Finance Revision: Key Concepts

Revising for finance exams requires a solid understanding of core concepts. Here’s a brief overview to get you started:

Time Value of Money

This fundamental principle states that money available today is worth more than the same amount in the future due to its potential earning capacity. Key formulas include:

• Present Value (PV): The current worth of a future sum of money or stream of cash flows, given a specified rate of return. Useful for evaluating investment opportunities.
• Future Value (FV): The value of an asset or investment at a specified date in the future, based on an assumed rate of growth. Helps in forecasting investment returns.
• Discount Rate: The rate used to calculate the present value of future cash flows. Reflects the risk and opportunity cost.

Financial Statement Analysis

Analyzing financial statements (balance sheet, income statement, and cash flow statement) is crucial for understanding a company’s financial health. Key ratios to remember:

• Liquidity Ratios (e.g., Current Ratio, Quick Ratio): Measure a company’s ability to meet its short-term obligations.
• Profitability Ratios (e.g., Gross Profit Margin, Net Profit Margin, Return on Equity): Assess a company’s ability to generate profit.
• Solvency Ratios (e.g., Debt-to-Equity Ratio, Times Interest Earned): Indicate a company’s ability to meet its long-term obligations.
• Efficiency Ratios (e.g., Inventory Turnover, Accounts Receivable Turnover): Measure how efficiently a company utilizes its assets.

Capital Budgeting

This involves the process of evaluating and selecting long-term investments. Key methods include:

• Net Present Value (NPV): The present value of future cash flows less the initial investment. A positive NPV indicates a profitable investment.
• Internal Rate of Return (IRR): The discount rate at which the NPV of an investment is zero. If the IRR is higher than the cost of capital, the investment is considered acceptable.
• Payback Period: The time it takes for an investment to generate enough cash flow to recover the initial investment. Simpler to calculate but ignores the time value of money.

Cost of Capital

Represents the return required by investors for providing capital to a company. Key components include:

• Cost of Equity: The return required by equity shareholders. Can be estimated using the Capital Asset Pricing Model (CAPM).
• Cost of Debt: The return required by debt holders. Usually the yield to maturity on a company’s bonds.
• Weighted Average Cost of Capital (WACC): The average cost of all sources of capital, weighted by their proportion in the company’s capital structure. Used as a discount rate in NPV calculations.

Working Capital Management

Focuses on managing a company’s current assets and liabilities to ensure efficient operations. Key areas include:

• Inventory Management: Optimizing inventory levels to minimize storage costs and avoid stockouts.
• Accounts Receivable Management: Managing credit policies and collection procedures to ensure timely payments from customers.
• Accounts Payable Management: Optimizing payment terms with suppliers to maximize cash flow.

This is just a brief overview. Remember to delve deeper into each topic and practice solving problems to solidify your understanding. Good luck with your finance revision!