Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 16 Mastering Financial Mangement

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objectives ① Understand why financial management is important in today’s uncertain economy. ② Identify a firm’s short- and long-term financial needs. ③ Summarize the process of planning for financial management. ④ Identify the services provided by banks and financial institutions for their business customers. ⑤ Describe the advantages and disadvantages of different methods of short-term debt financing. ⑥ Evaluate the advantages and disadvantages of equity financing. ⑦ Evaluate the advantages and disadvantages of long-term debt financing. 16 2

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Financial Management  Activities concerned with obtaining money and using it effectively 16 3 © DMITRY ASEEV/ SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Business Bankruptcies in the U.S. 16 4

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Need for Financial Management  Uses of funds dictate the type of financing needed by a business  Activities a business can undertake are determined by the types of financing available 16 5

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Need for Financial Management  Proper financial management must ensure Financing priorities are established in line with organizational goals and objectives Spending is planned and controlled Sufficient financing is available when it is needed A firm’s credit customers pay their bills on time and the number of past due accounts is reduced Bills are paid promptly The funds required for paying the firm’s taxes are available Excess cash is invested 16 6

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. CLASS EXERCISE  Many firms provide services of helping businesses plan their financial needs appropriately. Discuss how best to go about planning a small business

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Financial Reform After the Economic Crisis  President Obama signed the Dodd–Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010  New regulations will protect American families from unfair, abusive financial and banking practices 16 8

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Financial Reform After the Economic Crisis  Goals Hold Wall Street firms accountable for their actions End taxpayer bailouts Tighten regulations for major financial firms Increase government oversight 16 9  Debate Limiting executive pay and bonuses Limiting the size of the largest firms Curbing previously used speculative investment techniques

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Careers in Finance  Chief financial officer (CFO): High-level corporate executive who manages firm’s finances and reports directly to the company’s chief executive officer © NOTARYES/ SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Careers in Finance  Managers and employees in the finance area must: Have a strong background in accounting or mathematics Know how to use a computer to analyze data Be an expert at both written and oral communication 16 11

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Careers in Finance  Jobs available Bank officer Consumer credit officer Financial analyst Financial planner Loan officer Insurance analyst Investment account executive © YURI ARCURS/SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Short-Term Financing  Money that will be used for one year or less Cash flow: Movement of money into and out of an organization Speculative production: Time lag between production and the selling of goods © NAN728/ SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. FIGURE Cash Flow for a Manufacturing Business 16 14

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Long-Term Financing  Money that will be used for longer than one year Involves large amounts of money COURTESY U.S. DEPARTMENT OF DEFENSE

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Comparison of Short- and Long-Term Financing 16

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Risk–Return Ratio  High risk decision should generate higher financial returns for a business  More conservative decisions generate lower returns © EAST/ SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Financial Plan  Plan for obtaining and using the money needed to implement an organization’s goals and objectives © JIM WEST/ZUMA/CORBIS

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Three Steps of Financial Planning 16 19

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Developing the Financial Plan  Budget: Financial statement that projects income and/or expenditures over a specified future period  Cash budget: Financial statement that estimates cash receipts and cash expenditures over a specified period 16 20

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Developing the Financial Plan Zero-base budgeting: Budgeting approach in which every expense in every budget must be justified Capital budget: Estimates a firm’s expenditures for major assets and its long- term financing needs © DENIS OPOLJN/SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Developing the Financial Plan  Equity capital: Money received from the owners or from the sale of shares of ownership in a business  Debt capital: Borrowed money obtained through loans of various types 16 22

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Monitoring and Evaluating Financial Performance  Financial plans are implemented properly  Prevents minor problems from becoming major ones  Interim budgets may be prepared for comparison purposes © OMNITERRA IMAGES

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Financial Services Provided by Banks and Other Financial Institutions Traditional Banking Services for Business Clients Electronic Banking Services International Banking Services

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Savings and Checking Accounts  Provide a safe place to store money  Conservative means of investing  Certificate of deposit (CD): A document stating that the bank will pay the depositor a guaranteed interest rate on money left on deposit for a specified period of time  Check: Written order for a bank or other financial institution to pay a stated dollar amount to the business or person indicated on the face of the check

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Business Loans  Line of credit: Loan approved before the money is actually needed  Revolving credit agreement: Guaranteed line of credit  Collateral: Real estate or property pledged as security for a loan 16 26

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Basics of Getting a Loan  Basics of getting a loan Know potential lenders Fill out an application; submit a business plan and financial statements; compile references Meet with loan officer If denied, determine why 16 27

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Why Has the Use of Credit Transactions Increased?  For the merchant, credit and debit card transactions can be converted to cash and improve a firm’s cash flow.  Debit card: Electronically subtracts the amount of a purchase from bank account when the purchase is made © MAITREE LAIPITAKSIN/ SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Electronic Funds Transfer  Means of performing financial transactions through computer terminal Automated teller machines (ATMs) Automated clearinghouses (ACHs) Point-of-sale (POS) terminals Electronic check conversion (ECC) 16 29

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. International Banking Services  Letter of credit: Legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time  Banker’s acceptance: Written order for a bank to pay a third party a stated amount of money on a specific date © RICHARD B. LEVINE / ALAMY

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Short-Term Debt Financing  Short-term debt financing is 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 A close working relationship normally exists between borrower and lender 16 31

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Unsecured Short-Term Debt Financing Unsecured financing: Financing not backed by collateral Trade credit: Financing extended by a seller who does not require immediate payment Promissory notes: Written pledge by a borrower to pay a certain sum of money to a creditor at a specified future date 16 32

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Unsecured Short-Term Debt Financing Unsecured bank loans -Interest rates vary with each borrower’s credit rating -Prime interest rate: Lowest rate charged by a bank for a short-term loan -Compensating balance - 10 to 20 percent of the borrowed funds 16 33

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. FIGUE 19-6 Average Prime Interest Rate Paid by U.S. Businesses, 1990–February

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Unsecured Short-Term Debt Financing Commercial paper -Short-term promissory note issued by a large corporation -Interest rates are usually below that charged by banks for short-term loans 16 35

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Secured Short-Term Financing  Loans secured by inventory - Inventory is pledged as collateral  Loans secured by receivables - Amounts owed to a firm by its customers are pledged as collateral © RANDY DUCHAINE / ALAMY

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Factoring Accounts Receivable  Factor: Firm that specializes in buying other firms’ accounts receivable Buys accounts receivable for less than their face value © STEPHEN COBURN / SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Comparison of Short-Term Financing Methods 16 38

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Equity Financing  For sole proprietorships or partnerships Owner or partners invest money in the business Venture capital  For corporations Sale of stock Use of profits not distributed to owners Venture capital 16 39

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Selling Stock  Initial public offering: When a corporation sells common stock to the general public for the first time  Primary market: Investors purchase financial securities directly from the issuer of the securities

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Selling Stock  Investment banking firm: Assists corporations in raising funds usually by helping to sell new issues of stocks, bonds, or other financial securities © KYRYLO GREKOV/ SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Selling Stock  Advantages Firm does not have to repay money received from sale of stock Firm does not have to pay dividends to stockholders © ABLEIMAGES/ ALAMY

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Selling Stock  Secondary market is for existing financial securities that are traded between investors Securities exchange market Over-the-counter (OTC) market © TUPUNGATO/SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Selling Stock  Common stock: Stock whose owners may vote on corporate matters Claims on profits and assets are subordinate to the claims of others Stockholders are also asked to approve or disapprove of major corporate actions 16 44

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Selling Stock  Preferred stock: Stock whose owners usually do not have voting rights Claims on dividends and assets are paid before those of common-stock owners 16 45

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Using the Internet  The New York Stock Exchange and the Nasdaq are the two most cited equity markets. Each provides financial information about the companies it lists and news that might influence their stock values

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Retained Earnings  The portion of a corporation’s profits not distributed to stockholders Form of equity financing  Amount is determined by corporate management and approved by the board of directors 16 47

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Venture Capital and Private Placement  Venture capital - Money invested in small firms that have the potential to become very successful and extremely profitable Investors receive an equity or ownership position in the business and share in its profits © AUREMAR/ SHUTTERSTOCK

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Venture Capital and Private Placement  Private placement: Stock and other corporate securities are sold directly to: Insurance companies Pension funds Large institutional investors 16 49

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Long-Term Debt Financing  Financial leverage: Use of borrowed funds to increase the return on owners’ equity As the firm’s earnings are larger than the interest charged for the borrowed money, there is a positive effect on return on owners’ equity © RICHARD B. LEVINE / ALAMY

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Long-Term Loans  Term-loan agreement: Promissory note that requires a borrower to repay a loan in monthly, quarterly, semiannual, or annual installments Interest rate and repayment terms are based on: -Reasons for borrowing -firm’s credit rating -Value of collateral 16 51

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Analysis of the Effect of Additional Capital from Debt or Equity for Cypress Springs Plastics, Inc

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Bonds  A corporation’s written pledge that it will repay a specified amount of money with interest  Maturity date: Date on which a corporation is to repay borrowed money  Registered bond: Bond registered in the owner’s name by the issuing company 16 53

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Bonds  Types of bonds Debenture bond: Bond backed only by the reputation of the issuing corporation Mortgage bond: Bond secured by various assets of issuing firm Convertible bond: Bond that can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock 16 54

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Risk–Return Ratio for Corporate Bond Investors 16 55

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Corporate Bonds  Repayment provisions Bond indenture: Legal document that details all the conditions relating to a bond issue Serial bonds: Bonds of a single issue that mature on different dates Sinking fund: Sum of money to which deposits are made each year for the purpose of redeeming a bond issue Trustee: Individual or an independent firm that acts as a bond owner’s representative 16 56

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Comparison of Long-Term Financing Methods © CENGAGE LEARNING 2014

Copyright ©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. CLASS EXERCISE  For each of the following financial needs, identify whether short-term or long-term financing is most appropriate, and identify a typical source of financing. $250,000 for inventory $14 million for plant expansion $2.5 million for business start-up costs $120,000 to solve cash-flow problems $450,000 for automated manufacturing equipment $35,000 for immediate promotional needs 16 58