Mastering Financial Management

1. Mastering Financial Management Chapter 16

2. What Is Financial Management? • 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

3. 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.

4. Comparison of Short- and Long-Term Financing

5. Cash Flow for a Manufacturing Business

6. The Cash Flow Cycle Customers

7. Financial Management During the Economic Crisis • 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

8. Business Bankruptcies in the United States

9. Financial Management During the Economic Crisis (cont.) • 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

10. 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

11. Planning—the Basis of Sound Financial Management • 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 plan • Establish organizational goals • Do the budget-Determine how much money is needed to accomplish each goal • Identify sources of funds and which ones would be the best to use

12. The Three Steps of Financial Planning

13. Developing the Financial Plan • 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 measurable • Example: JMT has a goal to sell $40,000 worth of Mighty Missy products between now and June 1, 2012 • Goals must be realistic • Example: $40,000 should be not too high, and not too low

14. 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.

15. Developing the Financial Plan (cont.) • Step 3: Identifying sources of funds-Where should the money come from? • Sales revenues • Usually 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; long-term financing • Debt capital • Borrowed money obtained through loans • Proceeds from the sale of assets • But only if absolutely necessary or if the asset is no longer needed

16. Monitor and Evaluate Financial Performance! • 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.

17. Cash Budget for Stars and Stripes Clothing

18. 4 Main Sources of Funds(4 main sources of “capital”) • Sales • Equity-comes from the owners or the stockholders -Used almost exclusively for long-term financing • Debt-borrowed money • Sale of assets-drastic step

19. Financial Services Provided by Banks-3 Categories • Traditional Services • Electronic Banking Services • International Services

20. 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

21. International Banking • 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

22. 2 Types of Short-Term Financing (easier to get than long-term) • 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.

23. Sources of UnsecuredShort-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

24. Sources of UnsecuredShort-Term Financing (cont.) • Unsecured loans • Interest rates vary with each borrower’s credit rating • Primerate • 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

25. Average Prime Interest Rate Paid by U.S. Businesses

26. Sources of Secured Short-Term Financing • Loans secured by inventory • Loans secured by accounts receivables

27. 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

28. 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

29. Comparison of Short-Term Financing Methods

30. 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

31. 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

32. Sources of Equity Financing (cont.) • 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

33. 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

34. Sources of Equity Financing (cont.) • 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

35. 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

36. Effects of Additional Capital

37. 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.

38. 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

39. Comparison of Long-Term Financing Methods

40. 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

41. Chapter Quiz • When a firm sells its accounts receivable to raise short-term cash, it is engaging in a strategy called • factoring. • financial planning. • equity financing • debt financing. • drafting.

42. Chapter Quiz • Retained earnings, as a form of equity financing, are • gross earnings. • profits before taxes. • profits after taxes. • undistributed profits. • total owners’ equity.

43. Chapter Quiz • A short-term promissory note issued by large corporations is known as • a debenture agreement. • an equity agreement. • commercial paper. • a draft agreement. • a loan commitment.

44. Chapter Quiz • The primary sources of funds available to a business include all of the following except • debt capital. • equity capital. • sales revenue. • government grants. • sale of assets.

45. Chapter Quiz • What is an audit? • An examination of a company’s financial statements and accounting practices. • It is the same as a balance sheet. • It is a procedure currently being performed at many companies by the accounting firm of Arthur Anderson. • An examination of a company’s debt to equity ratio.

46. Chapter Quiz • List these assets from most liquid to least liquid: Equipment, inventory, accounts receivable, and cash. • Inventory, equipment, accounts receivable, cash • Cash, accounts receivable, inventory, equipment • Equipment, cash, accounts receivable, inventory. • Accounts receivable, equipment, inventory, cash.

47. Chapter Quiz • Which of the following is not considered one of the 3 most important financial statements: • Corporate Mission Statement. • Income Statement. • Balance Sheet. • Cash Flow Budget.

48. Chapter Quiz • Which items belong on an income statement? • Current assets. • Cost of Goods Sold. • Long-term liabilities. • Owner’s equity.

49. Chapter Quiz • 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 • .18 or 18% • .65 or 65% • .33 or 33% • None of the above.

50. Chapter Quiz • 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 $375,000 Current Liabilities $125,000 Cost of Goods Sold $200,000 • $300,000 • $250,000 • .25 or 25% • None of the above.