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Thursday morning. Finance. What is Finance?. Finance -- The function in a business that acquires funds for a firm and manages them within the firm. Finance activities include: Preparing budgets Creating cash flow analyses Planning for expenditures. Financial Management.
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Thursday morning Finance
What is Finance? • Finance -- The function in a business that acquires funds for a firm and manages them within the firm. • Finance activities include: • Preparing budgets • Creating cash flow analyses • Planning for expenditures
Financial Management • Financial Management -- The job of managing a firm’s resources to meet its goals and objectives.
Why Do Firms Fail Financially? • Undercapitalization • Poor control over cash flow • Inadequate expense control
Who’s Who in Finance • CFO -- Chief Financial Officer • CFP -- Certified Financial Planner • CFA -- Chartered Financial Analyst • Controller -- Chief Accounting Officer
Financial Forecasting • Short-Term Forecast -- Predicts revenues, costs and expenses for a period of one year or less. • Cash-Flow Forecast -- Predicts the cash inflows and outflows in future periods, usually months or quarters. • Long-Term Forecast -- Predicts revenues, costs, and expenses for a period longer than one year and sometimes as long as five or ten years.
Budgeting • Budget -- Sets forth management’s expectations for revenues and allocates the use of specific resources throughout the firm. • Budgets depend heavily on the balance sheet, income statement, statement of cash flows and short-term and long-term financial forecasts. • The budget is the guide for financial operations and expected financial needs.
Types of Budgets • Capital Budget -- Highlights a firm’s spending plans for major asset purchases that often require large sums of money. • Cash Budget -- Estimates cash inflows and outflows during a particular period like a month or quarter. • Operating (Master) Budget -- Ties together all the firm’s other budgets and summarizes its proposed financial activities.
The Master Budget: An Overview Sales budget Selling and administrative budget Production budget Ending inventory budget Direct materials budget Direct laborbudget Manufacturing overhead budget Cash Budget Budgetedincomestatement Budgetedbalance sheet
Establishing Financial Control • Financial Control -- A process in which a firm periodically compares its actual revenues, costs and expenses with its budget.
FACTORS USED in ASSESSING FINANCIAL CONTROL • Is the firm meeting its short-term financial commitments? (current ratio/quick ratio) • Is the firm producing adequate operating profits on its assets? (ROA) • How is the firm financing its assets? (debt or equity) • Are the firms owners receiving an acceptable return on their investment? (ROE/ROI)
WAYS to RAISE START-UP CAPITAL • Seek out a microloan from a microlender • Use asset-based lending or factoring • Turn to the web and seek out peer-to-peer lending • Research local banks • Sweet-talk vendors you want to do business with
Sources of Capital • Personal savings • Relatives • Former employers • Banks & finance companies • Government agencies • Venture capitalists -- Individuals or companies that invest in new businesses in exchange for partial ownership. (generally pooled funds professionally managed) • Angel investors – use their own funds • Super Angels
HOW SMALL BUSINESSES CAN IMPROVE CASH FLOW • Be more aggressive in collecting accounts receivable. • Offer customers discounts by paying early. • Take advantage of special payment terms from vendors. • Raise prices. • Use credit cards discriminately.
ALTERNATIVE SOURCES of FUNDS • Debt Financing -- The funds raised through various forms of borrowing that must be repaid. • Equity Financing -- The funds raised from within the firm from operations or through the sale of ownership in the firm (such as stock).
SHORT and LONG-TERM FINANCING • Short-Term Financing -- Funds needed for a year or less. • Long-Term Financing -- Funds needed for more than a year.
TYPES of SHORT-TERM FINANCING • Trade Credit -- The practice of buying goods or services now and paying for them later. • Businesses often get terms 2/10 net 30 when receiving trade credit. • What is this really worth?? • Promissory Note -- A written contract agreeing to pay a supplier a specific sum of money at a definite time.
DIFFERENT FORMS of SHORT-TERM LOANS • Commercial banks offer short-term loans like: • Secured Loans -- Backed by collateral. • Unsecured Loans -- Don’t require collateral from the borrower. • Line of Credit -- A given amount of money the bank will provide so long as the funds are available. • Lehman Brothers (repo market) • New York Times video – Hartsko • Grameen Bank
Factoring Your Accounts Receivable • Selling your AR for cash • Factor is an intermediary that buys a company’s AR, at a discount; and then collects the proceeds • Amount of discount is based on age of receivables, strength of business • Can be an expensive form of short-term financing
Commercial Paper • Commercial Paper -- Unsecured promissory notes in amounts of $100,000+ that come due in 270 days or less. • Since commercial paper is unsecured, only financially stable firms are able to sell it. • Assists in financing of current assets and payment of current liabilities; cannot be used on long-term assets
SETTING LONG-TERM FINANCING OBJECTIVES • Three questions of financial managers in setting long-term financing objectives: • What are the organization’s long-term goals and objectives? • What funds do we need to achieve the firm’s long-term goals and objectives? • What sources of long-term funding (capital) are available, and which will best fit our needs?
USING LONG-TERM DEBT FINANCING • Long-term financing loans generally come due within 3 -7 years but may extend to 15 or 20 years. • Term-Loan Agreement -- A promissory note that requires the borrower to repay the loan with interest in specified monthly or annual installments. • A major advantage of debt financing is the interest the firm pays is tax deductible.
USING DEBT FINANCING by ISSUING BONDS • Indenture Terms -- The terms of agreement in a bond issue. • Secured Bond -- A bond issued with some form of collateral (i.e. real estate). • Unsecured (Debenture) Bond -- A bond backed only by the reputation of the issuing company.
Securing Equity Financing • A company can secure equity financing by: • Selling shares of stock in the company. • Earning profits and using the retained earnings as reinvestments in the firm. • Attracting Venture Capital -- Money that is invested in new or emerging companies that some investors believe have great profit potential.
USING LEVERAGE for FUNDING NEEDS • Leverage -- Raising funds through borrowing to increase the firm’s rate of return. • Cost of Capital -- The rate of return a company must earn in order to meet the demands of its lenders and expectations of equity holders. • ROAvs ROE Excel example
Securities Markets • Securities markets are financial marketplaces for stocks and bonds and serve two primary functions: • Assist businesses in finding long-term funding to finance capital needs. • Provide private investors a place to buy and sell securities such as stocks and bonds.
TYPES of SECURITIES MARKETS • Securities markets are divided into primary and secondary markets: • Primary markets handle the sale of new securities. • Secondary markets handle the trading of securities between investors with the proceeds of the sale going to the seller. • Initial Public Offering (IPO) -- The first offering of a company’s stock. LinkedIn
INVESTMENT BANKERS and INSTITUTIONAL INVESTORS • Investment Bankers -- Specialists who assist in the issue and sale of new securities. Goldman Sachs • Institutional Investors -- Large organizations such as pension funds or mutual funds that invest their own funds or the funds of others. Vanguard, CALPERS
Stock Exchanges • Stock Exchange -- An organization whose members can buy and sell securities on behalf of companies and individual investors. • Over-the-Counter (OTC) Market -- Provides companies and investors with a means to trade stocks not listed on the national securities exchanges. • NASDAQ -- A telecommunications network that links dealers across the nation so they can exchange securities.
The SEC • Securities and Exchange Commission (SEC) -- The federal agency responsible for regulating the various stock exchanges; created in 1934 through the Securities and Exchange Act. • Prospectus -- A detailed registration statement that includes extensive economic and financial information that must be sent to prospective investors.
The Language of Stocks • Stocks -- Shares of ownership in a company. • Stock Certificate -- Evidence of stock ownership.Apple • Dividends -- Part of a firm’s profits that the firm may distribute to stockholders as either cash or additional shares.
Advantages of Issuing Stocks • Stockholders are owners of a firm and never have to be repaid their investment. • There’s no legal obligation to pay dividends. • Issuing stock can improve a firm’s balance sheet since stock creates no debt.
Disadvantages of Issuing Stocks • Stockholders have the right to vote for a company’s board of directors. • Issuing new shares of stock can alter the control of the firm. • Dividends are paid from after-tax profits and are not tax deductible. (double taxation) • The need to keep stockholders happy can affect management’s decisions.
Two Classes of Stock • Common Stock -- The most basic form; holders have the right to vote for the board of directors and share in the profits if dividends are approved. • Preferred Stock -- Owners are given preference in the payment of company dividends before common stock dividends are distributed. Preferred stock can also be: • Callable • Convertible • Cumulative
Key Stock Market Indicators • Dow Jones Industrial Average -- The average cost of 30 selected industrial stocks. • Critics say the 30-company Dow is too small a sample and suggest following the S&P 500. • S&P 500 tracks the performance of 400 industrial, 40 financial, 40 public utility, and 20 transportation stocks.
Stock Splits • Stock Splits -- An action by a company that gives stockholders two or more shares of additional stock for every share that’s outstanding. • Splits cause no change in the firm’s ownership structure and no change in the investment’s value. • Firms can never be forced to spilt their stocks. • Berkshire Hathaway
Learning the Language of Bonds • Bond -- A corporate certificate indicating that an investor has lent money to a firm. • The principal is the face value of the bond. • Interest -- The payment the bond issuer makes to the bondholders to compensate them for the use of their money. • Understanding Bond Quotes
Advantages of Issuing Bonds • Bondholders are creditors, not owners of the firm and can’t vote on corporate matters. • Bond interest is tax deductible. • Bonds are a temporary source of funding and are eventually repaid. • Bonds can be repaid before the maturity date if they contain a call provision. • Google, 2
Disadvantages of Issuing Bonds • Bonds increase debt and can affect the market’s perception of the firm. • Paying interest on bonds is a legal obligation. • If interest isn’t paid, bondholders can take legal action. • The face value of the bond must be repaid on the maturity date.
DIFFERENT CLASSES of CORPORATE BONDS • Unsecured bonds (debenture bonds): not backed by specific collateral. • Secured bonds: backed by collateral (land or equipment).
Investing in Mutual Funds • Mutual Fund -- An organization the buys stocks and bonds and then sells shares in those securities to the public. The fund pools investors’ money and buys stocks according to the fund’s purpose. • Enables investors to diversify their risks