Chapter 18 Chapter 19

CHAPTER 18 18.1 Promissory note • A document signed by a borrower promising to repay a loan at a specific date or predetermined terms. Secured bond • A debt instrument backed by collateral. Equity financing • A method of financing in which a company issues shares of its stock, reinvests company earnings, or obtains funds from venture capitalists. Line of credit • Unsecured credit extended to a borrower by a bank or vendor for a specific time. Operating budget • A forecast of estimated income, expenses, and revenue for a given period. Cost of capital • The expected rates of return for the diverse types of capital used to finance the business. Revolving credit • Line of credit where, for a fee, a customer can borrow up to a preapproved amount and use funds as needed. Debt financing • A method of financing in which a company receives a loan, issues bond, and receives trade credit, and promises to repay it. Finance and Financial Managers 1. Finance is the function of a business and acquires funds for the firm and manages within the firm 2. Financial management: is the job of managing the firm's resources to meet goals and objectives o Financial managers obtain funds and figure out how to use them in the best way o You need to be good at accounting to be a financial manager and understand finance o Key tasks: preparing budgets, doing cash flow analysis (analysis of money coming in), planning for expenditures Signs you need a CFO (Chief Financial Officer) 1. 2. 3. 4. 5. You do not have information on key things like cash flow, working capital, or forecasts No one is carefully watching and analyzing your expenses You are not aware of regulatory changes that could affect your business You can generate financial reports Shareholders are frustrated with the lack of CFO What worries Financial Mangers 1. 2. 3. 4. 5. 6. Market unpredictability Intest rates Cyberthreats Financial regulations from the government Volatility of the dollar Foreign competition The value of Understanding Finance 1. Key reasons a firm fails financially a. Undercapitalization (insufficient funds to start the business) b. Poor control of cash flow c. Inadequate expense control What is fiscal management? 1. Responsible for: paying bills, collecting overdue payments to make sure the company does not lose money due to bad debts (people or firms that do not pay bills) a. Finance functions are more vital to small businesses who have a smaller income 2. Financial managers should stay alert to new opportunities in finance (change in laws) 3. Pay taxes Financial Planning 1. Analyzing money flow patterns to optimize profits a. Forecasting the firm's short term and long-term needs b. Longterm- over one year c. Developing budgets to meet those needs d. Establishing financial control to see if the company is achieving their goals e. Types of budgets 1. Capital budget 2. Cash budget 3. Operating / master budget Financial Control- A process in which a firm periodically compares its actual revenues, costs, and expenses with its budget. 1. The US Banking System: explain it briefly a. Lends money from account holders' money to other people i. All money is thrown into a pool to keep the economy going b. Central banks (federal reserve systems)- make sure banks are doing everything correctly c. Doul banking system- the federal reserve supervises d. Investment banks- provide advisory about investments, take company's public e. Commercial banks- lend money and make money from interests f. Retail bank- normal bank for people to store money g. Credit unions- issue loans, typically issue people of a group (low-income, service) 2. How and WHY does the US government protect your money (assuming you live in the US) a. Why- capital requirements (emergency banking act of 1933) b. How- FDIC (federal deposit insurance corporation) insures money to the US Bank i. Less than 250,000 is insured on each deposit account 3. How does technology make banking more efficient? a. Online banking i. Apple pays, transfer checks ii. Less errors iii. Banking Intelligence (BI) provides information about the past, present, and future trends iv. Cheaper 4. Talk about international banking and what banking services are. a. International banking- provides financial accounts to clients b. International trade c. International businesses increase sales, acquire added resources and knowledge, and reduce the risk associated with being in only one country d. Risks- civil war, economic collapse, corruption, international regulation agencies and intelligence agencies e. Benefits- lower taxes, convenience of banking internationally 5 Cs of Credit maturity date • The exact date the issuer of a bond must pay the principal to the bondholder principal • The face value (dollar value) of a bond century bond • Bond with a 100-year maturity date sinking fund • A reserve account to ensure enough money will be available to pay bondholders on the bond’s maturity date debenture bonds • Bonds that are not backed by specific collateral Interest • The payment the bond issuer makes to the bondholder to compensate them for the use of their money 1. Character of barrow 2. 3. 4. 5. The browser's capacity to repay the student loan The capital being invested in the business by the barrower The conditions of the economy and the firm's industry The collateral the barrower has available to secure the loan PART B QUESTIONS I GOT WRONG Taxes represent __________ of the business. • • cash outflows Explanation: Tax payments represent an outflow of cash from the business. Therefore, financial managers must be involved in tax management and must keep abreast of changes in tax law. Financial managers also carefully analyze the tax implications of various managerial decisions to minimize the taxes paid by the business. Shanice works in finance for a small manufacturing company and is working on next year’s budget. She has been doing research to compare the cost of outsourcing some upcoming jobs versus the cost of purchasing the equipment to keep the jobs in-house. In what step in financial planning is Shanice involved? • • forecasting long-term financial needs Explanation: A long-term forecast predicts revenues, costs, and expenses for a period longer than one year, sometimes if five years. The long-term financial forecast gives top management, as well as operations managers, some sense of the income or profit potential of different strategic plans. Since Shanice is looking beyond a 12-month budget to project the equipment purchase payoff, she is forecasting long-term financial needs. Henry is currently in the process of projecting how much his firm will have to spend on supplies, travel, rent, advertising, and salaries for the coming fiscal year. Henry is working on the __________ budget. • • operating (master) Explanation: An operating (or master) budget ties together the firm’s other budgets and summarizes its proposed financial activities. If your job is to compare actual expenses incurred by your company with its budget, you are performing the task of • • financial control Explanation: Financial control is the process of periodically comparing actual revenues and expenses with the projected budget. CHAPTER 19 The Function of Securities Markets • • Securities Markets o Assist businesses in finding long term funding to finance capital needs o Provide private investors a place to buy and sell securities such as stocks and bonds Two types of markets: o Primary markets handle the sale of new securities o 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 public offering of a corporation’s stock The Function of Securities Markets The Role of Investment Bankers • • Investment Bankers- specialists who assist in the issue and sale of new securities Institutional investors- larger organizations, such as pension funds or mutual funds, invest their own funds of the fund of others Stock exchanges • An organization whose members can buy and sell securities for companies and investors o Over the counter (OTC) market- exchange that provides a means to trade stocks not listed on the national exchanges. Often bonds and currencies o NASDAQ (National Association of Securities Dealers Automated Quotations) a nationwide electronic system that communicates over the counter traders to brokers How businesses raise capital by selling stock Stocks • • • • Shares of ownership in a company Common stock- the most basic form of ownership in a firm o They can elect members of the company's board of directors and Bote on critical issues affecting the company, share in the firm's profits through dividends, and purchase new shares of common stock before anyone else Stock certificate- evidence of stock ownership that specifies the name of the company, the number of shares in represents, and the type of share begging issues Dividends- part of a firm's profits that the firm may distribute to stockholders as either cash payments or additional shares of stock o Over the long term a dividend can have a positive effect on the stock How businesses raise Captial by selling stock Advantages of issuing stock • • • Shareholders are owners of the firm and never have to be repaid for their investment There is no legal obligation to pay dividends Issuing stock can improve a firm's balance sheet since the stock does not create debt Disadvantages of issuing stock • • • Shareholders have the right to vote for a company's board of directors --> can alter the control of the firm Dividends are paid from after-tax profit and are not tax-deductible The need to keep stockholders happy can affect managers' decisions Accounting What is accounting? • The recording, classifying, summarizing, interpreting of all the financial events and transactions to provide management and other interested the information they need to make good decisions. • • • The method used to record and summarize accounting data into reports in an accounting system Stakeholders- those who have an interest in the business (employees, owners, creditors, unions, investors, government) make use of a firm's accounting information Accounting follows accepted accounting principles (GAAP) The Accounting Cycle Accounting cycle- a six step procedure that results in the preparation and analysis of the major financial statements • • 1. 2. 3. 4. 5. 6. Bookkeeping- the recording of business transitions o Bookkeepers record the transactions that the business has and post them into a record book or computer called a journal Double-entry bookkeeping- the practice of writing every business transaction into two places, done so they can check one list of transactions against the other for accuracy Analysis source documents (sales slips, travel records, etc.) Record transactions in journals Transfer journal entries to the general ledger Take a trial balance- are both documents the same? Prepare the financial statements Analyze financial statements Bookkeeper’s tools • • Ledger- a specialized accounting book or computer program in which information for accounting journals is accumulated into specific categories and posted so that managers can find all the information about one account in the same place Trial balance- a summary of all the financial data in the account ledgers that ensures the figures are correct and balanced Understanding key financial statements Fianacial statements- a summary of all the transactions that have occurred over a particular period 1. Balance sheet 2. Income statement 3. Statement of cash flow The accounting equation • Assets= liabilities + owners' equity o ALOE The Balance Sheet • • Reports a firm's financial condition at a specific time and is comprised of three major accounts: assets, liabilities, and owners' equity Assets = liability +owners' equity Classifying assets • Assets- economic resources (things of value) owned by a firm, items can be tangible or intangible • Liquidity- the ease with which an asset can be converted into cash Three categories of assets • • • Current assets- items that can or will be converted into cash within one year Fixed assets- assets that are permanent, such as land, buildings, and equipment Intangible assets- long-term assets (patents, trademarks, copyrights) that have no physical form but do have value Liabilities and Owners equity Accounts • Liabilities- what the business owes to others (debts). Common liability accounts: • • • Accounts payable- the current liabilities involving money owed to others for merchandise or services purchased on credit but not yet paid for Notes payable- short-term or long-term liabilities that a business promises to pay by a certain date Bonds payable- long- term liabilities that represent money lent to the firm that must be paid back Advantages of issuing bonds • • • • Bondholders are creditors, not owners, of the firm and cannot 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 are called Disadvantage of issuing bonds • • • Increase debt and can affect the market’s perception of the firm Paying interest on bonds is a legal obligation. If interest is not paid, bondholders can take legal action The face value of the bond must be repaid before the maturity date Owners' equity • • Owners' equity- the amount of the business that belongs to the owners minus any liabilities owned to the business o The part of the business that belongs to me minus what I owe Retained earnings- the accumulated earnings from a firm's profitable operation that were reinvested in the business and not paid out to stockholders in dividends The income statement • • The income statement- the financial statement that shows a firm's profit after costs, expenses, and taxes; it summarizes all the resources that have income into the firm (revenue), all the resources that have left the firm, expenses, and the resulting new income or net loss o Tell you if you are making money or not New income or new loss- revenue left over after all costs and expenses, including taxes are paid The formula for the income statement • • • Revenue - cost of goods sold = gross profit (gross margin) Gross profit – operating expenses = net income before taxes Net income before taxes – taxes = net income or loss An investment-banking firm underwrites a new issue of stocks and bonds by • buying the entire bond or stock issue a company wants to sell at an agreed-upon discount. preferred shares of the same company PART B QUESTIONS I GOT WRONG: Duong was trying to decide between purchasing the common stock shares of Longman Manufacturing, or preferred shares of the same company. As a student of business, you provide accurate information that • • preferred shareholders typically do not have voting rights. Companies are obligated to pay preferred shareholders their dividends before paying dividends to common stockholders. Explanation: Preferred stockholders have preference as to receiving dividends prior to any dividend distribution to common shareholders. Preferred shareholders rarely have voting rights in company decisions. They also have a prior claim on company assets if the firm is forced out of business and its assets sold.