Financial Management and Institutions

The Role of the Financial Manager Chief financial officer—top finance executive of a corporation; usually reports directly to the firm’s CEO. VP for Financial Management Treasurer Controller All address the risk-return trade-off A. Organizations are placing greater emphasis on measuring and reducing the costs of conducting business as well as increasing revenues and profits. B. Financial managers are executives responsible for developing and implementing their firm's financial plan and for determining the most appropriate sources and uses of funds. C. The finance organization of a typical company consists of three levels, including: •at the top is the CEO -- Chief Executive Officer •second there is the CFO -- Chief Financial Officer •thirdly, there are three executives, who are commonly called the vice president for financial management, the treasurer, and controller.

Organizational Structure of the Finance Function

The Role of the Financial Manager The Financial Plan Document specifying the funds a firm will need for a period of time, the timing of inflows and outflows, and the most appropriate sources and uses of funds. What funds will the firm require during the appropriate period of operations? How will it obtain necessary funds? When will it need more funds? 1. Financial managers develop their organization's financial plan, a document that specifies the funds needed by a firm for a period of time, the timing of inflows and outflows, and the most appropriate sources and uses of funds. 2. Based on forecasts of production costs, purchasing needs, and expected sales activities for the period covered 3. A good financial plan involves financial control, a process of checking actual revenues, costs, and expenses and comparing them against forecasts.

Sources of Funds Short-Term Sources of Funds Repaid within one year Includes: Trade credit Short-term loans Commercial paper Repurchase agreements a. trade credit -- is extended by suppliers when a firm receives goods or services, agreeing to pay for them at a later date b. short-term loans -- can be either unsecured - meaning that specific assets such as inventory are pledged as collateral c. commercial paper -- the interest on commercial paper is typically one or two percent lower than the rate on short-term bank loans; however, only large firms with unquestioned financial strength and stability are able to sell commercial paper.

Financial Management Short-term Uses for Excess Cash Will need back within a year Investments: U.S. Treasury bills Commercial paper Repurchase agreements Certificates of deposit a. U.S. Treasury bills •short-term securities issued by the U.S. Treasury and backed by the full faith and credit of the U.S. Government •are sold with a maturity of either 90 or 180 days, and have a minimum denomination of $10,000 b. commercial paper -- generally still considered to be a low-risk security c. repurchase agreements -- or repos, are an arrangement whereby one party sells a package of U.S. Government securities to another party, agreeing to buy back, or repurchase, the securities at a higher price on a later date d. certificates of deposit (CDs) •one-time deposit at a financial institution, such as a commercial bank, savings bank, or credit union, whose sizes and maturity dates vary considerably •all CDs with larger denominations are not federally insured, but can be sold more easily prior to maturity

Uses for Long-Term Excess Cash What does a business do with it’s excess cash? Cash not needed for investing in the business

Sources of Long-term Cash Repaid over many years Include: Long - term loans Bonds - similar to loans Equity financing – sell ownership in the business IPO – initial public offering Primary market Secondary market

Comparison of Debt and Equity Capital

Exercise Need to raise $100M Do you sell stocks or bonds?

Leverage Firm A Firm B Stock $10,000 $100,000 Bonds (10%) 90,000 Total Total Earnings $30,000 Bond Int. (9,000) Net Inc. $21,000 Ret. To shareholders 210% 30% The greater the percent you borrow, the greater your returns on equity Also the greater your loss Example Flip a house