Chapter Nineteen Mastering Financial Management

Copyright © Cengage Learning. All rights reserved. Learning Objectives 1.Explain the need for financing and financial management in business. 2.Summarize the process of planning for financial management 3.Describe the advantages and disadvantages of different methods of short-term debt financing. 4.Evaluate the advantages and disadvantages of equity financing. 5.Evaluate the advantages and disadvantages of long-term debt financing. 19 | 2

Chapter 19 Outline –What Is Financial Management? The Need for Financing The Need for Financial Management Careers in Finance –Planning—The Basis of Sound Financial Management Developing the Financial Plan Monitoring and Evaluating Financial Performance –Sources of Short-Term Debt Financing Sources of Unsecured Short-Term Financing Sources of Secured Short-Term Financing Factoring Accounts Receivable Cost Comparisons Copyright © Cengage Learning. All rights reserved.19 | 3

Chapter 19 Outline (cont’d) –Sources of Equity Financing Selling Stock Retained Earnings Venture Capital and Private Placements –Sources of Long-Term Debt Financing Long-Term Loans Corporate Bonds Cost Comparisons Copyright © Cengage Learning. All rights reserved.19 | 4

Copyright © Cengage Learning. All rights reserved. What Is Financial Management? All the activities concerned with obtaining money and using it effectively –Determining the best ways to raise money –Ensuring money is used in keeping with the organization’s goals –Planning The need for financing –When expenses are high or sales are low –Opportunities to expand 19 | 5

Copyright © Cengage Learning. All rights reserved. The Need for Financing Short-term financing –Money that will be used for one year or less Cash flow Inventory Long-term financing –Money that will be used for longer than one year –Often involves large amounts of money 19 | 6

Copyright © Cengage Learning. All rights reserved. The Need for Financial Management Risk-return ratio Proper financial management can ensure that –Financing priorities are in line with organizational goals and objectives –Spending is planned and controlled –Sufficient financing is available when it is needed –Credit customers pay on time and delinquencies are reduced –Bills are paid promptly –Taxes are paid in a timely manner –Excess cash is invested in interest-bearing securities 19 | 7

Copyright © Cengage Learning. All rights reserved. Skills and traits of successful financial managers –Responsible and honest –Strong background in accounting or math –Knowledge of how to use a computer to analyze data –Expert in written and oral communications Jobs –Bank officer –Credit officer –Financial analyst –Financial planner –Insurance analyst –Investment account executive Careers in Finance 19 | 8

Copyright © Cengage Learning. All rights reserved. Planning—The Basis of Sound Financial Management Financial plan –A plan for obtaining and using the money needed to implement an organization’s goals Developing the financial plan –Establishing organizational goals and objectives –Budgeting for financial needs –Identifying sources of funds 19 | 9

Copyright © Cengage Learning. All rights reserved. Developing the Financial Plan Establishing goals and objectives –Goals –Objectives –Must be specific and measurable –Must be realistic 19 | 10

Copyright © Cengage Learning. All rights reserved. Developing the Financial Plan (cont’d) Budgeting for financial needs –Budget –Cash budget Traditional Zero-based budgeting –Capital budget 19 | 11

Copyright © Cengage Learning. All rights reserved. Developing the Financial Plan (cont’d) Identifying sources of funds –Sales revenues –Equity capital –Debt capital –Proceeds from the sale of assets Monitoring and evaluating financial performance –Prevents minor problems from becoming major ones 19 | 12

Copyright © Cengage Learning. All rights reserved. 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 –There is a closer relationship between borrower and lender 19 | 13

Copyright © Cengage Learning. All rights reserved. Sources of Unsecured Short-Term Debt Financing Unsecured financing Trade credit Promissory notes 19 | 14

Copyright © Cengage Learning. All rights reserved. Sources of Unsecured Short-Term Debt Financing (cont’d) Unsecured bank loans –Interest rates vary with each borrower’s credit rating –Prime interest rate –Offered through promissory notes, a line or credit, or revolving credit agreement Commercial paper –Short-term promissory note issued by a large corporation –Interest rates are usually below that charged by banks for short-term loans 19 | 15

Copyright © Cengage Learning. All rights reserved. Sources of Secured Short-Term Debt Financing Loans secured by inventory –Inventory is pledged as collateral –Control of the inventory passes to the lender until the loan is repaid –The borrow must pay storage for the inventory –Floor planning Loans secured by receivables –Amounts owed the firm in the form of accounts receivable from trade credit given to customers are pledged as collateral –Quality of receivables is considered 19 | 16

Copyright © Cengage Learning. All rights reserved. Factoring Accounts Receivable Another method of raising short-term financing Factor –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 19 | 17

Copyright © Cengage Learning. All rights reserved. Sources of Equity Financing For sole proprietorships or partnerships –Owner or owners invest money in the business –Venture capital For corporations –Sale of stock –Use of profits not distributed to owners –Venture capital 19 | 18

Copyright © Cengage Learning. All rights reserved. Sources of Equity Financing (cont’d) Selling stock –Initial public offering When a corporation sells common stock to the general public for the first time –Advantages of selling stock Firm does not have to repay money received from sale of stock Firm does not have to pay dividends to stockholders –Two types of stock Common stock Preferred stock 19 | 19

Copyright © Cengage Learning. All rights reserved. Sources of Equity Financing (cont’d) Selling stock (cont.) –Common stock –Preferred stock –Par value –Convertible preferred stock 19 | 20

Copyright © Cengage Learning. All rights reserved. Sources of Equity Financing (cont’d) Retained earnings Venture capital Private Placement 19 | 21

Copyright © Cengage Learning. All rights reserved. Sources of Long-Term Debt Financing Financial leverage Lease 19 | 22

Copyright © Cengage Learning. All rights reserved. Sources of Long-Term Debt Financing (cont’d) Long-term loans –Term-loan agreement –Getting a loan Know potential lenders Maintain a good credit rating Fill out an application; submit a business plan and financial statements; compile references Meet with loan officer If denied, determine why 19 | 23

Copyright © Cengage Learning. All rights reserved. Sources of Long-Term Debt Financing (cont’d) Corporate bonds –Types of bonds Registered bond Debenture bond Mortgage bond Convertible bond 19 | 24

Copyright © Cengage Learning. All rights reserved. Sources of Long-Term Debt Financing (cont’d) Corporate bonds (cont.) –Repayment provisions for corporate bonds Bond indenture Call premium Serial bonds Sinking fund Trustee 19 | 25