Bus106 wk12 ch11 financial management

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BUS106 Financial Management - from UNDERSTANDING CANADIAN BUSINESS, 7th Canadian Edition (custom publication for Seneca); published by McGraw-Hill

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Bus106 wk12 ch11 financial management

  1. 1. Week 12, Chapter 11 Financial Management
  2. 2. Agenda Review Chapter 10 Financial Management Exercises/Discussion
  3. 3. Learning Objectives Importance of finance and financial management; responsibilities of financial managers The financial planning process and three key budgets Why firms need operating funds and where they find them Sources of short-term financing Sources of long-term financing
  4. 4. Finance: the business function that is responsible for cash – getting funds for the company and managing those funds within the company
  5. 5. Financial managers are responsible for seeing that the company pays its bills – Figure 11.1 A key responsibility is to obtain money and then control the use of that money effectively.
  6. 6. The Importance of Understanding Finance It’s vital that financial managers in any business stay abreast of changes and opportunities in finance and adjust to them. Financial managers also carefully analyze the tax implications of various managerial decisions in an attempt to minimize the taxes paid by the business. Image source: http://www.flickr.com/photos/duckiemonster/
  7. 7. Financial Planning – Figure 11.2
  8. 8. Forecasting financial needs is an important part of any firm’s financial plan. A short-term forecast predicts revenues, costs, and expenses for a period of one year or less. Part of the short-term forecast may be in the form of a cash flow forecast, which predicts the cash inflows and outflows in future periods, usually months or quarters. Image source: http://www.flickr.com/photos/horiavarlan/
  9. 9. A long-term forecast predicts revenues, costs, and expenses for a period longer than one year, and sometimes as far as five or ten years into the future. This forecast plays a crucial part in the company’s long-term strategic plan.
  10. 10. A budget sets forth management’s expectations for revenues and, on the basis of those expectations, allocates the use of specific resources throughout the firm. The budgeting process depends on the accuracy of the firm’s financial statements. Image source: http://www.flickr.com/photos/8759111@N02/
  11. 11. Budget Process Cash Flow Statement Income Statement Balance Sheet A budget is a financial plan.
  12. 12. There are usually several types of budgets established in a firm’s financial plan FINANCIAL PLAN capital budget cash budget operating (master) budget
  13. 13. The operating (master) budget ties together all of the firm’s other budgets and summarizes the business’s proposed financial activities. It s generally the most detailed. Image source: http://www.flickr.com/photos/gigile/ MASTER
  14. 14. A capital budget highlights a firm’s spending plans for major asset purchases that often require large sums of money.
  15. 15. A cash budget estimates a firm’s projected cash inflows and outflows that the firm can use to plan for any cash shortages or surpluses during a given period. Cash budgets are important guidelines that assist managers in anticipating borrowing, debt repayment, operating expenses, and short-term investments.
  16. 16. Establishing Financial Controls Financial control is a process in which a firm periodically compares its actual revenues, costs, and expenses with its budget. Most companies hold at least monthly financial reviews as a way to ensure financial control.
  17. 17. In virtually all organizations, there are certain needs for which funds must be available. Key areas include: Managing day-to-day needs of the business Controlling credit operations Acquiring needed inventory Making capital expenditures
  18. 18. Managing Day-to-Day Cash Needs of the Business “Time value” of money Pay as late as possible! Collect as early as possible! Challenge is to see that funds are available to meet daily cash needs without tying up funds that could be used for investment.
  19. 19. Controlling Credit Operations The major problem with selling on credit is that a large percentage of a non-retailer’s business assets could be tied up in its credit accounts (accounts receivable).
  20. 20. Acquiring Inventory Effective marketing implies a clear customer orientation. To satisfy customers, businesses must maintain inventories that often involve a sizable expenditure of funds. It’s important for a business of any size to understand that a poorly managed inventory system can seriously affect cash flow and drain its finances dry. Image source: http://www.flickr.com/photos/fdecomite/
  21. 21. Making Capital Expenditures Capital expenditures are major investments in either tangible long-term assets such as land, buildings, and equipment, or intangible assets such as patents, trademarks, and copyrights. These expenditures often require a huge portion of the organization’s funds.
  22. 22. Alternative Sources of Funds ShortTerm Financing Trade Credit Promissory Notes Family/Friends Banks, etc. Secured Loan Unsecured Loan Factoring Commercial Paper Long-Term Financing Debt Financing • Term-Loan • Selling Bonds Equity Financing Retained Earnings Venture Capital Selling Stock
  23. 23. Obtaining Short-term Financing The day-to-day operation of the firm calls for the careful management of short-term financial needs. Firms need to borrow short-term funds for purchasing additional inventory or for meeting bills that come due. Trade credit is the practice of buying goods or services now and paying for them later.
  24. 24. Obtaining Short-term Financing Trade credit It is common for business invoices to contain items such as 2/10, net 30. This means that the buyer can take a 2 percent discount if the invoice is paid within 10 days. The total bill is due (net) in 30 days if the purchaser does not take advantage of the discount.
  25. 25. Obtaining Short-term Financing A promissory note is a written contract with a promise to pay a supplier a specific sum of money at a definite time. Promissory notes can be sold by the supplier to a bank at a discount.
  26. 26. Obtaining Short-term Financing Many small firms obtain short-term funds by borrowing money from family and friends. Image source: http://images1.fanpop.com Because such funds are needed for periods of less than a year, friends or relatives are sometimes willing to help and the normal steps to obtain this type of funding are minimal.
  27. 27. Banks are highly sensitive to risk and are often reluctant to lend money to small, relatively new, businesses. Obtaining Short-term Financing commercial banks & other financial institutions
  28. 28. Obtaining Short-term Financing A secured loan is a loan that is backed by something valuable, such as property. The item of value is called collateral. If the borrower fails to pay the loan, the lender may take possession of the collateral.
  29. 29. Obtaining Short-term Financing The most difficult kind of loan to get from a bank or other financial institution is an unsecured loan. An unsecured loan doesn’t require a borrower to offer the lending institution any collateral to obtain the loan. The loan is not backed by any assets.
  30. 30. Obtaining Short-term Financing If a business develops a good relationship with a bank, the bank may open a line of credit for the firm. A line of credit is a given amount of unsecured funds a bank will lend to a business. In other words, a line of credit is not guaranteed to a business.
  31. 31. Obtaining Short-term Financing As businesses mature and become more financially secure, the amount of credit is often increased, much like the credit limit on your credit card. Some firms will even apply for a revolving credit agreement, which is a line of credit that’s guaranteed.
  32. 32. Obtaining Short-term Financing If a business is unable to secure a short- term loan from a bank, a financial manager may obtain short- term funds from commercial finance companies. These non-deposit types of organizations (often called non-banks) make short-term loans to borrowers who offer tangible assets.
  33. 33. Obtaining Short-term Financing Factoring Accounts Receivable One relatively expensive source of short-term funds for a firm is factoring, which is the process of selling accounts receivable for cash.
  34. 34. Obtaining Short-term Financing Sometimes a large corporation needs funds for just a few months and wants to get lower rates of interest than those charged by banks. One strategy is to sell commercial paper. Commercial paper consists of unsecured promissory notes, in amounts of $100,000 and up, that mature (come due) in 365 days
  35. 35. Obtaining Short-term Financing Readily available line of credit Convenient Extremely risky Costly (interest rates) Best used as a last resort Image source: http://www.flickr.com/photos/andresrueda/
  36. 36. Obtaining Long-Term Financing In setting long-term financing objectives, financial managers generally ask three major questions: 1. What are the organization’s long-term goals and objectives? 2. What are the financial requirements needed to achieve these long-term goals and objectives? 3. What sources of long-term capital are available?
  37. 37. Obtaining Long-Term Financing Firms can borrow funds by either getting a loan from a lending institution or issuing bonds. Debt financing involves borrowing money that the company has a legal obligation to repay.
  38. 38. Obtaining Long-Term Financing Debt Financing by Borrowing Money from Lending Institutions A term-loan agreement is a promissory note that requires the borrower to repay the loan in specified instalments (e.g., monthly or yearly). A major advantage of a business using this type of financing is that the interest paid on the long- term debt is tax-deductible but there is a risk/return trade-off
  39. 39. Obtaining Long-Term Financing Debt Financing by Issuing Bonds A bond is a long-term debt obligation of a corporation or government. A company that issues a bond has a legal obligation to make regular interest payments to investors and to repay the entire bond principal amount at a prescribed time, called the maturity date. Image source: http://www.jamesbondwallpapers.com
  40. 40. Equity Financing Equity financing involves selling stock (ownership in the firm), or using earnings that have been retained by the company to reinvest in the business (retained earnings). A business can also seek equity financing by selling ownership in the firm to venture capitalists.
  41. 41. Equity Financing Stocks represent ownership in a company. Both common and preferred shares form the company’s capital stock, also known as equity capital. The purchasers of stock become owners in the organization. The number of shares of stock that will be available for purchase is generally decided by the organization’s board of directors. The first time a corporation offers to sell new stock to the general public is called an initial public offering (IPO).
  42. 42. Common stock • a firm sells ownership rights by issuing shares • investors buy the stock hoping that it will appreciate Retained earnings • financing by retaining profits in the firm and not paying dividends to shareholders Equity Financing from Retained Earnings Retained earnings are often a major source of long-term funds, especially for small businesses, which have fewer financing alternatives, such as selling bonds or stock, than large businesses do.
  43. 43. Equity Financing from Venture Capital A start-up business typically has few assets and no market track record, so the chances of borrowing significant amounts of money from a bank are slim. Venture capital is money that is invested in new or emerging companies that are perceived as having great profit potential. Venture capital firms are a possible source of start-up capital for new companies or companies moving into expanding stages of business.
  44. 44. Equity Financing – issuing common shares A stock certificate is evidence of stock ownership that specifies the name of the company, the number of shares it represents, and the type of stock being issued. Dividends are part of a firm’s profits that may be distributed to shareholders as either cash payments or additional shares of stock. Common shares are the most basic form of ownership in a firm. In fact, if a company issues only one type of stock, it must be common. Image source: http://commons.wikimedia.org/
  45. 45. Equity Financing – issuing preferred shares Owners of preferred shares enjoy a preference (hence the term preferred) in the payment of dividends; they also have a prior claim on company assets if the firm is forced out of business and its assets are sold. Image source: http://www.denverstockexchange.com
  46. 46. Differences Between Debt and Equity Financing – Figure 11.5 TYPE OF FINANCING Debt Equity Management influence There’s usually none unless special conditions have been agreed on. Common shareholders have voting rights. Repayment Debt has a maturity date. Principal must paid. Stock has no maturity date. The company is never required to repay equity. Yearly obligations Payment of interest is a contractual obligation. The firm isn’t usually liable to pay dividends. Tax issues Interest is tax deductible. Dividends are paid from after-tax income and aren’t deductible.
  47. 47. Comparison of Bonds and Stock of Public Companies – Figure 11.7 Bonds Common Shares Preferred Shares Interest or Dividends Must be paid Yes No Depends Pays a fixed rate Yes No Usually Deductible from payor’s income tax Yes No No Canadian payee is taxed at reduced rate No Yes (if payor is Canadian) Yes (if payor is Canadian) Stock or bond Has voting rights No Yes Not normally May be traded on the stock exchange Yes Yes Yes Can be held indefinitely No Yes Depends Is convertible to common shares Maybe No Maybe
  48. 48. Chapter Summary Importance of finance and financial management; responsibilities of financial managers The financial planning process and three key budgets Why firms need operating funds and where they find them Sources of short-term financing Sources of long-term financing
  49. 49. 50 Homework

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