Ass. Prof. Dr. Özgür KÖKALAN İstanbul Sabahattin Zaim University

Chapter Objectives

1.

2.

Define Financial Management Sources of Funds 5-2

Financial Management

 Financial management is the process of managing the tasks related with capital budgeting and financing decisions within the organizations.

Working Capital

 Working capital primarily focuses on the current assets and current (shortterm) liabilities of the firm. Current assets less current liabilities simply states the firm’s working capital.

 The difference between the current assets and liabilities is also called net working capital.

 If the current assets exceed the current liabilities we might say that the firm has positive net working capital. This is the usual and typical situation, Otherwise, if the current assets were less than the current liabilities, then the company would possibly face a problem.

Cash Forecast

Financial managers prepare cash forecasts to assess the possible movements of cash in the near future.

As we previously stated, the cash situation of the company, especially in the recession or in buyers’ market conditions, has ' vital influence over the company’s achievements and survival. Therefore any organization in business should give utmost attention to its cash management.

Sources of Funds

 To operate a business, organizations need assets. The assets needed should be purchased by utilizing the company’s funds.  Organizations have two sources from which they can raise the’r needed funds. These sources are:  Equity Capital  Debt Capital

Equity Capital

 Funds raised from the organization’s shareholders are called equity capital. owners and  Equity capital is not borrowed money, therefore it is not supposed to be paid back to its providers. The owners or shareholders provide the funds to their organization and seek profit at the end of a specific period.

 When they seek the profit from business, they also take the risk of losing the money if the organization fails.

 Equity capital is provided through an owner’s cash or non cash investments in starting a business.

 One popular type of equity capital is venture capital.

Capital owners investing their money in the new, young and untried businesses in return for the excess profits is called venture capital.

 This capital investment is risky/

Debt Financing

     Funds raised through borrowing from creditors is called debt capital. Debt capital is a borrowed fund and therefore should be paid back to its provider (creditor) at a specified date, usually with interest payments. Creditors do not have managing rights in operations, since they are not the owners or stockholders. .

They only lend the money to be paid back to them at a specific time. But they have priority claims before the owners or shareholders on company assets.

 Creditors more be concerned about the organization’s giving them a guarantee for their lent funds to be paid with the interest at the maturity date. Many lenders may ask the borrower to give some concrete guarantees for their re-payment at the maturity date. Secured loans are those that provide guarantee for the lender given by the borrower in the form of bonds, assets and security deposits or mortgages.

 Unsecured loans do not provide any guarantee for the lender and therefore are more risky than secured loans

 Debt capital can be classified as short- or long-term debt.

 Short Term Debt: The debts to be paid back in less than one year are commonly called short-term debts.  These debts are used to meet the current needs for cash or inventory.

 Some common types of short-term debts are the trade credits, bank loans, commercial papers, and factoring.

   Trade Credit, is one of the primary sources of short-term debt that is provided by suppliers to finance the organization's purchasing goods and services from them.

These credits could be in unsecured or secured form.

Bank Loans, are the simplest and most common form of short-term debt provided by a commercial bank to finance the organization’s cash needs. These loans also can be in unsecured or secured form.

Commercial Papers, is one of the safe style of loans that enables the borrower to bypass the bank system. In this type, the organization (borrower) issues its own short term, unsecured notes (bonds) and sells them in the money market. Commercial papers should be paid back at the maturity date with interest. . The most common commercial paper maturity ranges up to 9 months

 Factoring, is another type of short-term loan.

Organizations sometimes sell their receivables collected from their customers with a discounted price to a financial institution (factoring companies) before the due time. Factoring companies (usually called factor), in turn, pay the organization immediately and collect the money from the principal debtors (customers of the borrower) on the maturity date.

Long Term Debts

Long term loans issued by financial institutions can benefit by usually large companies.

Financial institutions like banks sometimes receive huge international long-term credit facilities to be used to finance long term needs of the several recognized large companies in the national economy.

There are many kinds of long term debts. These are:  Corporate bonds  Financial leasing  Banks

   Corporate bonds are one of the long-term borrowing means by which organizations borrow money directly from the public. These bonds usually pay annual or semiannual coupons. Some of these bonds that give the bondholder an option to exchange each bond with specified number of shares of the common stocks of the organization are called

convertible bonds.

Financial Leasing is defined as a long-term rental agreement. Many companies lease or rent their assets such as machinery or equipment on a long-term basis instead of buying these assets with borrowed money. When the organization decides not to invest for its needed assets, it goes to a leasing company to make a long-term rental agreement for those assets. A leasing company (called lessor) pays the bill to the supplier and owns the assets.

Banks are the financial intermediaries that raise funds by borrowing money generated from individual savings and lend that money to other borrowers in the market.

Financial Markets, Instruments and Players

 Financial markets, are those in which the companies and governments raise funds by selling financial assets to the fund owners.  The major players in the financial markets are as follows:  Companies and institutions that seek funds by issuing financial assets to finance their various investments and operations are the primary borrowers in the market.

 Individuals in society are typically the net savers and seek financial assets that would maximize the return on their investment.

 Governments may act as the borrower/lender depending on their budgets. Their revenue/expenditure relationship determines its role as a borrower or lender.

 Other important players in the financial markets are the

financial market regulators

and the

financial

intermediaries. Intermediaries connect the lenders with the borrowers. They receive funds from the lenders and loans the same to the borrowers.Institutions like banks, investment companies, insurance companies and credit unions are examples of financial intermediaries.

 Financial markets are classified as money markets and capital markets.

 Money Market Players, The principal regulator and player in the money market that carries out money and credit policy in accordance with the needs of the economy is the Turkish Central Bank (TCB). The TCB regulates money markets in the country and sets rediscount ratios. It also executes treasury operations and takes all measures to protect the Turkish currency.

 Financial leasing companies, are also special business finance companies like factoring companies. They specialize in financing companies through long term rental agreements, They first purchase and then lease the assets to interested organizations for a set number of years.

    Investment bankers specialize in the sale of new com mercial papers and securities to the public while professional investment companies manage the money of investors such as individuals and companies, and institutions such as mutual funds.

Insurance companies protect the policyholders in return for their premium payments. These companies use these funds generated by policyholders to make long-term loans to companies and/or invest in government bonds.

Credit unions are member-owned financial cooperatives that pay interest to their member depositors and make loans to interested individuals.

Factoring companies are special business finance companies that provide specialized forms of short term , credits to businesses/

Money Market Instruments

 Money market instruments include short-term, marketable, highly liquid and low risk debt papers.

Some popular instruments in the money market are.

   Treasury bills are short-term papers issued by the government at discount prices to finance its spendings.

Certificates of deposit (CD) are time deposits issued by a bank stating that deposited money is payable at maturity.

Commercial papers are short-term, usually unsecured, debt issued by large organizations to be paid by the borrower at the maturity date.

 Repos (also called repurchase agreements) are a form of short-term, usually overnight, borrowings

Capital Market Players

   The Capital Markets Board (CMB) is the regulatory and supervisory authority in charge of security markets in Turkey empowered by the capital market law.

The Istanbul Stock Exchange (ISE) Borsa Istanbul.

was established as the only security exchange in Turkey to provide trading in equities, bonds and bills, revenue sharing certificates, private sector bonds, foreign securities and real estate certificates.

Intermediaries, such as investment companies including real estate and venture capital investment companies, mutual funds and private intermediaries, are licensed to operate in the capital markets regulated by the capital markets board.

Capital Market Instruments

 Capital markets include longer-term, relatively riskier diversified securities.This market can also be subclassified as longer-term fixed income markets, equity markets and

derivative markets for options and futures.

 The fixed-income capital market is composed of longer term securities like corporate bonds. The bonds usually are issued with maturities ranging from 5 to 30 years and make semiannual or annual interest payments to the holders.

 The equity market is composed of common or preferred stocks, which represent ownership shares in the corporations.

 Derivative markets are founded as a result of a great demand coming from financial institutions for risk reduction. The practice of offsetting risks is usually known as hedging.  Some new financial instruments help financial institution managers administer their risks in a better way, These financial instruments, called derivatives (or financial derivatives), are extremely useful risk reduction tools.

 They provide payoffs that are linked to the values of other assets such as previously issued bonds and securities, commodity prices or market index values.

Some samples of derivatives markets are; option markets, future markets, forward markets and swaps.

 Option market: To limit their downside risk managers buy options on commodities and currencies.

Options are contracts that give the buyer (the buyer of the option contract) the right to purchase or sell the commodities or instruments at a specified price agreed upon today (exercise price) within a specific period of time.

 Future market: Future contracts are agreements to purchase or sell an asset at a specified price set today at a specified date in the future

 Forward market: As we stated above the future contracts are usually standardized products that are tradable. They can be sold and purchased in the market. A forward contract is a typical future contract but tailor-made for the parties involved.

 Swaps are financial agreements that put one party under responsibility to exchange (swap) a set of payments it has for another set of payments owned by another party. There are two basic swaps: currency swaps involve the currency exchange and interest rate swaps involve the exchange of interest payments.