CHAPTER 15 Money and the Financial System

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CHAPTER 14 Accounting and Financial Statements

Financing theFinancing theEnterpriseEnterprise

CHAPTER 16 Financial Management and Securities Markets

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Working Capital ManagementWorking Capital ManagementWorking Capital ManagementWorking Capital Management

The management of short-term assets and liabilities

Current Assets: Short-term resources

• Cash

• Investments

• Accounts receivable

• Inventory

Current Liabilities: Short-term debts

• Accounts payable

• Accrued salaries

• Accrued taxes

• Short-term bank loans

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Transaction BalanceTransaction BalanceTransaction BalanceTransaction Balance

Cash kept on hand by a firm to pay normal daily expenses such as employee wages and bills for

supplies and utilities

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LockboxLockboxLockboxLockbox

An address, usually a commercial bank, at which a company receives

payments in order to speed collections from customers

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Electronic Funds TransferElectronic Funds TransferElectronic Funds TransferElectronic Funds Transfer

Frequently used to speed up collections

Also being used to pay bills online

Companies want to collect bills quickly and pay them slowly

• Paying electronically increases the speed of collections and disbursements to one day

• Checks are the slowest way to pay bills (generally 3-4 days)

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Investing Idle CashInvesting Idle CashInvesting Idle CashInvesting Idle Cash

Marketable Securities

Temporary investment of extra cash by organizations up to one year in U.S. Treasury bills, certificates of deposit, commercial paper, or eurodollar loans

Treasury Bills (T-bills)

Short-term debt obligations the U.S. government sells to raise money

Maturities between 1 week to 1 year

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Investing Idle CashInvesting Idle CashInvesting Idle CashInvesting Idle Cash

Commercial Certificates of Deposit (CDs)Issued by commercial banks and brokerages available in minimum amounts of $100,000, typically $1 million, and can be traded prior to maturity

Commercial PaperA written promise from one company to another to pay a specific amount of money

Restricted only to the largest and most respected companies

Eurodollar MarketA market for trading U.S. dollars in foreign countries

Any U.S. dollar-denominated deposit in non-U.S. bank is called eurodollar

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Accounts Receivable Accounts Receivable and Inventoryand Inventory

Accounts Receivable Accounts Receivable and Inventoryand Inventory

Occurs on the balance sheet after cash and marketable securities

Accounts Receivable Money owed to a business by credit customers

Companies often offer discounts for early payment and penalties for late payments

Optimizing Inventory Objective is to minimize firm’s investment in inventory without

experiencing production cutbacks

Radio frequency identification (RFID) technology helps firms track and optimize their inventories

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Managing Current LiabilitiesManaging Current LiabilitiesManaging Current LiabilitiesManaging Current Liabilities

Accounts Payable

Money an organization owes to suppliers for goods and services

Trade Credit

• Credit extended by suppliers for the purchase of their goods and services

• The most important account payable and most widely used source of short-term financing

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Current Liabilities: Bank LoansCurrent Liabilities: Bank LoansCurrent Liabilities: Bank LoansCurrent Liabilities: Bank Loans

Line of Credit

An arrangement by which a bank agrees to lend a specified amount of money to an organization upon request

Similar to a credit card, but often for millions of dollars

Secured Loans

Loans backed by collateral that the bank can claim if the borrowers do not repay the debt

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Current Liabilities: Bank LoansCurrent Liabilities: Bank LoansCurrent Liabilities: Bank LoansCurrent Liabilities: Bank Loans

Unsecured LoansLoans backed only by the borrower’s good reputation and previous credit rating

Prime RateThe interest rate that commercial banks charge their best customers for short-term loans

Interest rates on commercial loans can be fixed or variable (floating-rate loan)

Floating rate loans are appealing when interest rates are falling, but not when they rise

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Non-Bank LiabilitiesNon-Bank LiabilitiesNon-Bank LiabilitiesNon-Bank Liabilities

Short-term loans from insurance companies, pension funds, money market funds, or finance companies

Factor

An organization that purchases accounts receivables at a discount and assumes responsibility for collecting the accounts

Taxes and Employees’ Wages

Debt obligations to the firm

Additional nonbank liabilities that must be efficiently managed to ensure maximum profitability

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Managing Long-Term Managing Long-Term (Fixed) Assets(Fixed) Assets

Managing Long-Term Managing Long-Term (Fixed) Assets(Fixed) Assets

Expected to last for many years• Production facilities (plants), offices and equipment

Tend to be high-cost, making financing critical• Organizations need the most high-tech, up-to-date facilities

and equipment they can afford in order to be competitive

Obtaining long-term financing can be difficult• Leasing is a way of obtaining assets without purchasing

them

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Capital BudgetingCapital BudgetingCapital BudgetingCapital Budgeting

The process of analyzing the needs of business and selecting the assets that will maximize its value• Not an exact process

Managers must be flexible as new information becomes available

Assets and projects must be continuously reevaluated

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Pricing Long-Term MoneyPricing Long-Term MoneyPricing Long-Term MoneyPricing Long-Term Money

Factors to Consider:

How much cash will be generated

Cost of financing

Supply of funds available for investment

Accurately identifying opportunities with the greatest potential for ROI

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Financing with Financing with Long-Term LiabilitiesLong-Term Liabilities

Financing with Financing with Long-Term LiabilitiesLong-Term Liabilities

Debts that will be repaid over a number of years• Long-term loans

• Bond issues

Companies must raise money in the form of lines of credit or loans

Relying too heavily on debt can be dangerous • Companies may not earn enough to cover interest payments

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BondsBondsBondsBonds

Common form of long-term debt

Sold by large companies to raise long-term funds• Like corporate IOUs

• Bondholders basically loan the issuer cash

Indenture: The bond contract specifying all terms of agreement between the bondholder and the issuing organization

• Specifies interest payments, maturity date, repayment methods, etc.

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Types of BondsTypes of BondsTypes of BondsTypes of Bonds

Unsecured Bonds

Debentures, or bonds, that are not backed by specific collateral

Most common type

Secured Bonds

Bonds that are backed by specific collateral that must be forfeited in the event the issuing firm defaults

Serial Bonds

A sequence of small bond issues of progressively longer maturity

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Types of BondsTypes of BondsTypes of BondsTypes of Bonds

Floating-Rate Bonds

Bonds with interest rates that change with current interest rates otherwise available in the economy

Junk Bonds

Special type of high interest rate bond that carries higher inherent risks

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Financing with Owner’s EquityFinancing with Owner’s EquityFinancing with Owner’s EquityFinancing with Owner’s Equity

Owner’s Equity is the owner’s investment in an organization

All money and assets owners have brought into an organization

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Common StockCommon StockCommon StockCommon Stock

The most important source of capital for most new companies

Gives stockholders voting and control rights

Par Value: The amount printed on the stock certificate

Market Value: The price at which the stock is trading

Capital in Excess of Par: The difference between the market value and the par value

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Financing with Owner’s EquityFinancing with Owner’s EquityFinancing with Owner’s EquityFinancing with Owner’s Equity

Preferred Stock

Gives the stockholder preference in distribution of profits, but not voting and control rights

Is a safer investment than common stock

Retained Earnings

Earnings after expenses and taxes

Are reinvested in the assets of the firm and belong to the owners in the form of equity

The only long-term funds a company generates internally

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When a Company Has Profits Left When a Company Has Profits Left OverOver

When a Company Has Profits Left When a Company Has Profits Left OverOver

Retained Earnings

Reinvested in the assets of the firms

Dividend Yield

The dividend per share divided by the stock price

Not all companies pay dividends

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Financing Through Issuing StockFinancing Through Issuing StockFinancing Through Issuing StockFinancing Through Issuing Stock

Primary Market

New issue (first-time sale of stock) or initial public offering (IPO– when a company offers stock for sale for the first time)

Raise cash for issuing corporation

Secondary Market

Stock exchanges and OTC markets

Investors trade securities with each other

Does not raise cash for corporation

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Investment BankingInvestment BankingInvestment BankingInvestment Banking

Is the sale of stocks and bonds for corporations

Helps companies raise funds by matching people and institutions who have money to invest with corporations needing resources

A way for corporations to obtain financing

Many investment banks now offer other banking services• “One-stop shopping”

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Securities MarketsSecurities MarketsSecurities MarketsSecurities Markets

Provide the mechanism for buying and selling securities

The Stock Market Dramatic shifts in structure of exchanges

NY Stock Exchange and NASDAQ now are for-profit businesses

Most exchanges are or are becoming electronic– making organized exchanges less centralized and faster

Over-the-Counter Market (OTC) A network of dealers all over the country and world

No central location

Small stocks, illiquid bank stocks and penny stocks

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Measuring Market PerformanceMeasuring Market PerformanceMeasuring Market PerformanceMeasuring Market Performance

How are investments performing relative to the whole market?

Performance measures make comparison possible• Index: Compares current stock prices with a base price

• Average: The average of certain stock prices, usually calculated with complicated formulas

Financial bubbles can be hard to recognize, even with performance measures

Investors must stay well informed of business news

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Market Performance of Market Performance of Indonesia Capital Market (IDX)Indonesia Capital Market (IDX)

Market Performance of Market Performance of Indonesia Capital Market (IDX)Indonesia Capital Market (IDX)

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Source: www.idx.co.id