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Mastering financial management (FINANCIAL SERVICES PROVIDED BY BANKS AND…
Mastering financial management
Why financial management?
The Need for Financial Management
Financial management consists of all the activities concerned
with obtaining money and using it effectively
the uses of funds often dictate types of financing needed by a business
the activities a business can undertake are determined by the types of financing available.
financial manager ensure
• Financing priorities are established in line with
organizational goals and objectives.
• Spending is planned and controlled.
• Sufficient financing is available when it is needed both
now and in the future .
• A firm's credit customers pay their bills on time, and the 1'l
number of past due accounts is reduced.
• Bills are paid promptly to protect the firm's credit rating ~ and its ability to borrow money.
• The funds required for paying the firm's taxes are available when needed to meet tax deadlines.
• Excess cash is invested in certificates of deposit (CDs), government secunties, or conservative, marketable securities
Financial Reform After
the Economic Crisis
more regulations and reforms
became a high priority
Careers in Finance
chief financial officer (CFO): high-level corporate executive who manages a firm's finances and reports directly to the company's chief executive officer or president.
bank officer, consumer credit officer, financial analyst, financial
planner, loan officer, insurance analyst, and investment account executive.
traits and skills
Have a strong background in accounting or mathematics.
2 . Know how to use a computer to analyze data.
Be an expert at both written and oral communication.
THE NEED FOR FINANCING
Short-term financing: money that will be used for one year or less
certain business practices may affect a firm's cash flow and create a need for short-term financing
goal is to have sufficient money coming into the firm in
any period to cover the firm's expenses during that period
Cash flow is the movement of money into and out
of an organization
Speculative production: the time lag between the actual production of goods and when the goods are sold
increase inventory
Long-term financing: money that will be used for longer than one year
needed to start a new business
risk-return ratio is based on the principle that a high-risk decision should generate higher financial returns for a business
difficult to raise both short- and long-term financing in the
future because:
financial reform and increased regulations will lengthen the process required to obtain financing
both lenders and investors are more cautious about who receives financing
-> consider risk-return ratio
PLANNING: THE BASIS OF
SOUND FINANCIAL MANAGEMENT
financial plan: plan for obtaining and using the money needed to implement an organization's goals and objectives
Developing the Financial Plan
ESTABLISHING ORGANIZATIONAL GOALS AND OBJECTIVES, (goals and objectives must be measurable)
BUDGETING FOR FINANCIAL NEEDS
Budget: fmancial statement that projects income
expenditures, or both over a specified future period.
Cash budget: a financial statement that estimates cash receipts and cash expenditures over a specified period
approaches
traditional approach: each new budget is based on the dollar amounts contained in the budget for the preceding year
problem: leaves room for padding budget items to protect the (sometimes selfish) interests of the manager or his or her department -> eliminate by zero-base budgeting
Zero-base budgeting is a budgeting approach in which every
expense in every budget must be justified
Capital budget: estimates a firm's expenditures for major assets, including new product development, expansion of facilities, replacement of obsolete equipment, and mergers and acquisitions.
IDENTIFYING SOURCE OF DEMAND
Sale revenue: Future sales revenue generally provides the greatest part of a firm's financing
Equity capital
For a sole proprietorship or partnership: equity capital is provided by the owner or owners of the business.
For a corporation: equity capital is money obtained from the sale of shares of ownership in the business.
Equity capital is used almost exclusively for long-term financing
Debt capital: borrow money obtained through loans of various types
Monitoring and Evaluating
Financial Performance
FINANCIAL SERVICES PROVIDED BY BANKS AND OTHER FINANCIAL INSTITUTIONS
Traditional Banking Services
for Business Clients
Savings and checking accounts: passbook savings accounts
Certificate of Deposit (CD): document stating that the bank will pay the depositor a guaranteed interest rate on money left on deposit for a specified period of time
Check: written order for a bank or other institution to pay a stated dollar amount to the business or person indicated on the face of the check
Business Loans (short-term)
Line of Credit: a loan that is approved before the money is actually needed
Revolving Credit Agreement: a guaranteed line of credit (have commitment fee to exchange for guarantee)
Business Loans (long-term)
Collateral: real estate or property pledged as security for a loan
The Basics of Getting a Loan
preparation:
get to know potential lender (place to borrow: where your business does it banking)
check your firm's credit rating with national credit bureau (eg: D&B)
current business plan to prove you can repay ( what your business, how much funding needed, how it is repaid)
sometimes: current financial statement by independent public accountant, then a list of references (suppliers, other lenders, associated professionals,,,)
if rejected: think over the loan process
Credit and Debit Card Transactions
why merchants encourage credit cards: customer who don't have enough cash will use credit card
debit card: subtracts the amount of a customer's purchase from their account at the moment the purchase is made
credit card: extend short-term financing, do not make payment until receive next statement
Electronic Banking Service
Electronic Funds Transfer (EFT) system: a mean of performing financial transactions through a computer terminal (fast, eliminate costly paper checks)
ATMs: dispeses cash from customer's savings account or makes a cash advance charged to a credit card
AClearinghouses: reduce the number of paper checks, auto clearinghouses process checks, recurring bill payments, social security benefits, employees salaries
Point-of-sale (POS) terminals: computerized cash register located in retail store and connected to a bank's computer
Electronic check conversion (ECC): process to convert information from a paper check into electronic payment for merch,..
International Banking Serivice
Letter of Credit: legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time
banker acceptance: written order for a bank to pay a third party a stated amount of money on a specific state
bank currency exchange service
SOURCES OF SHORT-TERM DEBT FINANCING
Sources of Unsecured Short-term Financing
easier to obtain than long-term debt bc
less risk of nonpayment for lender
amount smaller
close working relationship usually exist
Unsecured Short-term Financing is financing that is not backed by collateral
Options
Trade credit: type of short-term financing extended by a seller who does not require immediate payment after delivery of merchandise
popular because most don't charge interest for trade credit (p408)
Promissory notes issued to suppliers: a written pledge by a borrower to pay a certain sum of money to a creditor at a specified future date
requires borrower to pay interest
advantages:
legally binding and enforceable contract
negotiable instrument
Unsecured Bank Loans: - Prime Interest Rate: lowest rate charged by a bank for a short-term loan
Commercial Paper: short-term promissory note issued by large corporation
secured by only the reputation of the issuing firm, no collateral is involved
interest rate = credit rating and ability to repay the commercial paper
Sources of Secured Short-Term Financing: most commonly pledged assest: inventories and accounts receivable
Loans secured by inventory
lender may insist inventory used as collateral be sored in public warehouse -> receipt -> no receipt no release merchs, release when the borrowed money is repaid
besides interest loans, also pay storage in public warehouse -> expensive
Loans secured by receivables
conduct thorough investigation to determine the quality of the receivables (the credit standing of the firm's customers and customers ability to repay their credit obligations)
if favorable determination is made -> approved
Factoring Accounts Receivable
factor: a firm specializing in buying other firm's accounts receivable for less than their face value but collect full face value when each account is due
-> profit by difference between face value of accounts receivable and the amount of factor has paid for them (based on risk the factor assume)
risk: probability that the accounts receivable will not be repaid when they mature
firm selling their face value get cash immediately, shift the task of collecting and the risk of nonpayment to factor
Cost Comparisons
p410 table
Sources of equity financing
Selling stock
Initial Public Offering and the Primary Market
Primary market: market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities
Investment banking firm: organization assists corporations in raising funds, usually by helping to sell new issues of stocks, bonds, or other financial securities
eventhough cost of selling stock is high, ongoing cost is low bc: - corporation have no obligation to repay money obtained from the sale of stock
no obligation to pay dividends to stockholder
Secondary Market
secondary market is market for existing financial securities that are traded between investors (investor sell shares to other investors)
usually transaction through securities exchange or over-the-counter (OTC) market
securities exchange: marketplace where member brokers meet to buy and sell securities
Over-the-counter market: network of dealers who buy and sell the stock of corporations that are not listed on a securities exchange
Common Stock (represent most basic form of ownership): stock whose owner may vote on corporate matters but whose claims on profits and assets are subordinate to the claims of others
Preferred stock: stock whose owner usually don't have voting rights but whose claims on dividends and assets are paid before those of common-stock owners
Retained Earnings
Retained Earnings: the portion of corporation's profits not distributed to stockholders
approved by board of directors
growing&small: no cash dividend
mature: 40-60%
utility: 80-90%
large: hefty bit of financing
Venture Capital, Angel Investors and Private Placements
venture capital: money invested in small firms that have the potential to become successful
consist of investors, partnership established by wealthy family or joint venture.
(beware of financial crisis)
Angel Investor: investor who provides financial backing for small business startups or entrepreneurs (focus on helping rather than earning profits)
private placement: occurs when stock and other corporate securities are sold directly to insurance companies, pension funds or large institutional investors (less government regulations and less cost)
SOURCES OF LONG-TERM DEBT FINANCING
financial leverage: the use of borrowed funds to increase the return on owners' equity
principle: as long as firms earning is larger than interest charged for the borrowed money
Long-term Loans
Term-loan agreement: a promissory note that requires a borrower to repay a loan in monthly, quarterly, semiannual or annual installments
interest rate and repayment terms based on factor: reasons. credit rating, value of collateral)
Corporate Bonds: corporation's written pledge that it will repay a specific amount of money with interest
factor that increase/decrease interest rate:
corporation ability to pay interest each year until maturity
corporation ability to repay the bond at maturity
Registered bond: bond registered in the owner's name by the issuing company (computer register are safer bc can't stolen, misplace or destroyed and easier when sold)
Maturity date: date on which a corporation is to repay borrowed money
Types of bonds:
Debenture bond: bond backed only by the reputation of the issuing corporation
Mortgage bond: corporate bond secured by various assets of the issuing firm
Convertible bond: bond that can be exchanged, at owner's option for a specific number of shares of the corporation's common stock
Repayment provisions for corporate bond
Bond indeture: legal document that details all the conditions relating to a bond issue
3 methods to ensure it have sufficient funds to redeem a bond issue:
serial bond: dons of a single issue that mature on different dates
sinking fund: a sum of money to which deposits are made each year for the purpose of redeeming a bond issue
pay off old bond by selling new bonds
trustee: an individual or an independent firm that acts as bond owner's representative
Cost comparison: table p.419