Mastering Financial Management Chapter 16 Mastering Financial Management

Learning Objectives Explain the need for financial management in business. Summarize the process of planning for financial management. Identify the services provided by banks and financial institutions for their business customers. Describe the advantages and disadvantages of different methods of short-term debt financing. Evaluate the advantages and disadvantages of equity financing. Evaluate the advantages and disadvantages of long-term debt financing.

Financial Management …all the activities concerned with obtaining money and using it effectively.

Need for Financing Reasons: Sources: Afterward: Start a business Keep it going Sources: Owners’ investment Borrowed Afterward: Pay expenses Provide profit

…money that will be used for one year or less. Short-Term Financing …money that will be used for one year or less.

Table 16.1: Comparison of Short- and Long-Term Financing Whether a business seeks short- or long-term financing depends on what the money will be used for.

…the movement of money into and out of an organization. Cash Flow …the movement of money into and out of an organization.

Customers The Cash Flow Cycle Sales Accounts Receivable Cash Inventory

Speculative Production …the time lag between actual production of goods and when the goods are sold.

Figure 16.1: Cash Flow for a Manufacturing Business

…money that will be used for longer than one year. Long-Term Financing …money that will be used for longer than one year.

Two-Sided Problem of Financing Uses of funds dictate type(s) of financing needed Activities undertaken determined by types of financing available

Risk-Return Ratio …a ratio based on the principle that a high-risk decision should generate higher financial returns for a business and more conservative decisions often generate lesser returns.

Proper Financial Management Financing priorities established with goals and objectives Spending planned/controlled Bills paid promptly Excess cash invested

Careers in Finance Chief Financial Officer (CFO): manages firm’s finances, reports to chief executive officer or president Lower-level positions: banking, insurance, investment, non-profits, government entities Requirements: Strong background in accounting/math Knowledge of computer use for data analysis Expertise in written/oral communication

Positions, Salaries, and Experience at Two Major Firms Title GMC Pepsico Exp./Education Junior Fin. Anal. $20-43.2K $45-50K B.B.A. Senior Fin. Anal. $46.9-82.6K $60-70K 3yr/MBA Division Controller $110-172K $70-80K 10yr/MBA CFO $200-350K $150-200K 15yr/MBA Swiss Finance Academy, “Corporate Finance Salaries,” www.careers-in-finance.com/cfsal.htm, accessed September 27, 2009.

Financial Plan …a plan for obtaining and using money needed to implement an organization’s goals.

Developing Financial Plan Establish Goals and Objectives Monitor & Evaluate Performance Budget for Needs Identify Sources

Figure 16.2: The Three Steps of Financial Planning

Budget …a financial statement that projects income and/or expenditures over a specified future period.

Figure 16.3: Sales Budget

Cash Budget …a financial statement that projects cash receipts and cash expenditures over a specified period.

Figure 16.4: Cash Budget

Capital Budget …a financial statement that estimates a firm’s expenditures for major assets and its long-term financing needs.

Approaches to Budgeting Traditional: base on budget of preceding year; modify to reflect revised goals and objectives; justify only new expenditures Zero-base: justify every expense

Primary Sources of Funds Sales Revenue Equity Capital Debt Capital Sales of Assets

Financial Services Provided by Banks and Other Financial Institutions Traditional Savings and Checking Accounts Business Loans Electronic Banking Automated Clearinghouses (ACHs) Point of Sale (POS) Terminals Electronic Check Conversion (ECC) International Letter of Credit Bankers Acceptance

Traditional Business Banking Services Savings and Checking Accounts Passbook Savings Certificate of Deposit Check Business Loans Short-Term Loans Line of Credit Revolving Credit Long-Term Loans Credit/Debit Card Transactions

Electronic Funds Transfer …a means of performing financial transactions through a computer terminal or telephone hookup.

Sources of Unsecured Short-Term Financing Unsecured financing is financing that is not backed by collateral. Trade Credit Promissory Note Unsecured Bank Loans Commercial Paper

Average Prime Interest Rate Source: Federal Reserve Bank website, www.federalreserve.gov, accessed October 17, 2008..

Sources of Secured Short-Term Financing Inventory Accounts Receivable- Factoring

Table 16.2: Comparison of Short-Term Financing Methods

Sources of Equity Financing Sale of Stock Initial Public Offering: common stock sold the first time to public Investment Banking Firm: assists firm in raising capital Retained Earnings: undistributed portion of firm’s profits Private Placement: securities sold directly to insurance companies, pension funds, large institutions, wealthy investors

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. www.nyse.com www.nasdaq.com

IPOs Can Raise Billions! Spotlight IPOs Can Raise Billions! Source: The Renaissance Capital IPO Home website, www.ipohome.com, accessed May 24, 2009.

Convertible Preferred can be exchanged for common Types of Stock Common Holders vote on corporate matters Holders’ claims on profits/assets subordinate to preferred Preferred Holders receive dividends first Dividend is specified Convertible Preferred can be exchanged for common

Sources of Long-Term Debt Financing Financial Leverage Use of borrowed funds to increase return on owners’ equity Term Loan Borrower required to repay loan in monthly, quarterly, semiannual, or annual installments

Corporate Bond …a corporation’s written pledge that it will repay a specified amount of money with interest. The maturity date is the date on which the amount borrowed must be repaid.

Types of Bonds Registered: registered in owner’s name by issuing company Debenture: backed only by issuing firm’s reputation Mortgage: secured by assets of firm Convertible: may be exchanged for a specified number of common stock shares

Bond Provisions Maturity date: 10 to 30 years Indenture: details conditions of bond issue Serial Bonds: single issue that matures on different dates Sinking fund: deposits made each year for purpose of redeeming bond issue Trustee: acts as bond owners’ representative

Table 16.4: Comparison of Long-Term Financing Methods

Chapter Quiz Which of the following would be considered a short- term financial need? New product development Cash flow problems Business start-up costs Mergers and acquisitions Expansion of facilities

Chapter Quiz 2. The least expensive form of short-term financing is promissory notes. prime rate loans. common stock. trade credit. factoring.

Chapter Quiz Which of the following statements is incorrect? A corporation can issue only common stock or preferred stock, but not both. IPO stands for initial public offering. Common stockholders have the right to vote on major corporate actions. A corporation is under no legal obligation to pay dividends to common stockholders. A corporation is under no legal obligation to buy back the stock you purchase.

Chapter Quiz 4. The portion of a corporation’s profits not distributed to stockholders is called retained earnings. undistributed profits. profit residue. income before taxes. net profit.

Chapter Quiz A __________ is the legal document that details all the conditions relating to a bond issue. bond indenture debenture statement bond contract security agreement collateral statement