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Chapter 16

Chapter 16. Mastering Financial Management. Learning Objectives. Explain the need for financial management in business. Summarize the process of planning for financial management. Identify the services provided by banks and financial institutions for their business customers.

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Chapter 16

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  1. Chapter 16 Mastering Financial Management

  2. Learning Objectives • Explain the need for financial management in business. • Summarize the process of planning for financial management. • Identify the services provided by banks and financial institutions for their business customers. • Describe the advantages and disadvantages of different methods of short-term debt financing. • Evaluate the advantages and disadvantages of equity financing. • Evaluate the advantages and disadvantages of long-term debt financing.

  3. Financial Management …all the activities concerned with obtaining money and using it effectively.

  4. Need for Financing • Reasons: • Start a business • Keep it going • Sources: • Owners’ investment • Borrowed • Afterward: • Pay expenses • Provide profit

  5. Short-Term Financing …money that will be usedfor one year or less.

  6. 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.

  7. Cash Flow …the movement of money into and out of an organization.

  8. Customers The Cash Flow Cycle

  9. Speculative Production …the time lag between actual production of goods and when the goods are sold.

  10. Figure 16.1: Cash Flow for a Manufacturing Business

  11. Long-Term Financing …money that will be used forlonger than one year.

  12. Two-SidedProblem of Financing • Uses of funds dictate type(s) of financing needed • Activities undertaken determined by types of financing available

  13. Risk-Return Ratio …a ratio based on the principle thata high-risk decision should generatehigher financial returns for a business and more conservative decisions often generate lesser returns.

  14. Proper Financial Management • Financing priorities established with goals and objectives • Spending planned/controlled • Bills paid promptly • Excess cash invested

  15. 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

  16. Positions, Salaries, and Experience at Two Major Firms Swiss Finance Academy, “Corporate Finance Salaries,” www.careers-in-finance.com/cfsal.htm, accessed September 27, 2009.

  17. Financial Plan …a plan for obtaining andusing money needed to implementan organization’s goals.

  18. Developing Financial Plan Establish Goals and Objectives Monitor & Evaluate Performance Budget for Needs Identify Sources

  19. Figure 16.2: The Three Steps of Financial Planning

  20. Budget …a financial statement that projectsincome and/or expenditures over aspecified future period.

  21. Figure 16.3: Sales Budget

  22. Cash Budget …a financial statement that projectscash receipts and cash expendituresover a specified period.

  23. Figure 16.4: Cash Budget

  24. Capital Budget …a financial statement that estimates a firm’s expenditures for major assets and its long-term financing needs.

  25. 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

  26. Primary Sources of Funds • Sales Revenue • Equity Capital • Debt Capital • Sales of Assets

  27. 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

  28. Traditional Business Banking Services • Savings and Checking Accounts • Passbook Savings • Certificate of Deposit • Check • Business Loans • Short-Term Loans • Line of Credit • Revolving Credit • Long-Term Loans • Credit/Debit Card Transactions

  29. Electronic Funds Transfer …a means of performing financial transactions through a computer terminal or telephone hookup.

  30. Sources of UnsecuredShort-Term Financing • Trade Credit • Promissory Note • Unsecured Bank Loans • Commercial Paper Unsecured financing is financing that is not backed by collateral.

  31. Average Prime Interest Rate Source: Federal Reserve Bank website, www.federalreserve.gov, accessed October 17, 2008..

  32. Sources of SecuredShort-Term Financing • Inventory • Accounts Receivable- Factoring

  33. Table 16.2: Comparison of Short-Term Financing Methods

  34. 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

  35. 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

  36. Spotlight IPOs Can Raise Billions! Source: The Renaissance Capital IPO Home website, www.ipohome.com, accessed May 24, 2009.

  37. 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

  38. 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

  39. 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.

  40. Types of Bonds • Registered: registered in owner’s name by issuing company • Debenture: backed only by issuing firm’s reputation • Mortgage: secured by assets of firm • Convertible: may be exchanged for a specified number of common stock shares

  41. 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

  42. Table 16.4: Comparison of Long-Term Financing Methods

  43. Chapter Quiz • Which of the following would be considered a short-term financial need? • New product development • Cash flow problems • Business start-up costs • Mergers and acquisitions • Expansion of facilities

  44. Chapter Quiz • 2. The least expensive form of short-term financing is • promissory notes. • prime rate loans. • common stock. • trade credit. • factoring.

  45. Chapter Quiz • Which of the following statements is incorrect? • A corporation can issue only common stock or preferred stock, but not both. • IPO stands for initial public offering. • Common stockholders have the right to vote on major corporate actions. • A corporation is under no legal obligation to pay dividends to common stockholders. • A corporation is under no legal obligation to buy back the stock you purchase.

  46. Chapter Quiz • 4. The portion of a corporation’s profits not distributed to stockholders is called • retained earnings. • undistributed profits. • profit residue. • income before taxes. • net profit.

  47. Chapter Quiz • A __________ is the legal document that details all the conditions relating to a bond issue. • bond indenture • debenture statement • bond contract • security agreement • collateral statement

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