Ch 16 Part 1

What is accounts receivable?

Accounts receivable represent sales for which the firm has not yet been paid. Because the product has been sold but cash has not yet been received, an account receivable amounts to a use of funds.

Property insurance

- Protects properties in case of fire, crime, etc.

How does a firm's basic approach to paying dividends can greatly affect its share price?

A stable history of dividend payments indicates good financial health. If a firm that has been making regular dividend payments cuts or skips a dividend, investors start thinking it has serious financial problems.

What are retained earnings?

profits that have been reinvested in the firm

What are three ways firms obtain equity financing?

selling new ownership shares (external financing) retaining earnings (internal financing) or through venture capital (external financing).

What are the three forms of long-term debt?

term loans, bonds, and mortgage loans.

What is the risk-return trade-off concept?

the greater the risk, the greater the potential return

Why do many big companies use commercial paper instead of short-term bank loans?

the interest rate on commercial paper is usually 1 to 3 percent below bank rates.

What is a return?

the opportunity for profit

What is risk?

the potential for loss, or the chance that an investment will not achieve the expected level of return

TRUE or FALSE: Most high-growth companies, such as those in technology-related fields, finance much of their growth through retained earnings and pay little or no dividends to stockholders. As they mature, many decide to begin paying dividends.

TRUE

TRUE or FALSE: Short-term financing is shown as a current liability on the balance sheet and is used to finance current assets and support operations.

TRUE

TRUE or FALSE: Short-term items should be financed with short-term funds, and long-term items should be financed with long-term funds.

TRUE

TRUE or FALSE: The financial manager's goal is to manage current assets so the firm has enough cash to pay its bills and to support its accounts receivable and inventory.

TRUE

TRUE or FALSE: because the claims of preferred stockholders on income and assets are second to those of debtholders, preferred stockholders require higher returns to compensate for the greater risk.

TRUE

What is financial management?

all the activities concerned with obtaining money and using it effectively

What are short term expenses?

also known as operating expenses, they are used to support current production and selling activities.

Why is preferred stock more expensive than debt financing?

because preferred dividends are not tax-deductible.

What is the financial manager's goal in cash management?

making sure that enough cash is on hand to pay bills as they come due and to meet unexpected expenses.

What is venture capital?

money provided by large investors to finance new products and new businesses that have a good chance to be very profitable

TRUE or FALSE: Dividends can be paid in cash or in stock. Stock dividends are payments in the form of more stock.

TRUE

What are the two types of bank loans?

lines of credit revolving credit agreements

What is a line of credit?

A financial arrangement between a firm and a bank in which the bank pre-approves credit up to a specified limit. The firm either pays a fee or keeps a certain percentage of the loan amount (generally 10 to 20 percent) in a checking account at the bank.

What is a term loan?

Consists of a contract between the borrower and the lender that spells out the amount and maturity of the loan, the interest rate, payment dates, the purpose of the loan, and other provisions such as operating and financial restrictions on the borrower to control the risk of default.

What are dividends?

Dividends are payments to stockholders from a corporation's profits.

The financial manager's goal is to collect money owed to the firm as quickly as possible while offering customers credit terms attractive enough to increase sales. Why is setting up credit and collection policies a balancing act for financial managers?

Easier credit policies or generous credit terms (a longer repayment period or larger cash discount) result in increased sales. On the other hand, the firm has to finance more accounts receivable. The risk of uncollectible accounts receivable also rises.

Long-term financing sources include both debt (borrowing) and equity (ownership). What are the advantages and disadvantages of equity financing?

Equity financing places few restrictions on the firm. The firm is not required to pay dividends or repay the investment. However, equity financing gives common stockholders voting rights that provide them with a voice in management. Equity is also more costly than debt. Unlike the interest on debt, dividends to owners are not tax-deductible expenses.

TRUE or FALSE: Financial management is only the responsibility of the finance department.

FALSE: All business decisions have financial consequences

What are the financial manager's responsibilities?

Financial managers analyze financial data prepared by accountants, monitor the firm's financial status, and prepare and implement financial plans. By doing this they maximize the value of the firm.

What are the key activities of the financial manager?

Financial planning: Preparing the financial plan, which projects revenues, expenditures, and financing needs over a given period. Investment (spending money): Investing the firm's funds in projects and securities that provide high returns in relation to their risks. Financing (raising money): Obtaining funding for the firm's operations and investments and seeking the best balance between debt (borrowed funds) and equity (funds raised through the sale of ownership in the business).

TRUE or FALSE: As expenditures tend to be costly and have a major effect on the firm's future, the financial manager uses a process called capital budgeting to analyze long-term projects and select those that offer the best returns while maximizing the firm's value.

TRUE

TRUE or FALSE: Because cash held in checking accounts earns little, if any, interest, the financial manager tries to keep cash balances low and to invest the surplus cash.

TRUE

To maximize the firm's value, the financial manager has to consider both short- and long-term consequences of the firm's actions. What are examples of actions that favor short term gains and actions that favor long term gains?

Maximizing profits favors making short-term gains over achieving long-term goals. What if a firm in a highly technical and competitive industry did no research and development? In the short run, profits would be high because research and development is very expensive. But in the long run, the firm might lose its ability to compete because of its lack of new products.

Product liabilities insurance-

Protects against claims from personal injuries orproperty damage due to products made, service, orsold by the business

Professional liability insurance

Protects against liability lawsuits due to any errorsor omissions from services provided byprofessionals and management

What is factoring?

Receiving cash in exchange for offering a company the rights to the cash that will be collected from your customers.

What are secured loans?

Secured loans require the borrower to pledge specific assets as collateral, or security. The secured lender can legally take the collateral if the borrower doesn't repay the loan.

The value of a publicly owned corporation is measured by the ____________________________. A private company's value is the ____________________________________.

Share price of its stock. Price at which it could be sold.

Explain the difference between short term vs long term expenses

Short-term expenses support the firm's day-to-day activities. For instance, athletic-apparel maker Nike regularly spends money to buy such raw materials as leather and fabric and to pay employee salaries. Long-term expenses are typically for fixed assets. For Nike, these would include outlays to build a new factory, buy automated manufacturing equipment, or acquire a small manufacturer of sports apparel.

what is commercial paper?

Short-term unsecured debt issued by large corporations

TRUE or FALSE: A company does not have to pay dividends to stockholders. But if investors buy the stock expecting to get dividends and the firm does not pay them, the investors may sell their stocks.

TRUE

TRUE or FALSE: A company whose sales and receipts are fairly predictable and regular throughout the year needs less cash than a company with a seasonal pattern of sales and receipts.

TRUE

TRUE or FALSE: Borrowers whose credit is not strong enough to qualify for unsecured loans use secured loans.

TRUE

TRUE or FALSE: Production, marketing, and finance managers usually have differing views about inventory.

TRUE Production managers want lots of raw materials on hand to avoid production delays. Marketing managers want lots of finished goods on hand so customer orders can be filled quickly. Financial managers want the least inventory possible without harming production efficiency or sales.

TRUE or FALSE: Like debt, preferred stock increases the firm's financial risk because it obligates the firm to make a fixed payment.

TRUE but preferred stock is more flexible. The firm can miss a dividend payment without suffering the serious results of failing to pay back a debt.

List the three key cash management strategies.

Temporarily investing surpluses in marketable securities Keeping a minimum cash balance to cover unexpected expenses or changes in projected cash flows. Shortening the time between the purchase of inventory or services and the collection of cash from sales.

What does the cost of inventory include?

The cost of inventory includes not only its purchase price, but also ordering, handling, storage, interest, and insurance costs.

Long-term financing sources include both debt (borrowing) and equity (ownership). What are the advantages and disadvantages of debt financing?

The major advantage of debt financing is the deductibility of interest expense for income tax purposes, which lowers its overall cost. In addition, there is no loss of ownership. The major drawback is financial risk: the chance that the firm will be unable to make scheduled interest and principal payments.

Why do retained earnings have a big advantage over other sources of equity capital?

They do not incur underwriting costs.

What does the inventory turnover ratio prove?

This ratio shows how quickly inventory moves through the firm and is turned into sales. If the turnover ratio number is too high, it means the company does not have enough inventory of products on hand to satisfy customer needs, which means they could take their business elsewhere.

What are the three main types of unsecured short-term loans?

Trade Credit/Accounts Payable Bank Loans Commercial Paper

What are three of the most popular marketable securities?

Treasury bills, certificates of deposit, and commercial paper.

What is a preffered stock?

Unlike common stock, preferred stock usually has a dividend amount that is set at the time the stock is issued. These dividends must be paid before the company can pay any dividends to common stockholders. Also, if the firm goes bankrupt and sells its assets, preferred stockholders get their money back before common stockholders do.

What is a revolving credit agreement?

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

What is a mortgage loan?

a long-term loan made against real estate as collateral. The lender takes a mortgage on the property, which lets the lender seize the property, sell it, and use the proceeds to pay off the loan if the borrower fails to make the scheduled payments. Long-term mortgage loans are often used to finance office buildings, factories, and warehouses.

What is a bond?

a way that people lend money to a company or government and in return they will be repaid the money they lent with interest.

How do financial managers try to shorten the time between the purchase of inventory or services and the collection of cash from sales?

collect money owed to the firm (accounts receivable) as quickly as possible pay money owed to others (accounts payable) as late as possible without damaging the firm's credit reputation minimize the funds tied up in inventory.

What are IPOs?

initial public offerings (enables existing stockholders, usually employees, family, and friends who bought the stock privately, to earn big profits on their investment)

What are long term expenditures?

investment in physical assets such as land, buildings, machinery, equipment, and information systems. They are also known as capital expenditures. Unlike operating expenses, which produce benefits within a year, the benefits from capital expenditures extend beyond one year.

What is common stock?

investments of assets into the business by the stockholders

What is trade credit?

the seller extends credit to the buyer between the time the buyer receives the goods or services and when it pays for them. When Goodyear sells tires to General Motors, GM does not have to pay cash on delivery. Instead, Goodyear regularly bills GM for its tire purchases, and GM pays at a later date. Until GM pays Goodyear, Goodyear has an account receivable from GM, and GM has an account payable to Goodyear.

What are the drawbacks of going public?

there is no guarantee an IPO will sell. It is also expensive. Big fees must be paid to investment bankers, brokers, attorneys, accountants, and printers. Once the company is public, it is closely watched by regulators, stockholders, and securities analysts. The firm also must reveal information such as operating and financial data, product details, financing plans, and operating strategies. Providing this information is often costly.

How do firms raise the funding they need?

they borrow money (debt), sell ownership shares (equity), and retain earnings (profits). The financial manager must assess all these sources and choose the one most likely to help maximize the firm's value.

What are an accountant's main responsibilities?

to collect and present financial data.