Financial Management and Accounting
Financial management covers the time value of money, capital budgeting, cost of capital, and working capital; accounting covers recording, reporting, and analysis. Know the accounting equation (assets = liabilities + equity) and the difference between accrual accounting (revenue recognized when earned) and cash accounting. Distinguish the balance sheet (a point in time) from the income statement and cash flow statement (periods).
Capital budgeting methods: net present value (NPV) discounts expected cash flows at the cost of capital and is preferred because it measures value added; internal rate of return (IRR) is the discount rate making NPV zero, with pitfalls such as multiple IRRs and scale neglect; payback ignores cash flows after the cutoff and the time value of money. Weighted average cost of capital (WACC) blends after-tax cost of debt and cost of equity. Leverage raises expected return and risk; the Modigliani-Miller logic says capital structure is irrelevant under restrictive assumptions without taxes.
Ratios: liquidity (current, quick), solvency (debt-to-equity, interest coverage), profitability (gross, net margin, ROE), and efficiency (inventory turnover, receivables days). Traps include mixing a stock (balance sheet) with a flow (income statement), forgetting that depreciation is non-cash, and treating IRR as always superior to NPV.
Worked example: a project costs 100 and returns 60 in each of two years; at 10 percent, NPV = 60/1.1 + 60/1.21 - 100 = 54.55 + 49.59 - 100 = 4.14, so accept it. Rule of thumb: independent projects, accept positive NPV; mutually exclusive, choose highest NPV.