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Chapter Twenty

Chapter Twenty. Mastering Financial Management. The Need for Financing. Short-term financing Money that will be used for one year or less Long-term financing Money that will be used for longer than one year Often involves large amounts of money. (Made in May; Sold in Sept).

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Chapter Twenty

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  1. Chapter Twenty Mastering Financial Management

  2. The Need for Financing • Short-term financing • Money that will be used for one year or less • Long-term financing • Money that will be used for longer than one year • Often involves large amounts of money

  3. (Made in May; Sold in Sept)

  4. The Three Steps of Financial Planning • 1) Establish organizational goals • What do I want • 2) Budget the money needed to accomplish these goals • What does it cost • 3) Identify the sources of those funds • How do I pay for it

  5. Budgeting for financial needs (What does it cost) • Cash budget-(short term) • Traditional • Uses dollar amounts from preceding year • Promotes frenzy spending of surpluses at period end • Zero-based budgeting • Every expense in every budget must be justified each year • Capital budget-(long term) • Estimates a firm’s expenditures for major assets and its long-term financing needs

  6. Identifying sources of funds (How do I pay for it) • Sales revenues • greatest part of financing; short term financing • Equity capital • Money from owners or sale of shares of ownership; long-term financing • Debt capital • Borrowed money obtained through loans • Proceeds from the sale of assets • older machinery, bond conversion

  7. Short-Term Debt Financing • Short-term financing is usually easier to obtain than long-term • Shorter repayment period means less risk of nonpayment • Amounts of short-term loans are smaller than long-term loans

  8. Sources of Unsecured Short-Term Debt Financing Unsecured financing - not backed by collateral • Trade credit • extended by a seller not requiring immediate payment at time of delivery • Promissory notes • A written pledge to pay money to a creditor at a specified future date - legal IOU • Unlike trade credit, promissory notes • usually include interest • Negotiable instruments

  9. Sources of Unsecured Short-Term Debt Financing • Unsecured bank loans • Interest rates vary with borrower’s credit rating • Offered through a line or credit, or credit cards • Commercial paper • Short-term promissory note issued by a large corporation • Interest rates are usually below that charged by banks for short-term loans • Used to gain interest on unused cash reserves

  10. Sources of Secured Short-Term Debt Financing • Loans secured by inventory • Inventory is pledged as collateral • Loans secured by receivables • trade credit given to customers is pledged as collateral • repayability of receivables determines their value to the factor

  11. Comparison of Short-Term Financing Methods

  12. Sources of Long-Term Debt Financing • Long-term loans - longer than 1 year • requires borrower to repay loan in periodic installments • Interest rate and repayment terms are based on: • the reasons for borrowing • the firm’s credit rating • the value of collateral

  13. Sources of Long-Term Debt Financing • Corporate bonds • A corporation’s written pledge that it will repay a specified amount of money with interest • Has a set interest rate until maturity that is paid up-front via discount • Types of bonds • Debenture bond—backed only by the reputation of the issuing corporation • Mortgage bond—secured by assets of the issuing firm • Convertible bond—can be exchanged for shares of the corporation’s common stock – why do this?

  14. Sources of Equity Financing (Long Term) • For sole proprietorships or partnerships • Owner or owners reinvest in the business • Venture capital • For corporations • Sale of stock • Use of profits not distributed to owners • Venture capital Venture capital • Money invested with the expectation that the firm has potential • Investors receive an equity position in the business and share in its profits

  15. Sources of Equity Financing (Long Term) • Selling stock • Initial public offering - IPO • When a corporation sells common stock to the general public for the first time • Preferred stock • owners who have no voting rights, but whose claims on profits are paid first • Common stock • owners who vote on corporate matters but whose claims on profits come second

  16. Comparison of Long-Term Financing Methods

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