Financial Planning & Analysis Flashcards

What is the primary purpose of a cash flow statement in financial planning?

Answer: To track the inflows and outflows of cash

The primary purpose of a cash flow statement in financial planning is to track the inflows and outflows of cash over a specific period. It categorizes cash activities into operating, investing, and financing, providing a clear picture of how a company generates and uses its cash. This statement is crucial for assessing liquidity, solvency, and overall financial health.

Which ratio is most useful for evaluating a company's short-term liquidity?

Answer: Current ratio

The current ratio is the most useful ratio for evaluating a company's short-term liquidity. It measures a company's ability to meet its short-term obligations with its short-term assets, calculated by dividing current assets by current liabilities. A higher current ratio generally indicates better short-term financial health and ability to cover immediate debts.

What is the key difference between fixed and variable costs in budgeting?

Answer: Fixed costs remain constant, variable costs change with production

Fixed costs, such as rent or insurance, remain constant regardless of the production volume or sales activity. In contrast, variable costs, like raw materials or direct labor, fluctuate directly with changes in the level of goods or services produced. This distinction is fundamental for businesses to understand their cost structure and make informed budgeting and pricing decisions.

Which financial planning concept involves 'paying yourself first'?

Answer: Automated savings from income

'Paying yourself first' is a core financial planning principle that prioritizes saving and investing before spending on discretionary items. Automated savings from income directly implements this by regularly transferring a predetermined portion of earnings into savings or investment accounts as soon as income is received. This ensures consistent progress towards financial goals, rather than relying on leftover funds.

What does NPV (Net Present Value) measure in capital budgeting?

Answer: Profitability of potential investments

Net Present Value (NPV) is a capital budgeting tool used to evaluate the profitability of potential investments or projects. It calculates the difference between the present value of future cash inflows and the present value of initial and subsequent cash outflows. A positive NPV indicates that the project is expected to generate more value than its cost, making it a potentially profitable investment.

Which financial statement shows a company's assets, liabilities, and equity at a specific point in time?

Answer: Balance sheet

The balance sheet is a fundamental financial statement that provides a snapshot of a company's financial position at a specific point in time. It details the company's assets (what it owns), liabilities (what it owes), and owner's equity (the residual value after liabilities are subtracted from assets). This statement adheres to the basic accounting equation: Assets = Liabilities + Equity.

What is the purpose of sensitivity analysis in financial planning?

Answer: To assess impact of variable changes on financial models

Sensitivity analysis in financial planning is used to assess how changes in key independent variables impact the outcomes of a financial model. It helps identify which variables have the most significant effect on results, such as project profitability or investment returns. This analysis allows planners to understand the robustness of their models and the potential risks associated with uncertain assumptions.

Which budgeting method allocates every dollar of income to specific expenses, savings, and debt repayment?

Answer: Zero-based budgeting

Zero-based budgeting (ZBB) is a budgeting method that requires all expenses to be justified for each new period, starting from a 'zero base.' Instead of simply adjusting previous budgets, every line item must be approved, ensuring that all spending is necessary and aligned with current objectives. This rigorous approach helps eliminate wasteful spending and optimizes resource allocation.

What does the debt-to-income (DTI) ratio measure in personal financial planning?

Answer: Debt burden relative to income

The debt-to-income (DTI) ratio measures an individual's total monthly debt payments relative to their gross monthly income. This ratio is a key indicator of a person's ability to manage monthly payments and repay new debts. Lenders frequently use DTI to assess creditworthiness, with a lower ratio generally indicating a healthier financial position and greater capacity for additional debt.