1. Portland State University Free Market Business Development Institute Financial Management 1 Management, Forecasting, and Decision Making in a Dynamic Financial Environment

2. Portland State University Free Market Business Development Institute Financial Management 2 Overview: What financial management entails Combining day-to-day cash management responsibilities with long-term planning objectives Analysis of past and present data for the purpose of deploying or investing the organization’s monetary and capital resources to greatest advantage Managing the firm’s cash, marketable securities, accounts receivable, inventory, equipment, and physical plant Making decisions about how assets are financed, use of short-tern versus long-term debt, leasing, and the use of debt versus equity Applying the disciplines of economics and accounting in the art and science of managing money…

3. Portland State University Free Market Business Development Institute Financial Management 3 Overview: The financial decision-making process

4. Portland State University Free Market Business Development Institute Financial Management 4 Overview: The financial structure of an organization Board of Directors President VP Sales VP Finance VP Mfg TreasurerController Tax DeptCost Acctg Financial Acctg Inventory MgrCredit Mgr Dir Capital Budgeting

5. Portland State University Free Market Business Development Institute Financial Management 5 Topics covered: Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

6. Portland State University Free Market Business Development Institute Financial Management 6 Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

7. Portland State University Free Market Business Development Institute Financial Management 7 Basics of capital budgeting: sales and cost forecasting Construction of pro forma statements Latest financial statements Sales forecast Cost accounting forecast Financial market data Preliminary projections Modifications and revisions Evaluation: are more revisions needed? Capital rationing: identification of projects to finance

8. Portland State University Free Market Business Development Institute Financial Management 8 Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

9. Portland State University Free Market Business Development Institute Financial Management 9 Time Value of Money: Money has different today than in the future Reasons: Inflation/deflation Opportunity costs: the foregone investment options Risk factors Less flexibility re: time preference for consumption Financial management remedy: Cash flow is “discounted” to reflect the reduction of value

10. Portland State University Free Market Business Development Institute Financial Management 10 Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

11. Portland State University Free Market Business Development Institute Financial Management 11 Investment appraisal using discounted cash flows Firms rarely have the resources to accept all good capital projects and investment opportunities Rationing capital for investment in a project or business requires careful analysis Two of the most common methods for ranking investments in projects are 1) net present value and 2) internal rate of return calculations Both methods take into consideration the time value of money

12. Portland State University Free Market Business Development Institute Financial Management 12 Investment appraisal using discounted cash flows Net present value Weighs the investment in absolute dollars against its return in discounted cash Formula is discounted incoming cash flows minus outgoing initial cash flows: [DISCOUNTED RETURN minus INVESTMENT] Requires assumption about the prevailing cost of money, also called a “hurdle rate” Discount rate varies for each period Typically uses calculator function or table Investment or project with highest NPV is deemed most desirable

13. Portland State University Free Market Business Development Institute Financial Management 13 Internal rate of return Weighs the investment relative to the cost of money (interest rate) Solves an equation: [INVESTMENT = FUTURE PAYMENT / (1+rate)] Determines rate of interest that would cause the discounted (incoming) cash flows to be equal to the investment (i.e., zero difference) Typically uses calculator function or table The investment option or project with the highest IRR is deemed most desirable Investment appraisal using discounted cash flows

14. Portland State University Free Market Business Development Institute Financial Management 14 Internal rate of return calculation drawbacks: Assumes cash flows can be reinvested at an IRR which may not be a reasonable assumption There may be multiple IRRs, requiring additional calculation using NPV before decision can be made Can lead to mistaken accept/reject decisions when evaluating mutually exclusive projects when there are differences in scale, size, or differences in the time patterns of cash flow Investment appraisal using discounted cash flows

15. Portland State University Free Market Business Development Institute Financial Management 15 The main difference between NPV and IRR calculations is the interest rate used and the form of the answer (dollars versus rate) Whichever method is used, the goal should be to maximize NPV for the overall budget that is accepted Firms using IRR therefore frequently also calculate NPV Investment appraisal using discounted cash flows summary

16. Portland State University Free Market Business Development Institute Financial Management 16 Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

17. Portland State University Free Market Business Development Institute Financial Management 17 Lease/buy/rent decision criteria: 1.Cash flow: to lease or rent requires smaller payments over time versus immediate cash outlay for purchase 2.Commitment: becoming “locked in” through purchases 3.Cost: overall cost for each method, including interest, down payments, transfer costs, etc. 4.Tax consequences: purchases and leases are eligible for depreciation offsets to income; cash outlays for rentals are usually deductible expenses 5.Obsolescence risk: related to commitment; leases and rental agreements usually allow for upgrade

18. Portland State University Free Market Business Development Institute Financial Management 18 Lease/buy/rent decision criteria: While some decisions may be based on NPV comparisons between the cost of debt to purchase and the cost of leasing, a decision matrix ensures consideration of all relevant variables Matrix scores are dependent on specific tax consequences and other situational conditions Important functional area perspectives include accounting and marketing

19. Portland State University Free Market Business Development Institute Financial Management 19 A hypothetical lease/buy/rent decision matrix showing positive and negative aspects, depending on the specifics of the item

20. Portland State University Free Market Business Development Institute Financial Management 20 Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

21. Portland State University Free Market Business Development Institute Financial Management 21 Sources of money: Equity Advantages: Equity is “risk capital” that carries no guarantee or protection regarding the original investment Usually has no requirement regarding payback or interest payments Disadvantages: Represents dilution of ownership that affects entrepreneur’s claim to profits and control

22. Portland State University Free Market Business Development Institute Financial Management 22 Sources of money: Equity Sources of equity funds: Personal funds and “sweat equity” in the form of time and labor Utilization of owner equipment and other resources Non-loan infusions from friends and relatives Employee investors Customer “membership” fees and prepayments Venture capitalists and other impersonal investors Joint venture partnerships

23. Portland State University Free Market Business Development Institute Financial Management 23 Sources of money: Debt Commercial loan from a bank Loan from friends and family Issuance and sale of bond Advantages: Provides opportunity to develop credit history Ownership is not diluted Disadvantages: Collateral and/or co-signers may be required Cost of capital may be high Restrictions may apply

24. Portland State University Free Market Business Development Institute Financial Management 24 Sources of money: Trade Credit Advantages of using suppliers as a credit source: Often easily obtained Amount of credit usually expands and contracts with the needs of the firm Often take the form of credit terms and cash discounts Typically does not involve a formal agreement or contract Fosters supplier commitment in the success of the business

25. Portland State University Free Market Business Development Institute Financial Management 25 Sources of money: Barter Arrangements Definition and considerations: Trade of goods and/or services Often linked by exchange or service organizations that may charge a fee plus take a percentage of the cash value Transactions are often taxable at cash value

26. Portland State University Free Market Business Development Institute Financial Management 26 Sources of money: Retained Earnings Definition and considerations: The major source of financing for larger firms Involves trade-off between payment of dividends to stockholders and investment in the firm Opportunity cost to stockholders requires careful evaluation of firm’s return on its investment of this source of financing

27. Portland State University Free Market Business Development Institute Financial Management 27 Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

28. Portland State University Free Market Business Development Institute Financial Management 28 International finance Risk unique to international finance: Fluctuating exchange rates Differing political risks related to expropriation of assets Economic system differences Legal and tax system complications Cultural differences related to financial systems Inflation/deflation rate uncertainty

29. Portland State University Free Market Business Development Institute Financial Management 29 Basics of capital budgeting Sales and cost forecasting Time value of money Investment appraisal Net present value, internal rate of return Lease/buy/rent decisions Sources of money International finance Financing small firms and startups

30. Portland State University Free Market Business Development Institute Financial Management 30 Financing small firms and startups Business start-ups fail largely due to inadequate funding Owner usually is required to commit savings, mortgage assets, and borrow from friends and family Government agencies often have targeted loan programs that provide funds and technical support

31. Portland State University Free Market Business Development Institute Financial Management 31 Sources: Financial, Budgeting & Cost Control (1996). Les Anderson, PhD., Portland, OR: Portland State University Financial Management: Theory and Practice (1999). Eugene F. Brigham, Louis C. Gapenski and Michael C. Ehrhardt, Stamford, CT: The Dryden Press Lecture notes from BA 561 Financial Management (2001). Janet Hamilton, PhD., Portland, OR: PSU The Essentials of Financial Management (1998). Omer L. Carey, PhD and Musa M.H. Essayyad, PhD., Piscataway, NJ: Research and Education Association