Chapter 18

Financial Management

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 Chapter Contents
The Role of Finance and Financial Managers
Financial Planning
The Need for Operating Funds
Obtaining Short-Term Financing
Obtaining Long-Term Financing

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

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 Name that Company
This company spends over $8 billion a year on research to
develop new products. It may take as long as 10 years
before the products are approved and introduced to the
market. Since long-term funding is critical in this business,
high-level managers are very involved in the finance
decisions.

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 The Role of Finance and Financial
Managers
Finance — The function in a business that acquires funds
for the firm and manages those funds within the firm.
Finance activities include:
• Preparing budgets
• Doing cash flow analysis
• Planning for expenditures

LO 18-1

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 The Role of Finance and Financial
Managers
Financial management — The job of managing a firm’s
resources to meet its goals and objectives.
Financial managers — Examine financial data and
recommend strategies for improving financial performance.
Financial managers are responsible for:
• Obtain funds
• Effectively control use of funds

LO 18-1

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 Figure 18.1 What Financial
Managers Do

Jump to long description in LO 18-1

appendix

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 The Role of Finance and Financial
Managers
The Value of Understanding Finance
• Most common reasons a firm fails financially:
1. Undercapitalization
2. Poor control over cash flow
3. Inadequate expense control

LO 18-1

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 Top Financial Concerns of Company
CFOs — Macro

Consumer demand

Federal-government policies

Price pressure from competitors

Credit markets/interest rates

Global financial instability

LO 18-1
Source: CFO Magazine, www.cfo.com, accessed November 2017.

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 Top Financial Concerns of Company
CFOs — Micro

Ability to maintain margins

Ability to forecast results

Maintaining morale/productivity

Cost of healthcare

Working-capital management

LO 18-1
Source: CFO Magazine, www.cfo.com, accessed November 2017.

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 Financial Planning
Financial planning involves analyzing short-term and long-
term money flows to and from the company.
Three key steps of financial planning:
1. Forecasting the firm’s short-term and long-term financial
needs
2. Developing budgets to meet those needs
3. Establishing financial controls to see if the company is
achieving its goals

LO 18-2

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 Figure 18.2 Financial Planning

Jump to long description in LO 18-2

appendix

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 Financial Planning
Forecasting Financial Needs
• 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.

LO 18-2

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 Financial Planning
Working with the Budget Process
• Budget — Sets forth management’s expectations 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.

LO 18-2

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 Financial Planning
Working with the Budget Process continued
• 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 (or master) budget — Ties together all the firm’s
other budgets and summarizes its proposed financial activities.

LO 18-2

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 Financial Planning
Establishing Financial Controls
• Financial control — A process in which a firm periodically
compares its actual revenues, costs, and expenses with its
budget.

LO 18-2

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 The Need for Operating Funds
Key needs for operational funds in a firm include:
• Managing day-by-day needs of the business
• Controlling credit operations
• Acquiring needed inventory
• Making capital expenditures
• Capital expenditures — Major investments in either tangible long-
term assets such as land, buildings, and equipment or intangible
assets such as patents, trademarks, and copyrights.

LO 18-3

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 The Need for Operating Funds
Alternative Sources of Funds
• Debt financing — Funds raised through various forms of
borrowing that must be repaid.
• Equity financing — Money raised from within the firm, from
operations or through the sale of ownership in the firm (stock or
venture capital).
• Short-term financing — Funds needed for a year or less.
• Long-term financing — Funds needed for more than a year.

LO 18-3

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 Obtaining Short-Term Financing
Trade Credit
• Trade credit — The practice of buying goods and services now
and paying for them later.
• Businesses often get terms such as 2/10, net 30 when receiving
trade credit.
• Promissory note — A agreement with a promise to pay a
supplier a specific sum of money at a definite time.

LO 18-4

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 Time Value of Cash
One thing you can never have too much of is cash.
Financial managers must make certain there is enough
cash available to meet daily financial needs and still have
funds to invest in its future. What does it mean when we
say cash has a time value?

LO 18-4
© Voronin76/Shutterstock RF

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 Obtaining Short-Term Financing
Family and Friends
• 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

LO 18-4

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 Obtaining Short-Term Financing
Commercial Banks
• Banks generally prefer to lend short-term money to larger,
established businesses.
• During difficult economic times, bank loans can virtually
disappear.

LO 18-4

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 Obtaining Short-Term Financing
Different Forms of Short-Term Loans
• Secured loan — Backed by collateral.
• Unsecured loan — Doesn’t require any collateral.
• Line of credit — Given amount of unsecured short-term funds a
bank will lend, provided the funds are readily available.

LO 18-4

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 Obtaining Short-Term Financing
Factoring Accounts Receivable
• Factoring — The process of selling accounts receivable for
cash.
• Factors charge more than banks, but many small businesses
don’t qualify for loans.

LO 18-4

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 Obtaining Short-Term Financing
Commercial Paper
• 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.

Credit Cards
• It is estimated that one-third of all small firms use credit cards to
finance their businesses.
• Credit cards are convenient but costly for a small business.

LO 18-4

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 Obtaining Long-Term Financing
In setting long-term financing objectives, financial
managers generally ask three questions:
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?

LO 18-5

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 Obtaining Long-Term Financing
Debt Financing
• Debt Financing by Borrowing from Lending Institutions
• Long-term financing loans generally come due within 3 to 7 years
but may extend to 15 or 20 years.
• Term-loan agreement — A promissory note that requires the
borrower to repay the loan in specified installments.
• A major advantage is that loan interest is tax-deductible.
• Risk/return trade-off — The principle that the greater the risk a
lender takes in making a loan, the higher the interest rate required.

LO 18-5

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 Obtaining Long-Term Financing
Debt Financing continued
• Debt Financing by Issuing Bonds
• Secured bond — A bond issued with some form of collateral, such
as real estate.
• Unsecured (debenture) bond — A bond backed only by the
reputation of the issuer.

LO 18-5

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 Obtaining Long-Term Financing
Equity Financing
• Equity Financing by Selling Stock
• Equity Financing from Retained Earnings
• Equity Financing from Venture Capital
• Venture capital — Money that is invested in new or emerging
companies that are perceived as having great profit potential.

LO 18-5

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 Obtaining Long-Term Financing
Comparing Debt and Equity Financing
• Leverage — Raising needed 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 its
equity holders.

LO 18-5

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