1. X100 Introduction to Business
Financial Management & Planning
X100 Introduction to Business
Finance
Financial
Management & Planning
Professor Kenneth EA Wendeln
X100
X100 Introduction to Business

2. Financial Management & Planning
How to manage the financial health of a company – decisions regarding the acquisition & ‘use of money’ to maximize the value of the company while achieving corporate objectives.
Types of Financial Management and Planning Tools:
Capital Budgeting
Capital Structure
Financial Ratios
Used to gain insight on how a firm operates as well as its RISK and RETURN
X100
Financial Management & Planning
X100 Introduction to Business

3. The Three Steps of Financial Planning
Financial Management & Planning
The Three Steps of Financial Planning
1. Establish Organizational
Goals & Objectives
Monitor & Evaluate
2. Budget the Money needed
to meet Goals & Objectives
3. Identify the Sources & Uses of Funds
Profit Revenue
Sales Revenue projections
Expense projections
for this planning period
Equity Capital
Money from SP or partner
Common Stock
Preferred Stock
Dividends
Debt Capital
Short-term borrowing
Long-term borrowing
Debt repayments
Use of Assets
Assets acquired for use in the business
Asset sales for Profit
Asset sales to raise Cash
X100
Financial Management & Planning
X100 Introduction to Business

4. Financial Management & Planning
The Cash Flow Cycle
Sales
Customers
Accounts Receivable
Inventory
Cash
X100
Financial Management & Planning
X100 Introduction to Business

5. Cash Flow for a Manufacturing Business
Financial Management & Planning
Cash Flow for a Manufacturing Business
Expenses  Sales Revenue  Cash Received
X100
Financial Management & Planning
X100 Introduction to Business

6. Financial Management & Planning
Corporate Cash Needs
Short-term (< 1 year) Financing Needs
Day-to-day operations
Payroll
Inventory needs
Accounts Receivable
Monthly expenses
Speculative production
Short—term promotional needs
Emergency/flexibility
Long-term (> 1 year) ‘Capital Budgeting’
Business startup costs
Research & new product development
Long-term marketing & promotion
Facilities expansion
Equipment replacement
Mergers and acquisitions
Whether a business seeks short- or long-term financing depends on what the money will be used for
X100
Financial Management & Planning
X100 Introduction to Business

7. Financing Debt vs Equity Capital
Financial Management & Planning
Financing Debt vs Equity Capital
Debt = Loan
Repayment
Principal
Interest
Equity =
Ownership
Voting Rights
Dividends
Reinvested ‘Retained’ Earnings
X100
Financial Management & Planning
X100 Introduction to Business

8. Differences between Debt & Equity Financing
Financial Management & Planning
Differences between Debt & Equity Financing
Conditions
Debt Financing
Equity Financing
Management Influence
Lenders - usually none, unless special conditions have been agreed upon
Common Stockholders are owners and have voting rights
Repayment
Debt has a maturity date.
Principal must be repaid
Stock has no maturity date. The company is never required to repay equity
Yearly Obligation
Payment of interest is a contractual obligation
The firm is not legally liable to pay dividends
Tax Benefits to the firm
Interest payments are tax deductible by the company
Dividends are paid from after tax funds & not tax deductible
X100
Financial Management & Planning
X100 Introduction to Business

9. Short-term (< 1 year) Debt Financing Methods
Financial Management & Planning
Short-term (< 1 year) Debt Financing Methods
Type of Financing
Cost
Repayment Period
Businesses that may use
Comments
Trade Credit
Low, if any
30-60 days
All businesses
‘Payment terms’, usually no finance charge
Promissory note to suppliers
Moderate
< 1 year
Unsecured but requires a legal document
Unsecured bank loan
Promissory note, line of credit, or revolving credit
Commercial paper
Large corporations with good credit
Unsecured, available only to large firms
Secured loan
High
Firms with questionable credit ratings
Collateral - usually inventory or A/R
Factoring of Accounts Receivable
Highest
None
Firms with large number of credit customers
A/R sold to factor specializing in other firms’ A/R
X100
Financial Management & Planning
X100 Introduction to Business

10. Long-term (> 1 Year) Debt Financing Methods
Financial Management & Planning
Long-term (> 1 Year) Debt Financing Methods
Type of Financing
Re-payment
Period
Interest Cost
Businesses that may use
Long-term loans
Yes
Usually 3 – 7 years
Interest rates between % - 14% depending on economic conditions and company’s financial stability
All firms that can meet the lender’s repayment, covenants, and collateral requirements
Corporate bonds
debenture
registered
mortgage
convertible
serial
Usually 10 – 30 years
Interest rates between % - 12% depending on economic conditions and financial stability of company issuing the bonds
Large corporations that the investors trust
Interest rate would depend on bond rating
X100
Financial Management & Planning
X100 Introduction to Business

11. Long-term Equity Financing Methods
Financial Management & Planning
Long-term Equity Financing Methods
Type of Financing
Re-payment
Period
Dividend Requirements
Businesses that may use
Common Stock No
None
Dividends not required
Common stockholders usually have voting rights
All corporations that sell stock to investors
Preferred Stock
Cumulative
Convertible
Dividends not required – but dividends must be paid to preferred stockholders before common stockholders receive any dividends
Large corporations that have an established investor base of common stockholders
X100
Financial Management & Planning
X100 Introduction to Business

12. Financial Management & Planning
Zimmer Balance Sheet Liabilities & Shareholders’ Equity
Financial Management & Planning
2006
2005
Current liabilities
Due in < 1 year
Long-term Liabilities
Over extended period
Contributed Capital =
Par value + paid in capital – treasury stock ( – 802.9)
Accumulated Earnings not paid as dividends to shareholders
X100
Financial Management & Planning
X100 Introduction to Business

13. Financial Management & Planning
Capital Structure - Leverage Using Equity + Debt for Financing
Using DEBT provides ‘LEVERAGE’ for the shareholders & increases their “Return on Owners’ Equity”
BUT………using more debt (which must be repaid) increases the RISK to the lenders & shareholders
X100
Financial Management & Planning
X100 Introduction to Business

14. Return on Owners’ Equity
Financial Management & Planning
Return on Owners’ Equity
Profitability ratio that provides an overall measure of a business’s performance.
Net income earned (after tax) per dollar of owners’ investment.
Net Income (after taxes)
Owners’ (Shareholders’) Equity
Typically between 15% and 25% for profitable companies
X100
Financial Management & Planning
X100 Introduction to Business

15. Capital Structure - Leverage Low Debt to Equity
Financial Management & Planning
Capital Structure - Leverage Low Debt to Equity
Financial leverage is the use of borrowed funds (debt) to increase return on owners’ equity. But leverage also decreases net profit.
Additional Equity Only
Owner’s equity $500,000
Additional equity ,000
Total owner’s equity $600,000
No Loan
Total Capital $600,000
Year-end Earnings
Operating profit $150,000
No interest
40% PBT ,000
Net profit $ 90,000
Return on Owners Equity 15.0%
($90,000/$600,000)
Additional Debt - Low
Owner’s equity $500,000
Additional equity
Total owner’s equity $500,000
Loan 10%) +100,000
Total Capital $600,000
Year-end Earnings
Operating profit $150,000
Interest 10%) ,000
40% PBT ,000
Net profit $ 84,000
Return on Owners Equity 16.8%
($84,000/$500,000)
X100
Financial Management & Planning
X100 Introduction to Business

16. Financial Management & Planning
Capital Structure - Leverage Medium Debt to Equity
Using financial leverage (debt) increases return on owners’ equity – but also increases the financial risk to lenders and shareholders.
Additional Equity Only
Owner’s equity $500,000
Additional equity ,000
Total owner’s equity $900,000
No Loan
Total Capital $900,000
Year-end Earnings
Operating profit $225,000
No interest
40% PBT ,000
Net profit $ 135,000
Return on Owners Equity 15.0%
($135,000/$900,000)
Additional Debt - Medium
Owner’s equity $500,000
Additional equity
Total owner’s equity $500,000
Loan 10%) +400,000
Total Capital $900,000
Year-end Earnings
Operating profit $225,000
Interest 10%) ,000
40% PBT ,000
Net profit $ 111,000
Return on Owners Equity 22.2%
($111,000/$500,000)
X100
Financial Management & Planning
X100 Introduction to Business

17. Financial Management & Planning
Capital Structure - Leverage High Debt to Equity
High financial leverage further increases financial risk to lenders & owners - may result in higher interest rates, decreasing net profit.
Additional Equity Only
Owner’s equity $500,000
Additional equity ,000
Total owner’s equity $1,200,000
No Loan
Total Capital $1,200,000
Year-end Earnings
Operating profit $300,000
No interest
40% PBT ,000
Net profit $ 180,000
Return on Owners Equity 15.0%
($180,000/$1,200,000)
Additional Debt - High
Owner’s equity $500,000
Additional equity
Total owner’s equity $500,000
Loan 12%) +700,000
Total Capital $1,200,000
Year-end Earnings
Operating profit $300,000
Interest 12%) - 84,000
40% PBT ,400
Net profit $ 129,600
Return on Owners Equity 25.9%
($129,600/$500,000)
X100
Financial Management & Planning
X100 Introduction to Business

18. Firm’s Cost of Capital Impact of Leverage & Risk
Financial Management & Planning
Firm’s Cost of Capital Impact of Leverage & Risk
Weighted Cost of Capital (Debt & Equity WCC)
Equity investors require a return at least as great as the ‘best alternative opportunity forgone’.
As ‘Leverage’ increases with more debt, the risk increases to the lenders & the shareholders, increasing the cost of both debt & equity.
‘Optimum’
Leverage
& WCC
Debt financing is lower risk & cost than equity, lowering the WCC.
Debt as %
Of Capital
Low Debt Financial Leverage High Debt
Source: adapted from The Real Cost of Capital
X100
Financial Management & Planning
X100 Introduction to Business

19. Financial Management & Planning
Key Financial Ratios
Financial Management & Planning
Profitability
Liquidity
Return on Owners’ Equity %
Current Ratio
# n.nn
EPS – Earnings per Share
$ DD.00
Acid Test or Quick Ratio
# n.nn
Return on Sales %
Asset Turnover
Accounts Receivable Turnover
X (times/year) or # days
Financial Leverage
Total Liabilities to Equity %
Inventory Turnover
X (times/year) or # days
X100
Financial Management & Planning
X100 Introduction to Business

20. Financial Management & Planning
X100
Financial Management & Planning
X100 Introduction to Business