Chapter 18 Financial Management McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc All rights reserved Chapter Eighteen LEARNING GOALS Explain the role and responsibilities of financial managers Outline the financial planning process, and explain the three key budgets in the financial plan Explain why firms need operating funds Identify and describe different sources of shortterm financing Identify and describe different sources of long-term financing 18-2 Profile CAROL TOMÉ Home Depot Tomé worked her way up to Chief Financial Officer (CFO) at Home Depot in 2001 • Home Depot was in a store building frenzy; adding more than 100 locations a year through 2005 • Tomé was at the center of tech transition by overseeing the distribution of $350 million in spending 18-3 Chapter Eighteen NAME that COMPANY At one time this company was the largest automobile maker in the world Due to severe financial problems in 2009, the company came very close to extinction A $7 billion government-backed loan and an additional $43 billion government investment in the company helped it survive It is now attempting a comeback as a much smaller company Name that company! 18-4 The Role of Finance and Financial Managers WHAT’S FINANCE? LG1 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 18-5 The Role of Finance and Financial Managers FINANCIAL MANAGEMENT LG1 Financial Management -The job of managing a firm’s resources to meet its goals and objectives 18-6 The Role of Finance and Financial Managers FINANCIAL MANAGERS LG1 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 18-7 Financial Planning WHO’S WHO in FINANCE LG2 • CFO Chief Financial Officer • CFP Certified Financial Planner • CFA Chartered Financial Analyst • Comptroller Chief Accounting Officer 18-8 The Role of Finance and Financial Managers LG1 WHAT FINANCIAL MANAGERS DO 18-9 The Role of Finance and Financial Managers LG1 WHAT WORRIES FINANCIAL MANAGERS • 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 July 2011 18-10 Factoring Accounts Receivable FACTORING LG4 Factoring The process of selling accounts receivable for cash •Factors charge more than banks, but many small businesses don’t qualify for loans 18-35 Commercial Paper COMMERCIAL PAPER LG4 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 18-36 Credit Cards CREDIT CARDS LG4 • Rates for small businesses grew almost 30% after the Credit Card Responsibility Accountability and Disclosure Act of 2009 was passed • Credit cards are convenient but costly for a small business Photo Courtesy of: Robert Scoble 18-37 Credit Cards LG4 WAYS to RAISE START-UP CAPITAL • 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 business with Source: Entrepreneur, www.entrepreneur.com, accessed July 2011 18-38 Progress Assessment PROGRESS ASSESSMENT • What does an invoice containing the terms 2/10, net 30 mean? • What’s the difference between trade credit and a line of credit? • What’s the key difference between a secured and an unsecured loan? • What’s factoring? What are some of the considerations factors consider in establishing their discount rate? 18-39 Obtaining Long-Term Financing LG5 SETTING LONG-TERM FINANCING OBJECTIVES • Three questions of financial managers in setting longterm financing objectives: What are the organization’s long-term goals and objectives? What funds we need to achieve the firm’s long-term goals and objectives? What sources of long-term funding (capital) are available, and which will best fit our needs? 18-40 Obtaining Long-Term Financing The FIVE “C”s of CREDIT LG5 The character of the borrow The borrower’s capacity to repay the loan The capital being invested in the business by the borrower The conditions of the economy and the firm’s industry The collateral the borrower has available to secure the loan 18-41 Debt Financing LG5 USING LONG-TERM DEBT FINANCING • Long-term financing loans generally come due within -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 18-42 Debt Financing LG5 USING DEBT FINANCING by ISSUING BONDS • 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 18-43 Equity Financing SECURING EQUITY FINANCING LG5 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 18-44 Equity Financing LG5 WANT to ATTRACT a VENTURE CAPITALIST? Can the company grow? Will we get our money back and more? Will it be worth our money and effort? Source: Entrepreneur, February 2011 18-45 Comparing Debt and Equity Financing LG5 DIFFERENCES BETWEEN DEBT and EQUITY FINANCING Types of Financing Conditions Debt None Unless special Management influence conditions have been agreed on Equity Common stock holders have voting rights Repayment Debt has a maturity date Stock has no maturity date Yearly obligations Payment of interest The firm isn’t legally liable to pay dividends Tax benefits Interest is tax deductible Dividends are not tax deductible 18-46 Comparing Debt and Equity Financing LG5 USING LEVERAGE for FUNDING NEEDS • 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 18-47 Lessons From the Financial Crisis LG5 LESSONS of the FINANCIAL CRISIS • 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 18-48 Progress Assessment PROGRESS ASSESSMENT • What are the two major forms of debt financing available to a firm? • How does debt financing differ from equity financing? • What are the three major forms of equity financing available to a firm? • What is leverage, and why firms choose to use it? 18-49 ... and Financial Managers FINANCIAL MANAGEMENT LG1 Financial Management -The job of managing a firm’s resources to meet its goals and objectives 18-6 The Role of Finance and Financial Managers FINANCIAL. . .Chapter Eighteen LEARNING GOALS Explain the role and responsibilities of financial managers Outline the financial planning process, and explain the three key budgets in the financial. .. Financial Managers FINANCIAL MANAGERS LG1 Financial Managers Examine financial data and recommend strategies for improving financial performance • Financial managers are responsible for: -