McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter
Eighteen
1. Explain the role and responsibilities of financial managers.
2. Outline the financial planning process, and explain the three key budgets in the financial plan.
3. Explain why firms need operating funds.
4. Identify and describe different sources of shortterm financing.
5. Identify and describe different sources of long-term financing.
18-2

Profile
Home Depot
• Tomé worked her way up to Chief Financial
Officer (CFO) at Home Depot in 2001.
• Home Depot was in a store building frenzy; adding more than 100 locations a year through 2005.
• Tomé was at the center of tech transition by overseeing the distribution of $350 million in spending.
18-3

Chapter
Eighteen
At one time this company was the largest automobile maker in the world. Due to severe financial problems in 2009, the company came very close to extinction. A $7 billion government-backed loan and an additional $43 billion government investment in the company helped it survive. It is now attempting a comeback as a much smaller company.
Name that company!
18-4

The Role of
Finance and
Financial
Managers
LG1
• 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
18-5

The Role of
Finance and
Financial
Managers
LG1
• Financial Management --
The job of managing a firm ’ s resources to meet its goals and objectives.
18-6

The Role of
Finance and
Financial
Managers
LG1
• Financial Managers -Examine financial data and recommend strategies for improving financial performance.
• Financial managers are responsible for:
Paying company bills
Collecting payments
Staying abreast of market changes
Assuring accounting accuracy
18-7

Financial
Planning
LG2
• CFO -Chief Financial
Officer
• CFP -Certified Financial
Planner
• CFA -Chartered Financial
Analyst
• Comptroller -Chief
Accounting Officer
18-8

The Role of
Finance and
Financial
Managers
LG1
18-9

The Role of
Finance and
Financial
Managers
LG1
• Consumer demand for their firm ’ s products
• Credit markets and interest rates
• Financial regulations from the government
• Volatility of the dollar
• Foreign competition
• Environmental regulations
Source: CFO Magazine, www.cfo.com
, accessed July 2011.
18-10

The Value of
Understanding
Finance
LG1
1) Undercapitalization
2) Poor control over cash flow
3) Inadequate expense control
18-11

The Value of
Understanding
Finance
LG1
• Consumer demand
• Federal-government policies
• Price pressure from competitors
• Credit markets/interest rates
• Global financial instability
Source: CFO Magazine, July/August 2010.
18-12

The Value of
Understanding
Finance
LG1
• Ability to maintain margins
• Ability to forecast results
• Maintaining morale/productivity
• Cost of healthcare
• Working-capital management
Source: CFO Magazine, July/August 2010.
18-13

Financial
Planning
LG2
• Financial planning involves analyzing short-term and long-term money flows to and from the company.
• Three key steps of financial planning:
1. Forecasting the firm ’ s short-term and long-term financial needs.
2. Developing budgets to meet those needs.
3. Establishing financial controls to see if the company is achieving its goals.
18-14

Forecasting
Financial
Needs
LG2
• 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.
18-15

Working with the Budget
Process
LG2
• 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.
18-16

Working with the Budget
Process
LG2
• 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.
18-17

Working with the Budget
Process
LG2
18-18

Establishing
Financial
Control
LG2
• Financial Control -A process in which a firm periodically compares its actual revenues, costs and expenses with its budget.
18-19

Establishing
Financial
Control
LG2
• Is the firm meeting its short-term financial commitments?
• Is the firm producing adequate operating profits on its assets?
• How is the firm financing its assets?
• Are the firms owners receiving an acceptable return on their investment?
18-20

Progress
Assessment
• Name three finance functions important to the firm ’ s overall operations and performance.
• What three primary financial problems cause firms to fail?
• How do short-term and long-term financial forecasts differ?
• What ’ s the purpose of preparing budgets? Can you identify three different types of budgets?
18-21

The Need for
Operating
Funds
LG3
• Managing day-by-day needs of the business
• Controlling credit operations
• Acquiring needed inventory
• Making capital expenditures
18-22

(Legal Briefcase)
• In Michigan, half of the state ’ s communities are in financial distress.
• Local Government and School District Fiscal
Accountability Act allows cities, towns, and school districts to be taken over by state-appointed emergency financial managers (EFMs) selected by the Governor.
• Indiana is considering similar legislation. New
York and other states’ boards have been given similar power.
18-23

The Need for
Operating
Funds
LG3
• Be more aggressive in collecting accounts receivable.
• Offer customers discounts for paying early.
• Take advantage of special payment terms from vendors.
• Raise prices.
• Use credit cards discriminately.
Source: American Express Small Business Monitor.
18-24

(Making Ethical Decisions)
• You ’ re a new hospital administrator at a small hospital that, like many others, is experiencing financial problems.
• You suggest discontinuing the hospital ’ s large stockpile of drugs and shift to ordering them just when they are needed.
• Some like the idea, but the doctors claim you ’ re sacrificing patients ’ well-being for cash. What do you do? What could be the result of your decision?
18-25

Alternative
Sources of
Funds
LG3
• 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).
18-26

Alternative
Sources of
Funds
LG3
• Short-Term Financing --
Funds needed for a year or less.
• Long-Term Financing --
Funds needed for more than a year.
18-27

Alternative
Sources of
Funds
LG3
Short-Term Funds
Monthly expenses
Unanticipated emergencies
Cash flow problems
Long-Term Funds
New-product development
Replacement of capital equipment
Mergers or acquisitions
Expansion of current inventory Expansion into new markets
Temporary promotional programs New facilities
18-28

Progress
Assessment
• Money has time value. What does this mean?
• Why is accounts receivable a financial concern of the firm?
• What ’ s the primary reason an organization spends a good deal of its available funds on inventory and capital expenditures?
• What ’ s the difference between debt and equity financing?
18-29

Trade Credit
LG4
• 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.
• Promissory Note -A written contract agreeing to pay a supplier a specific sum of money at a definite time.
18-30

Family and
Friends
LG4
• Many small firms obtain short-term financing from friends and family.
• If asking for help from family or friends, it ’ s important both parties :
1) Agree to specific loan terms
2) Put the agreement in writing
3) Arrange for repayment the same way they would for a bank loan
18-31

Commercial
Banks
LG4
• Banks generally prefer to lend shortterm money to larger, more established businesses.
• The recent financial crisis has made it difficult for even promising and well-organized businesses to get loans.
18-32

(Spotlight on Small Business)
• Peer-to-peer lending sites like Lending Club match small businesses with lenders and receive a fee for their services.
• Lendio claims to have developed a technology that matches business owners with the right type of business loan and lender.
• Lendio also offers services such as a business plan makeover and website design for a fee.
18-33

Different
Forms of
Short-Term
Loans
LG4
• 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.
Revolving Credit Agreement -A line of credit that
s guaranteed but comes with a fee.
18-34

Factoring
Accounts
Receivable
LG4
• Factoring -The process of selling accounts receivable for cash.
• Factors charge more than banks, but many small businesses don ’ t qualify for loans.
18-35

Commercial
Paper
LG4
• 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.
18-36

Credit Cards
LG4
• Rates for small businesses grew almost 30% after the
Credit Card Responsibility
Accountability and
Disclosure Act was passed.
• Credit cards are convenient but costly for a small business.
Photo Courtesy of: Robert Scoble
18-37

Credit Cards
LG4
• 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
Source: Entrepreneur, www.entrepreneur.com
, accessed July 2011.
18-38

Progress
Assessment
• What does an invoice containing the terms 2/10, net 30 mean?
• What ’ s the difference between trade credit and a line of credit?
• What ’ s the key difference between a secured and an unsecured loan?
• What ’ s factoring? What are some of the considerations factors consider in establishing their discount rate?
18-39

Obtaining
Long-Term
Financing
LG5
• Three questions of financial managers in setting longterm financing objectives:
1. What are the organization ’ s long-term goals and objectives?
2. What funds do we need to achieve the firm ’ s long-term goals and objectives?
3. What sources of long-term funding (capital) are available, and which will best fit our needs?
18-40

Obtaining
Long-Term
Financing
LG5
1. The character of the borrow.
2. The borrower ’ s capacity to repay the loan.
3. The capital being invested in the business by the borrower.
4. The conditions of the economy and the firm ’ s industry.
5. The collateral the borrower has available to secure the loan.
18-41

Debt
Financing
LG5
• 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.
18-42

Debt
Financing
LG5
• 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.
18-43

Equity
Financing
LG5
• 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 .
18-44

Equity
Financing
LG5
1. Can the company grow?
2. Will we get our money back and more?
3. Will it be worth our money and effort?
Source: Entrepreneur, February 2011.
18-45

Comparing
Debt and
Equity
Financing
LG5
Conditions
Management influence
Repayment
Yearly obligations
Tax benefits
Types of Financing
Debt
None. Unless special conditions have been agreed on.
Debt has a maturity date.
Equity
Common stock holders have voting rights.
Stock has no maturity date.
Payment of interest.
The firm isn ’ t legally liable to pay dividends.
Interest is tax deductible.
Dividends are not tax deductible.
18-46

Comparing
Debt and
Equity
Financing
LG5
• 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.
18-47

Lessons From the Financial
Crisis
LG5
• The recent financial crisis was the worst fall since the Great Depression.
• Led to the passage of sweeping financial reform.
• Government is increasing involvement and intervention.
18-48

Progress
Assessment
• What are the two major forms of debt financing available to a firm?
• How does debt financing differ from equity financing?
• What are the three major forms of equity financing available to a firm?
• What is leverage, and why do firms choose to use it?
18-49