Chapter 7.

B: Basics of Financial Management

 Learning Outcomes

• Explain the roles of finance and financial

manager’s play in the company’s overall strategy.
• Explain how a company develops its financial
plans, including forecasts and budgets.
• Identify the types of short- and long-term
financing.
• Identify some of the trends that are affecting the
practice of financial management.
 Financial Management

Financial Management:
The spending and raising of
a firm’s money – is both a
science and an art. CFOs
need a broad understanding
of their firm’s business and
industry, as well as
leadership ability and
creativity.
How Cash Flows through a Business
The Financial Manager’s Responsibilities and Activities

Preparing the financial plan, which projects

Financial revenues, expenditures, and financing needs
Planning over a given period.

Investing the company’s funds in projects and

Investment securities that provide high returns in relation
to their risks.

Obtaining funding for the company’s

Financing operations and investments and seeking the
best balance between debt and equity.
 Goal of a Financial Manager

Financial Manager
Opportunity for
Investment Financing Profit

Return!

= Maximizing
Financial the value of the Potential for Loss
Planning company to its
owners
Risk!
 Why Businesses Financially Fail

Any Ideas???
1.Undercapitalization
2. Poor control over cash flow
3. Inadequate expense control

http://www.reuters.com/article/us-teslamotors-cash-insight-idUSKCN0QE0DC20150810
https://www.google.com/search?q=tesla+stock+price&tbm=fin#scso=_acWTXNmhEZLh-gSG5YLADQ2:0&spf=1553188201170
 Risk and Return Factors

Any Ideas???

Changing patterns of market demand

Interest rates

General economic conditions

Marketing conditions

Social issues
 Forecasting the Future

Project revenues,
Short-Term Operating Plans for
costs of goods,
one-year period
Forecasts operating expenses

Strategic Plans for

Long-Term longer than a one-
Broader view of
financial activities
Forecasts year period
 Financial Planning Process

Forecast Cash Flow Budget Cash Needs

Short-term & Operating, Cash, &
Long-term Uses Capital

Compare Results Control Differences

Modify Forecasts & Actual vs. Projected
Budgets Flows
 Budgets

Cash
Forecast cash inflows and outflows
Budgets

Capital
Forecast outlays for fixed assets
Budgets

Operating
Forecast profits and expenses
Budgets
 Budgeting

• The importance of budgeting cannot be overlooked

• Critical for all businesses, large and small
• Many small businesses have a lack of financing skills
• Many budgets end up on a shelf. The process
becomes a formality
• But, Managers must be flexible…
 How Organizations Use Funds

Cash
Manage Daily Operations
• Salaries, taxes, interest payments
• Maximize investment potential (Time Value of Money)
Manage Accounts Receivable (credit)
• Credit entices customers
• BUT… a business then has high accounts receivable
• Cash and timely payment discounts
• Credit cards help to alleviate risk for the business
Acquire Inventory
• Inventory maintenance
Capital Expenditures
• Tangible or Intangible assets (Land, Buildings, Patents)
Obtaining Financing

Borrowing
Money
(Debt)

Sell
Retain
Ownership
Earnings
Shares
(Profits)
(Equity)
Debt vs. Equity Financing
 Debt Financing: Short Term
• Trade Credit (Account Payable): seller extends credit to buyer
o Ex. 2/10 net 30

• Banks/Financial Institutions:
o Build a relationship
o Secured loan- backed by collateral
o Unsecured loan- no collateral
o Line of credit- a given amount of unsecured funds. Speeds up the borrowing process
o Commercial finance companies- offer short term loans with collateral

• Commercial Paper: unsecured promissory notes

o Short term financing issued by a financially secure firm
o Fixed amount to be repaid and interest.
o Shorter term

• Factoring: selling accounts receivable for cash

o Expensive

• Credit Cards:
o Risky and costly

• Family/Friends:
o Make a formal agreement
o Be careful – can cause turmoil
 Debt Financing: Long Term

• Term-loan: long-term debt from a lending institution such as banks. Repaid in

installments, often require collateral
• Bonds: long-term debt issued by corporations and governments
o Interest = coupon rate
o Bond rating = risk to investors
o Maturity date
o Debenture bonds- unsecured
o Secured bonds- backed by collateral
o Callable bond- repaid before maturity date
o Convertible bond- can be converted into common shares
• Mortgage Loan: long-term loan with real estate as collateral
 Equity Financing: Long Term

• Stocks: shares of ownership in a company

o Common shares: ownership with voting rights (Board of Directors)
o Preferred shares: preference of dividends
o Initial public offering (IPO): the first public offering of a corporation’s stock
o Par value= $ amount of each stock
o Stock Certificate
o Dividends

• Retained Earnings: profits reinvested back into the business

• Venture Capital: money that is invested in new companies or ideas that have
immense profit potential
o Require high returns/ownership
 Making Use of Leverage

Leverage- Selling Bonds Equity- Sale of Stock

Common Stock $ 50,000 Common Stock $500,000
Bonds (@10%) $450,000 Bonds (@10%) 0
Funds Raised $500,000 Funds Raised $500,000
Earnings $125,000 Earnings $125,000
Less: Bond Interest $ 45,000 Total Earnings $125,000
Total Earnings $ 80,000
Return to $80,000 = 160% Return to $125,000
= 25%
Stockholders $50,000 Stockholders $500,000

Leverage: The amount of debt used to finance a firm's assets. A firm with
significantly more debt than equity is considered to be highly leveraged.
 Other Unique Funding Sources

Some innovative new sources of funding have emerged as organizations and entrepreneurs seek to reduce
financing costs and access capital when traditional sources such as banks and governments have become
less available.
1. Crowdfunding: The practice of funding a project or venture by raising many small amounts of money
from a large number of people, typically via the Internet. People have raised thousands or even millions
of dollars using websites such as Kickstarter, Indiegogo and Crowdfunder.
2. Microfinance: Providing access to small amounts of financing to those whom would otherwise not have
access to funds (unemployed or low-income individuals) in hopes of creating self-sufficiency.
3. Own-source Revenue – First Nations: The revenue that an Aboriginal government raises by levying
taxes and resource revenues or by generating business and other income.
(Source: Indigenous and Northern Affairs Canada: Fact Sheet – Own-Source Revenue:
https://www.aadnc-aandc.gc.ca/eng/1354117773784/1354117819765)
 Financing Pros and Cons

Source Pros Cons

Lending agencies: Access to large sums Difficult
to attain
Thorough analysis Obligation
Banks (loans)
Interest is tax deductible Collateral

Expensive
Debt

Bonds Control Legally bound

Temporary Interest

Callable

Trade credit Convenient Must budget

Least expensive Capitalize on discounts

Shares: Common No repayment Loss of control

No legal obligation to pay Dividends (not tax
or Preferred
No debt deductible)
Equity

Retained Earnings Optimum method (internal) Difficult

for large
No debt or payments expenditures
No loss of control

Venture Capital Earlyaccess to funds Expensive

Advice Loss of control

 The Future of the Financial Industry

The CFO’s Role Continues to Expand:

• Work with top management to develop and implement
the firm’s strategic direction
• Re-establish public trust
• Assure stakeholders of honest transactions
and reporting
• Maintain a higher profile with their companies’ boards