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Table of Contents

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  • This book is for those whose financial management focus is on small businesses. For you, we adapt the traditional financial management themes emphasized in corporate financial management courses to meet the needs of small businesses.
    • 1: Financial Management and the Firm

      Financial management is about, above all else, management. The verb manage comes from an Italian verb meaning “to handle” as in how a rider handles a horse. The management process can be applied to a wide variety of organizations and resources. In this book, we apply the management process to managing the financial resources of the small business as opposed to larger corporations.
    • 2: Alternative Forms of Business Organizations

      The way a business is organized influences its ability to reach its goals and objectives. This chapter focuses on legal forms of business organizations that are widely used in the U.S. These include sole proprietorships, general and limited partnerships, limited liability corporations (LLCs), S corporations, and C corporations. Partnerships, LLCs, and C corporations are found across a wide spectrum of business types and sizes.
    • 3: The Federal Tax System

      This chapter intends to present a few of the basic concepts related to taxes that are important from a financial management perspective. Our focus is on the federal tax code, because of its importance in determining after-tax profit and after-tax cash flow. Nevertheless, there are a number of additional taxes (e.g. state and local taxes) that can have a significant impact on a firm’s earnings and cash flow.
    • 4: Financial Statements

      Financial statements include balance sheets, the cash income statement, an accrual income statement (AIS), the statement of cash flow (SCF), and the sources and uses of funds (SAUF) statement. Coordinated financial statements (CFS) include beginning and ending period balance sheets, an AIS, and a SCF. We are particularly interested in the financial statements included in CFS because they are interdependent and when constructed consistently can help us identify inaccuracies in our data.
    • 5: Financial Ratios

      Coordinated financial statement (CFS) variables. CFS contain exogenous and endogenous variables. Exogenous variables take on values that can be observed or are determined by activities occurring outside of the firm. Endogenous variables take on values determined by activities within the firm and the values of exogenous variables.
    • 6: System Analysis

      We have already used the system properties of CFS to answer the question: “what is” the financial condition of the firm? We answered that question by constructing ratios that described the firm’s (S)olvency, (P)rofitability, (E)fficiency, (L)iquidity, and (L)everage (SPELL) ratios. However, the value of information gained from SPELL ratios has its limit. Answering “what is” kinds of questions is a static (timeless) analysis because its focus is on the current financial condition of the firm.
    • 7: Homogeneous Measures

      What adds complexity to the ranking process is that defenders and challengers are sometimes measured in different units. These differences in measures between challenging and defending investments may result in unstable and inconsistent rankings when more than one ranking method is used. This chapter intends to describe present value (PV) models that consistently and accurately rank defending and challenging investments using homogeneous (same) measures.
    • 8: Present Value Models

      Similarly, there are several different kinds of PV models, but they are designed for answering different kinds of questions. Each model has a comparative advantage for answering a particular kind of question. In what follows we examine some of the most important PV models and the questions they can be used to answer.
    • 9: Homogeneous Sizes

      This chapter recognizes that when we rank multiple challengers funded by one defender, their IRR and NPV rankings may be different. Furthermore, we observe that changes in the defender’s IRR may produce unstable NPV rankings.
    • 10: Homogeneous Terms

      Not all challengers and defenders have equal terms or economic lives. Therefore, we develop methods for ranking one-time mutually exclusive challengers of unequal terms which is the first goal of this chapter. An important characteristic of one-time investments is that owning a one-time investment does not require replacement in order to invest in a similar investment.
    • 11: Homogeneous Tax Rates

      It is popular to adjust a defender’s before-tax IRR to an after-tax IRR by multiplying it by (1 – T), where T is the average tax rate applied to the investment. This chapter points out that this method for adjusting the defender’s IRR for taxes is only appropriate in a few special cases. Finally, this chapter shows how to find appropriate tax rates for adjusting the defender’s IRR for taxes in a variety of tax environments.
    • 12: Homogeneous Rates of Return

      In this chapter, we find before and after-tax one-period rates of return on assets and equity by calculating cash flow and changes in operating and capital accounts. Operating accounts include accounts receivable (AR), inventories (Inv), accounts payable (AP), and accrued liabilities (AL). Depreciation (Dep) plus changes in realized capital gains measure changes in the firm’s capital account.
    • 13: Homogeneous Investment Types

      An investment is a commitment of resources for one or more periods. We invest instead of consume because we expect future investment earnings will more than compensate for the present investment sacrifice. If the commitment is to a firm, we talk about return on the firm’s assets (ROA). If the commitment is to an investment, we talk about the returns on an investment (ROI).
    • 14: Homogeneous Liquidity

      An investment may earn two types of returns (losses) for investors: (1) time-dated cash flow called current returns, and (2) capital gains (losses). This chapter demonstrates that capital gains earned on an investment depend on the investment’s pattern of future cash flow. This chapter also demonstrates that the combination of current returns versus capital gains (losses) has important liquidity implications for investors, especially when an investment is financed with debt capital.
    • 15: Homogeneous Risk Measures

      The study of risky events has application to capital budgeting problems. When we estimate future cash flow used in analyzing capital budgeting decisions, we are estimating risky outcomes associated with a risky event. Thus, we are faced with the challenge of satisfying the homogeneous measures principle applied to risk by adjusting future cash flow projections of a challenger and the cash flow predictions used to find the IRR of the defender to their certainty equivalent value.
    • 16: Loan Analysis

      Interest rates on loans are like opportunity costs, the loan amount is like an investment, and loan payments are like an investment’s cash flow. These and other similarities between PV models and loan formulas allow us to use PV tools to analyze different types of loans. This chapter will also identify the relationship between the term of a loan and the size of the loan payment.
    • 17: Land Investments

      Land’s immobility and durability make it unique among investments and deserving of special attention in PV analysis. Land’s immobility means that it cannot be moved and its services must be extracted by those physically on site. Durability means that land has the capacity to provide services over time without significant change in its service provision capacity.
    • 18: Leases

      There are several kinds of lease arrangements and several kinds of durables that are leased. Farmland is frequently leased as are machines, houses, cars, computers, coping equipment, buildings, breeding livestock, and many kinds of management services. In this chapter, we describe various types of leases, evaluate their advantages and disadvantages, and apply present value (PV) tools to analyze leasing benefits for both the lessor and the lessee.
    • 19: Financial Investments

      This chapter applies PV models developed earlier to financial investments. Large corporations and other business organizations require financial investments from a large number of small investors to provide funds for operation and growth. The collection of these funds would be impossible if each investor were required to exercise a managerial role over them.
    • 20: Yield Curves

      We pursue two objectives. The first objective is to demonstrate how to calculate the periodic discount rate for no-coupon bonds. The approach we describe can also be used to find periodic discount rates implied by bonds that are more complicated as well as other financial instruments. Our second objective is to connect the shapes and patterns of periodic interest rate curves and their corresponding yield curves patterns to predict future economic activity and opportunities and threats.
    • 21: One Thing More…

      The purpose of this chapter is to remind us that relationships and the intangible goods produced in relationships may be our most important resources that need careful managing.