1. Financing the Enterprise
CHAPTER 14 Accounting and Financial Statements
This is the final chapter. Chapter sixteen examines the importance of financial markets and securities markets. We will consider options available for short and long-term financing and capital budgeting. We will discuss the use of equity financing by issuing stock and conclude with a discussion on the various securities markets in the United States.
CHAPTER 15 Money and the Financial System
CHAPTER 16 Financial Management and Securities Markets
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2. Working Capital Management
The management of short-term assets and liabilities
Current Assets: Short-term resources
Cash
Investments
Accounts receivable
Inventory
Current Liabilities: Short-term debts
Accounts payable
Accrued salaries
Accrued taxes
Short-term bank loans
Working capital management only involves short-term assets and liabilities because they continually flow through an organization and therefore are said to be ‘working’.
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3. [ ] Transaction Balance
Cash kept on hand by a firm to pay normal daily expenses such as employee wages and bills for supplies and utilities
Managers in charge of working capital need to try to keep just enough cash on hand for normal expenses.
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4. Lockbox [ ]
An address, usually a commercial bank, at which a company receives payments in order to speed collections from customers
A lockbox manager (usually a bank) collects payments from the lockbox several times a day and deposits them in the company’s bank account. A lockbox is quicker than sending payments to the company’s main address and processing them from there– is only cost-effective for the largest companies.
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5. Electronic Funds Transfer
Frequently used to speed up collections
Also being used to pay bills online
Companies want to collect bills quickly and pay them slowly
Paying electronically increases the speed of collections and disbursements to one day
Checks are the slowest way to pay bills (generally 3-4 days)
This method is best for large organizations, especially international ones, that face slow and sometimes uncertain delivery of payments.
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6. …continued on next page
Investing Idle Cash
Marketable Securities
Temporary investment of extra cash by organizations up to one year in U.S. Treasury bills, certificates of deposit, commercial paper, or eurodollar loans
Treasury Bills (T-bills)
Short-term debt obligations the U.S. government sells to raise money
Maturities between 1 week to 1 year
Sometimes cash comes in more quickly than it is needed. Rather than leaving it idle, businesses will often invest it until it is needed (from one night to one year).
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7. Investing Idle Cash Commercial Certificates of Deposit (CDs)
Issued by commercial banks and brokerages available in minimum amounts of $100,000, typically $1 million, and can be traded prior to maturity
Commercial Paper
A written promise from one company to another to pay a specific amount of money
Restricted only to the largest and most respected companies
Eurodollar Market
A market for trading U.S. dollars in foreign countries
Any U.S. dollar-denominated deposit in non-U.S. bank is called eurodollar
The eurodollar market includes all countries outside the U.S.– not only Europe. The eurodollar market was originally developed by London banks (hence the name), but applies to all U.S. dollars deposited in foreign banks.
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8. Accounts Receivable and Inventory
Occurs on the balance sheet after cash and marketable securities
Accounts Receivable
Money owed to a business by credit customers
Companies often offer discounts for early payment and penalties for late payments
Optimizing Inventory
Objective is to minimize firm’s investment in inventory without experiencing production cutbacks
Radio frequency identification (RFID) technology helps firms track and optimize their inventories
Accounts receivable discounts and penalties are usually in the 1-2% range. Discounts reduce profits, but they also provide a company with cash sooner. Inventory surpluses and shortages can both be expensive and reduce a company’s efficiency. Optimizing inventory is an important task.
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9. Managing Current Liabilities
Accounts Payable
Money an organization owes to suppliers for goods and services
Trade Credit
Credit extended by suppliers for the purchase of their goods and services
The most important account payable and most widely used source of short-term financing
Trade credit varies depending on the organizations involved and the value of the items purchased.
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10. Current Liabilities: Bank Loans
Line of Credit
An arrangement by which a bank agrees to lend a specified amount of money to an organization upon request
Similar to a credit card, but often for millions of dollars
Secured Loans
Loans backed by collateral that the bank can claim if the borrowers do not repay the debt
Nearly all organizations receive short-term financing for operations from banks.
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11. Current Liabilities: Bank Loans
Unsecured Loans
Loans backed only by the borrower’s good reputation and previous credit rating
Prime Rate
The interest rate that commercial banks charge their best customers for short-term loans
Interest rates on commercial loans can be fixed or variable (floating- rate loan)
Floating rate loans are appealing when interest rates are falling, but not when they rise
Businesses and individuals build their credit rating from their history of borrowing and repaying on time and in full. A complaint during the most recent financial meltdown was that banks were unwilling to lend. This stemmed from two main causes: banks were trying to rebuild capital, and they did not want to take on extra risk.
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12. Non-Bank Liabilities
Short-term loans from insurance companies, pension funds, money market funds, or finance companies
Factor
An organization that purchases accounts receivables at a discount and assumes responsibility for collecting the accounts
Taxes and Employees’ Wages
Debt obligations to the firm
Additional nonbank liabilities that must be efficiently managed to ensure maximum profitability
Banks are not the only source of short-term funding available to organizations. Organizations are responsible for paying many different kinds of taxes that differ depending on the type of business the organization conducts.
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13. Managing Long-Term (Fixed) Assets
Expected to last for many years
Production facilities (plants), offices and equipment
Tend to be high-cost, making financing critical
Organizations need the most high-tech, up-to-date facilities and equipment they can afford in order to be competitive
Obtaining long-term financing can be difficult
Leasing is a way of obtaining assets without purchasing them
Most business failures stem from poor short-term financial planning, but long-term management of financial assets and liabilities is essential to the continued health of a business.
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14. Capital Budgeting
The process of analyzing the needs of business and selecting the assets that will maximize its value
Not an exact process
Managers must be flexible as new information becomes available
Assets and projects must be continuously reevaluated
Capital budgeting is one of the most important jobs of a financial manager.
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15. Pricing Long-Term Money
Factors to Consider:
How much cash will be generated
Cost of financing
Supply of funds available for investment
Accurately identifying opportunities with the greatest potential for ROI
Returns on investment must cover the operating costs of a project, plus interest expenses for the debt. All corporations only have a limited supply of funds to invest, but smaller, newer, riskier companies will have the hardest time getting the best rates for their investments. Costs of financing decrease for companies that manage their finances well over time.
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16. Financing with Long-Term Liabilities
Debts that will be repaid over a number of years
Long-term loans
Bond issues
Companies must raise money in the form of lines of credit or loans
Relying too heavily on debt can be dangerous
Companies may not earn enough to cover interest payments
In order to continue operations, most companies will have to accrue some long-term debt. This should be carefully managed, however. Firms that rely too heavily on debt could run into problems.
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17. Bonds Common form of long-term debt
Sold by large companies to raise long-term funds
Like corporate IOUs
Bondholders basically loan the issuer cash
Indenture: The bond contract specifying all terms of agreement between the bondholder and the issuing organization
Specifies interest payments, maturity date, repayment methods, etc.
The face value (initial sales price) of the bond is usually $1,000, but its value on the open market fluctuates with the economy.
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18. …continued on next page
Types of Bonds
Unsecured Bonds
Debentures, or bonds, that are not backed by specific collateral
Most common type
Secured Bonds
Bonds that are backed by specific collateral that must be forfeited in the event the issuing firm defaults
Serial Bonds
A sequence of small bond issues of progressively longer maturity
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19. Types of Bonds Floating-Rate Bonds
Bonds with interest rates that change with current interest rates otherwise available in the economy
Junk Bonds
Special type of high interest rate bond that carries higher inherent risks
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20. Financing with Owner’s Equity
Owner’s Equity is the owner’s investment in an organization
All money and assets owners have brought into an organization
In addition to long-term debt, organizations can use equity as a means of financing. As discussed in chapter 14, owner’s equity is the owner’s investment in an organization.
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21. Common Stock
The most important source of capital for most new companies
Gives stockholders voting and control rights
Par Value: The amount printed on the stock certificate
Market Value: The price at which the stock is trading
Capital in Excess of Par: The difference between the market value and the par value
Stockholders’ equity is in stock– which is an important source of funds for most new corporations. Stock can help organizations raise capital quickly. Common stock is one of two types of stock.
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22. Financing with Owner’s Equity
Preferred Stock
Gives the stockholder preference in distribution of profits, but not voting and control rights
Is a safer investment than common stock
Retained Earnings
Earnings after expenses and taxes
Are reinvested in the assets of the firm and belong to the owners in the form of equity
The only long-term funds a company generates internally
Preferred stock is the second type. Both types of stock have pros and cons, but preferred stock is generally considered desirable because it is more likely to pay reliable dividends.
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23. When a Company Has Profits Left Over
Retained Earnings
Reinvested in the assets of the firms
Dividend Yield
The dividend per share divided by the stock price
Not all companies pay dividends
When a company has profits left over after paying expenses and taxes, it may choose to reinvest the assets or distribute them as a dividend to shareholders.
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24. Financing Through Issuing Stock
Primary Market
New issue (first-time sale of stock) or initial public offering (IPO– when a company offers stock for sale for the first time)
Raise cash for issuing corporation
Secondary Market
Stock exchanges and OTC markets
Investors trade securities with each other
Does not raise cash for corporation
There are two markets for stock. The primary market is for first-time issues– the corporation issuing the stock receives the funds raised through this market. The secondary market is for stocks that have already been issued that are changing hands.
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25. Investment Banking Is the sale of stocks and bonds for corporations
Helps companies raise funds by matching people and institutions who have money to invest with corporations needing resources
A way for corporations to obtain financing
Many investment banks now offer other banking services
“One-stop shopping”
Large firms have client relationships with investment banking firms that help match them with investors so they can raise funds.
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26. Securities Markets
Provide the mechanism for buying and selling securities
The Stock Market
Dramatic shifts in structure of exchanges
NY Stock Exchange and NASDAQ now are for-profit businesses
Most exchanges are or are becoming electronic– making organized exchanges less centralized and faster
Over-the-Counter Market (OTC)
A network of dealers all over the country and world
No central location
Small stocks, illiquid bank stocks and penny stocks
Securities markets make it possible for owners to sell stocks and bonds to other investors– one may think of them as providers of liquidity.
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27. Measuring Market Performance
How are investments performing relative to the whole market?
Performance measures make comparison possible
Index: Compares current stock prices with a base price
Average: The average of certain stock prices, usually calculated with complicated formulas
Financial bubbles can be hard to recognize, even with performance measures
Investors must stay well informed of business news
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28. Market Performance of Indonesia Capital Market (IDX)
While the stock market took a major hit in late 2008, it had begun to recover by summer 2009, but continued to fluctuate in 2010.
Source:
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