Financial Management

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Nov 10, 2013 (3 years and 8 months ago)

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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 GOALS

Chapter

Eighteen

18
-
2


Tomé worked her way up to Chief Financial
Officer (CFO) at
Home Depot

in 2001.

CAROL TOMÉ

Home Depot

Profile


Home Depot was in a store
building frenzy; adding
more than 100 locations a
year through 2005.


Tomé was at the center of
tech transition by
overseeing the distribution
of $350 million in spending.

18
-
3

NAME that COMPANY

Chapter

Eighteen


At one time this company was the largest
automobile maker in the world. Due to severe
financial problems in 2009, the company came
very close to extinction. A $7 billion
government
-
backed loan and an additional $43
billion government investment in the company
helped it survive. It is now attempting a
comeback as a much smaller company.

Name that company!

18
-
4


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

WHAT

匠䙉乁乃䔿

The Role of
Finance and
Financial
Managers

LG1

18
-
5


Financial Management
--

The job of managing a firm

s
resources to meet its goals
and objectives.

FINANCIAL MANAGEMENT

LG1

The Role of
Finance and
Financial
Managers

18
-
6


Financial Managers
--

Examine financial data and
recommend strategies for improving financial
performance.

FINANCIAL MANAGERS

LG1

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

18
-
7


CFO
--

Chief Financial
Officer


CFP
--

Certified Financial
Planner


CFA
--

Chartered Financial
Analyst


Comptroller
--

Chief
Accounting Officer

WHO

匠坈传W渠䙉乁乃F

LG2

Financial
Planning

18
-
8

WHAT FINANCIAL

MANAGERS DO

LG1

The Role of
Finance and
Financial
Managers

18
-
9

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 regulations

Source: CFO Magazine,
www.cfo.com
, accessed July 2011.

LG1

The Role of
Finance and
Financial
Managers

18
-
10

1)
Undercapitalization

2)
Poor control over
cash flow

3)
Inadequate expense
control

WHY DO FIRMS

FAIL FINANCIALLY?

The Value of
Understanding
Finance

LG1

18
-
11

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
-
12

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
-
13


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 PLANNING

Financial
Planning

LG2

18
-
14


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 FORECASTING

Forecasting
Financial
Needs

LG2

18
-
15


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.

BUDGETING

Working with
the Budget
Process

LG2

18
-
16


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 BUDGETS

LG2

Working with
the Budget
Process

18
-
17

FINANICAL PLANNING

LG2

Working with
the Budget
Process

18
-
18


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

18
-
19

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
-
20


Name three finance functions important to the
firm

s overall operations and performance.


What three primary financial problems cause
firms to fail?


How do short
-
term and long
-
term financial
forecasts differ?


What

s the purpose of preparing budgets? Can
you identify three different types of budgets?

PROGRESS ASSESSMENT

Progress
Assessment

18
-
21


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
-
22


In Michigan, half of the state

s communities are
in financial distress.


Local Government and School District Fiscal
Accountability Act allows cities, towns, and school
districts to be taken over by state
-
appointed
emergency financial managers (EFMs) selected
by the Governor.


Indiana is considering similar legislation. New
York and other states’ boards have been given
similar power.

FINANCIAL ORDER or

FINANCIAL MARTIAL LAW?

(Legal Briefcase)

18
-
23

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
-
24


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
-
25


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).

USING ALTERNATIVE

SOURCES of FUNDS

Alternative
Sources of
Funds

LG3

18
-
26


Short
-
Term Financing
--

Funds needed for a year or
less.


Long
-
Term Financing
--

Funds needed for more than
a year.

SHORT and LONG
-
TERM

FINANCING

LG3

Alternative
Sources of
Funds

18
-
27

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

LG3

Alternative
Sources of
Funds

18
-
28


Money has time value. What does this mean?


Why is accounts receivable a financial concern of
the firm?


What

s the primary reason an organization
spends a good deal of its available funds on
inventory and capital expenditures?


What

s the difference between debt and equity
financing?

PROGRESS ASSESSMENT

Progress
Assessment

18
-
29


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
-
30


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

18
-
31


Banks generally
prefer to lend short
-
term money to larger,
more established
businesses.

DIFFICULTY of OBTAINING

SHORT
-
TERM FINANCING

Commercial
Banks

LG4


The recent financial crisis has made it difficult for
even promising and well
-
organized businesses to
get loans.

18
-
32


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
-
33


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 LOANS

LG4

Different
Forms of
Short
-
Term
Loans

18
-
34


Factoring
--

The
process of selling
accounts receivable for
cash.


Factors charge more
than banks, but many
small businesses don

t
qualify for loans.

FACTORING

LG4

Factoring
Accounts
Receivable

18
-
35


Commercial Paper
--

Unsecured promissory notes
in amounts of $100,000+ that come due in 270 days
or less.


Since commercial paper is unsecured, only
financially stable firms are able to sell it.

COMMERCIAL PAPER

Commercial
Paper

LG4

18
-
36


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 CARDS

Credit Cards

LG4

Photo Courtesy of: Robert Scoble

18
-
37

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
-
38


What does an invoice containing the terms
2/10,
net 30

mean?


What

s the difference between trade credit and a
line of credit?


What

s the key difference between a secured
and an unsecured loan?


What

s factoring? What are some of the
considerations factors consider in establishing
their discount rate?

PROGRESS ASSESSMENT

Progress
Assessment

18
-
39


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
-
40

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 CREDIT

LG5

Obtaining
Long
-
Term
Financing

18
-
41


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
-
42


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 BONDS

LG5

Debt
Financing

18
-
43


A company can secure equity financing by:

SECURING EQUITY FINANCING

Equity
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

18
-
44

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
-
45

DIFFERENCES BETWEEN

DEBT and EQUITY FINANCING

Comparing
Debt and
Equity
Financing

Types of Financing

Conditions

Debt

Equity

Management
influence

None. Unless special
conditions have been
agreed on.

Common stock
holders have voting
rights.

Repayment

Debt has a maturity
date.

Stock has no maturity
date.

Yearly obligations

Payment of interest.

The firm isn

t legally
liable to pay dividends.

Tax benefits

Interest is tax
deductible.

Dividends are not tax
deductible.

LG5

18
-
46


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 NEEDS

LG5

Comparing
Debt and
Equity
Financing

18
-
47


The recent financial crisis was the worst fall since
the Great Depression.

LESSONS of the

FINANCIAL CRISIS

LG5

Lessons From
the Financial
Crisis


Led to the passage of
sweeping financial
reform.


Government is
increasing involvement
and intervention.

18
-
48


What are the two major forms of debt financing
available to a firm?


How does debt financing differ from equity
financing?


What are the three major forms of equity
financing available to a firm?


What is leverage, and why do firms choose to
use it?

PROGRESS ASSESSMENT

Progress
Assessment

18
-
49