Financing the Enterprise - WordPress.com Capital Management • The managing of short -term assets and liabilities Since short-term assets and liabilities continually flow through

Part 6 Financing the

Enterprise

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CHAPTER 14 Accounting and Financial Statements

CHAPTER 15 Money and the Financial System

CHAPTER 16 Financial Management and Securities Markets

APPENDIX D Personal Financial Planning

© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

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Learning Objectives LO 16-1 Describe some common methods of managing current assets.

LO 16-2 Identify some sources of short-term financing (current liabilities).

LO 16-3 Summarize the importance of long-term assets and capital budgeting.

LO 16-4 Specify how companies finance their operations and manage fixed assets with long-term liabilities, particularly bonds.

LO 16-5 Discuss how corporations can use equity financing by issuing stock through an investment banker.

LO 16-6 Describe the various securities markets in the United States.

LO 16-7 Critique the short-term asset and liabilities of a small manufacturer, and recommend corrective action.

© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned,

duplicated, forwarded, distributed, or posted on a website, in whole or part.

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Managing Current Assets and Liabilities

Working Capital Management • The managing of short-term assets and liabilities

Since short-term assets and liabilities continually flow through an organization, they are said to be “working”

The terms current and short-term are used interchangeably

Current assets: cash, investments, accounts receivable and inventory – goal is maximize return on these assets

Current liabilities: accounts payable, accrued salaries, accrued taxes and short-term bank loans


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Managing Cash Idle cash does not make money and managers try to

keep just enough to pay bills as they fall due

Transaction Balances • Cash kept on hand by a firm to pay normal daily

expenses, such as employee wages and bills for supplies and utilities

Lockbox • An address, usually a commercial bank, at which a

company receives payments in order to speed collections from customers


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Investing Idle Cash

Sometimes cash comes in faster than needed to pay bills

Marketable Securities • Temporary investment of “extra” cash by organizations

for up to one year in U.S. Treasury bills, certificates of deposit, commercial paper, or Eurodollar loans

Treasury Bills (T-Bills) • Short-term debt obligations the U.S. government

sells to raise money

T-bills are considered risk free


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Short-Term Investment Possibilities for Idle Cash


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Method Is a Green Company in More Ways than One

Method sells eco-friendly household supplies and also generates more that $100 million in annual revenues.

Thanks to companies such as Method, finance executives are beginning to realize the financial benefits of going green.

Method aligns its environmental objectives with its cost-savings goals.

The operations and finance departments routinely work together to look at what ingredients and processes would save money while reducing Method’s environmental impact.


http://methodhome.com/




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Investing Idle Cash (cont.)

• Certificates of deposit issued by commercial banks and brokerage companies, available in minimum amounts of $100,000 which may be traded prior to maturity

Commercial Certificates of Deposit (CDs)

• A written promise from one company to another to pay a specific amount of money

Commercial Paper

• A market centered in London for trading U.S. dollars in foreign countries

Eurodollar Market


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Idle Cash

Individuals and companies can invest

their idle cash in marketable securities as

U.S. Treasury bills, commercial paper, and

eurodollar deposits


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Maximizing Accounts Receivable

Many businesses make a majority of sales on credit, so managing receivables is important

Discounts for early payment and extending credit comes at the cost of lowered profits

Credit ratings can be provided by credit bureaus, credit-rating agencies such as Dun and Bradstreet and industry trade groups


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Optimizing Inventory

Financial managers have to coordinate inventory purchases to manage cash flows

Optimal inventory levels are determined mainly by method of production

Excess inventory ties up money unnecessarily but inventory shortages could drive a customer to a competitor – forever


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Historically Low Interest Rates

Loans are important for most consumers purchasing a home or business

Interest rates have been at historic lows over the past few years but are expected to increase in the long run


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Accounts Payable Averting a cash shortfall with short-term funds

• Trade Credit is credit extended by suppliers for the purchase of their goods and services

Accounts Payable

Most suppliers offer discounts for early payment, offered as “1/10 net 30,” meaning a

1% discount if given is paid in 10 days and the full amount is due in 30 days


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Bank Loans

Most organizations obtain short-term funds from banks

• An arrangement by which a bank agrees to lend a specified amount of money to an organization upon request

Line of Credit

• Loans backed by collateral that the bank can claim if the borrowers do not repay them

Secured Loans

• Loans backed only by the borrowers’ good reputation and previous credit rating

Unsecured Loans

• The interest rate that commercial banks charge their best customers (usually large corporations) for short-term loans Prime Rate


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Nonbank Liabilities

Banks are not the only source of short-term funds

Factor • A finance company to which businesses sell their

accounts receivable – usually for a percentage of the total face value

o Other nonbank liabilities include: taxes owed to the government and wages owed to employees

o Taxes and employees’ wages represent debt obligations and the financial manager must plan to meet them as they come due


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Managing Fixed Assets

Long-Term (Fixed) Assets • Production facilities (plants), offices, and equipment

– all of which are expected to last for many years

Modern facilities and equipment are expensive, requiring long-term financing

Capital lease is a long-term contract and shows up on the balance sheet as an asset and liability

Operating lease is a short-term cancelable lease and does not show up on the balance sheet


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Capital Budgeting and Project Selection

Capital Budgeting • The process of analyzing the needs of the business

and selecting the assets that will maximize its value

This process continues after purchase as all assets and projects must be continually reevaluated against the company’s needs

Budgeting is not an exact process and managers must be flexible


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Qualitative Assessment of Capital Budgeting Risk

Highest Risk

Introduce a New Product in

Foreign Markets Expand into a New Market

Introduce a New Product in a

Familiar Market

Add to a Product Line

Buy New Equipment for Established

Market

Repair Old Machinery

Lowest Risk


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Pharmaceutical Companies and Risk

Pharmaceutical companies spend millions of dollars

developing drugs such as Zyprexa without

knowing if the drug will pass FDA approval and

have a significant margin


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Assessing Risk

Every investment carries some risk » The longer a project or asset is

expect to last, the greater its potential risk as it may become obsolete or wear out prematurely

» Risk is also affected by the stability and competitive nature of the marketplace and the world economy


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Pricing Long-Term Money

Returns from any project must cover not only operating costs but interest expenses on the debt used to finance the project

The most efficient and profitable companies attract the lowest-cost funds because they typically offer reasonable returns for low relative risk

New companies have a strong motivator to use financial resources wisely because they will, over time, reduce the costs of their funds and increase profit


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Financing with Long-Term Liabilities

Two common sources for long-term funds: Attracting new owners (equity financing)

Long-term liabilities (debt financing)

Long-Term Liabilities • Debts that will be repaid over a number of years,

such as long-term loans and bond issues

These take many different forms but the in the end, the key word is debt

Heavily indebted companies may not make it through a recession and be forced into bankruptcy


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Bonds: Corporate IOUs

Bonds • Debt instruments that larger companies

sell to raise long-term funds

o Bondholders enter into a contract, or indenture, with the bond issuer

o Bondholders receive regular interest payments and the face value of the bond on or before the maturity date

o The annual interest rate (often called coupon rate) is the percentage of face value the company pays yearly


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Types of Bonds

• Debentures, or bonds that are not backed by specific collateral

Unsecured Bonds

• Bonds backed by specific collateral that must be forfeited in the event the issuing firm defaults

Secured Bonds

• A sequence of small bond issues of progressively longer maturity Serial Bonds

• Bonds with interest rates that change with current interest rates otherwise available in the economy

Floating-Rate Bonds

• A special type of high interest-rate bond that carries higher inherent risks Junk Bonds


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Financing with Owners’ Equity

Corporate owners own shares of the company and stockholders’ equity includes common stock, preferred

stock and retained earnings

Retained Earnings • Earning after expenses and taxes that are

reinvested in the assets of the firm and belong to the owners in the form of equity

Retained earnings are the only long-term funds the company can generate internally


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Venture Firm Focuses on Smaller Cleantech Investments

Robert Fenwick-Smith prefers smaller clean-tech companies that are capital efficient, can reach profitability more quickly, and yield smaller but still profitable returns. He founded the venture capital firm Aravaipa Ventures in

2008 to invest in several smaller firms o Invests in four key areas: transportation efficiency, building

efficiency, water efficiency, and location efficiency • Spreads out the risk so the failure of one company will not lead

to enormous losses

o Invests only in firms that need no more than $5 million in funding and have the ability to generate revenue within the next year and a half

Won the Governor’s Award for Excellence in Cleantech Leadership in 2012


http://www.aravaipaventures.com/

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A Basic Stock Quote


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Estimated Common Stock Price-Earnings Ratios and Dividends for Selected Companies

Dividend Yield

The dividend per share divided by the stock

price


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Investment Banking

Primary Market • The market

where firms raise financial capital

Secondary Markets

• Stock exchanges and over-the-counter markets where investors can trade their securities with others

Investment Banking

• The sale of stocks and bonds for corporations


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High Frequency Trading High Frequency Trading has become popular over the last several years and has dramatically changed the landscape of the securities markets. High frequency trading is made possible by proprietary

algorithms created to allow computers to automatically trade stocks and securities in a matter of seconds.

Since the advent of this method, there have been severe crashes in the market due to failure of the technology or mistakes made by the computers. o These mistakes are usually corrected just as quickly as they

occur, however, it does make some wonder if replacing a human trader with an automated one is worth the risk.


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Securities Markets

Securities Markets • The mechanism for buying and selling

securities

» In the broadest sense, stocks and bonds markets are providers of liquidity

» Without liquid securities markets, investors would not risk their savings on securities


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Stock Markets

Stock markets exist around the world; the two biggest U.S. stock markets are the New York Stock Exchange (NYSE) and the NASDAQ market

Both exchanges are now publicly traded organizations, no longer not-for-profit

Electronic trading is faster and less expensive than floor trading and now accounts for most of the stock trading done worldwide

NASDAQ was traditionally an electronic market and the NYSE was traditionally a floor-traded market


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The Over-the-Counter Market

Over-The-Counter (OTC) Market • A network of dealers all over the country linked by

computers, telephones and Teletype machines

Most corporate bonds and all U.S. securities are traded over the counter

Therefore, the OTC accounts for the largest total dollar value of all the secondary markets


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Measuring Market Performance

Investors and financial managers need to know how a companies’ securities are performing compared with competitors’

Performance measures – averages and indexes – are very important to many different people

An index compares current stock prices with those in a specified base period

An average is the average of certain stock prices and some are weighted averages


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The 30 Stocks in the Dow Jones Industrial Average


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Measuring Market Performance (cont.)

The Dow Jones Industrial Average gained 10 times from August 1982 to the beginning of 2000

This was the Internet bubble and they are difficult to see until they burst

Before the housing bubble burst in October 2007, the Dow Jones hit an all time high

For investors to make sound financial decisions, it is important that they stay in touch with business news, markets, and indexes


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Solve the Dilemma Surviving Rapid Growth

Glasspray Corporation is a small firm that makes industrial fiberglass spray equipment

► Supplies a range of firms: ♦ Mom-and-pop boatmakers ♦ Major industrial giants (overseas and here at home)

► Just about every molded fiberglass resin product is constructed with the help of one or more of the company’s machines

► Has repeatedly run into trouble with regard to the management of its current assets and liabilities as a result of extremely rapid and consistent increases in year-to-year sales

© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned,

duplicated, forwarded, distributed, or posted on a website, in whole or part.

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Solve the Dilemma Surviving Rapid Growth (cont.)

President and founder Stephen T. Rose:

• Lamented the sad state of his firm’s working capital position

• “Our current assets aren’t and our current liabilities are!”

• To the top officers: “We can’t afford any more increases in sales! We’re selling our way into bankruptcy! Frankly, our working capital doesn’t!”

Discussion Questions • Normally, rapidly increasing

sales are a good thing. What seems to be the problem here?

• List the important components of a firm’s working capital. Include both current assets and current liabilities.

• What are some management techniques applied to current liabilities that Glasspray might use to improve its working capital position?


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Discussion

? How can a company speed up cash flow? Why should it?

? Describe the various types of marketable securities.

? How can companies use equity to finance their operations and long-term growth?

? What were some of the principle causes of the most recent recession?


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Financing the Enterprise - WordPress.com Capital Management • The managing of short -term assets and liabilities Since short-term assets and liabilities continually flow through