seventh edition copyright © by houghton mifflin company. all rights reserved. powerpoint...

Seventh EditionSeventh EditionCopyright © by Houghton Mifflin Company. All rights reserved.

PowerPoint Presentation by Charlie CookPowerPoint Presentation by Charlie Cook

20

Pride I Hughes I Kapoor Pride I Hughes I Kapoor

Chapter

Mastering Financial Management

Copyright © by Houghton Mifflin Company. All rights reserved. 20–2

What Is Financial Management?

• Financial management– All the activities concerned with obtaining money and using it

effectively.

• The need for financing– Short-term financing—money that will be used for one year or

less to sustain and support the firm’s needs for:• Cash flow—the movement of money into and out of an

organization; it can become a problem when the firm’s customer inventory financing activities conflict with cash inflows.

• Inventory—considerable cash investments are required.

– Long-term financing—money that will be used for longer than one year.


Comparison of Short- and Long-Term Financing

• Short-term financing needs– Cash-flow problems

– Current inventory needs

– Monthly expenses

– Speculative production

– Short-term promotional needs

– Unexpected emergencies

• Long-term financing needs– Business startup costs

– New-product development

– Long-term marketing activities

– Expansion of facilities

– Replacement of equipment

– Mergers and acquisitions

Corporate Cash Needs

Whether a business seeks short- or long-term financing depends on what the money will be used for.

Table 20.1


Cash Flow for a Manufacturing Business

January

Expenses

Sales revenues

March June December

Figure 20.1

Manufacturers often use short-term financing to pay expenses during the production process. Once goods are shipped to retailers and payment is received, sales revenues are used to repay short-term financing.


What Is Financial Management? (cont’d)

• The need for financial management– Proper financial management can ensure that:

• Financing priorities are in line with organizational goals and objectives.

• Spending is planned and controlled.

• Sufficient financing is available when it is needed.

• Excess cash is invested in interest-bearing securities.


Planning—The Basis of Sound Financial Management

• Financial plan– A plan for obtaining and using the money needed to implement

an organization’s goals.

• Developing the financial plan– Establishing goals and objectives detailing what the organization

intends to accomplish within a certain period of time.

– Budgeting for financial needs.• Budget—a financial statement that projects income and/or

expenditures over a specific future period.– Cash budget—a financial statement that projects cash receipts and

expenditures over a specific future period

– Traditional versus zero-based budgeting

– Capital budget


The Three Steps of Financial Planning

Budget the money neededto accomplish the goals andobjectives

Identify the sources of funds

Sales revenue Equity capital Debt capital

2

Revenueprojectionsfor thisplanningperiod

• Money fromsole proprietoror partnersCommon stockPreferred stock

• Short-termborrowingLong-termborrowing

•

Sale of assets

For profitTo raise cash

••

•••

3

Mo

nit

or

and

eva

lua

te

Establish organizationalgoals and objectives

1

Figure 20.2

After a financial plan has been developed, it must be monitored continually to ensure that it actually fulfills the firm’s goals and objectives.


Sales Budget for Stars and Stripes Clothing

Figure 20.3

STARS AND STRIPES CLOTHING

Sales Budget For January 1, 2002 to December 31, 2002

Department First quarter Second quarter Third quarter Fourth quarter Totals

Infants’ $ 50,000 $ 55,000 $ 60,000 $ 70,000 $235,000

Children’s 45,000 45,000 40,000 40,000 170,000

Women’s 35,000 40,000 35,000 50,000 160,000

Men’s 20,000 20,000 15,000 25,000 80,000

Totals $150,000 $160,000 $150,000 $185,000 $645,000

Usually the budgeting process begins with the construction of departmental budgets for sales and various expenses.


Planning—The Basis of Sound Financial Management (cont’d)

• Developing the financial plan (cont’d)– Identifying sources of funds

• Sales revenues—provide the greatest part of the firm’s financing.

• Equity capital—money received from the owners or from the sale of shares of ownership in the business.

• Debt capital—borrowed money obtained through loans.

• Proceeds from the sale of assets—assets are disposed of if absolutely necessary, when no longer needed, and when they don’t fit in the company’s core business.

• Monitoring and evaluating financial performance– Monitoring prevents minor problems from becoming major

ones.


Cash Budget for Stars and Stripes Clothing


Cash Budget For January 1, 2002 to December 31, 2002

First quarter Second quarter Third quarter Fourth quarter Totals

Cash sales and collections $150,000 $ 160,000 $ 150,000 $ 185,000 $645,000

Less payments

Purchases $110,000 $ 80,000 $ 90,000 $ 60,000 $340,000

Wages/salaries 25,000 20,000 25,000 30,000 100,000

Rent 10,000 10,000 12,000 12,000 44,000

Other expenses 4,000 4,000 5,000 6,000 19,000

Taxes 8,000 8,000 10,000 10,000 36,000

Total payments $157,000 $122,000 $142,000 $118,000 $539,000

Cash gain or (loss) $ (7,000) $ 38,000 $ 8,000 $ 67,000 $106,000

Figure 20.4

A company-wide cash budget projects sales, collections, purchases, and expenses over a specified period to anticipate cash surpluses and deficits.


Budget Comparison for Stars and Stripes Clothing


Sales Budget Update First Quarter, 2002

Department First quarter estimate Actual Sales Dollar difference

Infants’ $ 50,000 $ 45,600 $- 4,400

Children’s 45,000 48,200 +3,200

Women’s 35,000 36,300 +1,300

Men’s 20,000 21,100 +1,100

Totals $150,000 $151,200 $+1,200

Budget comparisons can point out areas that require additional planning or careful investigation.

Figure 20.5


Sources of Capital for Entrepreneurs (From ch. 6)

Figure 6.2

Source: Data developed from and provided by the NFIB Foundation and sponsored by the American Express Travel Related Services Company, Inc.

80

70

60

50

40

30

20

10

0Personalsavings

Friends,relatives

Investors

Start-up

Banks

Sources of Money

Suppliers Formerowners

All others

Purchase

Per

cen

t o

f B

us

ines

ses


Sources of Short-Term Debt Financing

• Sources of unsecured short-term financing– Reasons that short-term financing is easier to obtain:

• Shorter repayment period means less risk of nonpayment.

• Amounts of short-term loans are smaller than long-term loans.

• There is a closer relationship between borrower and lender.

– Unsecured financing—financing that is not backed by collateral.

– Trade credit— a type of short-term financing extended by a seller who does not require immediate payment after the delivery of the merchandise.

– Promissory notes issued to suppliers—a written pledge by a borrower (maker) to pay a certain sum of money to a creditor (payee) at a specified future date.


Sources of Short-Term Debt Financing (cont’d)

• Sources of unsecured short-term financing (cont’d)– Unsecured bank loans

• Promissory notes—loan for repayment on a specific date.

• Line of credit—prearranged short-term loan.

• Revolving credit agreement—a guaranteed line of credit available whenever the borrower should need it.

• Prime interest rate—the lowest rate charged by a bank for a short-term loan to its best customers.

– Commercial paper—short-term promissory note issued by a large corporation that is secured only by the reputation of the firm; no collateral is involved.



• Sources of secured short-term financing– Loans secured by inventory

• Inventory is pledged as collateral; control of the inventory passes to the lender until the loan is repaid.

– Floor planning—a method of financing in which the title to the inventory is given to lenders in return for short-term financing.

– Loans secured by receivables• Amounts owed the firm in the form of accounts receivable from

trade credit given to customers are pledged as collateral.

• Factoring accounts receivable– Factor—a firm that specializes in buying other firms’ accounts

receivable for discounted amounts with the expectation of collecting the receivables at full value.



• Cost comparisonsType of Financing Cost

Repayment Period

Businesses That May Use It Comments

Trade credit Low, if any 30 to 60 days All businesses Usually no finance charge

Promissory note Moderate 1 year or less

All businesses Usually unsecured but requires legal docu-ment

Unsecured bank loan

Moderate 1 year or less

All businesses Promissory note, line of credit, or revolving credit agreement generally required

Commercial paper

Moderate 1 year or less

Large corporations with high credit rat-ings

Available only to large firms

Secured loan High 1 year or less

Firms with question-able credit ratings

Inventory or accounts receivable often used as collateral

Factoring Highest None Firms that have large numbers of credit customers

Accounts receivable sold to a factor

Table 20.2


Sources of Equity Financing

• Selling stock– Initial public offering—when a corporation sells stock to the

public for the first time.

– Advantages of selling common stock:• Firm does not have to repay money received from sale of stock.

• Firm does not have to pay dividends on the money from the stock.

– Common stock—stock whose owners may vote on corporate matters, but whose claims on corporate profits and assets are subordinate to the claims of others.

– Preferred stock—stock whose owners usually do not have voting rights, but whose claims on dividends and assets are paid before those of common-stock owners.

– Par value—an assigned (and often arbitrary) dollar value printed on the stock certificate.


Sources of Equity Financing (cont’d)

• Selling stock (cont’d)– Call premium—a dollar amount over par value that the

corporation must pay investors when it redeems (buys back) either preferred stock or corporate bonds.

– Convertible preferred stock—preferred stock that the owner may exchange for a specified number of common-stock shares.

• Retained earnings– The portion of a business’s profits not distributed to

stockholders that is reinvested in the business.

• Venture capital– The money invested in a small firm with the expectation that the

firm has the potential to become very successful and increase in value.


Sources of Long-Term Debt Financing

• Financial leverage– The use of borrowed funds to increase the return on owners’

equity by earning more than the costs of the borrowed funds.• Lease—an agreement by which the right to use real estate,

equipment, or other assets is temporarily transferred from the owner to the user.

• Long-term loans– Term-loan agreement—a promissory note that requires a

borrower to repay a loan in monthly, quarterly, semiannual, or annual installments.


Analysis of the Effect of Additional Capital from Debt or Equity for Cypress Springs Plastics, Inc.

Table 20.3

Additional Debt Additional Equity

Owners’ equity $500,000 Owners’ equity $500,000

Additional equity + -0- Additional equity + 100,000

Total equity $500,000 Total equity $600,000

Loan (@ 9 percent) + 100,000 No loan + -0-

Total capital $600,000 Total capital $600,000

Year-end Earnings

Gross profit $95,000 Gross profit $95,000

Less loan interest – 9,000 No interest – -0-

Operating profit $86,000 Operating profit $95,000

Return on owners’ equity 17.2% Return on owners’ equity 15.8%

($86,000 $500,000 = 17.2%) ($95,000 $600,000 = 15.8%)


Sources of Long-Term Debt Financing (cont’d)

• Corporate bonds– Corporate bond—a corporation’s written pledge that it will

repay a specified amount of money with interest.

– Maturity date—the date on which the corporation is to repay the borrowed money.

– Types of bonds:• Registered bond—a bond registered in the owner’s name by the

issuing company.

• Debenture bond—a bond backed only by the reputation of the issuing corporation.

• Mortgage bond—a corporate bond secured by various assets of the issuing firm.

• Convertible bond—a bond that can be exchanged, at the owner’s option for a specified number of shares of the corporation’s common stock.

seventh edition copyright © by houghton mifflin company. all rights reserved. powerpoint...

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