Transcript Slide 1

Financial Management
Chapter 18
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Chapter 18 Objectives
After studying this chapter, you will be able to:
• Identify three fundamental concepts that affect
financial decisions and identify the primary
responsibilities of a financial manager.
• Describe the budgeting process, three major
budgeting challenges, and the four major types of
budgets.
• Compare the advantages and disadvantages of
debt and equity financing and explain the two
major considerations in choosing from financing
alternatives.
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Chapter 18 Objectives Cont.
• Identify the major categories of short-term debt
financing.
• Identify the major categories of long-term
financing.
• Describe the two options for equity financing and
explain how companies prepare an initial public
offering.
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The Role of Financial
Management
Financial Management:
Planning for a firm’s money needs and
managing the allocation and spending of funds.
• Balancing short-term and long-term demands
• Risk / return trade-off
• Balancing leverage and flexibility
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Financial Management: Three
Fundamental Concepts
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Developing a Financial Plan
Financial Plan: A document that outlines the
funds needed for a certain period of time, along
with the sources and intended uses of those funds.
The financial plan takes its input from three
information sources:
• Strategic plan
• Company’s financial statements
• External financial environment
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Finding and Allocating Funds
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Managing Accounts Receivable
and Accounts Payable
Accounts Receivable:
Accounts Payable:
Amounts that are
currently owed to a firm.
Amounts that a firm
currently owes to other
parties.
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Monitoring the Working
Capital Accounts
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The Budgeting Process
• Budget: A planning and control tool that
reflects expected revenues, operating expenses,
and cash receipts and outlays.
• Top down: Top executives specify amount of
money for each functional area.
• Bottom up: Individual supervisors add up
amounts needed based on number of
employees and expenses.
• Financial Control: The process of analyzing
and adjusting the basic financial plan to correct
for deviations from forecasted events.
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Budgeting Challenges
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The Budgeting Process
Hedging:
Protecting against cost increases with contracts
that allow a company to buy supplies in the
future at designated prices.
Zero-Based Budgeting:
A budgeting approach in which each year starts
from zero and must justify every item in the
budget, rather than simply adjusting the
previous year’s budget amounts.
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Types of Budgets
Start-up
Operating
Capital
Project
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Types of Budgets
Start-up budget (launch budget) identifies all the
money it will need to launch the business.
Operating budget (master budget) identifies all
sources of revenue and coordinates the spending of
those funds throughout the coming year.
Capital budget outlines expenditures for real estate,
new facilities, major equipment, and other capital
investments (Money paid to acquire something of
permanent value in a business).
Project budget identifies the costs needed to
accomplish a particular project.
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Financing Alternatives
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Debt versus Equity Financing
Debt financing; Arranging funding by borrowing money.
Equity financing; Arranging funding by selling ownership
shares in the company, publicly or privately.
When choosing between debt and equity financing,
companies consider a variety of issues;
• prevailing interest rates
• maturity
• the claim on income
• the claim on assets
• desire for ownership control
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Financing Alternatives
Short-term financing is any financing that
will be repaid within one year
Long-term financing is any financing that
will be repaid in a period longer than one year.
A company’s cost of capital is the average rate of
interest it must pay on its debt and equity financing.
The prime interest rate (often called simply the
prime) is the lowest interest rate offered on shortterm bank loans to preferred borrowers.
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Financing Alternatives
Leverage:
The technique of increasing the rate of return
on an investment by financing it with borrowed
funds.
Capital Structure :
A firm’s mix of debt and equity financing.
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Short-Term Financing Options
•
•
•
•
•
•
Credit cards
Trade credit
Secured loans
Unsecured loans
Commercial paper
Factoring and Accounts Receivables
Auctions
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Short-Term Financing Options
Credit cards are one of the most expensive forms
of financing, but they are sometimes the only form
available to business owners.
Trade credit, often called open-account
purchasing, occurs when suppliers provide goods
and services to their customers without requiring
immediate payment.
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Short-Term Financing Options
Secured loans are those backed by
something of value, known as collateral, that may
be seized by the lender in the event that the
borrower fails to repay the loan.
Unsecured loans are ones that require no
collateral. Instead, the lender relies on the
general credit record and the earning power of
the borrower.
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Short-Term Financing Options
Compensating Balance:
The portion of an unsecured loan that is kept on
deposit at a lending institution to protect the
lender and increase the lender’s return.
Line of Credit :
An arrangement in which a financial institution
makes money available for use at any time after
the loan has been approved.
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Short-Term Financing Options
When businesses need a sizable amount of money for
a short period of time, they can issue commercial
paper—short-term promissory notes, or contractual
agreements, to repay a borrowed amount by a
specified time with a specified interest rate.
Businesses with slow-paying trade credit customers
and tight cash flow have the option of selling their
accounts receivable, a method known as factoring;
where a company sells its accounts receivable to an
intermediary that collects from the customer.
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Sources of Long-Term Debt
Financing
Long-term
loans
Corporate
Bonds
Leases
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Sources of Long-Term Debt
Financing
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Long-Term Financing Options
Long-term loans, sometimes called term loans,
can have maturities between 1 and 25 years or
so, depending on the lender and the purpose of
the loan.
The Five C’s
Character
Capacity
Conditions
Capital
Collateral
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Long-Term Financing Options
Lease: An agreement to use an asset in
exchange for regular payment; similar to renting.
Rather than borrowing money to purchase an
asset, a firm may enter into a lease, under which
the owner of an asset (the lessor) allows another
party (the lessee) to use it in exchange for regular
payments.
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Long-Term Financing Options
When a company needs to borrow a large sum of
money, it may not be able to get the entire amount
from a single source. Under such circumstances, it
may try to borrow from many individual investors by
issuing bonds—certificates that obligate the
company to repay a certain sum, plus interest, to
the bondholder on a specific date.
• Secured bonds
• Debentures
• Convertible bonds
• Sinking fund
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Corporate Bonds
Secured Bonds: Bonds backed by specific assets that
will be given to bondholders if the borrowed amount is
not repaid.
Debentures: Corporate bonds backed only by the
reputation of the issuer.
Convertible Bonds: Corporate bonds that can be
exchanged at the owner’s discretion into common stock
of the issuing company
Sinking fund: When a corporation issues a bond
payable by asinking fund, it must set aside a certain
sum of money each year to pay the dept.
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Equity Financing
• Venture capital
• Going public
Private Equity: Ownership assets that aren’t publicly
traded; includes venture capital.
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Public Stock Offerings
Preparing the IPO
Registering the IPO
Selling the IPO
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Public Stock Offerings
Underwriter:
A specialized type of bank that buys the shares
from the company preparing an IPO and sells
them to investors.
Prospectus:
An SEC-required document that discloses required
information about the company, its finances, and
its plans for using the money it hopes to raise.
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