Ch 12 - Financial Management

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www.utm.my innovative entrepreneurial global 1

Chapter Twelve

Mastering Financial Management

SPL 1302 Basic Commerce

Dr. M. Khata Jabor

Department of Technical and Engineering Education

Faculty of Education


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Learning Objectives

1. Explain the need for financing and financialmanagement in business.

2. Summarize the process of planning for financialmanagement

3. Describe the advantages and disadvantages ofdifferent methods of short-term debt financing.

4. Evaluate the advantages and disadvantages ofequity financing.

5. Evaluate the advantages and disadvantages oflong-term debt financing.


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What Is Financial Management?

All the activities concerned with obtainingmoney and using it effectively

Determining the best ways to raise money

Ensuring money is used in keeping with the

organizations goals

Planning

The need for financing

When expenses are high or sales are low

Opportunities to expand


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The Need for Financing

Short-term financing Money that will be used for one year or less

Cash flowthe movement of money into and out of an

organization

Inventoryspeculative production (the time lagbetween the actual production of goods and when the

goods are sold)

Long-term financing

Money that will be used for longer than one year

Often involves large amounts of money


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Cash Flow for a Manufacturing Business


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Comparison of Short- and Long-Term Financing


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The Need for Financial Management

Risk-return ratio Based on the principle that a high-risk decision should generate

higher financial returns for a business and more conservativedecisions often generate lesser returns

Proper financial management can ensure that Financing priorities are in line with organizational goals and

objectives Spending is planned and controlled

Sufficient financing is available when it is needed

Credit customers pay on time and delinquencies are reduced

Bills are paid promptly

Taxes are paid in a timely manner Excess cash is invested in interest-bearing securities



Skills and traits of successful financial managers

Responsible and honest

Strong background in accounting or math

Knowledge of how to use a computer to analyze data

Expert in written and oral communications

Jobs

Bank officer

Credit officer

Financial analyst Financial planner

Insurance analyst

Investment account executive

Careers in Finance



PlanningThe Basis of Sound Financial

Management

Financial plan A plan for obtaining and using the money

needed to implement an organizations goals

Developing the financial plan

Establishing organizational goals and objectives

Budgeting for financial needs

Identifying sources of funds



The Three Steps of Financial Planning



Developing the Financial Plan

Establishing goals and objectives

Goal

An end state that the organization

expects to achieve over a 1- to 10-year period

Objectives

Specific statements detailing what the organization

intends to accomplish within a certain period of

time

Must be specific and measurable

Must be realistic



Developing the Financial Plan (contd)

Budgeting for financial needs Budget

A financial statement that projects income and/or expendituresover a specified future period

Usually begins with sales and various types of expenses

Cash budget

Projects cash receipts and expenditures over a specified futureperiod

Traditional Based on dollar amounts in budget for preceding year

Zero-based budgeting Every expense in every budget must be justified

Capital budget Estimates a firms expenditures for major assets and its long-term

financing needs



Sales Budget for Stars and Stripes Clothing



Cash Budget for Stars and Stripes Clothing



Developing the Financial Plan (contd)

Identifying sources of funds Sales revenues

Provide the greatest part of the firms financing

Equity capital

Money received from the owners or from the sale of shares ofownership in the business; long-term financing

Debt capital Borrowed money obtained through loans

Proceeds from the sale of assets

If absolutely necessary or when no longer needed

Monitoring and evaluating financial performance Prevents minor problems from becoming major ones



Short-Term Debt Financing

Short-term financing is usually easier toobtain than long-term

Shorter repayment period means less risk of

nonpayment

Amounts of short-term loans are smaller than

long-term loans

There is a closer relationship between borrowerand lender



Sources of Unsecured Short-Term Debt Financing

Unsecured financing

Financing not backed by collateral

Trade credit

Financing extended by a seller who does not require

immediate payment after the delivery of the merchandise

Promissory notes

A written pledge by a borrower to pay a certain sum of money

to a creditor at a specified future date

Unlike trade credit, promissory notes usually include interest

Legally binding

Negotiable instruments



Sources of Unsecured Short-Term Debt

Financing (contd)

Unsecured bank loans

Interest rates vary with each borrowers credit rating

Prime interest rate

The lowest rate charged by a bank for a short-term loan

Offered through promissory notes, a line or credit, or revolving

credit agreement

Commercial paper

Short-term promissory note issued by a large corporation

Interest rates are usually below that charged by banks for short-

term loans



Sources of Secured Short-Term Debt Financing

Loans secured by inventory

Inventory is pledged as collateral Control of the inventory passes to the lender until the

loan is repaid

The borrow must pay storage for the inventory

Floor planning The title to the inventory is given to lenders in return for short-

term financing

The borrow maintains control of the inventory

Loans secured by receivables

Amounts owed the firm in the form of accounts receivable

from trade credit given to customers are pledged as

collateral

Quality of receivables is considered



Factoring Accounts Receivable

Another method of raising short-term financing

Factor

A firm that specializes in buying other firms accountsreceivable

The factor buys accounts receivable for less than their face

value The factor collects the full dollar amounts when each

account is due

The factors profit is the difference between the face valueand what it paid for the accounts receivable

Profit is based on the risk (probability that the accountsreceivable will not be paid) the factor assumes


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Comparison of Short-Term Financing Methods


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Sources of Equity Financing

For sole proprietorships or partnerships Owner or owners invest money in the business

Venture capital

For corporations Sale of stock

Use of profits not distributed to owners

Venture capital


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Sources of Equity Financing (contd)

Selling stock

Initial public offering

When a corporation sells common stock to the

general public for the first time

Advantages of selling stock Firm does not have to repay money received from

sale of stock

Firm does not have to pay dividends to stockholders

Two types of stock Common stock

Preferred stock


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Selling stock (contd)

Common stock Stock whose owners may vote on corporate matters but whose

claims on profits and assets are subordinate to the claims ofothers

Preferred stock

Stock whose owners usually do not have voting rights, but whoseclaims on dividends and assets are paid before those of common-stock owners

Par value

An assigned (and often arbitrary) dollar value printed on a stock

certificate Convertible preferred stock

Preferred stock that the owner may exchange for a specifiednumber of shares of common stock


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Retained earnings

The portion of a corporations profits not distributed to stockholders

Venture capital

Money invested in a firm with the expectation that the firm has the

potential to become very successful and increase in value

Investors usually receive an equity position in the business and share in

its profits

Private Placement

Stocks and other corporate securities are sold directly to insurance

companies, pension funds, or large institutional investors


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Sources of Long-Term Debt Financing

Financial leverage

The use of borrowed funds to increase the return on ownersequity

As long as the firms earnings are larger than the interestcharged for the borrowed money, there is a positive effect onreturn on owners equity

Lease

An agreement by which the right to use real estate, equipment,or other assets is temporarily transferred from the owner tothe user

Sometimes used if a firm cannot obtain a loan to acquireproperty, buildings, or equipment

Can have tax advantages over long-term debt financing


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Effects of Additional Capital


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Sources of Long-Term Debt Financing (contd)

Long-term loans

Term-loan agreement For loans longer than 1 year

A promissory note that requires a borrower to repay a loan in monthly,

quarterly, semiannual, or annual installments

Interest rate and repayment terms are based on the reasons for

borrowing, the firms credit rating, the value of collateral

Getting a loan

Know potential lenders

Maintain a good credit rating

Fill out an application; submit a business plan and financial statements;

compile references

Meet with loan officer

If denied, determine why


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Corporate bonds A corporations written pledge that it will repay a specified

amount of money with interest

Maturity datethe date on which the corporation is to repaythe borrowed money

Interest is paid until maturity

Types of bonds Registered bonda bond registered in the owners name by the

issuing company

Debenture bonda bond backed only by the reputation of theissuing corporation

Mortgage bonda bond secured by various assets of the issuing

firm Convertible bonda bond that can be exchanged, at the owners

option, for a specified number of shares of the corporationscommon stock


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Corporate bonds (contd) Repayment provisions for corporate bonds

Bond indenturea legal document that details all theconditions relating to a bond issue

Call premiuman amount paid to the bond owner if thecorporation buys back the bond before the maturity date

Serial bondsbonds of a single issue that mature ondifferent dates

Sinking funda sum of money to which deposits are

made each year for the purpose of redeeming a bondissue

Trusteean individual or an independent firm that actsas the bond owners representative


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Comparison of Long-Term Financing Methods

Ch 12 - Financial Management

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