This document provides an overview of financial management and short-term financing options. It begins with learning objectives about the role of financial managers, the financial planning process, and sources of short-term and long-term financing. It then discusses key needs for operational funds in firms and different types of short-term financing available, including trade credit, promissory notes, and loans from commercial banks.

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CHAPTER 16
Financial
Management

2. ©McGraw-Hill Education.
LEARNING OBJECTIVES
1. Explain the role and responsibilities of financial
managers.
2. Outline the financial planning process, and explain
the three key budgets in the financial plan.
3. Explain why firms need operating funds.
4. Identify and describe different sources of short-term
financing.
5. Identify and describe different sources of long-term
financing.

3. ©McGraw-Hill Education.
SABRINA SIMMONS
Gap
• Simmons earned her
bachelor’s in finance at UC-
Berkeley and her MBA at
UCLA.
• Joined Gap as treasurer in
2001, balanced the books, and
eliminated the reliance on risky
investments.
• Encourages Gap to not be
afraid to create new brands,
even after failure. Photo credit: © Kim White/Bloomberg/Getty Images

4. ©McGraw-Hill Education.
NAME that COMPANY
This company spends over $6 billion a year on
research to develop new products even though it
may take as long as ten years before the products
are approved and introduced to the market. Since
long-term funding is very critical in our business,
high-level managers are very involved in the finance
decisions.
Name that company!

5. ©McGraw-Hill Education.
WHAT’S FINANCE? LO 16-1
Finance -- The function in a business that acquires
funds for a firm and manages them within the firm.
Finance activities include:
- Preparing budgets
- Creating cash flow analyses
- Planning for expenditures

6. ©McGraw-Hill Education.
FINANCIAL MANAGEMENT LO 16-1
Financial Management -- The job of managing a
firm’s resources to meet its goals and objectives.
Photo credit: D. Hurst / Alamy

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FINANCIAL MANAGERS LO 16-1
Financial Managers -- Examine financial data and
recommend strategies for improving financial
performance.
Financial managers are
responsible for:
- Paying company bills
- Collecting payments
- Staying abreast of market
changes
- Assuring accounting accuracy Photo credit: Ingram Publishing

8. ©McGraw-Hill Education.
WHO’S WHO in FINANCE LO 16-1
CFO -- Chief Financial Officer
CFP -- Certified Financial Planner
CFA -- Chartered Financial Analyst
Comptroller -- Chief Accounting Officer

9. ©McGraw-Hill Education.
FOUR SIGNS YOU NEED a CFO LO 16-1
1. You do not have information on key items like
cash flow, working capital, or forecasts.
2. No one is carefully watching and analyzing your
expenses.
3. You are not aware of regulatory changes that
could affect your business.
4. You are unable to generate financial reports.
Source: Karen Stern, St. Louis Small Business Monthly, January 2014.

10. ©McGraw-Hill Education.
WHAT FINANCIAL
MANAGERS DO LO 16-1
Jump to Appendix 1 for long image description

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WHAT WORRIES
FINANCIAL MANAGERS LO 16-1
• Consumer demand for their firm’s products
• Credit markets and interest rates
• Financial regulations from the government
• Volatility of the dollar
• Foreign competition
• Environmental regulations
Source: CFO Magazine, www.cfo.com, accessed November 2014.

12. ©McGraw-Hill Education.
WHY DO FIRMS
FAIL FINANCIALLY? LO 16-1
1) Undercapitalization
2) Poor control over cash
flow
3) Inadequate expense
control
Photo credit: © Montgomery Martin / Alamy

13. ©McGraw-Hill Education.
TOP FINANCIAL CONCERNS
of COMPANY CFOs - MACRO LO 16-1
• Consumer demand
• Federal-government policies
• Price pressure from
competitors
• Credit markets/interest rates
• Global financial instability
Source: CFO Magazine, www.cfo.com, accessed November 2014.
Photo credit: (c) Lars Niki

14. ©McGraw-Hill Education.
TOP FINANCIAL CONCERNS
of COMPANY CFOs - MICRO LO 16-1
• Ability to maintain margins
• Ability to forecast results
• Maintaining morale/productivity
• Cost of healthcare
• Working-capital management
Source: CFO Magazine, www.cfo.com, accessed November 2014.

15. ©McGraw-Hill Education.
FINANCIAL PLANNING 1 of 2 LO 16-2
Financial planning involves analyzing short-term and
long-term money flows to and from the company.
Three key steps of financial planning:
1. Forecasting the firm’s short-term and long-term financial
needs.
2. Developing budgets to meet those needs.
3. Establishing financial controls to see if the company is
achieving its goals.

16. ©McGraw-Hill Education.
FINANCIAL FORECASTING LO 16-2
Short-Term Forecast -- Predicts revenues, costs and
expenses for a period of one year or less.
Cash-Flow Forecast -- Predicts the cash inflows and
outflows in future periods, usually months or quarters.
Long-Term Forecast -- Predicts revenues, costs, and
expenses for a period longer than one year and
sometimes as long as five or ten years.

17. ©McGraw-Hill Education.
BUDGETING LO 16-2
Budget -- Sets forth management’s expectations for
revenues and allocates the use of specific resources
throughout the firm.
• Budgets depend heavily on the balance sheet,
income statement, statement of cash flows and
short-term and long-term financial forecasts.
• The budget is the guide for financial operations
and expected financial needs.

18. ©McGraw-Hill Education.
TYPES of BUDGETS LO 16-2
Capital Budget -- Highlights a firm’s spending plans for
major asset purchases that often require large sums of
money.
Cash Budget -- Estimates cash inflows and outflows
during a particular period like a month or quarter.
Operating (Master) Budget -- Ties together all the
firm’s other budgets and summarizes its proposed
financial activities.

19. ©McGraw-Hill Education.
FINANCIAL PLANNING 2 of 2 LO 16-2
Jump to Appendix 2 for long image description

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ESTABLISHING
FINANCIAL CONTROL LO 16-2
Financial Control -- A
process in which a firm
periodically compares its actual
revenues, costs and expenses
with its budget.
Photo credit: © Image Source, all rights reserved.

21. ©McGraw-Hill Education.
FACTORS USED in ASSESSING FINANCIAL
CONTROL LO 16-2
• Is the firm meeting its short-term financial
commitments?
• Is the firm producing adequate operating profits on
its assets?
• How is the firm financing its assets?
• Are the firms owners receiving an acceptable
return on their investment?

22. ©McGraw-Hill Education.
TEST PREP 1 of 4
1. Name three finance functions important to the
firm’s overall operations and performance.
2. What three primary financial problems cause
firms to fail?
3. How do short-term and long-term financial
forecasts differ?
4. What’s the purpose of preparing budgets? Can
you identify three different types of budgets?

23. ©McGraw-Hill Education.
KEY NEEDS for OPERATIONAL
FUNDS in a FIRM LO 16-3
• Managing day-by-day
needs of the business
• Controlling credit
operations
• Acquiring needed
inventory
• Making capital
expenditures
Photo credit: © ICP/age fotostock

24. ©McGraw-Hill Education.
HOW SMALL BUSINESSES
CAN IMPROVE CASH FLOW LO 16-3
• Be more aggressive in collecting accounts
receivable.
• Offer customers discounts for paying early.
• Take advantage of special payment terms from
vendors.
• Raise prices.
• Use credit cards discriminately.
Source: American Express Small Business Monitor.

25. ©McGraw-Hill Education.
GOOD FINANCE
or BAD MEDICINE?
• You are a new hospital administrator at a small
hospital that, like many others, is experiencing
financial problems.
• You suggest discontinuing the hospital’s large
stockpile of drugs and shift to ordering them just
when they are needed.
• Some like the idea, but the doctors claim you are
sacrificing patients’ well-being for cash. What do
you do? What could be the result of your decision?

26. ©McGraw-Hill Education.
USING ALTERNATIVE
SOURCES of FUNDS LO 16-3
Debt Financing -- The funds raised through various
forms of borrowing that must be repaid.
Equity Financing -- The funds raised from within the
firm from operations or through the sale of ownership in
the firm (such as stock).
Photo credit: P Kantor / Alamy

27. ©McGraw-Hill Education.
SHORT and LONG-TERM
FINANCING LO 16-3
Short-Term Financing -- Funds needed for a year or
less.
Long-Term Financing -- Funds needed for more than
a year.
Photo credit: D. Hurst/Alamy

28. ©McGraw-Hill Education.
WHY FIRMS NEED FINANCING
Jump to Appendix 3 for long image description
LO 16-3

29. ©McGraw-Hill Education.
TEST PREP 2 of 4
1. Money has time value. What does this mean?
2. Why is accounts receivable a financial concern of
the firm?
3. What’s the primary reason an organization
spends a good deal of its available funds on
inventory and capital expenditures?
4. What’s the difference between debt and equity
financing?

30. ©McGraw-Hill Education.
TYPES of
SHORT-TERM FINANCING 1 of 2 LO 16-4
Trade Credit -- The practice of buying goods or
services now and paying for them later.
Businesses often get terms such as 2/10 net 30
when receiving trade credit.
Promissory Note -- A written contract agreeing to pay
a supplier a specific sum of money at a definite time.

31. ©McGraw-Hill Education.
TYPES of
SHORT-TERM FINANCING 2 of 2 LO 16-4
Many small firms obtain short-term financing from
friends and family.
If asking for help from family or friends, it’s important
both parties:
1) Agree to specific loan terms
2) Put the agreement in writing
3) Arrange for repayment the same way they would for a
bank loan

32. ©McGraw-Hill Education.
DIFFICULTY of OBTAINING
SHORT-TERM FINANCING LO 16-4
The recent financial crisis has made it difficult for
even promising and well-organized businesses to
get loans.
Banks generally prefer to
lend short-term money to
larger, more established
businesses.
Photo credit: ©Dave and Les Jacobs LLC

33. ©McGraw-Hill Education.
THREADING the FINANCIAL NEEDLE
• Started thredUP with classmates
while studying for his MBA at
Harvard.
• Launched the company in 2009
as a way to buy and sell adult
clothing.
• Transitioned into children’s
clothes.
• The company continues to
attract huge investments to
further improve the site.
Photo credit: Courtesy of thredUP

34. ©McGraw-Hill Education.
DIFFERENT FORMS of
SHORT-TERM LOANS LO 16-4
Commercial banks offer short-term loans like:
- Secured Loans -- Backed by collateral.
- Unsecured Loans – Don’t require collateral from
the borrower.
- Line of Credit -- A given amount of money the
bank will provide so long as the funds are
available.
- Revolving Credit Agreement -- A line of credit
that’s guaranteed but comes with a fee.

35. ©McGraw-Hill Education.
FACTORING LO 16-4
Factoring -- The process of selling accounts receivable
for cash.
Factors charge more than banks, but many small
businesses don’t qualify for loans.

36. ©McGraw-Hill Education.
COMMERCIAL PAPER LO 16-4
Commercial Paper -- Unsecured promissory notes in
amounts of $100,000+ that come due in 270 days or
less.
Since commercial paper is unsecured, only
financially stable firms are able to sell it.

37. ©McGraw-Hill Education.
CREDIT CARDS LO 16-4
• Rates for small businesses
grew almost 30% after The
Credit Card Responsibility
Accountability and
Disclosure Act was passed.
• Credit cards are convenient
but costly for a small
business.
Photo Creditf: Robert Scoble

38. ©McGraw-Hill Education.
WAYS to RAISE
START-UP CAPITAL LO 16-4
• Seek out a microloan from a microlender
• Use asset-based lending or factoring
• Turn to the web and seek
out peer-to-peer lending
• Research local banks
• Sweet-talk vendors you
want to do business with
Sources: St. Louis Small Business Monthly, January 2014 and Entrepreneur, www.entrepreneur.com, accessed November 2014.
Photo credit: © Chris Ryan / age fotostock

39. ©McGraw-Hill Education.
HOW COMPANIES FAIL to
RAISE CAPITAL LO 16-4
1. There is no formalized business plan to show
need.
2. The company does not know how much to
request from a lender.
3. Poor credit.
4. Management is unrealistic about growth.
Source: St. Louis Small Business Monthly, January 2014.

40. ©McGraw-Hill Education.
TEST PREP 3 of 4
1. What does an invoice containing the terms 2/10,
net 30 mean?
2. What is the difference between trade credit and a
line of credit?
3. What is the key difference between a secured
and an unsecured loan?
4. What is factoring? What are some of the
considerations factors consider in establishing
their discount rate?

41. ©McGraw-Hill Education.
SETTING LONG-TERM
FINANCING OBJECTIVES LO 16-5
Three questions of financial managers in setting long-
term financing objectives:
1. What are the organization’s long-term goals and
objectives?
2. What funds do we need to achieve the firm’s long-term
goals and objectives?
3. What sources of long-term funding (capital) are available,
and which will best fit our needs?

42. ©McGraw-Hill Education.
The FIVE “C”s of CREDIT LO 16-5
1. The character of the borrow.
2. The borrower’s capacity to repay the loan.
3. The capital being invested in the business by the
borrower.
4. The conditions of the economy and the firm’s
industry.
5. The collateral the borrower has available to
secure the loan.

43. ©McGraw-Hill Education.
ARE THEY HEROS or HUSTLERS?
• Rich nations place their excess incomes into
sovereign wealth funds (SWFs).
• SWFs are hailed as heroes when billions are
invested in distressed companies. However, some
grow concerned with the presence of foreign
governments.
• Much of that concern seems to be unfounded
because of investigations by the U.S. government.

44. ©McGraw-Hill Education.
USING LONG-TERM
DEBT FINANCING LO 16-5
Long-term financing loans generally come due within
3 -7 years but may extend to 15 or 20 years.
Term-Loan Agreement -- A promissory note that
requires the borrower to repay the loan with interest in
specified monthly or annual installments.
A major advantage of debt financing is the interest
the firm pays is tax deductible.

45. ©McGraw-Hill Education.
USING DEBT FINANCING
by ISSUING BONDS LO 16-5
Indenture Terms -- The terms of agreement in a bond
issue.
Secured Bond -- A bond issued with some form of
collateral (i.e. real estate).
Unsecured (Debenture) Bond -- A bond backed only
by the reputation of the issuing company.

46. ©McGraw-Hill Education.
SECURING EQUITY FINANCING LO 16-5
A company can secure equity
financing by:
- Selling shares of stock in the
company.
- Earning profits and using the
retained earnings as
reinvestments in the firm.
- Attracting Venture Capital --
Money that is invested in new or
emerging companies that some
investors believe have great profit
potential.
Photo credit: © Adam Gault / age fotostock

47. ©McGraw-Hill Education.
WANT to ATTRACT a
VENTURE CAPITALIST? LO 16-5
1. Can the company
grow?
2. Will we get our money
back and more?
3. Will it be worth our
money and effort?
Source: Entrepreneur, www.entrepreneur.com, accessed November 2014.
Photo credit: © Adam Gault / age fotostock

48. ©McGraw-Hill Education.
DIFFERENCES BETWEEN
DEBT and EQUITY FINANCING LO 16-5
Jump to Appendix 4 for long image description

49. ©McGraw-Hill Education.
USING LEVERAGE for
FUNDING NEEDS LO 16-5
Leverage -- Raising funds through borrowing to
increase the firm’s rate of return.
Cost of Capital -- The rate of return a company must
earn in order to meet the demands of its lenders and
expectations of equity holders.

50. ©McGraw-Hill Education.
USING DEBT vs. EQUITY FINANCING LO 16-5
Additional Debt Additional Equity
Stockholders’ equity $500,000 Stockholders’ equity $500,000
Additional equity --- Additional equity $200,000
Total equity $500,000 Total equity $700,000
Bond @ 8% interest $200,000 Bond interest ---
Total shareholder equity $500,000 Total shareholder equity $700,000
Year-End Earnings
Gross profit $100,000 Gross profit $100,000
Less bond interest -$16,000 Less bond interest ---
Operating profit $84,000 Operating profit $100,000
Return on equity 16.8% Return on equity 14.3%
($84,000/$500,000 = 16.8%) ($100,000/$700,000 = 14.3%)

51. ©McGraw-Hill Education.
LESSONS LEARNED from the
RECENT FINANCIAL CRISIS LO 16-5
The recent financial crisis was the worst fall since
the Great Depression.
• Led to the passage of
sweeping financial
reform.
• Government is
increasing involvement
and intervention.
Photo credit: © Image Source, all rights reserved.

52. ©McGraw-Hill Education.
TEST PREP 4 of 4
1. What are the two major forms of debt financing
available to a firm?
2. How does debt financing differ from equity
financing?
3. What are the three major forms of equity
financing available to a firm?
4. What is leverage, and why do firms choose to
use it?

53. ©McGraw-Hill Education.
Appendix 1: WHAT FINANCIAL
MANAGERS DO
Financial managers are responsible for:
• Auditing
• Managing taxes
• Advising top management on financial matters
• Collecting funds (credit management)
• Controlling funds (funds management)
• Obtaining funds
• Budgeting
• Planning
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54. ©McGraw-Hill Education.
Appendix 2: FINANCIAL PLANNING 2 of 2
A graphic shows the relationship between financial
planning and budgeting.
Short-term forecasting and long-term forecasting help to
develop the financial plan.
The financial plan is used to develop an operating (master)
budget, a capital budget, and a cash budget.
Financial controls are put in place and feedback from
financial controls goes back to the original financial plan.
Return to slide

55. ©McGraw-Hill Education.
Appendix 3: WHY FIRMS NEED FINANCING
Short-term funds:
Monthly expenses
Unanticipated emergencies
Cash flow problems
Expansion of current inventory
Long-term funds:
New-product development
Replacement of capital equipment
Mergers or acquisitions
Expansion into new markets (domestic or global)
New facilities
Return to slide

56. ©McGraw-Hill Education.
Appendix 4: DIFFERENCES BETWEEN
DEBT and EQUITY FINANCING
Characteristics of Debt Financing:
• Management Influence: There’s usually none unless special
conditions have been agreed on.
• Repayment: Debt has a maturity date; principal must be repaid.
• Yearly obligations: Payment of interest is a contractual obligation.
• Tax benefits: Interest is tax-deductible.
Characteristics of Equity Financing:
• Management Influence: Common stockholders have voting rights.
• Repayment: Stock has no maturity date; the company is never
required to repay equity.
• Yearly obligations: The firm isn’t legally liable to pay dividends.
• Tax benefits: Dividends are paid from after-tax income and aren’t
deductible.
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