Basics of Finance Cheatsheet

Cheatsheet Content

1. Basics of Economics Definition: Study of how individuals, businesses, and governments allocate scarce resources to satisfy unlimited wants and needs. Branches: Microeconomics: Focuses on individual and business decision-making (supply, demand, pricing, market structures). Macroeconomics: Studies the economy as a whole (economic indicators, inflation, unemployment, growth). Key Concepts: Scarcity: Limited resources vs. unlimited wants. Opportunity Cost: Cost of the next best alternative. Supply & Demand: Relationship between availability and consumer desire. Market Equilibrium: Point where supply equals demand. Economic Systems: Traditional: Relies on customs and traditions. Command: Government makes all decisions. Market: Decisions by individuals/businesses based on supply/demand. Mixed: Combines command and market elements. Factors of Production: Land, Labor, Capital, Entrepreneurship. Economic Indicators: GDP: Total value of goods/services produced. Inflation: Rate at which general price levels rise. Unemployment Rate: Percentage of labor force unemployed. CPI: Measures changes in price level of consumer goods/services. Role of Government: Regulation, Taxation, Spending, Monetary Policy. Economic Theories: Classical, Keynesian, Monetarism, Supply-Side. 2. Basics of Finance Definition: Management of money and other valuables easily converted into cash. Concerned with maintenance and creation of economic value/wealth. Key Areas: Financial statements, time value of money, risk & return, risk management, interest rates, financial markets, investment basics, financial planning. 3. Importance of Finance Resource Allocation: Efficient distribution for optimal usage. Business Growth: Provides funds for expansion, innovation. Risk Management: Identifying, assessing, and managing financial risks. Personal Financial Health: Managing finances, investing, securing future. Decision Making: Informed decisions through analysis, budgeting. Economic Stability: Efficient capital markets and institutions. Corporate Governance: Transparency and accountability in reporting. Capital Acquisition: Raising capital for funding and operations. Wealth Management: Planning and managing wealth for security/growth. 4. Types of Finance Personal Finance: Managing individual/household financial activities (budgeting, saving, investing). Private or Corporate Finance: Expenditure and revenue of individuals and business firms. Objective: enhance profit. Public or Government Finance: Management of a country's revenue, expenditures, and debt load. Key Areas of Public Finance: Taxation, Government spending, Budgeting, Public debt, Fiscal policy. 5. Debit and Credit Debit: Transaction that removes funds from a bank account (debit card, bank transfer). Credit: Arrangement where a borrower receives value now and repays later with interest. Allows purchases or access to funds. Examples of Credit: Credit Card, Personal Loan, Mortgage. 6. Financial Statements The Balance Sheet: A financial statement showing a company's assets, liabilities, and equity at a specific point in time. Balance Sheet Equation: $ \text{Assets} = \text{Liabilities} + \text{Shareholder's Equity} $ Importance of Balance Sheet: Evaluates financial health (liquidity, solvency), decision-making tool, proof of creditworthiness. Assets: Resources owned by the company expected to bring future benefits. Current Assets: Easily convertible to cash (e.g., cash, accounts receivable). Fixed Assets: Not easily convertible to cash (e.g., buildings, machinery). Tangible Assets: Physical existence (e.g., equipment, inventory). Intangible Assets: No physical existence (e.g., patents, trademarks). Liabilities: Debts or obligations the company owes to others. Current Liabilities: Due within a year (e.g., accounts payable, short-term loans). Non-Current Liabilities: Due after one year (e.g., long-term debt, bonds payable). Owner's Equity / Earnings: $ \text{Owner's equity} = \text{total assets} - \text{total liabilities} $ Shareholders' Equity: Amount remaining for shareholders after debts and liquidation. Net Value Representation: Equity shows net value. Retained Earnings: Part of shareholders' equity, fixed percentage paid as dividends. Equity Values: Positive: Company has enough assets to pay liabilities. Negative: Liabilities exceed assets. Reading a Balance Sheet: Identify Reporting Date. Review Assets (liquidity, value, condition). Examine Liabilities (short-term, long-term debt). Analyze Shareholders' Equity (structure, retained earnings, financing). Check for Balance ($ \text{Assets} = \text{Liabilities} + \text{Equity} $). Look for Trends (growth, stability, issues). Profit and Loss Statement (Income Statement): Shows income and expenditures over a period, indicates profit/loss. Also known as: Statement of Operations, Earnings Statement. Part of core financial statements (with balance sheet and cash flow). Importance of Income Statement: Helps generate profit, assesses business strategies, provides reports, identifies expenses, overall analysis for investors. Users of Income Statement: Internal: Company management, board of directors. External: Investors, creditors, competitors. Advertising & Administrative Expenses: Advertising: Marketing costs, part of SG&A. Administrative: Not tied to specific departments (salaries, rent, supplies). Cash Flow Statement: Tracks inflow and outflow of cash over a specific period. Provides insights into cash movement, aids decision-making. Importance of Cash Flow Statement: Ensures sufficient cash, mitigates insolvency risk, shows detailed spending, maintains optimal cash balance. Generating Cash: Highlights strategies for cash generation (e.g., improving accounts receivable, better supplier terms). Short-Term Planning: Cash flow control (liquidity needs), financial decision-making (surpluses/deficits, borrowing, investing). Format of Cash Flow Statement: Operating Activities: Cash flows from primary business operations. Investment Activities: Cash flows from asset investments. Financial Activities: Cash flows from financing activities (loans, dividends). 7. Conceptual Understanding of Financial Terms Cost: The monetary value of resources used to produce goods or services. Expense: The cost of operations that a company incurs to generate revenue. Gross & Net Profit: Gross Profit: $ \text{Revenue} - \text{Cost of Goods Sold (COGS)} $ Net Profit (before tax): $ \text{Gross Profit} - \text{Operating Expenses} - \text{Interest Expense} - \text{Depreciation Expense} - \text{Duties} - \text{Insurance} $ Net Profit (after tax): $ \text{Net Profit (before tax)} - \text{Taxes} $ ROI (Return on Investment): Measure of profitability. $ \text{ROI} = \frac{\text{Net Profit (after tax)}}{\text{Initial Investment}} \times 100 $ Dividend: Portion of earnings distributed to shareholders. $ \text{Dividend per Share} = \frac{\text{Total Dividend Amount}}{\text{Number of Shares Outstanding}} $ Depreciation: Decrease in value of a fixed asset over its lifetime. Straight-Line Depreciation: $ \frac{\text{Cost of Asset} - \text{Residual Value}}{\text{Useful Life of an Asset}} $ Double-Declining Balance: $ \frac{\text{Cost of Asset} \times \text{Rate of Depreciation}}{100} $ Units-of-Production: $ \frac{\text{Cost of Asset} - \text{Salvage Value}}{\text{Useful Life in the Form of Units Produced}} $ Sum-of-the-Years' Digits: $ \frac{\text{Remaining Useful Life of Asset}}{\text{Sum of the Year's Digit}} \times \text{Depreciable Cost} $ Taxes: Mandatory financial charges by government. $ \text{Taxes} = \text{Net Profit (before tax)} \times \text{Corporate Tax Rate} $ Duties: Government-imposed taxes/tariffs on imported/exported goods. $ \text{Duty} = \text{Customs Value} \times \text{Duty Rate} $ Reserves: Portions of profit set aside to strengthen financial position and cover uncertainties. $ \text{Reserve Amount} = \text{Profit Available for Appropriation} \times \text{Percentage for Reserves} $ Insurance: Contract for financial protection/reimbursement against losses. $ \text{Insurance Premium} = \text{Value of Insured Item or Risk} \times \text{Premium Rate} $ 8. Time Value of Money Principle: A sum of money is worth more now than the same sum in the future due to its earning capacity. Applications: Loan amortization, investment valuation. Simple Interest: Interest charged/earned based on original principal amount. $ \text{SI} = \frac{P \times R \times T}{100} $ Where $P$=Principal, $R$=Rate of Interest (%), $T$=Time (Years). Compound Interest: Calculated on initial principal and accumulated interest. $ A = P(1 + \frac{r}{n})^{nt} $ Where $A$=final amount, $P$=initial principal, $r$=interest rate, $n$=times interest applied per period, $t$=time periods. $ \text{Compound Interest (CI)} = A - P $ Simple vs. Compound Interest: Compound interest yields higher earnings due to "interest on interest." 9. Interest Rates Definition: Percentage charged on borrowed money or earned through investment. Reflects cost of borrowing or reward for saving. Types: Fixed: Constant throughout loan period. Variable: Fluctuates based on market conditions. Nominal: Stated rate without inflation adjustment. Real: Adjusted for inflation, true cost of funds. Factors Affecting: Economic Growth: Strong growth increases demand for credit, raising rates; weak growth lowers rates to stimulate. Inflation: High inflation leads to higher rates to control spending; low inflation prompts lower rates to encourage borrowing. Supply and Demand: High demand for credit increases rates; low demand lowers rates. Government Policies (Monetary Policy): Federal Reserve actions (e.g., changing rates) influence economic policy. Central Bank Policies: Strategies (open market operations, discount rates, reserve requirements) influence rates. Credit Risks: Higher risk for lender means higher interest rate for borrower (base rate + risk premium). Time Period of Loan: Longer loan periods generally have higher rates due to increased risk. 10. Financial Markets Definition: Platforms where buyers and sellers trade financial assets (stocks, bonds, commodities, currencies). Functions: Price determination, liquidity provision, reduction of transaction costs, risk sharing. Role in Economy: Capital formation, efficient allocation of resources, price discovery. Types: Capital Markets: Stock market, bond market. Money Markets: Short-term debt instruments (Treasury bills). Derivatives Markets: Contracts based on underlying assets (options, futures). Foreign Exchange Markets: Currencies. Commodities Markets: Physical goods (gold, oil, agricultural products). Financial Instruments: Contracts with monetary value, can be traded. Examples: Cheques, Shares, Stocks, Bonds, Futures, Options contracts. 11. Investment Basics Importance: Assets acquired for income/appreciation, grow wealth, achieve financial goals. Types of Investments: Stocks, Bonds, Mutual Funds, Real Estate, Commodities, Cryptocurrencies. Risk and Return: Risk: Potential for losing invested capital. Return: Profit or loss from investment. Principle: Higher potential returns usually come with higher risk. Types of Risk: Systematic Risk: Market risk affecting all investments (recessions, interest rate changes). Unsystematic Risk: Specific to a company/industry (bankruptcy, regulatory changes). Diversification: Spreading investments across various assets to reduce risk. Investment Strategies: Value Investing, Growth Investing, Income Investing, Index Investing. Time Horizon for Investments: Short-Term ( 10 years). Investment Vehicles: Brokerage Accounts, Retirement Accounts (IRAs, 401(k)s), Education Savings Accounts (529 plans). 12. Risk Management Emergency Fund: Saving 3-6 months' living expenses. Insurance: Protecting against significant financial losses. Asset Allocation: Distributing investments across different asset classes. Common Investment Mistakes: Lack of diversification, timing the market, ignoring fees, emotional investing. 13. Financial Planning Definition: Setting financial goals, developing strategies, monitoring progress for long-term stability. Steps: Goal Setting: Identify short-term and long-term goals. Assessment: Evaluate current financial situation (income, expenses, assets, liabilities). Plan Development: Create detailed plan (budgeting, saving, investing). Implementation: Execute plan, make financial decisions. Monitoring and Reviewing: Track progress, make adjustments. Budgeting: Allocating income to expenses and savings. Saving: Setting aside money for future needs/emergencies. Investing: Growing wealth through vehicles (stocks, bonds, mutual funds, real estate). Risk Management: Protecting against financial risks (insurance). Retirement Planning: Preparing for financially secure retirement. Estate Planning: Planning asset distribution after death. Benefits: Financial security, goal achievement, stress reduction, improved decision-making. Tools & Resources: Financial software, financial advisors, educational resources (books, courses). Common Strategies: Diversification, emergency fund, debt management, tax planning.