Chptr 18.pdf

Emblem of Socio-Economic Empowerment of Women
Chapter 18
Financial
Management
Business in
Action 8e
Bovée/Thill

Learning Objectives
1. 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
2.
3.
debt and equity financing, and explain
major considerations in choosing from
alternatives.
Copyright © 2017 Pearson Education, Inc.
the two
financing
18-2

Learning Objectives (cont.)
4. Identify the major
financing.
Identify the major
financing.
categories of short-term debt
5. categories of long-term debt
6. Describe the two options for equity financing,
and explain how
public offering.
companies prepare an initial
Copyright © 2017 Pearson Education, Inc. 18-3

The Role of Financial Management
• Financial management
Planning for a firm’s money needs and
managing the allocation and spending
funds
of
• Risk/return trade-off
The balance of potential
potential rewards
risks against

Financial Management:
Exhibit 18.1
Three Fundamental Concepts

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
Strategic plan, company’s financial
statements, external financial environment

Exhibit 18.2 Finding and Allocating Funds

Managing Accounts Receivable
and Accounts Payable
• •
Accounts
receivable
Accounts
payable
Amounts that are Amounts that
firm currently
a
owes
currently
firm
owed to a
to other parties

Monitoring the
Exhibit 18.3
Working Capital Accounts

The Budgeting Process
• Budget
A planning and control tool that reflects
expected revenues, operating expenses,
cash receipts and outlays
and
• Financial control
The process of analyzing and adjusting the
basic financial plan to correct for deviations
from forecasted events

Budgeting Challenges
Exhibit 18.4

The Budgeting Process (cont.)
• Hedging
Protecting against cost increases with
contracts that allow a company to buy
supplies in the future at designated prices
18-12

The Budgeting Process (cont.)
• 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
amounts
the
previous year’s budget
18-13

Types of Budgets
• Start-up budget
A budget that identifies the money that a new
company will need to spend to launch
operations
• Operating budget
A budget that identifies all sources of revenue
and coordinates the spending of those funds
throughout the coming year
Also known as the master budget
18-14

Types of Budgets (cont.)
• Capital budget
A budget that outlines expenditures for
estate, new facilities, major equipment,
other capital investments
real
and
• Capital investments
Money paid to acquire something
permanent value in a business
of
18-15

Types of Budgets (cont.)
• Project budget
A budget that identifies the costs needed to
accomplish a particular project
18-16

Financing Alternatives:
Factors to Consider
• Debt financing
Arranging funding by borrowing money
• Equity financing
Arranging funding by selling ownership
shares in the company, publicly or privately
18-17

Debt Versus Equity Financing
Exhibit 18.5
Characteristic Debt
Financing
Equity Financing
Maturit
y
Specific: In most cases, specifiesa dateby which
debt
must be repaid.
NIA: Equity funding does not need to be
repaid.
Claim on
income
Nondiscretionary, usually a recurring cost and
usually fixed: Debt obligations must be repaid,
regard• less ofwhetherthe companyis profitable;
payments can
be regilar (e.g., monthly), balloon (repaid all at once),
or a
combination.
Discretionary cost: At management'sdiscretion
and if company is profrtable, shareholdersmay
receive dividends aftercreditorshave been paid;
howeter,
company is not required to pay dividends.
Residual: Shareholdershave claims only after
the nm
satisfiesclaims ofleriders.
Claim on
assets
Priority:lenders have priorclaims on
assets.
Influence over
management
Usually little: lenders usually have no influence <:Nel
management unless debitvehicles come with
concitions or management fails to makepayments on
time.
Varies:As owners of the company, shareholders
can
vote on some aspects of corporate operations,
althougl
in practiceonly large shareholdershave much
infu!nce.
Privateequity holders (such as venture
capitalists)can
have considerable Influence.
Tax
consequences
Deductible: Debt payments reduce taxable income,
lowering tax obligations.
NIA: Does not createany opportunttiesfor
compensation alternativessuch as stockoptions.
Not deductible: Oividerid payments arenot
tax
deducbble.
Employeebenefit
potential
Stock options: Issuing company shares creates
the
opportunityto use stockoptionsas a motivation
or
retention tool.
18-18

Length of T
erm
• •
Short-term
financing
Long-term
financing
Financing used to Financing used to
cover long-term
expenses such as
assets (generally
repaid over a period
of more than one
year)
cover current
expenses
(generally repaid
within a year)
18-19

Interest Rates
• Prime interest rate
The lowest rate of interest that banks charge
for short-term
customers
loans to their most creditworthy
18-20

Opportunity Cost
• Leverage
The technique of increasing the rate of return
on an investment by financing
borrowed funds
Capital structure
it with
•
A firm’s mix of debt and equity financing
18-21

Financial Leverage
Exhibit 18.6

Short-T
erm Debt
• Trade credit
Credit obtained by a purchaser directly
supplier
from a
• Secured loans
Loans backed up
can claim in case
of property
with assets that
of default, such
the lender
as a piece
18-23

Short-T
erm Debt (cont.)
• Unsecured loans
Loans that require a good credit rating
collateral
but no
• 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
18-24

Short-T
erm Debt (cont.)
• Line of credit
An arrangement in which a financial institution
makes money available for use at any time
after the loan has been approved
• Commercial paper
Short-term promissory notes, or contractual
agreements, to repay a borrowed amount by
a specified time with a specified interest rate
18-25

Sources of Long-Term
Exhibit 18.7
Debt Financing
18-26

Long-T
erm Loans
18-27

Leases
• Lease
An agreement to use
for regular payment
an asset in exchange
Similar to renting
18-28

Corporate Bonds
• Bonds
A method of funding in which the issuer
borrows from an investor and provides a
written promise to make regular interest
payments and repay the borrowed amount in
the future
18-29

Corporate Bonds (cont.)
• •
Secured bonds Debentures
Bonds backed by
specific assets that
will be given to
bondholders if the
Corporate bonds
backed only by the
reputation
issuer
of the
borrowed amount is
not repaid
18-30

Corporate Bonds (cont.)
• Convertible bonds
Corporate bonds that can be exchanged at
the
the
owner’s discretion into common stock of
issuing company
18-31

Private Equity
• Private equity
Ownership assets that aren’t publicly traded
Includes venture capital
18-32

Public Stock Offerings
18-33

Public Stock Offerings (cont.)
• 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
18-34

Applying What You’ve Learned
1. 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.
18-35
2.
3.

Applying What You’ve Learned (cont.)
4. Identify the major categories of short-term debt
financing.
Identify the major categories of long-term debt
financing.
5.
6. Describe the two options for equity financing,
and explain how
public offering.
companies prepare an initial
18-36

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