18 Financial Management

term-loan agreement

a promissory note that requires the borrower to repay the loan in specified installments

unsecured loans

loans that doesn't require any collateral.

equity financing

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

leverage

raising needed funds through borrowing to increase a firm's rate of return

operating (or master) budget

the budget that ties together the firm's other budgets and summarizes its proposed financial activities

trade credit

the practice of buying goods and services now and paying for them later

risk/return trade-off

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

factoring

the process of selling accounts receivable for cash

Captial Expenditures

Expenditures on equipment the business will use for many years.

short term forecasting predicts revenues, costs, and expenses for a period of one year or less. Part of this may be cash flow forecast, which predicts the cash and outflows in future periods, usually months or quarters. A long-term forecast predicts revenues, costs, and expenses for a period longer than a yea, sometimes as long as five to ten years. This plays a crucial part in the companies long-term strategic plan.

How do short-term and long-term financial forecasts differ?

Debt financing refers to funds raised by borrowing (going into debt)Equity financing is raised from selling ownership in the company, including to venture capitalists, or within the firm (through retained earnings)1

How does debt financing differ from equity financing?

the capital budget is the spending plan for expensive assets such as property, plant, and equipment. The cash budget is the projected cash balance at the end of a given period. The operating (master) budget summarizes the information in the other two budgets. It projects dollar allocations to various costs and expenses given various revenues.

What are the three budgets in a financial plan?

The three major forms of equity financing available to a firm are financing by selling stock, financing from retained earnings, and financing from venture capital.

What are the three major forms of equity financing available to a firm?

Debt financing comes from two sources: selling bonds and borrowing from individuals, banks, and other financial institutions. Bonds can be secured by some form of collateral or unsecured. The same is true of loans.

What are the two major forms of debt financing available to a firm?

Debt financing comes from two sources: selling bonds and borrowing from individuals, banks, and other financial institutions. Bonds can be secured by some form of collateral or can be unsecured. The same is true of loans.

What are the two major forms of debt financing?

financial managers plan, budget, control funds, obtain funds. collect funds, conduct audits, manage taxes, and advise top management on financial matters.

What do financial managers do?

This is a business invoice. It means the buyer can take a 2 percent discount for paying the invoice within 10 days. Otherwise the total bill (net) is due in 30 days.

What does an invoice containing the terms 2/10, net 30 mean ?

Leverage is borrowing funds to invest in expansion, major asset purchases, or research and development. Firms measure risk of borrowing agains the higher potential for profits.

What is leverage, and why do firms choose to use it?

A line of credit is an agreement by a bank to lend a specified amount of money to the business at any time, if the money is available.

What is meant by a line of credit?

Budgets set forth management's expectations for revenues and, on the basis of those expectations, allocates the use of specific resources throughout the firm. Three different types of budgets are : - capital budget - cash budget - operating or master budget

What is the purpose of preparing budgets in an organization? Can you identify three different types of budgets?

1. undercapitalization 2. poor control over cash flow 3. inadequate expense control

What three primary financial problems cause firms to fail?

a corporation's unsecured promissory note maturing in 270 days of less.

What's commercial paper?

An unsecured loan has no collateral backing it. Secured loans have collateral backed by assets such as accounts receivable, inventory, or other property of value.

What's the difference between a secured loan and an unsecured loan?

A trade of credit is is the least expensive and most convenient form of short-term financing. Businesses can buy goods today and pay for them sometime in the future. A line of credit is is an agreement by a bank to lend a specified amount of money to the business at any time, if the money is available.

What's the difference between trade credit and a line of credit?

Providing credit to customers is often necessary to keep current customers happy and to attract new customers. The problem with selling on credit is that as much as 25 percent of the firm's assets could be tied up in accounts receivable. This forces the business to use it own funds to pay for goods or services sold to customers who bought on credit.

Why is accounts receivable a major financial concern to the firm?

Trade credit is the least expensive and most convenient form of short-term financing. Businesses can buy goods today and pay for them sometime in the future.

Why should businesses use trade credit?

capital budget

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

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

financial control

a process in which a firm periodically compares its actual revenues, costs, and expenses with its budget

Financial managers

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

finance

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

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

leverage is borrowing funds to invest in expansion, major asset purchases, or research and development. Firms measure the risk of borrowing against the potential for higher profits.

what's leverage, and how do firms use it?

1- managing day-by-day operations 2- controlling credit operations 3- acquiring needed inventory 4- making capital expenditures

What are firms' major financial needs?

Debt financing is the sale of bonds to investors and long-term loans from banks and other financial institutions. Equity financing is obtained through the sale of company stock, from the firm's retained earnings, or from venture capital firms.

What are the major sources of long-term financing?

An unsecured loan has no collateral backing it. Secured loans have collateral backed by assets such as accounts receivable, inventory, or other property of value.

What's the key difference between a secured and an unsecured loan?

secured loans

loans backed by collateral (something valuable, such as property).

promissory note

a written agreement with a promise to pay a supplier a specific sum of money at a definite time.

Cash flow forecast

forecast that predicts the cash inflows and outflows in future periods, usually months or quarters

debt financing

funds raised through various forms of borrowing that must be repaid

No, factoring means selling accounts receivable at a discounted rate to a factor ( an intermediary that pays cash for those accounts and keeps the funds it collects on them.

Is factoring a form of secured loan?

1. undercapitalization 2. poor control over cash flow 3. inadequate expense control

What are the most common ways firms fail financially?

The process of selling accounts receivable for cash.

What is factoring?

The primary difference between debt and equity financing is that debt must be repaid at maturity, while there is no obligation to repay equity financing. Interest must be paid on debt while the company is under no obligation to issue dividends on equity financing. The interest paid is tax deductible while dividends are not. Finally, debt holders do not have the right to vote on company matters as equity holders do.

What's the difference between debt and equity financing?

debt financing raises funds by borrowing. Equity financing raises funds from within the firm through investment of retained earnings, sale of stock to investors, or sale of part ownership to venture capitalist.

What's the difference between debt financing and equity financing?

Short-term financing raises funds to be repaid in less than a year, whereas long-term financing raises funds to be repaid over a longer period.

What's the difference between short-term and long-term financing?

To attract customers a firm must purchase inventory as well as invest in tangible long-term assets such as land, buildings, and equipment, or intangible assets such as patents, trademarks, and copyrights.

What's the primary reason an organization spends a good deal of its available funds on inventory and capital expenditures?

cash budget

a budget that estimates cash inflows and outflows during a particular period like a month or a quarter

line of credit

A given amount of unsecured short-term funds a bank will lend to a business, provided the funds are readily available.

Time value of money means money can grow over time through interest earned compounded

Money has time value. What does this mean?

venture capital

Money that is invested in new or emerging companies that are perceived as having great profit potential

financial planning, budgeting, and the establishment of financial control.

Name three financial functions important to the firm's overall operations and performance.