CHAPTER 18. Financial Management

capital budget

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

line of credit

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

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.

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.

cash budget

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

What is meant by a line of credit and a revolving credit agreement?

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. A revolving credit agreement is a line of credit that guarantees a loan will be available—for a fee.

revolving credit agreement

A line of credit that is guaranteed but usually comes with a fee.

secured loan

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

unsecured loan

A loan that doesn't require any collateral.

financial control

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

term-loan agreement

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

promissory note

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

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

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 are firms' major financial needs?

Businesses need financing for four major tasks: (1) managing day-by-day operations, (2) controlling credit operations, (3) acquiring needed inventory, and (4) making capital expenditures.

What's commercial paper?

Commercial paper is a corporation's unsecured promissory note maturing in 270 days or less.

What are the two major forms of debt financing?

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 major sources of long-term financing?

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's the difference between debt financing 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 capitalists.

What do financial managers do?

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

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.

short-term forecast

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

cash flow forecast

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

short-term financing

Funds needed for a year or less.

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.

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

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.

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.

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).

venture capital

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

Is factoring a form of secured loan?

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).

commercial finance companies

Organizations that make short-term loans to borrowers who offer tangible assets as collateral.

leverage

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

What's the difference between short-term and long-term 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.

operating (or master) budget

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

What are the three budgets in a financial plan?

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.

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.

What are the most common ways firms fail financially?

The most common financial problems are (1) undercapitalization, (2) poor control over cash flow, and (3) inadequate expense control.

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.

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.

indenture terms

The terms of agreement in a bond issue.

Why should businesses use trade credit?

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.

commercial paper

Unsecured promissory notes of $100,000 and up that mature (come due) in 270 days or less.