IMA CMA Part 2 (Strategic Financial Management) Glossary

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Beta: Beta measures the systematic risk of an asset relative to the market portfolio, equal to the covariance of the asset's return with the market return divided by the variance of the market return. A beta of 1.0 means the asset moves in line with the market. $\beta_i = \frac{\text{Cov}(R_i, R_M)}{\text{Var}(R_M)}$

Capital Asset Pricing Model (CAPM): CAPM relates expected return on an asset to its systematic risk via the security market line. The expected return equals the risk-free rate plus beta times the market risk premium. $E[R_i] = R_f + \beta_i \cdot (E[R_M] - R_f)$
Capital Structure: Capital structure refers to the mix of debt and equity an organization uses to finance its operations and growth. Choices among long-term debt, preferred equity, and common equity are influenced by tax effects, financial distress costs, and signaling considerations.
Cost of Debt: Cost of debt is the effective rate an organization pays on its borrowed funds, typically expressed on an after-tax basis because interest is tax-deductible. After-tax cost of debt equals the pre-tax yield times one minus the marginal tax rate. $k_d^{\text{after-tax}} = k_d \cdot (1 - t)$
Cost of Equity: Cost of equity is the return shareholders require to compensate for the risk of holding the firm's equity. It is most commonly estimated using CAPM or the dividend discount model.
Current Ratio: Current ratio is current assets divided by current liabilities, a liquidity measure that estimates the firm's ability to meet short-term obligations. A ratio of 1.0 means current assets just cover current liabilities; industry context determines what is healthy. $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$

DuPont Identity: The DuPont identity decomposes return on equity (ROE) into three drivers: net profit margin, asset turnover, and equity multiplier (financial leverage). It separates operating efficiency, asset use efficiency, and capital structure effects. $\text{ROE} = \frac{\text{NI}}{\text{Sales}} \cdot \frac{\text{Sales}}{\text{Assets}} \cdot \frac{\text{Assets}}{\text{Equity}}$

Enterprise Risk Management (ERM): ERM is a structured framework for identifying, assessing, and managing all material risks to an organization. The COSO ERM framework integrates strategy and performance with risk appetite, risk response, and risk governance.

Free Cash Flow (FCF): Free cash flow is cash from operations minus capital expenditures, representing cash available to debt and equity holders after the firm has funded its required investments. FCF to equity further deducts net interest after tax and net debt issuance.
Foreign Corrupt Practices Act (FCPA): The FCPA is a US federal statute that prohibits payments to foreign officials to obtain or retain business and requires public companies to maintain accurate books and records and adequate internal accounting controls. Enforcement is shared between the DOJ and SEC.

Hedging: Hedging is the use of financial instruments such as forwards, futures, swaps, or options to offset specific exposures, typically foreign exchange, interest rate, or commodity price risk. Effective hedges reduce variance of cash flows or earnings.

Internal Rate of Return (IRR): IRR is the discount rate that sets the net present value of a project's cash flows to zero. A project with IRR above the cost of capital is accepted; below, rejected. Multiple IRRs arise when cash flows change sign more than once. $\sum_{t=0}^{N} \frac{CF_t}{(1+\text{IRR})^t} = 0$
IMA Statement of Ethical Professional Practice: The IMA Statement of Ethical Professional Practice sets four standards every IMA member commits to: competence, confidentiality, integrity, and credibility. It also defines a resolution process when ethical conflicts arise.

Net Present Value (NPV): NPV is the sum of discounted project cash flows minus initial investment, computed at the firm's cost of capital. A positive NPV indicates the project creates value for shareholders; NPV is the preferred capital-budgeting decision rule. $\text{NPV} = \sum_{t=0}^{N} \frac{CF_t}{(1+r)^t}$

Operating Cycle: Operating cycle is the average time from purchasing inventory to collecting cash from customers. It equals days inventory outstanding plus days sales outstanding. The cash conversion cycle further subtracts days payables outstanding.
Opportunity Cost: Opportunity cost is the return forgone by selecting one alternative over the next-best alternative. In capital budgeting and decision analysis, only opportunity costs (and other relevant costs) belong in the analysis.

Payback Period: Payback period is the number of years required for cumulative cash inflows to recover the initial investment. It is simple but ignores time value of money and post-payback cash flows; discounted payback partially addresses the time-value issue.

Quick Ratio: Quick ratio is the most-liquid current assets (cash, marketable securities, receivables) divided by current liabilities, excluding inventory. It is a stricter liquidity measure than current ratio when inventory is not readily convertible to cash. $\text{Quick Ratio} = \frac{\text{Cash} + \text{Marketable Securities} + \text{Receivables}}{\text{Current Liabilities}}$

Return on Assets (ROA): ROA measures the profitability per dollar of assets, equal to net income divided by average total assets. It reflects how efficiently management uses its asset base regardless of capital structure when the numerator is operating profit after tax.
Return on Equity (ROE): ROE measures profitability per dollar of shareholders' equity, equal to net income divided by average common equity. The DuPont identity decomposes ROE into operating efficiency, asset use efficiency, and leverage.

Sensitivity Analysis: Sensitivity analysis changes one input variable at a time to observe the impact on NPV, IRR, or another outcome. It identifies which inputs have the largest leverage on the decision and where additional research or hedging effort is most valuable.
Sunk Cost: A sunk cost is a past cash outlay that cannot be recovered regardless of future decisions. Sunk costs are irrelevant to any forward-looking decision; including them is a common decision-analysis error.

Weighted Average Cost of Capital (WACC): WACC is the firm's overall cost of capital, weighted by the market value proportions of debt and equity in the capital structure. It is the appropriate discount rate for projects of average risk financed in line with the target capital structure. $\text{WACC} = \frac{D}{D+E} \cdot k_d (1-t) + \frac{E}{D+E} \cdot k_e$
Working Capital: Working capital equals current assets minus current liabilities, the short-term capital tied up in operations. Negative working capital can signal aggressive payables management or liquidity stress; positive working capital indicates a buffer for short-term obligations.