Public Enterprise Management Ch12. Accounting and financial management — financial ratios, capita...

Business Administration Ch12. Accounting and Financial Management

Financial management and accounting are differentiating sections in public enterprise business administration exams. Rather than mathematical calculation principles, it is important to grasp the absolute assumptions and the direction of conclusions (increase/decrease) of each theory.

1. Basics of Accounting and Financial Statements

(1) The Big Four Financial Statements

Statement of Financial Position: Shows assets, liabilities, and equity at a “specific point in time”. (Assets = Liabilities + Equity)
Statement of Profit or Loss and Other Comprehensive Income: Shows business performance (revenue, expenses, net income) over a “certain period”.
Statement of Cash Flows: Shows cash changes classified by operating, investing, and financing activities (fund raising/repayment).
Statement of Changes in Equity: Shows the size and changes in equity.

(2) Asset Inventory Unit Cost and Depreciation

Ending Inventory Valuation: Beginning Inventory + Current Period Purchases - Cost of Goods Sold = Ending Inventory
Assuming Inflation: Order in which profit (tax) is recorded highest: FIFO (First-In, First-Out) > Moving Average > Weighted Average > LIFO (Last-In, First-Out)
Tangible Asset Depreciation: (Process of allocating tangible asset value)
- Depreciable Amount = Acquisition Cost - Salvage Value
- Straight-Line Method: Same depreciation every year.
- Declining-Balance Method / Sum-of-the-Years’-Digits Method: Large depreciation amount in the early years, decreasing over time (Accelerated Depreciation Method).

2. Financial Value and Ratio Analysis ★

Summary of Major Financial Ratios
Category	Meaning	Core Ratios
Liquidity Ratio	Short-term debt-paying ability	Current Ratio (Current Assets/Current Liabilities) Quick Ratio (Quick Assets/Current Liabilities)
Stability (Leverage)	Long-term payment and debt-coverage ratio	Debt-to-Equity Ratio (Liabilities/Equity) Interest Coverage Ratio (Operating Income/Interest Expense)
Profitability Ratio	Margin generation ability	ROA (Net Income/Total Assets), ROE (Net Income/Total Equity)
Activity Ratio	Asset utilization efficiency	Accounts Receivable Turnover, Inventory Turnover
Stock-Related Ratio	Stock market valuation	PER (Stock Price/EPS), PBR (Stock Price/Book Value Per Share)

CVP Analysis (Short-Term Break-Even Point)

Break-Even Point (BEP): Total Revenue = Total Cost (Fixed Costs + Variable Costs)
Contribution Margin (CM): Sales Revenue - Variable Costs. (This contributes to recovering fixed costs and creating operating income.)

3. Economic Analysis of Investment (Capital Budgeting)

When reviewing the feasibility of an investment, there are methods that consider the time value of money (discount rate) and methods that do not.

Technique Type	Technique Name	Acceptance Criteria	Disadvantages
Non-Discounted Techniques (Ignoring time value)	Payback Period Method	When shorter than the target period	Ignores cash flows after payback
	Accounting Rate of Return Method	When greater than the target rate of return	Based on accounting profit rather than cash flow
Discounted Techniques (Considering time value, recommended)	Net Present Value (NPV) Method	When NPV > 0	Cost of capital estimation is practically difficult
	Internal Rate of Return (IRR) Method	When IRR > Cost of Capital	Multiple internal rates of return may exist, value additivity principle does not hold

Why NPV is Rated Superior to IRR Because the Net Present Value (NPV) method uses the ‘cost of capital (realistic)’ as the reinvestment rate of return, satisfies the ‘principle of value additivity’ when summing multiple investment projects, and ultimately aligns with the highest financial goal of ‘maximizing firm value’.

4. Portfolio Theory and CAPM

(1) Decomposition of Portfolio Risk

Total Risk = Systematic Risk + Unsystematic Risk
Unsystematic Risk: Unique risks such as strikes or lawsuits of individual companies. Can be “eliminated (offset)” through “diversification” across multiple stocks. Elimination effect is maximized when the correlation coefficient is -1.
Systematic Risk: Market-wide factors such as inflation, interest rates, and war. Cannot be eliminated even through diversification.

(2) Capital Asset Pricing Model (CAPM)

Shows that the equilibrium rate of return on a stock is determined by the sum of the risk-free rate and the risk premium for systematic risk (beta $\beta$ ). (Reflects the market-wide risk premium)

Line represented: Security Market Line (SML)
Above the SML, the stock is “undervalued” (return is higher than required), and below it is “overvalued”.

5. Capital Structure Theory (MM 1958)

구분	MM's Capital Structure Theory without Corporate Tax	Capital Structure Theory with Corporate Tax (Bankruptcy/Agency Theory)
Basic Proposition	Firm value is independent of capital structure (debt-to-equity ratio). Value remains V even when using debt.	Due to the corporate tax shield of interest, firm value is highest when using 100% debt.
WACC (Cost of Capital) Changes	Due to the offset between the cost of debt and cost of equity, Weighted Average Cost of Capital (WACC) remains unchanged.	Bankruptcy Cost Theory: Firm value increases up to a certain point (early stage), then decreases as bankruptcy costs grow (optimal capital structure exists).

Information Asymmetry (Pecking Order Theory): Managers tend to raise funds in the order of internal retained earnings (most preferred) → debt (next) → new stock issuance (last resort, unfavorable).

6. Derivatives Basics: Options and Futures

(1) Options

Call Options vs Put Options
Category	Right	Situation to Exercise for Profit (In-the-Money)
Call Option	Right to buy	Current Market Price > Agreed Strike Price (since it can be bought cheap)
Put Option	Right to sell	Current Market Price < Agreed Strike Price (since it can be sold expensive)

Put-Call Parity: Equilibrium equation between European call and put options.

(2) Futures vs Forwards

Futures: “Organized exchange”, “Standardized terms”, “Daily settlement”, clearinghouse “guarantees contract fulfillment” (settled by reversing trades).
Forwards: “Over-the-counter (OTC) market”, direct contracts between parties, physical delivery at maturity, high risk.

This completes the delivery of the core theories in business administration.