Chapter 18
Financial
Management
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter
Eighteen
LEARNING GOALS
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
The Role of
Finance and
Financial
Managers
WHAT’S FINANCE?
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
• Financial Management -- The job of managing a firm’s resources
to meet its goals and objectives.
18-3
The Role of
Finance and
Financial
Managers
LG1
WHAT FINANCIAL
MANAGERS DO
18-4
The Value of
Understanding
Finance
LG1
TOP FINANCIAL CONCERNS
of COMPANY CFOs - MACRO
• Consumer demand
• Federal-government policies
• Price pressure from
competitors
• Credit markets/interest rates
• Global financial instability
• Foreign competition
Source: CFO Magazine, July/August 2010.
18-5
The Value of
Understanding
Finance
LG1
TOP FINANCIAL CONCERNS
of COMPANY CFOs - MICRO
• Ability to maintain margins
• Ability to forecast results
• Maintaining
morale/productivity
• Cost of healthcare
• Working-capital management
• Environmental regulations
Source: CFO Magazine, July/August 2010.
18-6
Financial
Planning
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.
18-7
Forecasting
Financial
Needs
FINANCIAL FORECASTING
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.
18-8
Working with
the Budget
Process
BUDGETING
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.
18-9
Working with
the Budget
Process
TYPES of BUDGETS
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.
18-10
Working with
the Budget
Process
FINANICAL PLANNING
LG2
18-11
Establishing
Financial
Control
LG2
FACTORS USED in ASSESSING
FINANCIAL CONTROL
• Financial Control -- A process in which a firm
periodically compares its actual revenues, costs
and expenses with its budget
• 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?
18-12
The Need for
Operating
Funds
LG3
KEY NEEDS for OPERATIONAL
FUNDS in a FIRM
• Managing day-by-day
needs of the business
• Controlling credit
operations
• Acquiring needed
inventory
• Making capital
expenditures
18-13
The Need for
Operating
Funds
LG3
HOW SMALL BUSINESSES
CAN IMPROVE CASH FLOW
• 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.
18-14
GOOD FINANCE
or BAD MEDICINE?
(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?
18-15
Alternative
Sources of
Funds
WHY FIRMS NEED FINANCING
LG3
Short-Term Funds
Long-Term Funds
Monthly expenses
New-product development
Unanticipated emergencies
Replacement of capital equipment
Cash flow problems
Mergers or acquisitions
Expansion of current inventory
Expansion into new markets
Temporary promotional programs
New facilities
18-16
The Value of
Understanding
Finance
LG1
WHY DO FIRMS
FAIL FINANCIALLY?
1) Undercapitalization
2) Poor control over
cash flow
3) Inadequate expense
control
18-17
Obtaining
Long-Term
Financing
The FIVE “C”s of CREDIT
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.
18-18
Credit Cards
LG4
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
Source: Entrepreneur, www.entrepreneur.com, accessed July 2011.
18-19
Alternative
Sources of
Funds
LG3
USING ALTERNATIVE
SOURCES of FUNDS
• Debt Financing -- The funds raised through various
forms of borrowing that must be repaid.
• Short Term or Long Term
• Equity Financing -- The funds raised from within
the firm from operations or through the sale of
ownership in the firm (such as stock).
18-20
Comparing
Debt and
Equity
Financing
LG5
DIFFERENCES BETWEEN
DEBT and EQUITY FINANCING
Types of Financing
Conditions
Debt
Equity
Management
influence
None. Unless special
conditions have been
agreed on.
Common stock
holders have voting
rights.
Repayment
Debt has a maturity
date.
Stock has no maturity
date.
Yearly obligations
Payment of interest.
The firm isn’t legally
liable to pay dividends.
Tax benefits
Interest is tax
deductible.
Dividends are not tax
deductible.
18-21
Trade Credit
LG4
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.
• Promissory Note -- A written contract agreeing to
pay a supplier a specific sum of money at a definite
time.
18-22
Credit Cards
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
18-23
Factoring
Accounts
Receivable
FACTORING
LG4
• Factoring -- The
process of selling
accounts receivable for
cash.
• Factors charge more
than banks, but many
small businesses don’t
qualify for loans.
18-24
Family and
Friends
LG4
TYPES of
SHORT-TERM FINANCING
• 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
18-25
Commercial
Banks
LG4
DIFFICULTY of OBTAINING
SHORT-TERM FINANCING
• 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.
18-26
Different
Forms of
Short-Term
Loans
LG4
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.
- Revolving Credit Agreement -- A line of
credit that’s guaranteed but comes with a fee.
18-27
Commercial
Paper
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.
18-28
Debt
Financing
LG5
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.
18-29
Obtaining
Long-Term
Financing
LG5
SETTING LONG-TERM
FINANCING OBJECTIVES
• 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?
18-30
Debt
Financing
LG5
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.
18-31
Equity
Financing
SECURING 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.
18-32
Equity
Financing
LG5
WANT to ATTRACT a
VENTURE CAPITALIST?
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.
18-33
Comparing
Debt and
Equity
Financing
LG5
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.
18-34