Chapter 16 Mastering Financial Management

Chapter 16: Mastering Financial Management 16-1: Why Financial Management? o Understand why financial management is important in today’s competitive economy. o Financial management consists of all the activities concerned with obtaining money and using it effectively. Financial management can be viewed as a two-sided problem. On one side, the uses of funds often dictate the type or types of financing needed by a business. On the other side, the activities a business can undertake are determined by the types of financing available. Financial managers must ensure that funds are available when needed, that they are obtained at the lowest possible cost, and that they are used as efficiently as possible. The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law to stabilize the economy, improve oversight of the financial industry, and protect consumers. And today, there is an ongoing debate if more regulations are needed. Still, there are a number of rewarding jobs in finance for qualified job applicants. 16-2: The Need for Financing o Identify a firm’s short- and long-term financial needs. o Short-term financing is money that will be used for one year or less. There are many short-term needs, but cash flow, speculative production, and inventory are three for which financing is often required. Long-term financing is money that will be used for more than one year. Such financing may be required for a business start-up, for a merger or an acquisition, for new product development, for long-term marketing activities, for replacement of equipment, or for expansion of facilities. According to financial experts, business firms will find it more difficult to raise both short- and long-term financing in the future because of increased regulations and more cautious lenders. Financial managers must also consider the risk–return ratio when making financial decisions. 16-3: Planning—The Basis of Sound Financial Management o Summarize the process of planning for financial management. o A financial plan begins with an organization’s goals and objectives. Next, a firm’s goals and objectives are “translated” into departmental budgets that detail expected income and expenses. From these budgets, which may be combined into an overall cash budget, the financial manager determines what funding will be needed. Whereas departmental and cash budgets emphasize short-term financing needs, a capital budget can be used to estimate a firm’s expenditures for major assets and its long-term financing needs. The four principal sources of financing are sales revenues, equity capital, debt capital, and proceeds from the sale of assets. Once the needed funds have been obtained, the financial manager is responsible for monitoring and evaluating the firm’s financial activities. 16-4: Financial Services Provided by Banks and other Financial Institutions o Identify the services provided by banks and financial institutions for their business customers. o Banks and other financial institutions offer today’s business customers a tempting array of services. Among the most important banking services are savings accounts and certificates of deposit, checking accounts, short- and long-term loans, and credit-card and debit-card processing. Increased use of electronic funds transfer systems (automated teller machines, automated clearinghouse systems, point-of-sale terminals, and electronic check conversion) also will change the way that business firms bank and conduct typical business transactions. For firms in the global marketplace, a bank can provide letters of credit and banker’s acceptances that will reduce the risk of nonpayment for sellers. Banks and financial institutions also can provide currency exchange to reduce payment problems for import or export transactions. 16-5: Sources of Short-Term Debt Financing o Describe the advantages and disadvantages of different methods of short-term debt financing. o Most short-term financing is unsecured; that is, no collateral is required. Sources of unsecured short-term financing include trade credit, promissory notes issued to suppliers, unsecured bank loans, and commercial paper. Sources of secured short-term financing include loans secured by inventory and accounts receivable. A firm may also sell its receivables to factors. Trade credit is the least-expensive source of short-term financing. The cost of financing through other sources generally depends on the source and on the credit rating of the firm that requires the financing. Factoring is generally the most expensive approach. 16-6: Sources of Equity Financing o Evaluate the advantages and disadvantages of equity financing. o The first time a corporation sells stock to the general public is referred to as an initial public offering (IPO). With an IPO, the stock is sold in the primary market. Once sold in the primary market, investors buy and sell stock in the secondary market. Usually, secondary market transactions are completed through a securities exchange or the over-the-counter market. Common stock is voting stock; holders of common stock elect the corporation’s directors and often must approve major corporate actions. Holders of preferred stock must be paid dividends before holders of common stock are paid any dividends. Another source of equity funding is retained earnings, which is the portion of a business’s profits not distributed to stockholders. Venture capital—money invested in small (and sometimes struggling) firms that have the potential to become very successful—is yet another source of equity funding. Angel investors can also provide the money needed to start or expand small businesses. Finally, a private placement can be used to sell stocks and other corporate securities. 16-7: Sources of Long-Term Debt Financing o Evaluate the advantages and disadvantages of long-term debt financing. o For a small business, debt financing is generally limited to loans. Large corporations have the additional option of issuing corporate bonds. Regardless of whether the business is small or large, it can take advantage of financial leverage. Financial leverage is the use of borrowed funds to increase the return on owners’ equity. The rate of interest for long-term loans usually depends on the financial strength of the borrower, the reason for borrowing, and the kind of collateral pledged to back up the loan. Long-term business loans are normally repaid in 3 to 7 years but can be as long as 15 to 20 years. Money realized from the sale of corporate bonds must be repaid when the bonds mature. In addition, the corporation must pay interest from the time the bonds are issued until maturity. Maturity dates for bonds generally range from one to 30 years after the date of issue. Three types of bonds—debentures, mortgage bonds, and convertible bonds—are sold to raise debt capital. When comparing the cost of long-term financing, the ongoing costs of using stock (equity) to finance a business are low. The most expensive is a long-term loan (debt).