BUSA 1105 Exam 3-Chapters 9, 10, 8, & 2

factor

a company that provides short-term financing to firms by purchasing their accounts receivables at a discount, making a profit by collecting the full amount of payment from the firm's customers; may refuse to buy if it is too high of a risk

cash budget

a detailed forecast of future cash flows that helps financial managers identify when their firm is likely to experience temporary shortages or surpluses of cash, which helps managers determine when the firm is likely to need additional funds to meet short-term cash shortages and when surplus cash will be available to pay things off; an important financial planning tool

line of credit

a financial arrangement between a firm and a bank in which the bank pre-approves credit up to a specified limit, provided that the firm maintains an acceptable credit rating

securities broker

a financial intermediary that acts as an agent for investors who want to buy and sell financial securities; earn commissions and fees for the services they provide

depository institutions

a financial intermediary that obtains funds by accepting checking and savings deposits and then lending those funds to borrowers; commercial banks most common, but also includes credit unions and savings and loan institutions

Dodd-Frank Act

a law enacted in the aftermath of the financial crisis of 2008-2009 that strengthened government oversight of financial markets and placed limitations on risky financial strategies such as heavy reliance on leverage; established a Financial Stability Oversight Council to monitor financial markets and identify and respond to emerging risks and a Consumer Financial Protection Bureau to protect consumers from predatory lending practices by financial institutions

covenant

a restriction lenders impose on borrowers as a condition of providing long-term debt financing; (eg, requiring the borrower to carry a specified amount of liability insurance; requiring the borrower to agree not to borrow any additional funds until the current loan is paid off); sometimes restrict the size of bonuses or pay raises the firm can grant to employees; purpose is to protect creditors by preventing the borrower from pursuing policies that might undermine its ability to repay the loan; great for lenders, borrowers often view them as highly restrictive

average collection period

accounts receivable/average daily credit sales; lower value indicates firm's customers are paying for their purchases more quickly; the lower the number, the better

savings and loan associations

also called S&Ls or thrifts; traditionally accepted only savings account deposits and used them to make mortgage loans; regulations on these were relaxed in the early 1890's, allowing them to accept checking account deposits and make a broader range of loans, but, the major focus of this industry is still mortgage loans; began declining in importance well before the Great Recession, although the collapse in the housing market of the time affected it

treasury bills

also called T-bills; short-term marketable IOUs issued by the U.S. federal government; basically risk-free; are often considered a "cash equivalent;" because of their short-term nature and nearly zero risk, the average return is low; have the smallest range of returns; ten-year treasury bonds generally produce higher returns and greater range of returns because of the increased risk of holding the bond for such a long time; that typically mature in 4, 13, or 26 weeks

budgeted income statement

also called a pro forma income statement; a key tool in financial planning; projection showing how a firm's budgeted sales and costs will affect expected net income; uses information from the sales budget, various cost budgets, and other assumptions to develop a forecast of net income for the planning period; can help the firm evaluate how much internal financing (funds generated by earnings) will be available

debt-to-asset ratio

also called debt ratio; firm's total liabilities/total assets; higher the ratio, the more leveraged a firm is

certificate of deposit

an interest-earning deposit that requires the funds to remain deposited for a fixed term and withdrawal of the funds before the term expires results in a financial penalty

negative interest rates

below 0% interest rates used by central banks when economies aren't growing, have mixed effects (eg, you are paid interest on a loan and the bank charges interest out of your savings account)

similarity between corporate stocks and corporate bonds

both are marketable

angel investors and venture capitalists

both typically invest in risky opportunities that offer the possibility of high rates of return and provide funds in exchange for a share of ownership

pro forma financial statements

budgeted income statement and budgeted balance sheet; provide a framework for analyzing the impact of the firm's plans on the financing needs of the company

term loan

calls for a regular schedule of fixed payments sufficient to ensure that the principal (the amount initially borrowed) and interest are repaid by the end of the loan's term; usually backed by collateral and often include covenants in agreements

funds used to meet short-term needs typically

come from different places than the funds used to meet long-term needs

asset-backed commercial paper

commercial paper backed by collateral

short-term bank loans

common form of short-term financing; usually due within 30-90 days, but can be up to a year; firm signs a promissory note when negotiating a loan with a bank; sometimes requires collateral

financial ratio analysis

computing ratios that compare values of key accounts listed on a firm's financial statements; one way financial managers evaluate a firm's current strengths and weaknesses; liquidity, asset management, leverage, and profitability are four most important categories

credit unions

cooperative not-for-profit organization; strives to pay higher interest rates on member deposits and charge lower interest rates on loans; open to individuals who belong to a specific field of membership (eg, employees who work for a specific employer and their family members); are a much smaller player in financial markets than commercial banks

inventory turnover rate

cost of goods sold/average inventory levels; measures how many times a firm's inventory is sold and replaced each year

financial planning

developing plans that build on the firm's strengths and correct its weaknesses; step taken after ratio analysis; invloves input from a variety of areas; financial managers should work closely with managers from different departments and the firm's accountants

spread

difference between the prices at which securities dealers buy and sell a security

disadvantages of equity financing

doesn't yield the same tax benefits as debt financing; existing owners might not want a firm to issue more stock, since doing so might dilute their share of ownership; a company that relies mainly on this forgoes the opportunity to use financial leverage

institutional investors

don't accept deposits; amass huge pools of financial capital from other sources and use them to acquire a portfolio of many different assets (eg, mutual funds, insurance companies, pension funds); invest heavily in corporate stock and hold the majority of shares in most major U.S. corporations and most corporate bonds and government securities

communism

economic and political system that has public ownership of virtually all enterprises under the direction of a strong central government; political philosopher Karl Marx outlined core principles in his Communist Manifesto; supposed to dramatically improve the lot of the worker at the expense of the super-rich, but countries that adopted this didn't thrive; ended in authoritarian governments that suspended even the most basic individual rights and choices; crippling shortages and surpluses developed without a free market; corruption infected government; began to collapse and was replaced with democracy and the free market after being put under enormous pressure from people under this and the rest of the world

fidicuary duty

emphasized by financial managers; goal of maximizing the market price of stock because they have a legal and ethical obligation to make decisions consistent with the financial interests of their firm's owners; established in Dodge v. Ford Motor Co.

stakeholders in a company

employees, customers, creditors, suppliers, stockholders, and society as a whole; stockholders are the ones at risk

asset management ratios

financial ratios that measure how effectively a firm is using its assets to generate revenues or cash; also called activity ratios (eg, inventory turnover rate, average collection period)

liquidity ratios

financial ratios that measure the ability of a firm to obtain the cash it needs to pay its short-term debt obligations as they come due and to pay off its liabilities that come due in the next year (eg, current ratio)

spontaneous financing

financing that arises during the natural course of business without the need for special arrangements; trade credit sometimes referred to as this

corporate bonds

formal IOU's issued by a corporation rather than getting a formal bank loan; marketable certificates of debt

debt financing

funds provided by lenders (creditors); most companies use this and equity to fund their operations

equity

funds provided by the owners of a company; most firms use a combination of this and debt financing to acquire needed assets; comes from two major sources: retained earnings and money directly invested by stockholders who purchase newly issued stock

high turnover rate

good because it indicates that a firm can continue its daily operations with a small amount of inventory on hand; expensive to have unsold inventory sitting on shelves (low inventory turns); replenishes inventory levels more frequently, leave less cash tied up in inventory, which means those funds can be used elsewhere

being socially responsible

good strategy for achieving the goal of shareholder wealth maximization, especially if managers take a long-term perspective; recquires long-term commitment to the needs of many different stakeholders; can be a major issue that confronts financial managers as they seek to maximize the market price of stock

revolving credit agreement

guaranteed line of credit in which a bank makes a binding commitment to provide a business with funds up to a specified credit limit at any time during the term of the agreement; bank requires the borrowing firm to pay a commitment fee based on the unused amount of funds and interest on the used funds; interest rate is higher than commitment fee

liquid asset

in finance, an asset that can quickly be converted into cash with little risk of loss; possible to have too many of these

risk

in financial management, refers to the degree of uncertainty regarding the outcome of a decision

current assets

include cash and other assets expected to be converted into cash in the next year (eg, accounts receivable, inventory, prepaid expenses)

earnings per share ratio (EPS)

indicates how much net income a firm earned per share of common stock outstanding; net income-preferred dividends/ average number of shares common stock outstanding

borrowers

individuals and organizations that need additional funds to achieve their financial goals

savers

individuals and organizations willing to defer using some of their income to earn a financial return and build their wealth

advantages of factoring

instead of having to wait for customers to pay, the firm gets its money almost immediately; since the factor is responsible for collection efforts, the firm using the factor may be able to save money by eliminating its own collection department; the factor typically assumes the risk for bad debts on any receivables it buys

advantages of debt financing

interest payments a firm makes on debt are a tax-deductible expense, enables the firm to acquire additional funds without requiring existing stockholders to invest more of their own money or the sale of stock to new investors (which would dilute the ownership of existing owners), if the firm invests the borrowed funds profitably, the use of debt can substantially improve the return on equity to the shareholders

the main source of wealth for start-up firms

is the personal wealth of the owner

for a firm to continue attracting the financial capital it needs to achieve its goals

it must provide value to its stockholders

serious shortcoming of cash

it offers little or no returns

a corporation benefits from its stock only when

it's newly issued

Dodge vs. Ford Motor Co.

legal foundation of fiduciary duty established; court ruled that "a business corporation is organized and carried on primarily for the profit of the stockholders;" recent legal rulings and scholarship reaffirm fiduciary duty

contractual agreements when a firm borrows money

legally binding requirement to repay the money borrowed (called the principal) plus interest, and these payments take precedence over any payments to owners; often requires the firm to pledge collateral, such as real estate, financial securities, or equipment, to back the loan; if the firm is unable to make the required payments, the lenders can use this collateral to recover what they are owed

financial markets

markets that transfer funds from savers to borrowers; companies would find it difficult to obtain the financial resources needed to meet payrolls, invest in new facilities, develop new products, and compete effectively in global markets without these; work well only when savers and borrowers have confidence in the soundness of key financial institutions and in the fairness of the market outcomes; if depositors lose confidence in their banks or if investors discover that financial markets are rigged by unethical practices, the financial system breaks down

advantages of equity financing

more flexible and less risky than debt financing; imposes no required payments; a firm can skip dividend payments to stockholders without having to worry that it will be pushed into bankruptcy; and a firm doesn't have to agree to covenants

to meet increasing sales, a growing firm

must hire more labor and buy more supplies; workers and suppliers may expect to be paid long before the company's customers pay their bills, leading to a temporary cash crunch

return on equity ratio (ROE)

net income (profit)/owners' equity; measures income earned per dollar invested by the stockholders

cooperatives

not-for-profit organizations that are owned by their depositors

managers base their ananlysis of proposals

on expected cash flows, and actual cash flows can be quite different

current ratio

one of the simplest and most commonly used liquidity ratios; current assets/current liabilities; the larger this ratio is, the easier it is for a firm to pay off its short-term debts; below 1.0 indicates that a company does not have enough current assets to pay short-term liabilities

key sources of long-term investment

owners investing in their company, long-term debt, term loans, corporate bonds, reinvesting earnings

securities dealers

participate directly in securities markets, buying and selling stocks and bonds for their own account; earn a profit by spread

terms of trade credit

presented on the invoice for a shipment from a supplier in most cases; (eg, 2/10 net 30=30 days before payment is due, 2 percent discount is paid within 10 days); suppliers will grant only after they've evaluated the creditworthiness of the firm, but once they've granted this credit to a company, they generally continue offering it as long as the firm satisfies the terms of the credit arrangements; automatically adjusts as business conditions change and the company places larger or smaller orders with its suppliers

budgeted balance sheet

pro forma balance sheet; a key tool in financial planning; statement that forecasts the types and amounts of assets a firm will need to implement its future plans and how the firm will finance those assets; helps financial managers determine the amount of additional financing (liabilities and owners' equity) the firm must arrange to acquire assets a firm will need to achieve its future plans

financial plans must

provide a roadmap the firm can use to improve financial performance and acquire resources needed to achieve its short-term and long-term objectives

money market mutual funds

raise money by selling shares to large numbers of investors and pooling the funds to purchase a portfolio of short-term, liquid securities; an affordable way for small investors to get into the market for securities, which would otherwise be beyond their means, making these funds a particularly attractive cash equivalent for smaller firms; advantages=relatively low cost, many are professionally managed, variety of options, liquidity; downsides= professional management is oftennot cheap, when professional managers engage in a lot of trading, significant tax consequences are associated with those financial gains

leverage ratios

ratios that measure the extent to which a firm relies on debt financing in its capital structure (eg, debt-to-asset ratio)

profitability ratios

ratios that measure the rate of return a firm is earning on various measures of investment (eg, return on equity, earnings per share)

cash

refers to a firm's holdings of currency (paper money and coins issued by the government) plus demand deposits (the balance in its checking account); most people report cash equivalents along with cash

deleveraging

replacing much of the debt in their capital structure with more equity

accounts receivable

represents what customers who buy on credit owe the firm; key elements are setting credit terms, establishing credit standards, and deciding on an appropriate collection policy; converted into cash when bills are paid

when a company supports its local community through corporate philanthropy or cause-related marketing

resulting goodwill may boost sales and create a more favorable business climate

cash equivalents

safe and highly liquid assets that many firms list with their cash holdings on their balance sheet

commercial paper

short-term (and usually unsecured (no collateral backing it)) promissory notes issued by large corporations; can be issued up to 270 days, usually used in 30 days, and sometimes 2; biggest issuers are financial institutions; popular because it typically carries a lower interest rate than commercial banks charge on short-term loans; ca be issued only by firms with excellent credit ratings

promissory note

specifies the length of the loan, the rate of interest the firm must pay, and other terms and conditions of the loan; signed by a firm when borrowing short-term from a bank

trade credit

spontaneous financing granted by sellers when they deliver goods and services to customers without requiring immediate payment (suppliers ship materials, parts, or goods to a firm without requiring payment at the time of delivery and allow the firm to coinserve existing cash with a "buy now, pay later,"policy, thus avoiding the need to acquire funds from other sources).; one of the most important sources of short-term financing; particularly important to small businesses

inventories

stocks of finished goods, work-in-process, parts, and materials that firms hold as a part of doing business; can be a significant expense

net present value (NPV)

sum of the present values of expected future cash flows from an investment-cost of that investment; most common method financial managers use to evaluate capital budgeting proposals; positive number means that the present value of the expected cash flows from a project is greater than the cost of the project, oppostie applies to a negative value

present value

the amount of money that, if invested today at a given rate of interest (called the discount rate), would grow to become some future amount in a specified number of time periods; how financial managers compare cash flows at different points in time

if inventory turnover rates are too high

the company isn't keeping enough goods in stock, causing stockouts, which frustrates customers and results in lost sales if they take their business elsewhere

current liabilities

the debts that must be repaid a year from the date on a balance sheet

when a firm provides it employees with a good work environment

the employees are likely to have better morale and greater loyalty, resulting in higher productivity and lower employee turnover

when conflicts arise between the long-term interests of owners and those of other stakeholders

the fiduciary duty required of financial managers generally leads them to make decisions that are most consistent with the interests of ownership

finance

the functional area of business that is concerned with finding the best sources and uses of financial capital

financial capital

the funds a firm uses to acquire its assets and finance its operations; can be earned by direct contributions from owners, reinvestment of earnings, loans from the bank, credit provided by suppliers, and newly issued stocks and bonds (for corporations)

financial managers emphasize

the goal of maximizing the market price of stock because of their fiduciary duty; more pragmatic reason is that firms who fail to create shareholder wealth are unlikely to be viewed as attractive investments; most widely accepted goal is to maximize the value of the firm to its owners

capital structure

the mix of equity and debt financing a firm uses to meet its permanent financing needs

determining which sources of funds to tap

the next step after financial managers have identified the amount of financial capital needed to carry out their firm's plans; affected by stage of development and the reason funds are needed

risk-return trade-off

the observation that financial opportunities that offer high rates of return are generally riskier than opportunities that offer lower rates of return; one of the most important lessons of financial management

retained earnings

the part of a firm's net income it reinvests; reflects the share of the firm's earnings used to finance the purchase of assets, pay off liabilities, and reinvest in the business; stockholders prefer this to dividends because it promotes the financial health of the firm; extent to which these are used depends on the economy

time value of money

the principle that a dollar received today is worth more than a dollar received in the future

capital budgeting

the procedure a firm uses to plan for investments in assets or projects that it expects will yield benefits for more than a year; the process a firm uses to evaluate long-term investment proposals

disadvantages of debt financing

the requirement to make fixed payments even if you're in a tight spot and creditors often impose covenants on the borrower, which can cause unintended problems

financial leverage

the use of debt to meet a firm's financing needs; too much is very risky; a highly ___ firm relies heavily on debt; main advantage is it magnifies the return on the stockholders' investment when times are good; main disadvantage is that it also reduces the financial return to stockholders when times are bad; if financial returns seem too good to be true, they probably are in the long run

before financial managers can determine the best financial strategies for their firm

they must identify existing strengths and weaknesses

incentives for top executives are often

tied to the firm's short-term business (eg, bonuses, raises, other perks)

financial intermediaries

usually come between savers and boworrers in the U.S. and other well-developed marketing countries so that financing occurs indirectly (eg, depository institutions, institutional investors, securities brokers, securities dealers, investment banks)

customers are more likely to keep coming back

when a company respects the needs of customers by providing high-quality goods and services at competitive prices and listens and responds fairly to their concerns

rather than get specific loans frequently, many firms

work out arrangements with their bankers to obtain pre-approval so that they can draw on funds as needed