1. Chapter Twenty Mastering Financial Management

2. Copyright © Houghton Mifflin Company. All rights reserved.20 - 2 Learning Objectives 1.Explain the need for financing and financial management in business. 2.Summarize the process of planning for financial management 3.Describe the advantages and disadvantages of different methods of short-term debt financing. 4.Evaluate the advantages and disadvantages of equity financing. 5.Evaluate the advantages and disadvantages of long-term debt financing.

3. Copyright © Houghton Mifflin Company. All rights reserved.20 - 3 What Is Financial Management? All the activities concerned with obtaining money and using it effectively –Determining the best ways to raise money –Ensuring money is used in keeping with the organization’s goals –Planning The need for financing –When expenses are high or sales are low –Opportunities to expand

4. Copyright © Houghton Mifflin Company. All rights reserved.20 - 4 The Need for Financing Short-term financing –Money that will be used for one year or less Cash flow—the movement of money into and out of an organization Inventory—speculative production (the time lag between 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

5. Copyright © Houghton Mifflin Company. All rights reserved.20 - 5 Cash Flow for a Manufacturing Business

6. Copyright © Houghton Mifflin Company. All rights reserved.20 - 6

7. Copyright © Houghton Mifflin Company. All rights reserved.20 - 7 The Need for Financial Management 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 –Excess cash is invested in interest-bearing securities

8. Copyright © Houghton Mifflin Company. All rights reserved.20 - 8 Careers in Finance 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

9. Copyright © Houghton Mifflin Company. All rights reserved.20 - 9 Planning—The Basis of Sound Financial Management Financial plan –A plan for obtaining and using the money needed to implement an organization’s goals Developing the financial plan –Establishing organizational goals and objectives –Budgeting for financial needs –Identifying sources of funds

10. Copyright © Houghton Mifflin Company. All rights reserved.20 - 10 The Three Steps of Financial Planning

11. Copyright © Houghton Mifflin Company. All rights reserved.20 - 11 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

12. Copyright © Houghton Mifflin Company. All rights reserved.20 - 12 Developing the Financial Plan (cont’d) Budgeting for financial needs –Budget A financial statement that projects income and/or expenditures over a specified future period Usually begins with sales and various types of expenses –Cash budget Projects cash receipts and expenditures over a specified future period 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 firm’s expenditures for major assets and its long-term financing needs

13. Copyright © Houghton Mifflin Company. All rights reserved.20 - 13 Sales Budget for Stars and Stripes Clothing

14. Copyright © Houghton Mifflin Company. All rights reserved.20 - 14 Cash Budget for Stars and Stripes Clothing

15. Copyright © Houghton Mifflin Company. All rights reserved.20 - 15 Developing the Financial Plan (cont’d) Identifying sources of funds –Sales revenues Provide the greatest part of the firm’s financing –Equity capital Money received from the owners or from the sale of shares of ownership 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

16. Copyright © Houghton Mifflin Company. All rights reserved.20 - 16 Class Exercise For each of the following financial needs, identify whether short-term or long-term financing is most appropriate, and identify a typical source of financing. –$250,000 for inventory –$14 million for plant expansion –$2.5 million for business start-up costs –$120,000 to solve cash-flow problems –$450,000 for automated manufacturing equipment –$35,000 for immediate promotional needs

17. Copyright © Houghton Mifflin Company. All rights reserved.20 - 17 Chapter Quiz 1.Which of the following would be considered a long- term financial need? a)Cash flow problems b)New product development c)Inventory needs d)Monthly expenses e)Salary expense 2.The most expensive form of short-term financing is a)trade credit. b)promissory notes. c)prime rate loans. d)factoring. e)common stock.

18. Copyright © Houghton Mifflin Company. All rights reserved.20 - 18 Chapter Quiz (cont’d) 3.Which of the following statements is incorrect? a)A corporation has a legal obligation to pay stockholders a dividend. b)IPO stands for initial public offering. c)A corporation can issue common or preferred stock. d)Stock is a form of equity financing. e)Retained earnings are a form of equity financing. 4.__________ is the use of borrowed funds to increase the return on owners’ equity. a)Financial leverage b)Equity financing c)Leasing d)Venture capital e)Factoring

19. Copyright © Houghton Mifflin Company. All rights reserved.20 - 19 Chapter Quiz (cont’d) 5.A corporate bond secured by various assets of the issuing firm is a __________ bond. a)mortgage b)indenture c)debenture d)convertible e)registered

20. Copyright © Houghton Mifflin Company. All rights reserved.20 - 20 Answers to Chapter Quiz 1.Which of the following would be considered a long- term financial need? a)Cash flow problems b)New product development c)Inventory needs d)Monthly expenses e)Salary expense 2.The most expensive form of short-term financing is a)trade credit. b)promissory notes. c)prime rate loans. d)factoring. e)common stock.

21. Copyright © Houghton Mifflin Company. All rights reserved.20 - 21 Answers to Chapter Quiz (cont’d) 3.Which of the following statements is incorrect? a)A corporation has a legal obligation to pay stockholders a dividend. b)IPO stands for initial public offering. c)A corporation can issue common or preferred stock. d)Stock is a form of equity financing. e)Retained earnings are a form of equity financing. 4.__________ is the use of borrowed funds to increase the return on owners’ equity. a)Financial leverage b)Equity financing c)Leasing d)Venture capital e)Factoring

22. Copyright © Houghton Mifflin Company. All rights reserved.20 - 22 Answers to Chapter Quiz (cont’d) 5.A corporate bond secured by various assets of the issuing firm is a __________ bond. a)mortgage b)indenture c)debenture d)convertible e)registered