Financial Management: Accounting, Finance, and Analysis
Financial accounting
Financial accounting reports to external users under accrual accounting: revenue is recognized when earned, and expenses are matched to the periods they benefit. Know the balance sheet, income statement, statement of cash flows, and statement of changes in equity. Depreciation allocates the cost of long-lived assets and is a noncash expense; it affects net income and taxes but not operating cash flow directly.
Finance and analysis
Finance concepts include time value of money, net present value, internal rate of return, payback, cost of capital, leverage, and working capital management. NPV is generally preferred for mutually exclusive projects because it measures value added in dollars; IRR can mislead when project scale or cash-flow timing differs. Ratio analysis covers liquidity (current, quick), solvency (debt-to-equity, interest coverage), profitability (gross, net, return on assets, return on equity), and activity (inventory turnover, receivables collection). DuPont analysis decomposes return on equity into margin, asset turnover, and leverage.
Traps
Questions often confuse the current ratio with the quick ratio; the quick ratio excludes inventory and prepaid items. Net income is not cash flow. FIFO versus LIFO changes cost of goods sold and ending inventory during inflation. A capital budgeting question may present a high IRR project that destroys value if NPV is negative.
Worked example
Current assets are $500,000, inventory is $200,000, and current liabilities are $250,000. The current ratio is 2.0 ($500,000 ÷ $250,000). The quick ratio is 1.2 (($500,000 − $200,000) ÷ $250,000). The company is liquid, but nearly half of current assets are inventory, so the quick ratio gives a stricter view.