Answers to Chapter Questions

CHAPTER 1: Overview of Budgets and Financial Models

  1. The main goal of all budgets is to provide a tangible and quantifiable estimate of the receipt and allocation of resources. A budget represents a core element of a financial model.

  2. The two main components of a Master Budget are an Operating Budget and a Financial Budget.

  3. A financial model is a quantitative representation of a company's past, present, and future business operations.

  4. The three components of standard consolidated financial statements are the Balance Sheet, the Income Statement, and the Statement of Cash Flows.

  5. Free cash flows represent the cash available to all providers of capital (providers of both debt and equity)—in other words, the amount of cash a business generates (or, conversely, consumes) over a given timeframe after paying all of its "required" costs for that period.

  6. A business should use sensitivity analyses to model the effect of changing input variables on some output of interest, such as net income. Contribution margin analyses should be used to determine a business's operating leverage and breakeven point (both in terms of units and in terms of dollars). A business should use financial analyses to assess financial performance using metrics such as gross margin, net profit margin, and return on equity, among others.

  7. Valuation is the process of determining how much a company is worth.

  8. A capitalization chart represents, or tabulates, the ownership structure of a business.

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