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*Chapter Eighteen

Financial Management

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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• Finance -- The function in a business that within the firm.

• Finance activities include:

- Preparing budgets

- Creating cash flow analyses

- Planning for expenditures

WHAT’S FINANCE?The Role of Finance and Financial Managers

LG1

18-2

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• Financial Management -- The job of managing a firm’s resources to meet its goals and objectives.

FINANCIAL MANAGEMENTThe Role of Finance and Financial Managers

LG1

18-3

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• Financial Managers -- Examine financial data and recommend strategies for improving financial performance. Financial managers are responsible for:

- Paying company bills

- Collecting payments

- Staying abreast of market changes

- Assuring accounting accuracy

FINANCIAL MANAGERSThe Role of Finance and Financial Managers

LG1

18-4

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*WHAT FINANCIAL

MANAGERS DOLG1

The Role of Finance and Financial Managers

18-5

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*WHAT WORRIES FINANCIAL

MANAGERSLG1

The Role of Finance and 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. 18-6

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• Undercapitalization

• Poor control over cash flow

• Inadequate expense control

WHY DO FIRMS FAIL FINANCIALLY?

The Value of Understanding Finance

LG1

18-7

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*TOP FINANCIAL CONCERNS of

COMPANY CFOsLG1

• Ability to accurately forecast financial results

• Maintaining productivity during an economic downturn

• Balance sheet weakness

• Rising cost of healthcare

• Attracting and retaining top quality employees

Source: CFO Magazine, www.cfo.com.

The Value of Understanding Finance

18-8

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• 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

18-9

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• CFO -- Chief Financial Officer

• CFP -- Certified Financial Planner

• CFA -- Chartered Financial Analyst

• Comptroller -- Chief Accounting Officer

WHO’S WHO in FINANCEFinancial Planning

LG2

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• 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

18-11

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• 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 in the FIRMWorking with the Budget Process

LG2

18-12

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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 BUDGETSWorking with the Budget Process

LG2

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*FINANICAL PLANNING

Working with the Budget Process

LG2

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• 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

Establishing Financial Control

LG2

• 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?

18-16

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• 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

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*WAYS to RAISE

START-UP CAPITAL

The Need for Operating Funds

LG3

• Seek out a microloan from a microlender

• Use asset-based lending or factoring

Source: Entrepreneur Magazine, March 2009.

• Turn to the web and seek out peer-to-peer lending

• Research local banks

• Sweet-talk vendors you want to do business with

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*HOW SMALL BUSINESSES CAN IMPROVE CASH FLOW

The Need for Operating Funds

LG3

• Be more aggressive in collecting accounts receivable.

• Offer customers discounts by paying early.

• Take advantage of special payment terms from vendors.

• Raise prices.

• Use credit cards discriminately.

Source: American Express Small Business Monitor. 18-19

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• 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

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• 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

Alternative Sources of Funds

LG3

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*WHY FIRMS NEED FINANCING

Alternative Sources of Funds

LG3

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

18-22

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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

Obtaining Short-Term Financing

LG4

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• 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

Different Forms of Short-Term Loans

LG4

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• 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 PAPERCommercial Paper

LG4

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• 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

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1. The character of the borrower.

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

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• 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

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• 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

Debt Financing by Issuing Bonds

LG5

18-29

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*WHEN GOVERNMENT BAILOUTS PAY OFF

LG5

DebtFinancing

Company Year Amount

Lockheed 1971 $250 Million (Paid Back)

City of New York 1973 $6.9 Billion (Paid Back)

Chrysler 1980 $1.5 Billion (Paid Back)

Saving & Loan Industry 1984 $160 Billion (Not Paid Back)

Airline Industry 2001 $15 Billion (Not Paid Back)

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*DIFFERENCES BETWEEN DEBT

and EQUITY FINANCING

Comparing Debt and Equity Financing

LG5

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.

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Review Only

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• Antonucci was a former player who has held sports-related jobs since earning her MBA.

TONYA ANTONUCCIWomen’s Professional Soccer League (WPS)

Profile

• She needed to see that WPS didn’t make the same financial mistakes the previous league did.

• WPS plays in smaller stadiums, has partnerships with the men’s league and has a salary cap.

18-33

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• As a new financial manager, you notice employees’ have “who cares” attitudes about financial controls.

• You suggest the company do something about it.

• The CEO says things have always been that way and it’s best not to rock the boat. What do you do? What could be the result of your decision?

SAIL SMOOTHLY or ROCK the BOAT?

Making Ethical Decisions

18-34

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• Small businesses are in a struggle to stay afloat as financial institutions hold onto money and consumers are slow to buy.

• James “Hoss” Boyd’s electrical business is doing well, but he’s having a cash flow problem.

• Boyd and others are calling for help and the Small Business and Entrepreneurship Council are trying to find a solution.

KEEPING the CASH FLOWING in HARD TIMES

Spotlight on Small Business

18-35

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• Financing constraints and challenges, political instability, and other factors make global trade difficult.

• Efforts such as international factoring make it a bit easier.

• International factoring involves an exporter, the U.S. factor, a foreign factor and an importer.

• Each fills its role to make the transaction safe.

MAKING SURE IT’S a DONE DEALLegal Briefcase

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• A company can secure equity financing by:

- 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.

SECURING EQUITY FINANCING Equity Financing

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 NEEDS

LG5

Comparing Debt and Equity Financing

18-38

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• Sovereign wealth funds (SWFs) were established to hold funds of a nation if its surplus is too large to reinvest.

• Countries like the U.A.E. and Kuwait had large surpluses the led them to U.S. investments.

• People question if the presence of foreign governments in U.S. business will impact U.S. policy.

SHARING the WEALTH?Reaching Beyond Our Borders

18-39

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

• How does debt financing differ from equity financing?

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

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

PROGRESS ASSESSMENTProgress Assessment

18-40

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• 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? Identify the different types.

PROGRESS ASSESSMENTProgress Assessment

18-41

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• Why are 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 ASSESSMENTProgress Assessment

18-42