mastering financial management

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 3 | Slide 1

Mastering Financial Management

Chapter

16


All the activities concerned with obtaining money and using it effectively• Determining the best ways to raise money• Ensuring money is used in keeping with the

organization’s goal The need for financing

• When expenses are high or sales are low• Opportunities to expand

What Is Financial Management?


2 Main Types of Financing

Short-term financing• Money that will be used for one year or less

– Cash flow—the movement of money into and out of an organization

– Inventory—speculative production (the time lag between the actual production of goods and when the goods are sold). Some businesses need to “stock up” before Christmas, for example.

Long-term financing• Money that will be used for longer than one year• Often involves large amounts of money• Examples-for new product development, replacing

old equipment, mergers and acquisitions, etc.


Comparison of Short- and Long-Term Financing


Cash Flow for a Manufacturing Business


The Cash Flow Cycle

Sales

Accounts Receivable

Cash

Inventory

Customers


During the economic crisis it has been:• More difficult to get many traditional sources

of short- and long-term financing-Remember we discussed how hard it is to get a loan these days?

• The number of corporations selling stock for the first time to the general public decreased

• The number of businesses filing for bankruptcy increased

Financial Management During the Economic Crisis


Business Bankruptcies in the United States


Proper financial management at all times must ensure that:• Financing priorities are established in line with

organizational goals• Spending is planned and controlled• Sufficient financing is available when it is needed and that

it can be had for reasonable interest.• Credit customers pay their bills on time and past-due or

delinquent accounts are reduced• Bills are paid promptly to protect the firm’s credit rating

and ability to borrow money• Funds are always available to pay taxes on time• Excess cash is invested in CDs, government securities,

or conservative marketable securities

Financial Management During the Economic Crisis (cont.)


Financial Management After the Economic Crisis

• Goals of the Dodd-Frank Wall Street Reform and the Consumer Protection Act are:

– Hold Wall Street firms accountable for their actions– End taxpayer bailouts– Tighten regulations for major financial firms– Increase government oversight

• Still a debate about:– Limiting executive pay and bonuses– Limiting the size of the largest firms– Curbing previously used speculative investment techniques

The risk-return ratio• Based on the principle that a high-risk decision should

generate higher financial returns for a business and more conservative decisions often generate lesser returns


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

implement an organization’s goals-pg 450

3 steps in developing the financial plan1. Establish organizational goals2. Do the budget-Determine how much money is

needed to accomplish each goal3. Identify sources of funds and which ones would be

the best to use

Planning—the Basis of Sound Financial Management


The Three Steps of Financial Planning


Step 1: Establishing organizational goals• Goal

– An end result that an organization expects to achieve over a one- to ten-year period

– Goals must be specific and measurableo Example: JMT has a goal to sell $40,000 worth of

Mighty Missy products between now and June 1, 2012

– Goals must be realistic o Example: $40,000 should be not too high, and not

too low

Developing the Financial Plan


Developing the Financial Plan (cont.)

Step 2: Do the Budget• Budget

– A financial statement that projects income and/or expenditures over a specified future period-pg 451

– Usually begins with sales and various types of expenses

• Cash budget– Projects cash receipts and expenditures over a specified period

• Capital budget– Estimates a firm’s expenditures for major assets and its

long-term financing needs – Example: expenses for new facility, replacing old equipment, etc.


Developing the Financial Plan (cont.)

Step 3: Identifying sources of funds-Where should the money come from?1. Sales revenues

• Usually provide the greatest part of the firm’s financing2. Equity capital

• Money received from the owners or from the sale of shares of ownership in the business; long-term financing

3. Debt capital• Borrowed money obtained through loans

4. Proceeds from the sale of assets• But only if absolutely necessary or if the asset is no longer

needed


• After the financial plan is in place, don’t forget to see if it’s working as early as possible. This will prevent minor problems from becoming major ones!

• Can do weekly, monthly, and/or quarterly budgets to see if the company is on track to meet its financial goals.

Monitor and Evaluate Financial Performance!


Cash Budget for Stars and Stripes Clothing


1. Sales

2. Equity-comes from the owners or the stockholders

-Used almost exclusively for long-term financing

3. Debt-borrowed money

4. Sale of assets-drastic step

4 Main Sources of Funds(4 main sources of “capital”)


Traditional Services

Electronic Banking Services

International Services

Financial Services Provided by Banks-3 Categories


Traditional Banking Services (for Business Clients)

Checking accounts

Savings accounts• Includes CDs and money markets

Short- and long-term loans• Line of credit—a loan that is approved before the money is

actually needed• Revolving credit agreement—a guaranteed line of credit• Collateral—real estate or property pledged as security for a loan

Credit cards and debit cards


Popular methods of paying for import and export transactions• Letter of credit

– A legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time

• Banker’s acceptance– A written order for the bank to pay a third party a

stated amount of money on a specific date

Currency exchange– Exchanging one currency for another so the

transaction can go through

International Banking


Unsecured

Secured (unusual unless there’s bad credit)

Note: Just because a business has to borrow money doesn’t mean it’s in trouble. On the contrary, good financial management often means regular, responsible borrowing of many different kinds.

2 Types of Short-Term Financing (easier to get than long-term)


Sources of Unsecured Short-Term Financing-must be repaid in one year

or less Short-term financing is usually used for solving cash flow

problems, purchasing inventory, emergencies

Unsecured- not backed by collateral

Trade credit• Financing extended by a seller who does not require

immediate payment after the delivery of the merchandise

Promissory notes• A written pledge by a borrower to pay a certain sum of

money to a creditor at a specified future date• Unlike trade credit, promissory notes usually include

interest• Are legally binding


Sources of Unsecured Short-Term Financing (cont.)

Unsecured loans• Interest rates vary with each borrower’s credit rating• Prime rate

– The lowest rate charged by a bank for a short-term loan-pg 458• Offered through promissory notes, a line of credit,

or revolving credit agreement Commercial paper

• Short-term promissory note issued by a large corporation saying that it will pay back money borrowed from the public

• Interest rates are usually below that charged by banks for short-term loans


Average Prime Interest Rate Paid by U.S. Businesses


Sources of Secured Short-Term Financing

Loans secured by inventory

Loans secured by accounts receivables


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• If the lender requires storage of inventory used

as collateral in a public warehouse, the borrowerpays storage fees

Loans secured by receivables• Amounts owed to a firm by its customers are pledged

as collateral• Quality of receivables is considered• When customer pays off the receivable the money

needs to go straight to the bank for payment on the loan


Sources of Secured Short-Term Financing (cont.)

Factoring accounts receivable• Factor

– A firm that specializes in buying other firms’ accounts receivable-pg 459

• The factor buys accounts receivable for less than their face value but gives the money to the company right away and doesn’t have to worry about collecting

• The factor then collects the full dollar amounts when each account comes due

• The factor’s profit is the difference between the face value and what it paid for the accounts receivable

• Profit is based on the risk (the probability that the accounts receivable will not be paid) the factor assumes


Comparison of Short-Term Financing Methods


Sources of Equity Financing

For sole proprietorships or partnerships• Owner or owners invest money in the business• Venture capital

For corporations• Sale of stock• Use of profits not distributed to owners (retained

earnings)• Venture capital


Sources of Equity Financing (cont.)

Selling stock• Initial public offering

– When a corporation sells common stock to the general public for the first time

• Advantages of selling stock– Firm does not have to repay money received

from sale of stock– Firm does not have to pay dividends to stockholders

unless it decides to



Selling stock (cont.)• Common stock

– Stock whose owners may vote on corporate matters but whose claims on 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


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.

http://www.nyse.com http://www.nasdaq.com

http://www.nyse.com/

http://www.nasdaq.com/



Retained earnings• The portion of a corporation’s profits not distributed

to stockholders-Facebook currently has almost $2 billion in retained earnings which is a large amount considering the company is so new.

Venture capital• Money invested in small (and sometimes struggling) firms

that have the potential to become very successful and extremely profitable

• Investors usually receive an equity or ownership position in the business and share in its profits


Long-Term Financing-Debt Financing

“Leverage”• The use of borrowed funds to increase the

return on owners’ equity

• As long as the firm’s earnings are larger than the interest charged for the borrowed money, there is a positive effect on return on owners’ equity


Effects of Additional Capital


Sources of Long-Term Debt Financing (cont.)

Long-term loans• Term-loan agreement

– For loans longer than one year.– A promissory note requires a borrower to repay a loan in monthly,

quarterly, semiannual, or annual installments.– Interest rate and repayment terms are based on the reasons for

borrowing, the firm’s credit rating, and the value of collateral.• The basics of getting a loan

– Know potential lenders.– Maintain a good credit rating.– Fill out an application, submit a business plan

and financial statements, and compile references.– Meet with loan officer.– If denied, determine why.


Sources of Long-Term Debt Financing (cont.)

Corporate bonds• A corporation’s written pledge that it will repay a

specified amount of money with interest• Maturity date—the date on which a corporation is

to repay borrowed money• Interest is paid until maturity


Comparison of Long-Term Financing Methods


Class Exercise

For each of the following financial needs, identify whether short-term or long-term financing is most appropriate• $250,000 for inventory• $14 million for plant expansion• $2.5 million for business start-up costs• $120,000 to solve cash-flow problems• $450,000 for automated manufacturing equipment• $35,000 for immediate promotional needs


Chapter Quiz

1. When a firm sells its accounts receivable to raise short-term cash, it is engaging in a strategy called

A. factoring.B. financial planning.C. equity financingD. debt financing.E. drafting.


Chapter Quiz

2. Retained earnings, as a form of equity financing, are

A. gross earnings.B. profits before taxes.C. profits after taxes.D. undistributed profits.E. total owners’ equity.


Chapter Quiz

3. A short-term promissory note issued by large corporations is known as

A. a debenture agreement.B. an equity agreement.C. commercial paper.D. a draft agreement.E. a loan commitment.


Chapter Quiz

4. The primary sources of funds available to a business include all of the following except

A. debt capital.B. equity capital.C. sales revenue.D. government grants.E. sale of assets.


Chapter Quiz

5. What is an audit?

A. An examination of a company’s financial statements and accounting practices.

B. It is the same as a balance sheet.C. It is a procedure currently being performed at

many companies by the accounting firm of Arthur Anderson.

D. An examination of a company’s debt to equity ratio.


Chapter Quiz

6. List these assets from most liquid to least liquid: Equipment, inventory, accounts receivable, and cash.

A. Inventory, equipment, accounts receivable, cash

B. Cash, accounts receivable, inventory, equipment

C. Equipment, cash, accounts receivable, inventory.

D. Accounts receivable, equipment, inventory, cash.


Chapter Quiz

7. Which of the following is not considered one of the 3 most important financial statements:

A. Corporate Mission Statement.B. Income Statement.C. Balance Sheet.D. Cash Flow Budget.


Chapter Quiz

8. Which items belong on an income statement?

A. Current assets.B. Cost of Goods Sold.C. Long-term liabilities.D. Owner’s equity.


Chapter Quiz

9. Calculate the Return on Sales ratio for a company that shows the following information:

Gross Sales $300,000

Net Income after Taxes $ 50,000

Net Sales $ 275,000

A. .18 or 18% B. .65 or 65%C. .33 or 33%D. None of the above.


Chapter Quiz

10. Calculate the amount of Working Capital for a company that shows the following information:

Gross Sales $500,000 Net Income after Taxes $110,000

Current Assets $375,000Current Liabilities $125,000Cost of Goods Sold $200,000

A. $300,000 B. $250,000C. .25 or 25%D. None of the above.

mastering financial management

Documents

cengage learning

proper financial management

economic crisisgoals

financing priorities

controlledsufficient

longterm financingmoney

used speculat

government securities