Managing the Firm’s Finances Chapter 21

Chapter 21 Learning Goals 1.W 1.What roles do finance and the financial manager play in the firm’s overall strategy? 2.H 2.How does a firm develop its financial plans, including forecasts and budgets? 3.W 3.What types of short-term and long-term expenditures does a firm make? 4.W 4.What are the main sources and costs of unsecured and secured short-term financing?

Chapter 21 Learning Goals (cont’d.) 5.H 5.How do the two primary sources of long- term financing compare? 6.W 6.What are the major types, features, and costs of long-term debt? 7.W 7.When and how do firms issue equity, and what are the costs? 8.W 8.What trends are affecting the field of financial management?

Learning Goal 1 WWhat roles do finance and the financial manager play in the firm’s overall strategy? –Finance involves managing firm’s money –Financial manager decides How much money is needed and when How best to use the available funds How to get the required financing –Financial manager’s responsibilities Financial planning Investing (spending money) Financing (raising money) –Goal of the financial manager Maximize the value of the firm

Financial management: The art & science of managing a firm’s money so that it can meet its goals

The Role of Finance Goal:Goal: to maximize the value of the firm to its owners balance risk and return financial planning investment (spending money) financing (raising money)

Performance for Shareholders most admired performance for shareholders Fortune magazine’s 6 most admired for performance for shareholders: General Electric41.0% total return in 1998 Coca-Cola1.3% Microsoft114.6% Dell Computer248.5% Berkshire Hathaway52.2% Wal-Mart Stores107.6% Source: Fortune, Mar. 1, 1999, p. 72.

Cash Flow Through a Business $ Borrowed funds Sale of fixed assets Collection of accounts receivable Payment of expenses Purchase of inventory Payment of dividends Purchase of fixed assets Cash sales Owners’ investment

Learning Goal 2 HHow does a firm develop its financial plans, including forecasts and budgets? –Planning process ForecastsForecasts –Based on the demand for the firm’s products –Short-term forecasts »Project expected revenues and expenses for one year »Basis for cash budgets used to plan day-to-day operations –Long-term forecasts »Project revenues and expenses for 2 to 10 years

Financial Planning forecasts –operating plans (short-term) –strategic plans (long-term) budgets –cash –capital –operating

Learning Goal 3 WWhat types of short-term and long-term expenditures does a firm make? –Short-term expenditures Supplies Inventory Wages –Long-term expenditures Fixed assets –Land –Buildings –Equipment Projects are carefully analyzed by financial managers to determine which offer best returns

How Organizations Use Funds short-term expenses –cash management –accounts receivable –inventory long-term expenditures –capital expenditures –capital budgeting

Learning Goal 4 WWhat are the main sources and costs of unsecured and secured short-term financing? –Main sources of unsecured short-term financing Trade credit Bank loans Commercial paper –Secured short-term financing Require pledge of assets as security for loan Selling accounts receivable outright at a discount

Obtaining Short-term Financing unsecured short-term loans –trade credit, bank loans, commercial paper secured short-term loans –collateral, factoring

Learning Goal 5 HHow do the two primary sources of long- term financing compare? –Debt financing Interest is tax-deductible Requires payment of interest and principal on specified dates –Equity Common and preferred stock Permanent form of financing Firm may or may not pay dividends Dividends are not tax-deductible

Raising Long-term Financing debt financing –financial risk –term loan, bonds, mortgage loan equity financing –common stock, dividends, retained earnings, preferred stock, venture capital

Raising Long-term Financing Internet Companies Using Venture Capital Source: Newsweek, Dec. 13, 1999, p. 63.

Learning Goal 6 WWhat are the major types, features, and costs of long-term debt? –Long-term debt Types –Term loans »Secured or unsecured »5- to 12-year maturity –Bonds »10- to 30-year maturity –Mortgage loans »Secured by real estate Costs more than short-term financing

Learning Goal 7 WWhen and how do firms issue equity, and what are the costs? –Chief sources of equity financing Common stock –Cost includes issuing costs and potential dividend payments Retained earnings –Profits reinvested in firm Preferred stock –More expensive than debt –Dividends not tax-deductible –Claims are secondary to those of debtholders –Less expensive than common stock Venture capital –Often a source of equity financing for young companies

Debt vs. Equity Financing Management Claim on income & assets Maturity Tax treatmentDebt creditors have none greater claim stated maturity interest is deductibleEquity stockholders vote residual claim no maturity dividends not deductible

Use of Corporate Assets most admired corporate assets Fortune’s most admired for use of corporate assets: Cisco Systems Berkshire Hathaway Coca-Cola Least admired Least admired: MedPartners Oxford Health Plans Trump Hotels & Casinos Source: Fortune, Mar. 1, 1999, p. 72.

Learning Goal 8 WWhat trends are affecting the field of financial management? –Globalization Brings additional complexity to financial management Financial managers must be prepared to invest and raise funds overseas Transactions must be made in multiple currencies –Financial managers are spending more time on risk management Identifying and evaluating risks Selecting techniques to control and reduce risk

Trends in Finance Finance goes global Risk management –credit risk, market risk, operational risk Global Association of Risk Professionals –The Global Association of Risk Professionals is a not-for-profit organization of over 8,000 professionals: from 16 different countries employed in major accounting & banking companies 16 different industries 19 different focus areas Source: The Global Association of Risk Professionals,