Chapter Twenty Mastering Financial Management

The Need for Financing Short-term financing –Money that will be used for one year or less Long-term financing –Money that will be used for longer than one year Often involves large amounts of money

(Made in May; Sold in Sept)

The Three Steps of Financial Planning 1) Establish organizational goals What do I want 2) Budget the money needed to accomplish these goals What does it cost 3) Identify the sources of those funds How do I pay for it

Budgeting for financial needs ( What does it cost) –Cash budget-(short term) Traditional –Uses dollar amounts from preceding year –Promotes frenzy spending of surpluses at period end Zero-based budgeting –Every expense in every budget must be justified each year –Capital budget-(long term) Estimates a firm’s expenditures for major assets and its long-term financing needs

Identifying sources of funds (H ow do I pay for it ) –Sales revenues greatest part of financing; short term financing –Equity capital Money from owners or sale of shares of ownership; long-term financing –Debt capital Borrowed money obtained through loans –Proceeds from the sale of assets older machinery, bond conversion

Short-Term Debt Financing Short-term financing is usually easier to obtain than long-term –Shorter repayment period means less risk of nonpayment –Amounts of short-term loans are smaller than long-term loans

Sources of Unsecured Short-Term Debt Financing Unsecured financing - not backed by collateral Trade credit –extended by a seller not requiring immediate payment at time of delivery Promissory notes –A written pledge to pay money to a creditor at a specified future date - legal IOU –Unlike trade credit, promissory notes usually include interest Negotiable instruments

Sources of Unsecured Short-Term Debt Financing Unsecured bank loans –Interest rates vary with borrower’s credit rating –Offered through a line or credit, or credit cards Commercial paper –Short-term promissory note issued by a large corporation –Interest rates are usually below that charged by banks for short-term loans –Used to gain interest on unused cash reserves

Sources of Secured Short-Term Debt Financing Loans secured by inventory –Inventory is pledged as collateral Loans secured by receivables trade credit given to customers is pledged as collateral repayability of receivables determines their value to the factor

Factoring Accounts Receivable Factor - A firm that specializes in buying other firms’ accounts receivable The factor buys accounts receivable for less than their face value The factor collects the full dollar amounts when each account is due The factor’s profit is the difference between the face value and what it paid for the accounts receivable Profit is based on the risk (probability that the accounts receivable will not be paid) the factor assumes

Comparison of Short-Term Financing Methods

Sources of Long-Term Debt Financing Long-term loans - longer than 1 year requires borrower to repay loan in periodic installments –Interest rate and repayment terms are based on: the reasons for borrowing the firm’s credit rating the value of collateral

Sources of Long-Term Debt Financing Corporate bonds –A corporation’s written pledge that it will repay a specified amount of money with interest –Has a set interest rate until maturity that is paid up- front via discount –Types of bonds Debenture bond—backed only by the reputation of the issuing corporation Mortgage bond—secured by assets of the issuing firm Convertible bond—can be exchanged for shares of the corporation’s common stock – why do this?

Sources of Equity Financing (Long Term) For sole proprietorships or partnerships –Owner or owners reinvest in the business –Venture capital For corporations –Sale of stock –Use of profits not distributed to owners –Venture capital Venture capital Money invested with the expectation that the firm has potential Investors receive an equity position in the business and share in its profits

Sources of Equity Financing (Long Term) Selling stock –Initial public offering - IPO When a corporation sells common stock to the general public for the first time –Preferred stock owners who have no voting rights, but whose claims on profits are paid first –Common stock owners who vote on corporate matters but whose claims on profits come second

Comparison of Long-Term Financing Methods