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Business inAction 6eBovée/ThillBusiness inAction 6eBovée/Thill

FinancialManagementFinancialManagement

Chapter 18Chapter 18

The Role of Financial Management

Financial Management

Planning for a firm’s money needs andmanaging the allocation and spending offunds

Risk/ Return Trade-Off

The balance of potential risks againstpotential rewards

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Developing a Financial Plan

Financial Plan

A document that outlines the funds neededfor a certain period of time, along with thesources and intended uses of those funds

Strategic plan, company’s financialstatements, external financial environment

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Managing Accounts Receivable andAccounts Payable

AccountsReceivable

Amounts that arecurrently owed to afirm

Accounts Payable

Amounts that a firmcurrently owes toother parties

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The Budgeting Process

Budget

A planning and control tool that reflectsexpected revenues, operating expenses, andcash receipts and outlays

Financial Control

The process of analyzing and adjusting thebasic financial plan to correct for deviationsfrom forecasted events

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The Budgeting Process

Hedging

Protecting against cost increases withcontracts that allow a company to buysupplies in the future at designated prices

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The Budgeting Process (cont.)

Zero-Based Budgeting

A budgeting approach in which each yearstarts from zero and must justify every item inthe budget, rather than simply adjusting theprevious year’s budget amounts

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Types of Budgets

Start-Up Budget

A budget that identifies the money a newcompany will need to spend to launch operations

Operating Budget

A budget that identifies all sources of revenueand coordinates the spending of those fundsthroughout the coming year

Also known as the master budget

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Types of Budgets (cont.)

Capital Budget

A budget that outlines expenditures for realestate, new facilities, major equipment, andother capital investments

Capital Investments

Money paid to acquire something ofpermanent value in a business

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Types of Budgets (cont.)

Project Budget

A budget that identifies the costs needed toaccomplish a particular project

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Financing Alternatives:Factors to Consider

Debt Financing

Arranging funding by borrowing money

Equity Financing

Arranging funding by selling ownershipshares in the company, publicly or privately

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Length of Term

Short-TermFinancing

Financing used tocover currentexpenses(generally repaidwithin a year)

Long-TermFinancing

Financing used tocover long-termexpenses such asassets (generallyrepaid over a periodof more than oneyear)

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Interest Rates

Prime Interest Rate

The lowest rate of interest that banks chargefor short-term loans to their most creditworthycustomers

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Opportunity Cost

Leverage

The technique of increasing the rate of returnon an investment by financing it withborrowed funds

Capital Structure

A firm’s mix of debt and equity financing

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Financing Alternatives:Short-Term Debt

Trade Credit

Credit obtained by a purchaser directly from asupplier

Secured Loans

Loans backed up with assets that the lendercan claim in case of default, such as a pieceof property

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Financing Alternatives:Short-Term Debt (cont.)

Unsecured Loans

Loans that require a good credit rating but nocollateral

Compensating Balance

The portion of an unsecured loan that is kepton deposit at a lending institution to protectthe lender and increase the lender’s return

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Financing Alternatives:Short-Term Debt (cont.)

Line of Credit

An arrangement in which a financial institutionmakes money available for use at any timeafter the loan has been approved

Commercial Paper

Short-term promissory notes, or contractualagreements, to repay a borrowed amount bya specified time with a specified interest rate

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Leases

Lease

An agreement to use an asset in exchangefor regular payment; similar to renting

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Corporate Bonds

Bonds

 A method of funding in which the issuerborrows from an investor and provides awritten promise to make regular interestpayments and repay the borrowed amount inthe future

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Corporate Bonds

Secured Bonds

Bonds backed byspecific assets thatwill be given tobondholders if theborrowed amount isnot repaid

Debentures

Corporate bondsbacked only by thereputation of theissuer

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Corporate Bonds (cont.)

Convertible Bonds

Corporate bonds that can be exchanged atthe owner’s discretion into common stock ofthe issuing company

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Private Equity

Private Equity

Ownership assets that aren’t publicly traded;includes venture capital

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