1. Chapter 18
Financial
Management
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter
Eighteen
LEARNING GOALS
1. Explain the role and responsibilities of financial
managers.
2. Outline the financial planning process, and explain
the three key budgets in the financial plan.
3. Explain why firms need operating funds.
4. Identify and describe different sources of short-
term financing.
5. Identify and describe different sources of long-term
financing.
18-2

3. Profile
CAROL TOMÉ
Home Depot
• Tomé worked her way up to Chief Financial
Officer (CFO) at Home Depot in 2001.
• Home Depot was in a store
building frenzy; adding
more than 100 locations a
year through 2005.
• Tomé was at the center of
tech transition by
overseeing the distribution
of $350 million in spending.
18-3

4. Chapter
Eighteen
NAME that COMPANY
At one time this company was the largest
automobile maker in the world. Due to severe
financial problems in 2009, the company came
very close to extinction. A $7 billion
government-backed loan and an additional $43
billion government investment in the company
helped it survive. It is now attempting a
comeback as a much smaller company.
Name that company!
18-4

5. The Role of
Finance and
Financial
Managers
WHAT’S FINANCE?
LG1
• Finance -- The function in a business that acquires
funds for a firm and manages them within the firm.
• Finance activities include:
- Preparing budgets
- Creating cash flow analyses
- Planning for expenditures
18-5

6. The Role of
Finance and
Financial
Managers
FINANCIAL MANAGEMENT
LG1
• Financial Management
-- The job of managing a
firm’s resources to meet its
goals and objectives.
18-6

7. The Role of
Finance and
Financial
Managers
FINANCIAL MANAGERS
LG1
• Financial Managers -- Examine financial data
and recommend strategies for improving financial
performance.
• Financial managers are
responsible for:
- Paying company bills
- Collecting payments
- Staying abreast of market
changes
- Assuring accounting
accuracy
18-7

8. Financial
Planning
WHO’S WHO in FINANCE
LG2
• CFO -- Chief Financial
Officer
• CFP -- Certified Financial
Planner
• CFA -- Chartered
Financial Analyst
• Comptroller -- Chief
Accounting Officer
18-8

9. The Role of
Finance and
Financial
Managers
WHAT FINANCIAL
LG1 MANAGERS DO
18-9

10. The Role of
Finance and
Financial WHAT WORRIES FINANCIAL
Managers
LG1 MANAGERS
• Consumer demand for their
firm’s products
• Credit markets and interest
rates
• Financial regulations from
the government
• Volatility of the dollar
• Foreign competition
• Environmental regulations
Source: CFO Magazine, www.cfo.com, accessed July 2011.
18-10

11. The Value of
Understanding
Finance WHY DO FIRMS
LG1 FAIL FINANCIALLY?
1) Undercapitalization
2) Poor control over
cash flow
3) Inadequate expense
control
18-11

12. The Value of
Understanding
Finance
TOP FINANCIAL CONCERNS
LG1 of COMPANY CFOs - MACRO
• Consumer demand
• Federal-government policies
• Price pressure from
competitors
• Credit markets/interest rates
• Global financial instability
Source: CFO Magazine, July/August 2010.
18-12

13. The Value of
Understanding
Finance
TOP FINANCIAL CONCERNS
LG1 of COMPANY CFOs - MICRO
• Ability to maintain margins
• Ability to forecast results
• Maintaining
morale/productivity
• Cost of healthcare
• Working-capital
management
Source: CFO Magazine, July/August 2010.
18-13

14. Financial
Planning FINANCIAL PLANNING
LG2
• Financial planning involves analyzing short-term
and long-term money flows to and from the
company.
• Three key steps of financial planning:
1.
18-14

15. Forecasting
Financial
Needs FINANCIAL FORECASTING
LG2
• Short-Term Forecast -- Predicts revenues,
costs and expenses for a period of one year or less.
• Cash-Flow Forecast -- Predicts the cash
inflows and outflows in future periods, usually months
or quarters.
• Long-Term Forecast -- Predicts revenues,
costs, and expenses for a period longer than one
year and sometimes as long as five or ten years.
18-15

16. Working with
the Budget
Process BUDGETING
LG2
• Budget -- Sets forth management’s expectations
for revenues and allocates the use of specific
resources throughout the firm.
• Budgets depend heavily on the balance sheet,
income statement, statement of cash flows and
short-term and long-term financial forecasts.
• The budget is the guide for financial operations
and expected financial needs.
18-16

17. Working with
the Budget
Process TYPES of BUDGETS
LG2
• Capital Budget -- Highlights a firm’s spending
plans for major asset purchases that often require
large sums of money.
• Cash Budget -- Estimates cash inflows and
outflows during a particular period like a month or
quarter.
• Operating (Master) Budget -- Ties together
all the firm’s other budgets and summarizes its
proposed financial activities.
18-17

18. Working with
the Budget
Process FINANICAL PLANNING
LG2
18-18

19. Establishing
Financial
Control
ESTABLISHING
LG2 FINANCIAL CONTROL
• Financial Control -- A
process in which a firm
periodically compares its actual
revenues, costs and expenses
with its budget.
18-19

20. Establishing
Financial FACTORS USED in ASSESSING
Control
LG2 FINANCIAL CONTROL
• Is the firm meeting its short-term financial
commitments?
• Is the firm producing adequate operating profits
on its assets?
• How is the firm financing its assets?
• Are the firms owners receiving an acceptable
return on their investment?
18-20

21. Progress
Assessment PROGRESS ASSESSMENT
• Name three finance functions important to the
firm’s overall operations and performance.
• What three primary financial problems cause
firms to fail?
• How do short-term and long-term financial
forecasts differ?
• What’s the purpose of preparing budgets? Can
you identify three different types of budgets?
18-21

22. The Need for
Operating
Funds
KEY NEEDS for OPERATIONAL
LG3 FUNDS in a FIRM
• Managing day-by-day
needs of the business
• Controlling credit
operations
• Acquiring needed
inventory
• Making capital
expenditures
18-22

23. FINANCIAL ORDER or
FINANCIAL MARTIAL LAW?
(Legal Briefcase)
• In Michigan, half of the state’s communities are in
financial distress.
• Local Government and School District Fiscal
Accountability Act allows cities, towns, and
school districts to be taken over by state-
appointed emergency financial managers (EFMs)
selected by the Governor.
• Indiana is considering similar legislation. New
York and other states’ boards have been given
similar power.
18-23

24. The Need for
Operating HOW SMALL BUSINESSES
Funds
LG3 CAN IMPROVE CASH FLOW
• Be more aggressive in
collecting accounts receivable.
• Offer customers discounts for
paying early.
• Take advantage of special
payment terms from vendors.
• Raise prices.
• Use credit cards discriminately.
Source: American Express Small Business Monitor.
18-24

25. GOOD FINANCE
or BAD MEDICINE?
(Making Ethical Decisions)
• You’re a new hospital administrator at a small
hospital that, like many others, is experiencing
financial problems.
• You suggest discontinuing the hospital’s large
stockpile of drugs and shift to ordering them just
when they are needed.
• Some like the idea, but the doctors claim you’re
sacrificing patients’ well-being for cash. What do
you do? What could be the result of your
decision?
18-25

26. Alternative
Sources of
Funds
USING ALTERNATIVE
LG3 SOURCES of FUNDS
• Debt Financing -- The
funds raised through various
forms of borrowing that must
be repaid.
• Equity Financing -- The
funds raised from within the
firm from operations or
through the sale of ownership
in the firm (such as stock).
18-26

27. Alternative
Sources of
Funds
SHORT and LONG-TERM
LG3 FINANCING
• Short-Term Financing
-- Funds needed for a year
or less.
• Long-Term Financing
-- Funds needed for more
than a year.
18-27

28. Alternative
Sources of
Funds WHY FIRMS NEED FINANCING
LG3
Short-Term Funds Long-Term Funds
Monthly expenses New-product development
Unanticipated emergencies Replacement of capital equipment
Cash flow problems Mergers or acquisitions
Expansion of current inventory Expansion into new markets
Temporary promotional programs New facilities
18-28

29. Progress
Assessment PROGRESS ASSESSMENT
• Money has time value. What does this mean?
• Why is accounts receivable a financial concern of
the firm?
• What’s the primary reason an organization
spends a good deal of its available funds on
inventory and capital expenditures?
• What’s the difference between debt and equity
financing?
18-29

30. Trade Credit
TYPES of
LG4 SHORT-TERM FINANCING
• Trade Credit -- The practice of buying goods or
services now and paying for them later.
• Businesses often get terms 2/10 net 30 when
receiving trade credit.
• Promissory Note -- A written contract agreeing
to pay a supplier a specific sum of money at a
definite time.
18-30

31. Family and
Friends TYPES of
LG4 SHORT-TERM FINANCING
• Many small firms obtain short-term financing from
friends and family.
• If asking for help from family or friends, it’s
important both parties:
1) Agree to specific loan terms
2) Put the agreement in writing
3) Arrange for repayment the same way they would
for a bank loan
18-31

32. Commercial
Banks DIFFICULTY of OBTAINING
LG4 SHORT-TERM FINANCING
• Banks generally
prefer to lend short-
term money to larger,
more established
businesses.
• The recent financial crisis has made it difficult for
even promising and well-organized businesses to
get loans.
18-32

33. EXPLORING the
FINANCING UNIVERSE
(Spotlight on Small Business)
• Peer-to-peer lending sites like Lending Club
match small businesses with lenders and receive
a fee for their services.
• Lendio claims to have developed a technology
that matches business owners with the right type
of business loan and lender.
• Lendio also offers services such as a business
plan makeover and website design for a fee.
18-33

34. Different
Forms of
Short-Term DIFFERENT FORMS of
Loans
LG4 SHORT-TERM LOANS
• Commercial banks offer short-term loans like:
- Secured Loans -- Backed by collateral.
- Unsecured Loans -- Don’t require collateral
from the borrower.
- Line of Credit -- A given amount of money
the bank will provide so long as the funds are
available.
- Revolving Credit Agreement -- A line of
credit that’s guaranteed but comes with a fee.
18-34

35. Factoring
Accounts
Receivable
FACTORING
LG4
• Factoring -- The
process of selling
accounts receivable for
cash.
• Factors charge more
than banks, but many
small businesses don’t
qualify for loans.
18-35

36. Commercial
Paper COMMERCIAL PAPER
LG4
• Commercial Paper -- Unsecured promissory
notes in amounts of $100,000+ that come due in 270
days or less.
• Since commercial paper is unsecured, only
financially stable firms are able to sell it.
18-36

37. Credit Cards
CREDIT CARDS
LG4
• Rates for small
businesses
grew almost
30% after the
Credit Card
Responsibility
Accountability
and Disclosure
Act was
passed.
Photo Courtesy of: Robert Scoble
• 18-37

38. Credit Cards
WAYS to RAISE
LG4 START-UP CAPITAL
• Seek out a microloan from a microlender
• Use asset-based lending or factoring
• Turn to the web and seek
out peer-to-peer lending
• Research local banks
• Sweet-talk vendors you
want to do business with
Source: Entrepreneur, www.entrepreneur.com, accessed July 2011.
18-38

39. Progress
Assessment PROGRESS ASSESSMENT
• What does an invoice containing the terms 2/10,
net 30 mean?
• What’s the difference between trade credit and a
line of credit?
• What’s the key difference between a secured and
an unsecured loan?
• What’s factoring? What are some of the
considerations factors consider in establishing
their discount rate?
18-39

40. Obtaining
Long-Term
Financing
SETTING LONG-TERM
LG5 FINANCING OBJECTIVES
• Three questions of financial managers in setting long-
term financing objectives:
1. What are the organization’s long-term goals and
objectives?
2. What funds do we need to achieve the firm’s long-term
goals and objectives?
3. What sources of long-term funding (capital) are
available, and which will best fit our needs?
18-40

41. Obtaining
Long-Term
Financing The FIVE “C”s of CREDIT
LG5
1. The character of the borrow.
2. The borrower’s capacity to repay the loan.
3. The capital being invested in the business by
the borrower.
4. The conditions of the economy and the firm’s
industry.
5. The collateral the borrower has available to
secure the loan.
18-41

42. Debt
Financing USING LONG-TERM
LG5 DEBT FINANCING
• Long-term financing loans generally come due
within 3 -7 years but may extend to 15 or 20
years.
• Term-Loan Agreement -- A promissory note
that requires the borrower to repay the loan with
interest in specified monthly or annual installments.
• A major advantage of debt financing is the
interest the firm pays is tax deductible.
18-42

43. Debt
Financing USING DEBT FINANCING
LG5 by ISSUING BONDS
• Indenture Terms -- The terms
of agreement in a bond issue.
• Secured Bond -- A bond
issued with some form of collateral
(i.e. real estate).
• Unsecured (Debenture)
Bond -- A bond backed only by
the reputation of the issuing
company.
18-43

44. Equity
Financing SECURING EQUITY FINANCING
LG5
• A company can secure equity financing by:
- Selling shares of stock in the
company.
- Earning profits and using the
retained earnings as
reinvestments in the firm.
- Attracting Venture Capital
-- Money that is invested in
new or emerging companies
that some investors believe
have great profit potential.
18-44

45. Equity
Financing WANT to ATTRACT a
LG5 VENTURE CAPITALIST?
1. Can the company
grow?
2. Will we get our money
back and more?
3. Will it be worth our
money and effort?
Source: Entrepreneur, February 2011.
18-45

46. Comparing
Debt and
Equity DIFFERENCES BETWEEN
Financing
LG5 DEBT and EQUITY FINANCING
Types of Financing
Conditions Debt Equity
None. Unless special Common stock
Management influence conditions have been holders have voting
agreed on. rights.
Debt has a maturity Stock has no maturity
Repayment
date. date.
The firm isn’t legally
Yearly obligations Payment of interest.
liable to pay dividends.
Interest is tax Dividends are not tax
Tax benefits
deductible. deductible.
18-46

47. Comparing
Debt and
Equity USING LEVERAGE for
Financing
LG5 FUNDING NEEDS
• Leverage -- Raising funds through borrowing to
increase the firm’s rate of return.
• Cost of Capital -- The rate of return a company
must earn in order to meet the demands of its lenders
and expectations of equity holders.
18-47

48. Lessons From
the Financial
Crisis
LESSONS of the
LG5 FINANCIAL CRISIS
• The recent financial crisis was the worst fall since
the Great Depression.
• Led to the passage of
sweeping financial
reform.
• Government is
increasing involvement
and intervention.
18-48

49. Progress
Assessment PROGRESS ASSESSMENT
• What are the two major forms of debt financing
available to a firm?
• How does debt financing differ from equity
financing?
• What are the three major forms of equity
financing available to a firm?
• What is leverage, and why do firms choose to
use it?
18-49