BUS106 Financial Management - from UNDERSTANDING CANADIAN BUSINESS, 7th Canadian Edition (custom publication for Seneca); published by McGraw-Hill

1. Week 12, Chapter 11
Financial Management

2. Agenda
Review Chapter 10
Financial
Management
Exercises/Discussion

3. Learning Objectives
Importance of finance
and financial
management;
responsibilities of
financial managers
The financial planning
process and three key
budgets
Why firms need
operating funds and
where they find them
Sources of short-term
financing
Sources of long-term
financing

4. Finance: the business function that is responsible for cash – getting
funds for the company and managing those funds within the
company

5. Financial managers are responsible for seeing that the company
pays its bills – Figure 11.1
A key responsibility is to obtain money and then control
the use of that money effectively.

6. The Importance of Understanding Finance
It’s vital that financial managers in any business stay
abreast of changes and opportunities in finance and
adjust to them.
Financial managers also carefully analyze the tax
implications of various managerial decisions in an
attempt to minimize the taxes paid by the business.
Image source: http://www.flickr.com/photos/duckiemonster/

7. Financial Planning – Figure 11.2

8. Forecasting financial needs is an important part of any firm’s
financial plan.
A short-term forecast predicts
revenues, costs, and expenses for
a period of one year or less.
Part of the short-term forecast
may be in the form of a cash
flow forecast, which predicts
the cash inflows and outflows in
future periods, usually months or
quarters.
Image source: http://www.flickr.com/photos/horiavarlan/

9. A long-term forecast predicts revenues, costs, and expenses for a
period longer than one year, and sometimes as far as five or ten
years into the future.
This forecast plays a crucial part in the
company’s long-term
strategic plan.

10. A budget sets forth management’s expectations for revenues and,
on the basis of those expectations, allocates the use of specific
resources throughout the firm.
The budgeting process
depends on the accuracy
of the firm’s financial
statements.
Image source: http://www.flickr.com/photos/8759111@N02/

11. Budget Process
Cash Flow
Statement
Income
Statement
Balance
Sheet
A budget is a financial plan.

12. There are usually several types of budgets established in a firm’s
financial plan
FINANCIAL
PLAN
capital
budget
cash
budget
operating
(master)
budget

13. The operating (master) budget ties together all of the firm’s
other budgets and summarizes the business’s proposed financial
activities. It s generally the most detailed.
Image source: http://www.flickr.com/photos/gigile/
MASTER

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

15. A cash budget estimates a firm’s projected cash inflows and
outflows that the firm can use to plan for any cash shortages or
surpluses during a given period.
Cash budgets are important
guidelines that assist managers in
anticipating borrowing, debt
repayment, operating expenses,
and short-term investments.

16. Establishing Financial Controls
Financial control is a process in which a firm
periodically compares its actual revenues,
costs, and expenses with its budget.
Most companies hold at
least monthly financial
reviews as a way to
ensure financial control.

17. In virtually all organizations, there are certain needs for which
funds must be available. Key areas include:
Managing
day-to-day
needs of the
business
Controlling
credit
operations
Acquiring
needed
inventory
Making
capital
expenditures

18. Managing Day-to-Day Cash Needs of the Business
“Time value” of money
Pay as late as possible!
Collect as early as possible!
Challenge is to see that funds are
available to meet daily cash needs
without tying up funds that could be
used for investment.

19. Controlling Credit Operations
The major problem with selling
on credit is that a large percentage of
a non-retailer’s business assets could be
tied up in its credit accounts (accounts
receivable).

20. Acquiring Inventory
Effective marketing implies a clear customer orientation.
To satisfy customers, businesses must maintain inventories that often
involve a sizable expenditure of funds.
It’s important for a business of any size to understand that a poorly
managed inventory system can seriously affect cash flow and drain
its finances dry.
Image source: http://www.flickr.com/photos/fdecomite/

21. Making Capital Expenditures
Capital expenditures are major
investments in either tangible
long-term assets such as land,
buildings, and equipment, or
intangible assets such as
patents, trademarks, and copyrights.
These expenditures often require a
huge portion of the organization’s
funds.

22. Alternative Sources of Funds
ShortTerm
Financing
Trade Credit
Promissory Notes
Family/Friends
Banks, etc.
Secured Loan
Unsecured Loan
Factoring
Commercial Paper
Long-Term
Financing
Debt Financing
• Term-Loan
• Selling Bonds
Equity Financing
Retained Earnings
Venture Capital
Selling Stock

23. Obtaining Short-term Financing
The day-to-day operation of the firm calls for the careful
management of short-term financial needs.
Firms need to borrow short-term
funds for purchasing additional
inventory or for meeting bills that
come due.
Trade credit is the practice
of buying goods or
services now and paying
for them later.

24. Obtaining Short-term Financing
Trade credit
It is common for business invoices to contain items such as 2/10,
net 30.
This means that the buyer can take a 2 percent discount if the
invoice is paid within 10 days.
The total bill is due (net) in 30 days if the purchaser does not take
advantage of the discount.

25. Obtaining Short-term Financing
A promissory note is a
written contract with a
promise to pay a supplier
a specific sum of money
at a definite time.
Promissory notes can be
sold by the supplier to a
bank at a discount.

26. Obtaining Short-term Financing
Many small firms
obtain short-term
funds by borrowing
money from
family and
friends.
Image source: http://images1.fanpop.com
Because such funds
are needed for periods
of less than a year,
friends or relatives are
sometimes willing to
help and the normal
steps to obtain this
type of funding are
minimal.

27. Banks are
highly
sensitive
to risk and
are often
reluctant to
lend money
to small,
relatively
new,
businesses.
Obtaining Short-term Financing
commercial
banks & other
financial
institutions

28. Obtaining Short-term Financing
A secured loan is a loan that is backed by something valuable,
such as property. The item of value is called collateral.
If the borrower
fails to pay the
loan, the lender
may take
possession of the
collateral.

29. Obtaining Short-term Financing
The most difficult kind of loan to get from a bank or
other financial institution is an unsecured loan.
An unsecured loan doesn’t require a borrower to offer the
lending institution any collateral to obtain the loan. The loan is
not backed by any assets.

30. Obtaining Short-term Financing
If a business develops a good relationship with a bank, the
bank may open a line of credit for the firm.
A line of credit is a given amount of unsecured funds a bank
will lend to a business. In other words, a line of credit is
not guaranteed to a business.

31. Obtaining Short-term Financing
As businesses mature and become more
financially secure, the amount of credit
is often increased, much like the credit
limit on your credit card.
Some firms will even apply for a
revolving credit agreement, which
is a line of credit that’s
guaranteed.

32. Obtaining Short-term Financing
If a business is
unable to
secure a short-
term loan from
a bank, a
financial
manager may
obtain short-
term funds
from
commercial
finance
companies.
These non-deposit types
of organizations (often
called non-banks)
make short-term loans
to borrowers who offer
tangible assets.

33. Obtaining Short-term Financing
Factoring Accounts Receivable
One relatively expensive
source of short-term
funds for a firm is factoring,
which is the process of selling
accounts receivable for cash.

34. Obtaining Short-term Financing
Sometimes a large corporation needs
funds for just a few months and wants
to get lower rates of interest than
those charged by banks.
One strategy is to sell
commercial paper.
Commercial paper consists of unsecured
promissory notes, in amounts of
$100,000 and up, that mature (come due)
in 365 days

35. Obtaining Short-term Financing
Readily available line of credit
Convenient
Extremely risky
Costly (interest rates)
Best used as a
last resort
Image source: http://www.flickr.com/photos/andresrueda/

36. Obtaining Long-Term Financing
In setting long-term financing objectives,
financial managers generally ask three major
questions:
1. What are the organization’s
long-term goals and objectives?
2. What are the financial
requirements needed to achieve
these long-term goals and
objectives?
3. What sources of long-term capital
are available?

37. Obtaining Long-Term Financing
Firms can borrow funds by
either getting a loan
from a lending institution
or issuing bonds.
Debt financing
involves borrowing
money that the
company has a
legal obligation to
repay.

38. Obtaining Long-Term Financing
Debt Financing by Borrowing
Money from Lending Institutions
A term-loan agreement is a
promissory note that requires the
borrower to repay the loan in
specified instalments (e.g.,
monthly or yearly).
A major advantage of a business
using this type of financing is that
the interest paid on the long-
term debt is tax-deductible
but there is a risk/return
trade-off

39. Obtaining Long-Term
Financing
Debt Financing by
Issuing Bonds
A bond is a long-term
debt obligation of a
corporation or
government.
A company that issues a
bond has a legal
obligation to make
regular interest
payments to investors
and to repay the entire
bond principal amount
at a prescribed time,
called the maturity date.
Image source: http://www.jamesbondwallpapers.com

40. Equity Financing
Equity financing involves
selling stock
(ownership in the
firm), or using
earnings that have
been retained by the
company to reinvest in
the business (retained
earnings).
A business can also seek
equity financing by
selling ownership in the
firm to venture
capitalists.

41. Equity Financing
Stocks represent ownership in a company. Both common and
preferred shares form the company’s capital stock, also known
as equity capital.
The purchasers of stock become owners in the organization.
The number of shares of stock that will be available for
purchase is generally decided by the organization’s board of
directors.
The first time a corporation offers to sell new stock to the
general public is called an initial public offering (IPO).

42. Common stock
• a firm sells ownership rights by issuing shares
• investors buy the stock hoping that it will appreciate
Retained earnings
• financing by retaining profits in the firm and
not paying dividends to shareholders
Equity Financing from Retained Earnings
Retained earnings are often a major
source of long-term funds, especially
for small businesses, which have
fewer financing alternatives, such as
selling bonds or stock, than large
businesses do.

43. Equity Financing from Venture Capital
A start-up business typically has few
assets and no market track record, so
the chances of borrowing significant
amounts of money from a bank are
slim.
Venture capital is money that is
invested in new or emerging companies
that are perceived as having great
profit potential.
Venture capital firms are a possible
source of start-up capital for new
companies or companies moving into
expanding stages of business.

44. Equity Financing – issuing common shares
A stock certificate is evidence of stock
ownership that specifies the name of the
company, the number of shares it represents, and
the type of stock being issued.
Dividends are part of a firm’s profits that may be
distributed to shareholders as either cash payments
or additional shares of stock.
Common shares are the most basic form of
ownership in a firm. In fact, if a company issues
only one type of stock, it must be common.
Image source: http://commons.wikimedia.org/

45. Equity Financing – issuing preferred shares
Owners of preferred
shares enjoy a preference
(hence the term preferred)
in the payment of
dividends; they also have
a prior claim on
company assets if the
firm is forced out of
business and its assets are
sold.
Image source: http://www.denverstockexchange.com

46. Differences Between Debt and Equity Financing – Figure 11.5
TYPE OF FINANCING
Debt Equity
Management
influence
There’s usually none
unless special
conditions have been
agreed on.
Common
shareholders have
voting rights.
Repayment
Debt has a maturity
date. Principal must
paid.
Stock has no
maturity date. The
company is never
required to repay
equity.
Yearly obligations
Payment of interest
is a contractual
obligation.
The firm isn’t usually
liable to pay
dividends.
Tax issues
Interest is tax
deductible.
Dividends are paid
from after-tax
income and aren’t
deductible.

47. Comparison of Bonds and Stock of Public Companies – Figure 11.7
Bonds
Common
Shares
Preferred
Shares
Interest or Dividends
Must be paid Yes No Depends
Pays a fixed rate Yes No Usually
Deductible from payor’s income tax Yes No No
Canadian payee is taxed at reduced
rate
No Yes (if payor
is Canadian)
Yes (if payor
is Canadian)
Stock or bond
Has voting rights No Yes
Not
normally
May be traded on the stock exchange Yes Yes Yes
Can be held indefinitely No Yes Depends
Is convertible to common shares Maybe No Maybe

48. Chapter Summary
Importance of finance and financial management;
responsibilities of financial managers
The financial planning process and three key budgets
Why firms need operating funds and where they find
them
Sources of short-term financing
Sources of long-term financing

50. 50
Homework