Free CMA Part 2 Exam Flashcards

Current Ratio = Current Assets / Current Liabilities. Quick Ratio = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities. The quick ratio is the stricter test because it excludes inventory (the least liquid current asset), measuring ability to meet short-term obligations without selling inventory.

Cash Ratio = (Cash + Cash Equivalents + Marketable Securities) / Current Liabilities. The most conservative liquidity measure, it counts only assets that are already cash or immediately convertible to cash, ignoring receivables and inventory entirely.

ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage = (Net Income/Sales) x (Sales/Total Assets) x (Total Assets/Equity). It decomposes ROE into profitability, efficiency, and leverage so you can see WHICH driver explains a change in return on equity.

ROA = Net Income / Total Assets (return generated per dollar of assets, ignoring how they were financed). ROE = Net Income / Shareholders' Equity (return to owners). ROE exceeds ROA whenever a firm uses debt profitably, because leverage multiplies equity returns.

Inventory Turnover = Cost of Goods Sold / Average Inventory. Days Sales in Inventory = 365 / Inventory Turnover. Higher turnover (fewer days) signals efficient inventory management; very high turnover may also warn of stockouts and lost sales.

CCC = Days Sales Outstanding + Days Inventory Outstanding - Days Payables Outstanding. It measures the number of days cash is tied up in operations. A shorter (or negative) cycle means the firm finances less of its working capital and frees up cash.

AR Turnover = Net Credit Sales / Average Accounts Receivable. Days Sales Outstanding (DSO) = 365 / AR Turnover, the average collection period. Rising DSO can signal weakening collections or looser credit terms.

Times Interest Earned = EBIT / Interest Expense. It measures how many times operating earnings cover interest obligations. A ratio below ~1.5-2.0x signals elevated default risk; the higher the ratio, the greater the cushion for creditors.

Debt-to-Equity = Total Debt / Total Equity. Debt-to-Total-Assets = Total Debt / Total Assets. Both are leverage (solvency) ratios. D/E expresses leverage relative to owners' capital; debt-to-assets expresses the share of assets funded by creditors.

Gross Margin = Gross Profit / Sales (after COGS). Operating Margin = Operating Income (EBIT) / Sales (after COGS and operating expenses). Net Margin = Net Income / Sales (after everything, including interest and tax). Comparing the three isolates where profitability erodes.

P/E = Market Price per Share / Earnings per Share, showing how much investors pay per dollar of earnings (a market-value ratio). Earnings Yield = EPS / Price = the inverse of P/E. A high P/E typically signals high expected growth.

The degree to which reported earnings reflect sustainable, cash-backed operating performance rather than accruals, one-time items, or aggressive accounting. High-quality earnings are repeatable and closely track operating cash flow; large gaps between net income and operating cash flow are a red flag.

Statements expressed in percentages: income statement items as a percent of sales, and balance sheet items as a percent of total assets. They enable vertical (within-period) and cross-company comparison regardless of absolute size, highlighting structural shifts in cost or asset mix.

WACC = (E/V x Re) + (D/V x Rd x (1 - Tax Rate)), where E = equity value, D = debt value, V = E + D, Re = cost of equity, Rd = pre-tax cost of debt. Debt is multiplied by (1 - tax rate) because interest is tax-deductible. WACC is the firm's blended hurdle rate.

Re = Rf + Beta x (Rm - Rf), where Rf = risk-free rate, Beta = systematic risk, and (Rm - Rf) = market risk premium. The Capital Asset Pricing Model prices only systematic (non-diversifiable) risk; firm-specific risk is assumed diversified away.

After-Tax Cost of Debt = Pre-Tax Yield x (1 - Tax Rate). Because interest expense is tax-deductible, the government effectively subsidizes part of borrowing cost, making debt the cheapest source of capital. This tax shield is why debt lowers WACC up to a point.

The mix of debt and equity that minimizes WACC and therefore maximizes firm value. Adding cheap debt lowers WACC at first (tax shield), but beyond a point the rising risk of financial distress raises both Rd and Re, pushing WACC back up. The trade-off theory balances tax benefits against distress costs.

In a frictionless world (no taxes, no bankruptcy costs), MM Proposition I says capital structure is irrelevant to firm value. With corporate taxes, the interest tax shield makes value rise with leverage. Real-world distress and agency costs offset this, producing an optimal structure.

DOL = % Change in EBIT / % Change in Sales = Contribution Margin / EBIT. It measures sensitivity of operating income to sales changes and rises with FIXED operating costs. High DOL means small sales swings cause large EBIT swings (business risk).

DFL = % Change in EPS / % Change in EBIT = EBIT / (EBIT - Interest). It measures sensitivity of EPS to EBIT changes and rises with FIXED financing (interest) costs. DOL captures business risk from fixed operating costs; DFL captures financial risk from fixed financing costs.

DTL = DOL x DFL = % Change in EPS / % Change in Sales. It combines operating and financial leverage to show how a change in sales magnifies all the way down to earnings per share, capturing the firm's total risk profile.

Managing current assets and current liabilities to balance liquidity against profitability. Net Working Capital = Current Assets - Current Liabilities. An aggressive policy holds less working capital (higher return, higher risk); a conservative policy holds more (lower return, lower risk).

EOQ = square root of (2 x D x S / H), where D = annual demand, S = ordering cost per order, H = holding cost per unit per year. It is the order size that minimizes total inventory cost by balancing ordering costs against carrying (holding) costs.

Approx. Annual Cost = (Discount % / (100% - Discount %)) x (365 / (Payment Period - Discount Period)). For terms like 2/10 net 30, forgoing the discount costs roughly 37% annualized, so it usually pays to borrow and take the discount.

Residual dividend policy pays out only cash left after funding all positive-NPV projects, so dividends fluctuate. Stable policy smooths a predictable dividend regardless of short-term earnings. A dividend signals management's confidence; cuts are read as bad news (signaling theory).

Both increase share count without changing total firm value or a shareholder's proportional ownership. A stock dividend (e.g., 10%) transfers retained earnings to paid-in capital; a stock split (e.g., 2-for-1) only restates par value and share count. Neither sends cash to shareholders.

Transaction exposure: gains/losses on existing cross-currency contracts before settlement. Translation exposure: accounting effect of consolidating foreign-subsidiary financials. Economic exposure: long-run effect of currency moves on competitive position and cash flows.

Break-Even in Units = Fixed Costs / Contribution Margin per Unit. Break-Even in Dollars = Fixed Costs / Contribution Margin Ratio. The contribution margin per unit = Selling Price - Variable Cost per Unit; the CM ratio = CM per unit / Selling Price.

Units for Target Profit = (Fixed Costs + Target Operating Profit) / Contribution Margin per Unit. To target an AFTER-tax profit, first gross it up: pre-tax target = after-tax target / (1 - tax rate), then apply the formula.

Margin of Safety = Actual (or Budgeted) Sales - Break-Even Sales. As a percentage = Margin of Safety / Actual Sales. It measures how far sales can fall before the firm hits break-even and starts losing money; a larger cushion means lower risk.

A relevant cost is a future cost that DIFFERS between alternatives and is the only kind that should affect a decision. A sunk cost is already incurred, cannot be changed, and is ALWAYS irrelevant. Ignoring sunk costs avoids the 'throwing good money after bad' trap.

The contribution or benefit forgone by choosing one alternative over the next-best one. It never appears in the accounting records but is a relevant cost in decision analysis. Example: using a machine for product A means forgoing the contribution it could earn on product B.

Compare the relevant cost to make (variable production cost + any avoidable fixed costs + opportunity cost of the freed capacity) against the purchase price to buy. Unavoidable fixed costs that continue either way are irrelevant and must be excluded from the comparison.

Accept a one-time order if the price exceeds the incremental (relevant) cost, provided there is idle capacity. With idle capacity, fixed costs are usually irrelevant. If the order requires displacing regular sales, add the opportunity cost of those lost contribution margins.

Process a joint product further only if incremental revenue from further processing exceeds incremental processing cost. Joint costs incurred before the split-off point are sunk and irrelevant to this decision, no matter how they were allocated among products.

Drop a segment only if its avoidable fixed costs plus variable costs exceed its revenue (i.e., its segment margin is negative). Allocated common (unavoidable) fixed costs that continue after dropping the segment are irrelevant and can mislead the decision if included.

When a resource is scarce, maximize contribution margin PER UNIT OF THE CONSTRAINT, not per unit of product. Rank products by CM per machine-hour (or other bottleneck) and produce the highest-ranked first. The Theory of Constraints focuses on relieving the bottleneck to raise throughput.

Cost-plus pricing adds a markup to cost (simple but ignores demand). Target pricing starts from the market price customers will pay, subtracts a required profit, and derives a target cost the firm must engineer toward. Target costing is market-driven; cost-plus is internally driven.

Elasticity = % Change in Quantity Demanded / % Change in Price. Demand is elastic (>1) when a price increase reduces total revenue, and inelastic (<1) when a price increase raises total revenue. Pricing strategy depends heavily on where demand sits on this spectrum.

Expected Value = sum of (probability x payoff) across outcomes. Decision trees lay out sequential choices and chance events, folding back expected values to choose the branch with the best expected payoff. Expected Value of Perfect Information = EV with perfect info minus EV without it.

NPV = sum of (Cash Flow_t / (1 + r)^t) - Initial Investment, where r is the required rate (often WACC). Accept a project if NPV > 0, because it adds value above the cost of capital. NPV is the theoretically preferred capital-budgeting metric.

IRR is the discount rate that makes NPV = 0. Decision rule: accept a project if IRR > the required rate of return (hurdle rate / WACC). IRR assumes interim cash flows are reinvested at the IRR itself, which can overstate return for high-IRR projects.

For mutually exclusive projects, NPV and IRR can rank differently due to scale or cash-flow timing. When they conflict, follow NPV because it measures dollar value added and uses a more realistic (WACC) reinvestment assumption. IRR can also produce multiple rates with non-conventional cash flows.

Payback Period = time to recover the initial investment from cash inflows. Simple payback ignores the time value of money and all cash flows after payback. Discounted payback uses present values but still ignores post-payback flows. Both are liquidity/risk screens, not value measures.

PI = PV of Future Cash Flows / Initial Investment (equivalently 1 + NPV/Investment). Accept if PI > 1. PI is useful for ranking projects under capital rationing because it measures value created per dollar invested, helping prioritize when funds are limited.

Managerial flexibility embedded in a project that traditional NPV ignores: the option to expand, abandon, defer, or switch. Because flexibility has value, a project's true worth = static NPV + the value of its real options. Ignoring them understates value for uncertain projects.

ERM is a firm-wide, integrated process for identifying, assessing, and managing risks against the entity's risk appetite to create and protect value. The COSO ERM framework links risk management to strategy and performance, treating risk as both threat and opportunity rather than a siloed checklist.

Four core responses after assessing a risk. Avoid: exit the activity. Reduce (mitigate): lower likelihood or impact via controls. Share (transfer): shift risk via insurance or hedging. Accept (retain): take no action because the risk is within appetite. The choice weighs cost of the response against residual risk reduced.

Hedging offsets an existing exposure with an opposite position. Forwards/futures lock a price; options give the right but not the obligation to transact (capping downside while keeping upside, for a premium); swaps exchange cash-flow streams (e.g., fixed-for-floating interest). Hedging reduces variability, not expected value.

Built on four overarching standards: Competence, Confidentiality, Integrity, and Credibility. When facing an ethical conflict, first follow your organization's established policy; if unresolved, escalate to successively higher levels of management (excluding any superior involved). Discuss with an objective advisor or the IMA Ethics Helpline before considering resignation.