Financial Management
Chapter 18
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
1. Explain the role and responsibilities of financial managers.
2. Outline the financial planning process, and explain the three key budgets in the financial plan.
3. Explain why firms need operating funds.
4. Identify and describe different sources of short-term financing.
5. Identify and describe different sources of long-term financing.
LEARNING GOALSChapter Eighteen
18-2
• Finance -- The function in a business that acquires funds for a firm and manages them within the firm.
• Finance activities include:
- Preparing budgets
- Creating cash flow analyses
- Planning for expenditures
- Financial Management -- The job of managing a firm’s resources to meet its goals and objectives.
WHAT’S FINANCE?The Role of Finance and Financial Managers
LG1
18-3
• Financial Managers -- Examine financial data and recommend strategies for improving financial performance.
FINANCIAL MANAGERSLG1
The Role of Finance and Financial Managers
• Financial managers are responsible for:- Paying company bills
- Collecting payments
- Staying abreast of market changes
- Assuring accounting accuracy
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• CFO -- Chief Financial Officer
• CFP -- Certified Financial Planner
• CFA -- Chartered Financial Analyst
• Comptroller -- Chief Accounting Officer
WHO’S WHO in FINANCELG2
Financial Planning
18-5
WHAT FINANCIAL MANAGERS DOLG1
The Role of Finance and Financial Managers
18-6
WHAT WORRIES FINANCIAL MANAGERS
• Consumer demand for their firm’s products
• Credit markets and interest rates
• Financial regulations from the government
• Volatility of the dollar
• Foreign competition
• Environmental regulationsSource: CFO Magazine, www.cfo.com, accessed July 2011.
LG1
The Role of Finance and Financial Managers
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1) Undercapitalization
2) Poor control over cash flow
3) Inadequate expense control
WHY DO FIRMS FAIL FINANCIALLY?
The Value of Understanding Finance
LG1
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TOP FINANCIAL CONCERNS of COMPANY CFOs - MACRO
• Consumer demand
• Federal-government policies
• Price pressure from competitors
• Credit markets/interest rates
• Global financial instability
Source: CFO Magazine, July/August 2010.
LG1
The Value of Understanding Finance
18-9
TOP FINANCIAL CONCERNS of COMPANY CFOs - MICRO
• Ability to maintain margins
• Ability to forecast results
• Maintaining morale/productivity
• Cost of healthcare
• Working-capital management
Source: CFO Magazine, July/August 2010.
LG1
The Value of Understanding Finance
18-10
• Financial planning involves analyzing short-term and long-term money flows to and from the company.
• Three key steps of financial planning:
1. Forecasting the firm’s short-term and long-term financial needs.
2. Developing budgets to meet those needs.
3. Establishing financial controls to see if the company is achieving its goals.
FINANCIAL PLANNINGFinancial Planning
LG2
18-11
• Short-Term Forecast -- Predicts revenues, costs and expenses for a period of one year or less.
• Cash-Flow Forecast -- Predicts the cash inflows and outflows in future periods, usually months or quarters.
• Long-Term Forecast -- Predicts revenues, costs, and expenses for a period longer than one year and sometimes as long as five or ten years.
FINANCIAL FORECASTINGForecasting Financial Needs
LG2
18-12
• Budget -- Sets forth management’s expectations for revenues and allocates the use of specific resources throughout the firm.
• Budgets depend heavily on the balance sheet, income statement, statement of cash flows and short-term and long-term financial forecasts.
• The budget is the guide for financial operations and expected financial needs.
BUDGETINGWorking with the Budget Process
LG2
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• Capital Budget -- Highlights a firm’s spending plans for major asset purchases that often require large sums of money.
• Cash Budget -- Estimates cash inflows and outflows during a particular period like a month or quarter.
• Operating (Master) Budget -- Ties together all the firm’s other budgets and summarizes its proposed financial activities.
TYPES of BUDGETSLG2
Working with the Budget Process
18-14
• Financial Control -- A process in which a firm periodically compares its actual revenues, costs and expenses with its budget.
ESTABLISHING FINANCIAL CONTROL
Establishing Financial Control
LG2
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FACTORS USED in ASSESSING FINANCIAL CONTROL
• Is the firm meeting its short-term financial commitments?
• Is the firm producing adequate operating profits on its assets?
• How is the firm financing its assets?
• Are the firms owners receiving an acceptable return on their investment?
LG2
Establishing Financial Control
18-16
• Managing day-by-day needs of the business
• Controlling credit operations
• Acquiring needed inventory
• Making capital expenditures
KEY NEEDS for OPERATIONAL FUNDS in a FIRM
The Need for Operating Funds
LG3
18-17
HOW SMALL BUSINESSES CAN IMPROVE CASH FLOW
• Be more aggressive in collecting accounts receivable.
• Offer customers discounts for paying early.
• Take advantage of special payment terms from vendors.
• Raise prices.
• Use credit cards discriminately.
Source: American Express Small Business Monitor.
LG3
The Need for Operating Funds
18-18
• You’re a new hospital administrator at a small hospital that, like many others, is experiencing financial problems.
• You suggest discontinuing the hospital’s large stockpile of drugs and shift to ordering them just when they are needed.
• Some like the idea, but the doctors claim you’re sacrificing patients’ well-being for cash. What do you do? What could be the result of your decision?
GOOD FINANCE or BAD MEDICINE?
(Making Ethical Decisions)
18-19
• Debt Financing -- The funds raised through various forms of borrowing that must be repaid.
• Equity Financing -- The funds raised from within the firm from operations or through the sale of ownership in the firm (such as stock).• Short-Term Financing -- Funds
needed for a year or less.
• Long-Term Financing -- Funds needed for more than a year.
USING ALTERNATIVE SOURCES of FUNDS
Alternative Sources of Funds
LG3
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WHY FIRMS NEED FINANCING
Short-Term Funds Long-Term Funds
Monthly expenses New-product development
Unanticipated emergencies Replacement of capital equipment
Cash flow problems Mergers or acquisitions
Expansion of current inventory Expansion into new markets
Temporary promotional programs New facilities
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Alternative Sources of Funds
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• Trade Credit -- The practice of buying goods or services now and paying for them later.
• Businesses often get terms 2/10 net 30 when receiving trade credit.
• Promissory Note -- A written contract agreeing to pay a supplier a specific sum of money at a definite time.
TYPES of SHORT-TERM FINANCING
Trade Credit
LG4
18-22
• Many small firms obtain short-term financing from friends and family.
• If asking for help from family or friends, it’s important both parties:1) Agree to specific loan terms
2) Put the agreement in writing
3) Arrange for repayment the same way they would for a bank loan
TYPES of SHORT-TERM FINANCING
Family and Friends
LG4
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• Banks generally prefer to lend short-term money to larger, more established businesses.
DIFFICULTY of OBTAININGSHORT-TERM FINANCING
Commercial Banks
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• The recent financial crisis has made it difficult for even promising and well-organized businesses to get loans.
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• Peer-to-peer lending sites like Lending Club match small businesses with lenders and receive a fee for their services.
• Lendio claims to have developed a technology that matches business owners with the right type of business loan and lender.
• Lendio also offers services such as a business plan makeover and website design for a fee.
EXPLORING the FINANCING UNIVERSE
(Spotlight on Small Business)
18-25
• Commercial banks offer short-term loans like:
- Secured Loans -- Backed by collateral.
- Unsecured Loans -- Don’t require collateral from the borrower.
- Line of Credit -- A given amount of money the bank will provide so long as the funds are available.
- Revolving Credit Agreement -- A line of credit that’s guaranteed but comes with a fee.
DIFFERENT FORMS of SHORT-TERM LOANSLG4
Different Forms of Short-Term Loans
18-26
• Factoring -- The process of selling accounts receivable for cash.
• Factors charge more than banks, but many small businesses don’t qualify for loans.
• Commercial Paper -- Unsecured promissory notes in amounts of $100,000+ that come due in 270 days or less.
FACTORING / COMMERCIAL PAPERLG4
Factoring Accounts Receivable
18-27
• Rates for small businesses grew almost 30% after the Credit Card Responsibility Accountability and Disclosure Act was passed.
• Credit cards are convenient but costly for a small business.
CREDIT CARDSCredit Cards
LG4
Photo Courtesy of: Robert Scoble
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WAYS to RAISE START-UP CAPITAL
• Seek out a microloan from a microlender
• Use asset-based lending or factoring
Source: Entrepreneur, www.entrepreneur.com, accessed July 2011.
• Turn to the web and seek out peer-to-peer lending
• Research local banks
• Sweet-talk vendors you want to do business with
LG4
Credit Cards
18-29
• Three questions of financial managers in setting long-term financing objectives:
1. What are the organization’s long-term goals and objectives?
2. What funds do we need to achieve the firm’s long-term goals and objectives?
3. What sources of long-term funding (capital) are available, and which will best fit our needs?
SETTING LONG-TERM FINANCING OBJECTIVES
Obtaining Long-Term Financing
LG5
18-30
1. The character of the borrow.
2. The borrower’s capacity to repay the loan.
3. The capital being invested in the business by the borrower.
4. The conditions of the economy and the firm’s industry.
5. The collateral the borrower has available to secure the loan.
The FIVE “C”s of CREDITLG5
Obtaining Long-Term Financing
18-31
• Long-term financing loans generally come due within 3 -7 years but may extend to 15 or 20 years.
• Term-Loan Agreement -- A promissory note that requires the borrower to repay the loan with interest in specified monthly or annual installments.
• A major advantage of debt financing is the interest the firm pays is tax deductible.
USING LONG-TERM DEBT FINANCING
Debt Financing
LG5
18-32
• Indenture Terms -- The terms of agreement in a bond issue.
• Secured Bond -- A bond issued with some form of collateral (i.e. real estate).
• Unsecured (Debenture) Bond -- A bond backed only by the reputation of the issuing company.
USING DEBT FINANCING by ISSUING BONDSLG5
Debt Financing
18-33
• A company can secure equity financing by:
SECURING EQUITY FINANCINGEquity Financing
- Selling shares of stock in the company.
- Earning profits and using the retained earnings as reinvestments in the firm.
- Attracting Venture Capital -- Money that is invested in new or emerging companies that some investors believe have great profit potential.
LG5
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WANT to ATTRACT a VENTURE CAPITALIST?LG5
Equity Financing
1. Can the company grow?
2. Will we get our money back and more?
3. Will it be worth our money and effort?
Source: Entrepreneur, February 2011.18-35
DIFFERENCES BETWEEN DEBT and EQUITY FINANCING
Comparing Debt and Equity Financing
Types of Financing
Conditions Debt Equity
Management influenceNone. Unless special conditions have been agreed on.
Common stock holders have voting rights.
RepaymentDebt has a maturity date.
Stock has no maturity date.
Yearly obligations Payment of interest.The firm isn’t legally liable to pay dividends.
Tax benefitsInterest is tax deductible.
Dividends are not tax deductible.
LG5
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• Leverage -- Raising funds through borrowing to increase the firm’s rate of return.
• Cost of Capital -- The rate of return a company must earn in order to meet the demands of its lenders and expectations of equity holders.
USING LEVERAGE for FUNDING NEEDSLG5
Comparing Debt and Equity Financing
18-37
• The recent financial crisis was the worst fall since the Great Depression.
LESSONS of the FINANCIAL CRISISLG5
Lessons From the Financial Crisis
• Led to the passage of sweeping financial reform.
• Government is increasing involvement and intervention.
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