CHAPTER 18 Financial Management McGraw-Hill/Irwin Copyright © 2015 by the McGraw-Hill Companies, Inc All rights reserved LEARNING OBJECTIVES 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 short-term financing Identify and describe different sources of long-term financing 18-2 SABRINA SIMMONS Gap • Simmons earned her bachelor’s in finance at UCBerkeley 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 18-3 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! 18-4 WHAT’S FINANCE? LO 18-1 • 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 18-5 FINANCIAL MANAGEMENT LO 18-1 • Financial Management -The job of managing a firm’s resources to meet its goals and objectives 18-6 FINANCIAL MANAGERS LO 18-1 • 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 18-7 WHO’S WHO in FINANCE LO 18-1 • CFO Chief Financial Officer • CFP Certified Financial Planner • CFA Chartered Financial Analyst • Comptroller Chief Accounting Officer 18-8 FOUR SIGNS YOU NEED a CFO LO 18-1 You not have information on key items like cash flow, working capital, or forecasts No one is carefully watching and analyzing your expenses You are not aware of regulatory changes that could affect your business You are unable to generate financial reports Source: Karen Stern, St Louis Small Business Monthly, January 2014 18-9 WHAT FINANCIAL MANAGERS DO LO 18-1 18-10 WAYS to RAISE START-UP CAPITAL LO 18-4 • 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 business with Sources: St Louis Small Business Monthly, January 2014 and Entrepreneur, www.entrepreneur.com, accessed November 2014 18-38 HOW COMPANIES FAIL to RAISE CAPITAL LO 18-4 There is no formalized business plan to show need The company does not know how much to request from a lender Poor credit Management is unrealistic about growth Source: St Louis Small Business Monthly, January 2014 18-39 TEST PREP • What does an invoice containing the terms 2/10, net 30 mean? • What is the difference between trade credit and a line of credit? • What is the key difference between a secured and an unsecured loan? • What is factoring? What are some of the considerations factors consider in establishing their discount rate? 18-40 SETTING LONG-TERM FINANCING OBJECTIVES LO 18-5 • 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? 18-41 The FIVE “C”s of CREDIT LO 18-5 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 18-42 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 18-43 USING LONG-TERM DEBT FINANCING LO 18-5 • 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 18-44 USING DEBT FINANCING by ISSUING BONDS LO 18-5 • 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 18-45 SECURING EQUITY FINANCING LO 18-5 • 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 18-46 WANT to ATTRACT a VENTURE CAPITALIST? LO 18-5 Can the company grow? Will we get our money back and more? Will it be worth our money and effort? Source: Entrepreneur, www.entrepreneur.com, accessed November 2014 18-47 DIFFERENCES BETWEEN DEBT and EQUITY FINANCING LO 18-5 18-48 USING LEVERAGE for FUNDING NEEDS LO 18-5 • 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 18-49 USING DEBT vs EQUITY FINANCING LO 18-5 18-50 LESSONS LEARNED from the RECENT FINANCIAL CRISIS LO 18-5 • 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 18-51 TEST PREP • 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? 18-52 ... FIRM LO 18-3 • Managing day -by- day needs of the business • Controlling credit operations • Acquiring needed inventory • Making capital expenditures 18-23 HOW SMALL BUSINESSES CAN IMPROVE CASH... aware of regulatory changes that could affect your business You are unable to generate financial reports Source: Karen Stern, St Louis Small Business Monthly, January 2014 18-9 WHAT FINANCIAL... very critical in our business, high-level managers are very involved in the finance decisions Name that company! 18-4 WHAT’S FINANCE? LO 18-1 • Finance The function in a business that acquires