of ordinary annuity, 406–407 simple interest, 403 Staffing, 32, 474 Standards, establishing, 339 Start-up business capital, 52–55 expenses, 50–51, 177, 188–189, 322–323, 474 forecasting, 175–177 See also FICA (Federal Insurance Contribution Act) taxes Stated (coupon, nominal, quoted) rate, 254, 257–258, 361, 474 State employment taxes, 230, 474 Statement of cash flows, 474 of financial position, 474 Statement Studies (Robert Morris Associates), 116 Stock common, 365–366, 465 defined, 474 investment strategies, 369–370 par value of, 365, 471 preferred, 367–370, 471 www.downloadslide.net 486 Index Stock bonus plans, 383, 474 Stockholders, 365 Straight-line depreciation, 321–322 Strategic planning, 30, 474 Strengths (in SWOT analysis), 44, 474 Subchapter S corporation, 38, 40–41, 70, 474 Subprime mortgages, 302, 474 Subsistence, Succession plan, 52 Supply, law of, 11–14, 469 Supply and demand, 17 Supply curve, 15, 474 Supply of money saved, 11–15, 474 Supply tables, 12, 474 Surveys of customers, 157, 474 of sales forces, 156–157, 474 SWOT analysis defined, 44, 474 opportunities, 44, 471 strengths, 44, 474 threats, 45–46, 475 weaknesses, 44–45, 475 Systematic risk, 21, 474 Taxes capital budgeting and, 321–323 corporation and, 38, 40–42, 70, 474 defined, 8, 474 FICA, 77, 467 flat-tax proposals, 10–11 income, 70–71, 76, 79, 230, 361, 474 Medicare, 9, 77, 230, 470 municipal bonds and, 360–361 net income after, 70, 470 net income before, 70 non-profit organization and, 43–44 partnership and, 70, 79 payroll, 230, 383 progressive, 8, 472 proportional, 9, 472 real estate and, 374–375, 472 regressive, 9, 472 retirement planning and, 378–383, 385–386 sales, 9, 75–76, 230–231 Social Security, 9, 77, 230, 474 sole proprietorship and, 35, 70 Taxes payable, 76, 475 Tax-Exempt Status for Your Organization (IRS), 43 Tax-factor benefits, 321–322, 474 Tax-factor costs, 320, 474 Tax Reform Act of 1986, 321 Tax-sheltered annuities (TSAs, 403b plans), 381, 474 T-bills, (short term), 252, 358, 360, 470, 475 T-bonds (long term), 360, 475 Testamentary trusts, 389, 475 Theory of constraints (TOC), 198, 475 Threats (in SWOT analysis), 45–46, 475 TI BA II Plus calculator in retirement programs, 403–411 Time series (internal or intrinsic) forecasting models defined, 158–159, 475 exponential smoothing model, 165–167, 467 linear regression model, 168–174, 469 mean absolute deviation (MAD), 161–163, 470 moving average model, 159–161, 470 selecting the model, 167 weighted moving average model, 163–165, 475 Times-interest-earned ratio, 107–108, 475 Time value of money amortization, overview of, 300–304 combining lump sum and annuities into same problem, 304–308 defined, 244, 475 future value of annuity due, 286–291 future value of lump sum, 260–263 future value of ordinary annuity, 280–285 internal rate of return (IRR), 268–271 overview of, 253–254 present value and amortization, 298–300 present value of annuity due, 294–298 present value of future lump sum, 263–268 present value of ordinary annuity, 291–293 rule of 72, 270–271, 473 using calculators to calculate, 412–415 using spreadsheets to calculate, 399–412 using tables to calculate, 417–423 T-notes (medium term), 360, 475 Total assets, 75, 76, 77, 475 turnover ratio, 103, 131, 475 Total cost (TC), 221–222, 338 Total current liabilities, 475 Total liabilities, 73, 77, 475 Trade discounts, 231–233 defined, 475 single equivalent discount, 232, 474 Translated, 316 Treasury bonds See U.S Treasury bonds Trend variation, 167–168, 475 Triple-net lease, 231 Trusts defined, 475 irrevocable, 389, 469 living, 389, 469 Rabbi (irrevocable grantor), 389, 469 revocable, 389, 473 testamentary, 389, 475 20–80 rule (Pareto’s Law), 227 Unlimited liability, 35, 37, 39 Unsecured debt (debenture), 361, 454, 475 Unsystematic risk, 21–22, 475 U.S Chamber of Commerce, 55 Use assets See Fixed assets U.S Federal Bankruptcy Court, 145 U.S Small Business Administration (SBA), 46, 49, 68, 247, 475 U.S Treasury bonds defined, 360, 475 T-bills, (short term), 252, 358, 360, 475 T-bonds (long term), 360, 475 T-notes (medium term), 360, 475 Value absolute, 161, 463 book, 78, 85–86, 365, 366, 464 market, 366, 470 par, 365, 471 salvage (residual), 328, 473 See also Time value of money Value Line Investment Survey (Value Line Publications), 97, 116 Vanguard, 372 Variable costs, 69–70, 132, 475 Variable expenses, 66, 177, 475 Variance, 188, 475 Venture capitalist, 55, 475 Vertical analysis, 97–99, 475 Wages, minimum, Warranty, 68, 158, 475 www.downloadslide.net Index Weighted average cost of capital (WACC), 325–326, 334, 475 Weighted moving average model, 163–165, 475 Weaknesses (in SWOT analysis), 44–45, 475 What-if (sensitivity) analysis, 330, 403 Wills, 388, 475 Working capital (current assets) account for, 82 commitment costs, 319, 320, 475 defined, 72, 208, 475 gross, 208, 468 net, 208, 471 Working capital management of accounts receivable, 214–218, 352 487 of cash, 210–213 defined, 208–210, 475 of inventory, 219 of marketable securities, 213–214 Work-in-process inventories, 225, 475 WorldCom, 86 Z (zero balance) report, 230 ... can develop more of an understanding of finance, we must begin by understanding the basic economic concepts that relate to finance ECONOMIC CONCEPTS OF FINANCE The U.S economy operates on the... initial caps or all caps Library of Congress Cataloging-in-Publication Data Adelman, Philip J Entrepreneurial finance / Philip J Adelman, DeVry University, Alan M Marks, DeVry University.—6 Edition... tax rates are established by legislation at the federal, state, and local levels The percentage is a proportion and is calculated by taking the amount paid, dividing it by the gross income received,