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Thursday morning

Thursday morning. Finance. What is Finance?. Finance -- The function in a business that acquires funds for a firm and manages them within the firm. Finance activities include: Preparing budgets Creating cash flow analyses Planning for expenditures. Financial Management.

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Thursday morning

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  1. Thursday morning Finance

  2. What is Finance? • Finance -- The function in a business that acquires funds for a firm and manages them within the firm. • Finance activities include: • Preparing budgets • Creating cash flow analyses • Planning for expenditures

  3. Financial Management • Financial Management -- The job of managing a firm’s resources to meet its goals and objectives.

  4. What Financial Managers Do

  5. Why Do Firms Fail Financially? • Undercapitalization • Poor control over cash flow • Inadequate expense control

  6. Who’s Who in Finance • CFO -- Chief Financial Officer • CFP -- Certified Financial Planner • CFA -- Chartered Financial Analyst • Controller -- Chief Accounting Officer

  7. Financial Forecasting • Short-Term Forecast -- Predicts revenues, costs and expenses for a period of one year or less. • Cash-Flow Forecast -- Predicts the cash inflows and outflows in future periods, usually months or quarters. • Long-Term Forecast -- Predicts revenues, costs, and expenses for a period longer than one year and sometimes as long as five or ten years.

  8. Budgeting • Budget -- Sets forth management’s expectations for revenues and allocates the use of specific resources throughout the firm. • Budgets depend heavily on the balance sheet, income statement, statement of cash flows and short-term and long-term financial forecasts. • The budget is the guide for financial operations and expected financial needs.

  9. Types of Budgets • Capital Budget -- Highlights a firm’s spending plans for major asset purchases that often require large sums of money. • Cash Budget -- Estimates cash inflows and outflows during a particular period like a month or quarter. • Operating (Master) Budget -- Ties together all the firm’s other budgets and summarizes its proposed financial activities.

  10. Capital Budgeting Example

  11. The Master Budget: An Overview Sales budget Selling and administrative budget Production budget Ending inventory budget Direct materials budget Direct laborbudget Manufacturing overhead budget Cash Budget Budgetedincomestatement Budgetedbalance sheet

  12. The Cash Budget

  13. Establishing Financial Control • Financial Control -- A process in which a firm periodically compares its actual revenues, costs and expenses with its budget.

  14. FACTORS USED in ASSESSING FINANCIAL CONTROL • Is the firm meeting its short-term financial commitments? (current ratio/quick ratio) • Is the firm producing adequate operating profits on its assets? (ROA) • How is the firm financing its assets? (debt or equity) • Are the firms owners receiving an acceptable return on their investment? (ROE/ROI)

  15. WAYS to RAISE START-UP CAPITAL • Seek out a microloan from a microlender • Use asset-based lending or factoring • Turn to the web and seek out peer-to-peer lending • Research local banks • Sweet-talk vendors you want to do business with

  16. Sources of Capital • Personal savings • Relatives • Former employers • Banks & finance companies • Government agencies • Venture capitalists -- Individuals or companies that invest in new businesses in exchange for partial ownership. (generally pooled funds professionally managed) • Angel investors – use their own funds • Super Angels

  17. HOW SMALL BUSINESSES CAN IMPROVE CASH FLOW • Be more aggressive in collecting accounts receivable. • Offer customers discounts by paying early. • Take advantage of special payment terms from vendors. • Raise prices. • Use credit cards discriminately.

  18. ALTERNATIVE SOURCES of FUNDS • Debt Financing -- The funds raised through various forms of borrowing that must be repaid. • Equity Financing -- The funds raised from within the firm from operations or through the sale of ownership in the firm (such as stock).

  19. SHORT and LONG-TERM FINANCING • Short-Term Financing -- Funds needed for a year or less. • Long-Term Financing -- Funds needed for more than a year.

  20. Why Firms Need Financing

  21. TYPES of SHORT-TERM FINANCING • Trade Credit -- The practice of buying goods or services now and paying for them later. • Businesses often get terms 2/10 net 30 when receiving trade credit. • What is this really worth?? • Promissory Note -- A written contract agreeing to pay a supplier a specific sum of money at a definite time.

  22. DIFFERENT FORMS of SHORT-TERM LOANS • Commercial banks offer short-term loans like: • Secured Loans -- Backed by collateral. • Unsecured Loans -- Don’t require collateral from the borrower. • Line of Credit -- A given amount of money the bank will provide so long as the funds are available. • Lehman Brothers (repo market) • New York Times video – Hartsko • Grameen Bank

  23. Factoring Your Accounts Receivable • Selling your AR for cash • Factor is an intermediary that buys a company’s AR, at a discount; and then collects the proceeds • Amount of discount is based on age of receivables, strength of business • Can be an expensive form of short-term financing

  24. Commercial Paper • Commercial Paper -- Unsecured promissory notes in amounts of $100,000+ that come due in 270 days or less. • Since commercial paper is unsecured, only financially stable firms are able to sell it. • Assists in financing of current assets and payment of current liabilities; cannot be used on long-term assets

  25. SETTING LONG-TERM FINANCING OBJECTIVES • Three questions of financial managers in setting long-term financing objectives: • What are the organization’s long-term goals and objectives? • What funds do we need to achieve the firm’s long-term goals and objectives? • What sources of long-term funding (capital) are available, and which will best fit our needs?

  26. USING LONG-TERM DEBT FINANCING • Long-term financing loans generally come due within 3 -7 years but may extend to 15 or 20 years. • Term-Loan Agreement -- A promissory note that requires the borrower to repay the loan with interest in specified monthly or annual installments. • A major advantage of debt financing is the interest the firm pays is tax deductible.

  27. USING DEBT FINANCING by ISSUING BONDS • Indenture Terms -- The terms of agreement in a bond issue. • Secured Bond -- A bond issued with some form of collateral (i.e. real estate). • Unsecured (Debenture) Bond -- A bond backed only by the reputation of the issuing company.

  28. Securing Equity Financing • A company can secure equity financing by: • Selling shares of stock in the company. • Earning profits and using the retained earnings as reinvestments in the firm. • Attracting Venture Capital -- Money that is invested in new or emerging companies that some investors believe have great profit potential.

  29. USING LEVERAGE for FUNDING NEEDS • Leverage -- Raising funds through borrowing to increase the firm’s rate of return. • Cost of Capital -- The rate of return a company must earn in order to meet the demands of its lenders and expectations of equity holders. • ROAvs ROE Excel example

  30. Securities Markets • Securities markets are financial marketplaces for stocks and bonds and serve two primary functions: • Assist businesses in finding long-term funding to finance capital needs. • Provide private investors a place to buy and sell securities such as stocks and bonds.

  31. TYPES of SECURITIES MARKETS • Securities markets are divided into primary and secondary markets: • Primary markets handle the sale of new securities. • Secondary markets handle the trading of securities between investors with the proceeds of the sale going to the seller. • Initial Public Offering (IPO) -- The first offering of a company’s stock. LinkedIn

  32. INVESTMENT BANKERS and INSTITUTIONAL INVESTORS • Investment Bankers -- Specialists who assist in the issue and sale of new securities. Goldman Sachs • Institutional Investors -- Large organizations such as pension funds or mutual funds that invest their own funds or the funds of others. Vanguard, CALPERS

  33. Stock Exchanges • Stock Exchange -- An organization whose members can buy and sell securities on behalf of companies and individual investors. • Over-the-Counter (OTC) Market -- Provides companies and investors with a means to trade stocks not listed on the national securities exchanges. • NASDAQ -- A telecommunications network that links dealers across the nation so they can exchange securities.

  34. The SEC • Securities and Exchange Commission (SEC) -- The federal agency responsible for regulating the various stock exchanges; created in 1934 through the Securities and Exchange Act. • Prospectus -- A detailed registration statement that includes extensive economic and financial information that must be sent to prospective investors.

  35. The Language of Stocks • Stocks -- Shares of ownership in a company. • Stock Certificate -- Evidence of stock ownership.Apple • Dividends -- Part of a firm’s profits that the firm may distribute to stockholders as either cash or additional shares.

  36. Advantages of Issuing Stocks • Stockholders are owners of a firm and never have to be repaid their investment. • There’s no legal obligation to pay dividends. • Issuing stock can improve a firm’s balance sheet since stock creates no debt.

  37. Disadvantages of Issuing Stocks • Stockholders have the right to vote for a company’s board of directors. • Issuing new shares of stock can alter the control of the firm. • Dividends are paid from after-tax profits and are not tax deductible. (double taxation) • The need to keep stockholders happy can affect management’s decisions.

  38. Two Classes of Stock • Common Stock -- The most basic form; holders have the right to vote for the board of directors and share in the profits if dividends are approved. • Preferred Stock -- Owners are given preference in the payment of company dividends before common stock dividends are distributed. Preferred stock can also be: • Callable • Convertible • Cumulative

  39. Key Stock Market Indicators • Dow Jones Industrial Average -- The average cost of 30 selected industrial stocks. • Critics say the 30-company Dow is too small a sample and suggest following the S&P 500. • S&P 500 tracks the performance of 400 industrial, 40 financial, 40 public utility, and 20 transportation stocks.

  40. Stock Splits • Stock Splits -- An action by a company that gives stockholders two or more shares of additional stock for every share that’s outstanding. • Splits cause no change in the firm’s ownership structure and no change in the investment’s value. • Firms can never be forced to spilt their stocks. • Berkshire Hathaway

  41. UNDERSTANDING STOCK QUOTATIONS

  42. Learning the Language of Bonds • Bond -- A corporate certificate indicating that an investor has lent money to a firm. • The principal is the face value of the bond. • Interest -- The payment the bond issuer makes to the bondholders to compensate them for the use of their money. • Understanding Bond Quotes

  43. Advantages of Issuing Bonds • Bondholders are creditors, not owners of the firm and can’t vote on corporate matters. • Bond interest is tax deductible. • Bonds are a temporary source of funding and are eventually repaid. • Bonds can be repaid before the maturity date if they contain a call provision. • Google, 2

  44. Disadvantages of Issuing Bonds • Bonds increase debt and can affect the market’s perception of the firm. • Paying interest on bonds is a legal obligation. • If interest isn’t paid, bondholders can take legal action. • The face value of the bond must be repaid on the maturity date.

  45. Bond Ratings

  46. DIFFERENT CLASSES of CORPORATE BONDS • Unsecured bonds (debenture bonds): not backed by specific collateral. • Secured bonds: backed by collateral (land or equipment).

  47. DIFFERENCES BETWEEN DEBT and EQUITY FINANCING

  48. Investing in Mutual Funds • Mutual Fund -- An organization the buys stocks and bonds and then sells shares in those securities to the public. The fund pools investors’ money and buys stocks according to the fund’s purpose. • Enables investors to diversify their risks

  49. Comparing Investments

  50. AVERAGE ANNUAL RETURN of ASSET CLASSES (1926-2007)

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