17 Chapter Financial Management

Learning Objectives LO 17.1 Define the role of financial managers. LO 17.2 Describe the parts of a financial plan and the financial planning process. LO 17.3 Outline how organizations manage their assets. LO 17.4 Discuss the two major sources of funds for a business and capital structure. LO 17.5 Identify sources of short-term financing for businesses. LO 17.6 Discuss long-term financing options. LO 17.7 Describe mergers, acquisitions, buyouts, and divestitures.

Financial Management Finance: The business function of planning, obtaining, and managing the company’s funds to accomplish its objectives as effectively and efficiently as possible Maximizing overall worth Meeting expenses Investing in assets Increasing profits to shareholders

FIGURE 17.1 The Finance Organization at a Typical Firm The Role of the Financial Manager Financial managers: The executives who develop and carry out their firm’s financial plan and decide on the most appropriate sources and uses of funds FIGURE 17.1 The Finance Organization at a Typical Firm

The Role of the Financial Manager (cont’d) Risk-return trade-off: the process of maximizing the wealth of the firm’s shareholders by striking the right balance between risk and return

Financial Planning Financial plan: a document that specifies the funds needed by a firm for a period of time, the timing of cash inflows and outflows, and the most appropriate sources and uses of funds Financial plans are built by answering the following questions: What funds will the firm require during the planning period? When will the firm need additional funds? Where will the firm obtain the necessary funds? Based on the forecasts of production costs, purchasing needs, plant/equipment expenses, and sales activities for a given period

Managing Assets Sound financial management requires assets to be managed and acquired effectively and efficiently Assets What a firm owns Use of funds

Short-Term Assets Also known as current assets Cash Marketable securities Accounts receivable Inventory

Test Your Knowledge All of the following are short-term assets except a) inventory. b) accounts receivable. c) equipment. d) cash. Answer: c

Capital Investment Analysis Long-lived assets Produce economic benefit for more than one year Substantial investments Capital investment analysis Expansion: new assets Replacement: upgrading assets

Managing International Assets Today’s firms have facilities and assets worldwide Sales occur outside of the home country International assets require the management of activities to reduce the financial risk of exchange rates

Sources of Funds and Capital Structure Debt capital consists of funds obtained through borrowing Equity capital consists of funds provided by the firm’s owners when they reinvest their earnings, make additional contributions, liquidate assets, issue shares to the general public, or raise capital from outside investors

FIGURE 17.2 How Leverage Works Leverage and Capital Structure Decisions Goal: increasing the rate of return on funds invested by borrowing funds Note: The example assumes that both companies have $100 million in capital. Leverage Company consists of $50 million in equity and $50 million in bonds (with an interest rate of 10 percent). Equity Company consists of $100 million in equity and no bonds. This example also assumes no corporate taxes. FIGURE 17.2 How Leverage Works

Mixing Short and Long-Term Funds Short-term funds Current liabilities Less expensive Volatile interest rates Long-term funds Long-term debt and equity Used for long-term assets

Dividend Policy Dividends are periodic cash payments to shareholders Highest dividend yielding stocks Financial managers must make decisions regarding their dividend policy Should we pay a dividend? When should it be paid?

Short-Term Funding Options Trade credit Short-term loans Commercial paper

Test Your Knowledge Trade credit is a source of long-term financing. a) True b) False   Answer: b

Sources of Long-Term Financing Public sale of shares and bonds Private placements Venture capitalists Private equity funds Hedge funds

Test Your Knowledge Why would a firm prefer to sell its bonds through private placement rather than an initial public offering? a) Firms typically receive more favourable repayment terms from private holders. b) There are more buyers for private placements than publicly traded bonds. c) It is often cheaper for the firm to sell securities privately. d) Private placements reduce the risk of default. Answer: c

Buyouts, and Divestitures Mergers, Acquisitions, Buyouts, and Divestitures Financial managers evaluate mergers, acquisitions, and other opportunities by comparing costs and benefits Tender offer Leveraged buyouts (LBOs) Divestiture Selloff Spinoff

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