Finance: Acquiring and Using Funds to Maximize · PDF file• Why is working capital...

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9 Finance: Acquiring and Using Funds to Maximize Value

©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Finance:Acquiring and Using Funds toMaximize Value

• How does maximizing financial value relate to social responsibility?

• How do financial managers use key ratios?

• How do financial managers use budgeted financial statements and cash budgets?

• Why is working capital management important?

• How do financial managers evaluate capital budgeting proposals?

• How do financial managers determine the firm’s capital structure?

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What Motivates Financial Decisions?

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What types of assets do we need to achieve goals?How do we get the funds we need?

• Evaluate financial performance

• Plan financial resources

• Manage working capital

• Evaluate investment opportunities

• Determine appropriate strategy

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Shareholder Value and Social Responsibility: Does Good Behavior Pay Off?

• Historically, the goal of the firm has been to:

Maximize the value of the firm to its owners

• Publicly traded firms aim to maximize their stock price

• The emphasis on shareholder value may seem to conflict with social responsibility

• But, a long-term perspective can balance value with responsibility

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Evaluating Current Conditions: Where Do We Stand?

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• Financial ratios provide insight into financial strengths and weaknesses

• Use financial data from balance sheet and income statement

• Companies can compare their ratios with other businesses

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Key Financial Ratios

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RATIO TYPE HOW IT IS COMPUTED

Current Liquidity: ability to pay short-term liabilities.

Current AssetsCurrent Liabilities

InventoryTurnover

Asset Management: how firm is using assets to generate revenue.

Cost of Good SoldAverage Inventory

Debt-to-equity Leverage: extent to which a firm relies on debt.

Total DebtTotal Owner’s Equity

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Key Financial Ratios

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RATIO TYPE HOW IT IS COMPUTED

Debt-to-assets

Leverage: measures the extent to which a firm relies on debt

Total DebtTotal Assets

Return on equity

Profitability: compares the amount of profit compared to resources invested

Net Income – Preferred DivAvg Common Stock Equity

Return on assets


Net IncomeAverage Total Assets

Earnings per share


Net Income – Preferred DivAvg # of Shares Out

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Financial Planning: Providing a Road Map for the Future

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• What assets must be obtained?

• How much additional financing is needed?

• How much can the firm generate Internally? Externally?

• When will external financing be required?

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Basic Planning Tools: Budgeted Financial Statements and Cash Budget

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Budgeted Income Statement –forecasts the sales,

expenses and net income

Budgeted Balance Sheet –forecasts the types and amounts

of assets a firm will need to carry out plans.

Cash Budget – detailed projection of cash flows to

determine when cash shortages and surpluses will occur.

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Cash Budget for Oze-Moore

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Managing Working Capital: Current Events

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Net Working Capital:Difference between current assets and liabilities

Working capital must be managedAppropriate level of current assetsCurrent liabilities needed to finance activities

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Managing Current Assets: Cash

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• Need cash to pay bills• Cash does not earn returns• Report cash equivalents as cash

Commercial PaperT-BillsMoney Market Mutual Funds

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Managing Current Assets: Cash

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Commercial Paper

• Short-term unsecured promissory note (IOUs).

T-bills

• Short-term IOUs issued by the U.S. government.

Money Market Mutual Funds

• Pooled funds to purchase a portfolio of short-term, liquid securities

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Managing Current Assets: Accounts Receivable

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Set Credit Terms

Establish Credit Standards

Design Appropriate Collection Policy

Accounts Receivable - Money which is owed to a company by a customer for products and services provided on credit.

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Managing Current Assets: Inventory

• Inventory: finished goods, work-in-process, parts and materials

• Customers are disappointed when they cannot find desired products on the shelves

• But, inventory ties up cash and it is a major investment

• Inventory management is a part of overall working capital management

• Inventory policies are included in operations strategy

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Short-term Financing: Arranging for Quick Cash

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• Spontaneous FinancingTrade Credit

• Short-Term Bank LoansLine of CreditRevolving Credit

• Factoring• Commercial Paper

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Capital Budgeting: In It for the Long Haul

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• Replace machines and equipment

• New machines and equipment

• A new factory, warehouse or office

• Introduce a new product line

Capital Budgeting

a systematic evaluation of a

firm’s major long-run capital

investment opportunities.

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Evaluating Capital Budgeting Proposals: Time Value of Money

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Managers must evaluate costs and benefits of investment that occur over a period of many years.

Time Value of Money – a dollar received today is worth more than a dollar received in the future

Compounding – earning interest in the current period on interest from previous periods

Present Value – How much a given amount of cash received in a future period is worth today, given the time value of money

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Using Net Present Value to Evaluate Capital Budgeting Proposals

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Net present value is the present value of all cash flows associated with an investment, including the

initial (negative) cash flow of the investment.

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How a Present Value of $1,000 Grows to a Future Value in 4 years

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Choosing the Sources of Long-term Capital: Loaners vs. Owners

• Capital Structure – the mix of equity and debt financing a firm uses for financing needs

Debt Financing – creditorsEquity Financing - owners

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Pros and Cons of Debt Financing

Debt is a legally binding agreement to repay the money plus interest

Debt requires fixed payments

Many lenders require collateral which lenders can use to recover balance

Interest payments are tax-deductible

Avoids additional investment of stockholders

Some lenders impose covenants on the borrower

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Pros and Cons of Equity Financing

• Equity financing:

Money invested from newly issued stock

Earning the company reinvested

• No required payments—dividend payments can be skipped

• Does not yield tax benefits

• Dilutes ownership

• Does not provide leverage

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Financing Leverage: Using Debt to Magnify Gains (And Losses)

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Financial Leverage:• Heavy debt in capital structure• Potential high returns to owners• Increased risk

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How Financial Leverage Affects the Return of Equity

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Looking Back

• How does maximizing financial value relate to social responsibility?

• How do financial managers use key ratios?

• How do financial managers use budgeted financial statements and cash budgets?

• Why is working capital management important?

• How do financial managers evaluate capital budgeting proposals?

• How do financial managers determine the firm’s capital structure?

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