Fundamentals of Finance cheat sheet

Key terms

Investment decisions

Deciding which assets and projects to commit the organisation's funds to, evaluated using the capital budgeting techniques in the chapter on project appraisal.

Dividend decisions

Deciding how much of the profit earned to distribute to shareholders versus retain for reinvestment (see the chapter on the dividend decision).

Financing decisions

Deciding the mix of debt and equity used to fund the organisation's investments (see the chapter on sources of business finance), which in turn determines its cost of capital (see the chapter on the cost of capital).

Liquidity decisions

Deciding how to manage short-term assets and liabilities so the organisation can meet its obligations as they fall due (see the chapter on working capital management).

Similarities and differences

Both draw on the same underlying transaction data, but accounting is chiefly concerned with recording and reporting what has already happened, while finance is chiefly concerned with using that data to decide what to do next; accounting looks backward to inform, finance looks forward to decide.

Cost accounting

Supplies the detailed cost data (per unit, per department) finance needs to evaluate a project's likely cash flows.

Financial accounting

Supplies the audited historical statements finance uses to assess an organisation's existing financial position before making a new decision.

Management accounting

Supplies forward-looking budgets and variance analysis finance draws on for planning and control alongside its own techniques.

Routine

The day-to-day administrative finance activities: processing payments, managing cash receipts, record-keeping and routine reporting.

Non-Routine (Managerial)

The higher-level decisions this paper is built around: investment appraisal, financing structure, dividend policy and working capital strategy, requiring judgement rather than routine processing.

Financial

Maximising shareholder wealth is the primary financial objective assumed throughout this paper, typically proxied by maximising the market value of the firm's ordinary shares; profit maximisation is a related but weaker objective, since it ignores the timing, risk and financing of that profit.

Non-financial goals

Employee welfare, customer satisfaction, environmental and social responsibility, and long-term survival, objectives a firm also pursues alongside its financial goal.

Overlaps and conflicts among the objectives

Financial and non-financial goals often reinforce each other (satisfied customers and employees support long-term financial performance), but can also conflict in the short term, spending on staff welfare or environmental measures can reduce reported profit even while supporting the firm's long-term value.

Principal

The party who delegates authority and whose interests are meant to be served, shareholders in the classic corporate example.

Agent

The party appointed to act on the principal's behalf, management in the classic corporate example, who may not always act purely in the principal's interest.

Ordinary shareholders and management

Shareholders want value maximised; management may instead pursue growth, job security, or perks that serve their own interests first.

Shareholders and debenture holders

Shareholders may favour riskier projects that benefit equity if they succeed, while lenders bear the downside without sharing the upside, a conflict debt covenants exist to manage.

Shareholders and external auditors

Shareholders rely on the auditor for an independent check on management's own reporting, a relationship that only works if the auditor's independence from management is genuinely maintained.

Shareholders and Government

Government (as tax authority and regulator) wants compliance and its due share of profit; shareholders want returns maximised, which can create an incentive toward aggressive tax or regulatory positions.