Business 111 Chapter 16

The _______ _________ of money is the idea that money in your possession today is worth more than money that will be in your possession in the future

Time value

True or False: A positive aspect of a firm accepting credit cards is that the bank carries the risk of the credit, not the firm

True

Equity financing from retained earnings

When a company keeps the profits it makes and reinvests it in the company. A company that uses them saves interest payments, dividends (payments for investing in stock), and any possible underwriting fees for issuing bonds or stock. Retained earnings also create no new ownership in the firm, as stock does

Stock

When a company sells a part of ownership in the company. This is how the company gets their money.

Capital budget

a budget that highlights a firm's spending plans for major asset purchases that often require large sums of money

Unsecured loan

a loan that doesn't require or is not backed by any collateral. Unsecured loans are more difficult to obtain because of that. Lenders give unsecured loans only to highly regarded customers—long-standing businesses or those considered financially stable.

Term loan agreement

a promissory note that requires the borrower to repay the loan with interest in specified installments. It is tax deductible.

Examples of short term funds

-Monthly expenses -Unanticipated emergencies -Cash flow problems -Expansion of current inventory -Temporary promotional programs

Examples of long term funds

-New product development -Replacement of capital equipment -Mergers or acquisitions -Expansion into new markets (domestic or global) -New facilities

Trade credit

-The practice of buying goods or services now and paying for them later. -It is the most widely used source of short-term funding, the least expensive, and the most convenient. -Small businesses rely heavily on trade credit from as do large firms -When a firm buys merchandise, it receives an invoice (bill) -Business invoices contain terms such as 2/10 and net 30. This means that the buyer can take a 2 percent discount for paying the firm within 10 days. Otherwise the total bill (net) is due in 30 days -Finance managers pay close attention to such discounts because they create opportunities to reduce the firm's costs -Some suppliers hesitate to give trade credit to an organization with a poor credit rating, no credit history, or a history of slow payment. They may insist that the customer sign a promissory note

Factoring

-The process of selling accounts receivable for cash -A factor is financial institution or bank that agrees to buy the firm's accounts receivable, at a discount, for cash -The discount depends on the age of the accounts receivable, the nature of the business, and the condition of the economy -When the factor collects the accounts receivable that were originally owed to the firm, the factor keeps them -Factors charge high interest rates, more than a bank's -Factoring is an expensive way of raising short term funds -Factoring is popular among small businesses -A company can reduce its factoring cost if it agrees to reimburse the factor for slow paying accounts or to assume risk for customers who don't pay at all -Factoring is not a loan; it is the sale of a firms assets (accounts receivable) -Factoring is common in the textile and furniture business

Which of the following are inventory management procedures a firm uses to control inventory costs?

-Tracking inventory turn-over ratios -Holding less inventory in slow sales periods -JIT (just-in-time) inventory management

Accepting credit cards can be useful to small businesses by

-providing ease of payment for customers -providing the business with payment more quickly

Three types of budgets

1. Capital budget 2. Cash budget 3. Operating (or master) budget

Three 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 whether the company is achieving its goals

The most common reasons a firm fails financially

1. Under-capitalization (insufficient funds to start the business) 2. Poor control over cash flow 3. Inadequate expense control

Three questions financial managers ask in setting long term financing objectives

1. What are our 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?

Unsecured bond

A bond backed only by the reputation of the issuer; also called a debenture bond.

Secured bond

A bond issued with some form of collateral, such as real estate, equipment, or other pledged assets. If the bond's indenture terms are violated (not paying interest payments), the bondholder can issue a claim on the collateral

Cash budget

A budget that estimates cash inflows and outflows during a particular period like a month or a quarter. It helps managers anticipate borrowing needs, debt repayment, operating expenses, and short-term investments, and is often the last budget prepared.

What is the importance of acquiring needed inventory?

A carefully constructed inventory policy helps manage the firm's available funds and maximize profitability. Just-in-time inventory control and other such methods can reduce the funds a firm must tie up in inventory. Carefully evaluating its inventory turnover ratio can also help a firm control the outflow of cash for inventory. A business of any size must understand that poorly managed inventory can seriously affect cash flow and run its resources dry.

To encourage a customer to pay its bills on time or early, a firm will often offer:

A discount for payment before a certain date

Bond

A financial contract issued by an organization. It is when a company borrows money from another institution or person and promises to repay the amount borrowed, with interest, on a certain date. It is considered debt financing

Budget

A financial plan that sets forth management's expectations and, on the basis of those expectations, allocates the use of specific resources throughout the firm

Line of credit

A given amount of unsecured short-term funds a bank will lend to a business, provided the funds are readily available. It speeds up the borrowing process since a firm does not have to apply for a new loan every time it needs funds

Revolving credit agreement

A line of credit that's guaranteed but usually comes with a fee

Secured loan

A loan that is backed by collateral (a valuable asset such as property). If the borrower fails to pay back the loan, the lender may take possession of the collateral. Collateral removes some of the bank's risk in lending the money.

Internal auditor

A member of a firm's financial department that checks journals, ledgers, and financial statements to make sure all transactions are in accordance with generally accepted accounting principals (GAAP).

Cash flow forecast

A part of the short term forecast. Forecast that predicts the cash inflows and outflows in future periods, usually months or quarters

Financial control

A process in which a firm periodically compares its actual revenues, costs and expenses with its budget. Such control procedures help managers identify variances to the financial plan and allow them to take corrective action if necessary. Financial controls also help reveal which specific accounts, departments, and people are varying from the financial plan. Finance managers can judge whether these variances are legitimate and thereby merit adjustments to the plan.

Promissory note

A written contract with a promise to pay a supplier a specific sum of money at a definite time. Promissory notes are negotiable. The supplier can sell them to a bank at a discount (the amount of the promissory note minus a fee for the bank's services in collecting the amount due), and the business is then responsible for paying the bank

Pledging

Accounts receivable are used as collateral for a loan; a percentage of the value of a firm's accounts receivable pledged (usually 75%) is advanced to the borrowing firm- as customers pay off their accounts, the funds received are forwarded to the lender in repayment of the funds that were advanced

What are operating funds?

An organization needs operating funds for: -Managing day to day needs of a business -Controlling credit operations -Acquiring needed inventory -Making capital expenditures

Financial planning

Analyzing short term and ling term money flows to and from the firm. Its overall objective is to optimize the firm's profitability and make the best use of its money

Borrowing from commercial banks

Banks, being sensitive to risk, generally prefer to lend short-term money to larger, established businesses. How much a business borrows and for how long depends on the kind of business it is, and how quickly it can resell the merchandise it purchases with a bank loan or use it to generate funds. In a large business, specialists in a company's finance and accounting departments do a cash flow forecast. Small-business owners generally lack such specialists and must monitor cash flow themselves.

How can a firm raise needed money?

Borrowing money (debt) Selling ownership (equity) Earning profits (retained earnings)

Key components of a financial managers job

Buying merchandise on credit (accounts payable) and collecting payments from customers (accounts receivable). They also analyze the tax implications of managerial decisions to minimize the taxes the business must pay.

Credit cards

Credit cards provide a readily available line of credit that can save time. Credit cards are extremely costly and risky. Interest rates are high.

With regard to tax considerations in financing, the fact that interest is tax deductible is a sign of ________ financing

Debt

Forecasting

Determines the amount of funding the firm will need over various periods and the appropriate sources for obtaining those funds

A smaller firm may have more cash management problems than a larger one, including:

Fewer options to finance credit cards

What is the importance of credit?

Financial managers know that in today's highly competitive business environment, making credit available helps keep current customers happy and helps attract new ones

How do financial managers maximize profit?

Financial managers often try to minimize cash expenditures to free up funds for investment in interest-bearing accounts. They suggest the company pay its bills as late as possible (unless a cash discount is available for early payment). They also advise companies to try to collect what's owed them as fast as possible, to maximize the investment potential of the firm's funds

Long term forecast

Forecast that predicts revenues, costs, and expenses for a period longer than 1 year, and sometimes as far as 5 or 10 years into the future. This forecast plays a crucial part in the company's long-term strategic plan, which asks questions such as: What business are we in? Should we be in it five years from now? How much money should we invest in technology and new plant and equipment over the next decade? Will we have cash available to meet long-term obligations?

Short term forecast

Forecast that predicts revenues, costs, and expenses for a period of one year or less

Short term financing

Funds needed for a year or less

What does a budget depend on?

It depends heavily on the accuracy of the firm's balance sheet, income statement, statement of cash flows, and short-term and long-term financial forecasts, which all need to be as accurate as possible.

Are long term loans cheaper or more expensive than short term loans?

Long-term loans are both larger and more expensive to the firm than short-term loans. Since the repayment period can be quite long, lenders assume more risk and usually require collateral, which may be real estate, machinery, equipment, company stock, or other items of value. Lenders may also require certain restrictions to force the firm to act responsibly

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.

Borrowing from family and friends

Many small firms obtain short-term funds by borrowing money from family and friends. Such loans can create problems, however, if all parties do not understand cash flow. If an entrepreneur decides to ask family or friends for financial assistance, it's important that both parties (1) agree to specific loan terms, (2) put the agreement in writing, and (3) arrange for repayment in the same way they would for a bank loan.

What is the value of money?

Money has a time value. The interest a firm gains on its investment is important in maximizing its profit it will gain. Efficient cash management is particularly important to small firms since their access to capital is much more limited than larger businesses

Venture capital

Money that is invested in new or emerging companies that are perceived as having great profit potential. Venture capitalists invest in a company in return for part ownership of the business. They expect higher-than-average returns and competent management performance for their investment.

Is financial management only concerned with items involving cash?

No. Credit, loans, and stock are also part of financial management

What are the two key tasks of a financial manager?

Obtain funds and effectively control the use of those funds. Controlling funds includes managing the firm's cash, credit accounts (accounts receivable) and inventory.

Tasks of financial managers

Obtaining funds, budgeting, planning, auditing, managing taxes, advising top management on financial matters, collecting funds (credit management) and controlling funds (funds management), and cash management

Commercial finance companies

Organizations that make short-term loans to borrowers who offer tangible assets like property, as collateral. Commercial finance companies will often make loans to businesses that cannot get short-term funds elsewhere. They charge higher interest rates than banks.

Stockholders

People who purchase stock and become owners of a public corporation

What do finance activities include?

Preparing budgets, doing cash flow analysis, and planning for the major expenditure of funds on stuff like plant, equipment, and machinery.

Leverage

Raising funds through borrowing to increase the firm's rate of return

What is good financial management?

Sound financial management determines the amount of money needed and the appropriate sources from which to obtain it

Operating (or master) budget

The budget that ties together the firm's other budgets and summarizes its proposed financial activities. More formally, it estimates costs and expenses needed to run a business, given projected revenues. The firm's spending on supplies, travel, rent, technology, advertising, and salaries is determined in the operating budget.

Finance

The function in a business that acquires funds for the firm and manages them within the firm

What are the inflows and outflows of cash recorded on the cash flow forecast based on?

The inflows and outflows of cash recorded in the cash flow forecast are based on expected sales revenues and various costs and expenses incurred, as well as when they are due for payment. A business often uses its past financial statements as a basis for projecting expected sales and various costs and expenses.

Risk return trade off

The principle that the greater the risk a lender takes in making a loan, the higher the interest rate required

What is the problem with credit?

The problem with selling on credit is that as much as 25 percent of the business's assets could be tied up in its credit accounts (accounts receivable). This forces the firm to use its own funds to pay for goods or services sold to customers who bought on credit. Financial managers in such firms often develop efficient collection procedures, like offering cash or quantity discounts to buyers who pay their accounts by a certain time. They also scrutinize old and new credit customers to see whether they have a history of meeting credit obligations on time

Indenture terms

The terms of agreement in a bond issue. It is the bond term, interest, and repayment date

Long term financing

funds needed for more than a year (usually 2 to 10 years)

Debt financing

funds raised through various forms of borrowing that must be repaid

The problem with selling on credit is that extending credit to the customer is practically the same as ______ the customer

lending funds to

Financial managers

managers who examine financial data prepared by accountants and recommend strategies for improving the financial performance of the firm

Equity financing

money raised from within the firm, from operations or through the sale of ownership in the firm (stock or venture capital)

One reason a firm is cautious about extending credit is:

much of a firm's total assets can be tied up in accounts receivable (credit accounts)

Financial management

the job of managing a firm's resources so it can meet its goals and objectives

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. If the firm's earnings are larger than the interest payments on borrowed funds, business owners can realize a higher rate of return than if they used equity financing

Commercial paper

unsecured promissory notes of $100,000 and up that mature or come due in 270 days or less. Commercial paper states a fixed amount of money the business agrees to repay to the lender (investor) on a specific date at a specified rate of interest. A quick path to short-term funds at a lower interest rate than banks. Because commercial paper is unsecured, only financially stable firms (mainly large corporations with excellent credit reputations) are able to sell it. Commercial paper is short term.