Chapter 16
Mastering Financial Management
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Learning Objectives
1. Explain the need for financial management in business.
2. Summarize the process of planning for financial management.
3. Identify the services provided by banks and financial institutions for their business customers.
4. Describe the advantages and disadvantages of different methods of short-term debt financing.
5. Evaluate the advantages and disadvantages of equity financing.
6. Evaluate the advantages and disadvantages of long-term debt financing.
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Financial Management
…all the activities concerned with obtaining money and using it effectively.
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Need for Financing
Reasons:• Start a business• Keep it going
Sources:• Owners’ investment• Borrowed
Afterward:• Pay expenses• Provide profit
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Short-Term Financing
…money that will be usedfor one year or less.
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Table 16.1: Comparison of Short- and Long-Term Financing
Whether a business seeks short- or long-term financing depends on what the money will be used for.
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Cash Flow
…the movement of money into and out of an organization.
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The Cash Flow Cycle
CustomersCustomers
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Speculative Production
…the time lag between actual production of goods and when the goods are sold.
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Figure 16.1: Cash Flow for a Manufacturing Business
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Long-Term Financing
…money that will be used forlonger than one year.
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Two-Sided Problem of Financing
Uses of funds dictate type(s) of financing needed
Activities undertaken determined by types of financing available
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Risk-Return Ratio
…a ratio based on the principle thata high-risk decision should generate
higher financial returns for a business and more conservative decisions often
generate lesser returns.
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Proper Financial Management
Financing priorities established with goals and objectives
Spending planned/controlled
Bills paid promptly Excess cash invested
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Careers in Finance
Chief Financial Officer (CFO): manages firm’s finances, reports to chief executive officer or president
Lower-level positions: banking, insurance, investment, non-profits, government entities
Requirements:• Strong background in accounting/math• Knowledge of computer use for data
analysis• Expertise in written/oral communication
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Positions, Salaries, and Experience at Two Major Firms
Title GMC Pepsico Exp./Education
Junior Fin. Anal. $20-43.2K $45-50K B.B.A.
Senior Fin. Anal. $46.9-82.6K $60-70K 3yr/MBA
Division Controller $110-172K $70-80K 10yr/MBA
CFO $200-350K $150-200K 15yr/MBA
Swiss Finance Academy, “Corporate Finance Salaries,” www.careers-in-finance.com/cfsal.htm, accessed September 27, 2009.
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Financial Plan
…a plan for obtaining andusing money needed to implement
an organization’s goals.
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Developing Financial Plan
Budget for NeedsBudget for NeedsBudget for NeedsBudget for Needs
Identify SourcesIdentify SourcesIdentify SourcesIdentify Sources
Establish Goals Establish Goals and Objectivesand ObjectivesEstablish Goals Establish Goals and Objectivesand Objectives
Monitor & Monitor & Evaluate Evaluate PerformancePerformance
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Figure 16.2: The Three Steps of Financial Planning
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Budget
…a financial statement that projectsincome and/or expenditures over a
specified future period.
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Figure 16.3: Sales Budget
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Cash Budget
…a financial statement that projectscash receipts and cash expenditures
over a specified period.
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Figure 16.4: Cash Budget
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Capital Budget
…a financial statement that estimates a firm’s expenditures for major assets and its
long-term financing needs.
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Approaches to Budgeting
Traditional: base on budget of preceding year; modify to reflect revised goals and objectives; justify only new expenditures
Zero-base: justify every expense
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Primary Sources of Funds
Sales Revenue Equity Capital Debt Capital Sales of Assets
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Financial Services Provided byBanks and Other Financial Institutions
Traditional• Savings and Checking Accounts• Business Loans
Electronic Banking• Automated Clearinghouses (ACHs)• Point of Sale (POS) Terminals• Electronic Check Conversion (ECC)
International• Letter of Credit• Bankers Acceptance
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Traditional Business Banking Services
1. Savings and Checking Accountsa) Passbook Savingsb) Certificate of Depositc) Check
2. Business Loansa) Short-Term Loansb) Line of Creditc) Revolving Creditd) Long-Term Loans
3. Credit/Debit Card Transactions
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Electronic Funds Transfer
…a means of performing financial transactions through a computer
terminal or telephone hookup.
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Sources of UnsecuredShort-Term Financing
Trade Credit Promissory Note Unsecured Bank Loans Commercial Paper
Unsecured financing is financing that is not backed by collateral.
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Average Prime Interest Rate
Source: Federal Reserve Bank website, www.federalreserve.gov, accessed October 17, 2008..
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Sources of Secured Short-Term Financing
Inventory
Accounts Receivable- Factoring
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Table 16.2: Comparison of Short-Term Financing Methods
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Sources of Equity Financing
Sale of Stock• Initial Public Offering: common stock sold the
first time to public• Investment Banking Firm: assists firm in
raising capital Retained Earnings: undistributed portion of
firm’s profits Private Placement: securities sold directly to
insurance companies, pension funds, large institutions, wealthy investors
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Using the Internet
• The New York Stock Exchange and the NASDAQ are the two most cited equity markets. Each provides financial information about the companies it lists and news that might influence their stock values.
www.nyse.com
www.nasdaq.com
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SpotlightIPOs Can Raise Billions!
Source: The Renaissance Capital IPO Home website, www.ipohome.com, accessed May 24, 2009.
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Types of Stock
Common• Holders vote on corporate matters• Holders’ claims on profits/assets subordinate to
preferred
Preferred• Holders receive dividends first• Dividend is specified
Convertible Preferred can be exchanged for common
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Sources ofLong-Term Debt Financing
Financial Leverage Use of borrowed funds to increase return on owners’ equity
Term LoanBorrower required to repay loan in monthly, quarterly, semiannual, or annual installments
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Corporate Bond
…a corporation’s written pledge thatit will repay a specified amount of
money with interest.
The maturity date is the date on which the amount borrowed must be repaid.
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Types of Bonds
1. Registered: registered in owner’s name by issuing company
2. Debenture: backed only by issuing firm’s reputation
3. Mortgage: secured by assets of firm
4. Convertible: may be exchanged for a specified number of common stock shares
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Bond Provisions
Maturity date: 10 to 30 years
Indenture: details conditions of bond issue
Serial Bonds: single issue that matures on different dates
Sinking fund: deposits made each year for purpose of redeeming bond issue
Trustee: acts as bond owners’ representative
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Table 16.4: Comparison of Long-Term Financing Methods
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1. Which of the following would be considered a short-term financial need?
a) New product developmentb) Cash flow problemsc) Business start-up costsd) Mergers and acquisitionse) Expansion of facilities
Chapter Quiz
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2. The least expensive form of short-term financing is
a) promissory notes.b) prime rate loans.c) common stock.d) trade credit.e) factoring.
Chapter Quiz
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3. Which of the following statements is incorrect?
a) A corporation can issue only common stock or preferred stock, but not both.
b) IPO stands for initial public offering.c) Common stockholders have the right to vote on
major corporate actions.d) A corporation is under no legal obligation to pay
dividends to common stockholders.e) A corporation is under no legal obligation to buy
back the stock you purchase.
Chapter Quiz
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4. The portion of a corporation’s profits not distributed to stockholders is called
a) retained earnings.b) undistributed profits.c) profit residue.d) income before taxes.e) net profit.
Chapter Quiz
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5. A __________ is the legal document that details all the conditions relating to a bond issue.
a) bond indentureb) debenture statementc) bond contractd) security agreemente) collateral statement
Chapter Quiz