Part 6 Financing the Enterprise
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1 Part 6 Financing the Enterprise 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.
2 16-2 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
3 16-3 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.
4 16-4 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
5 16-5 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
6 16-6 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
7 16-7 Short-Term Investment Possibilities for Idle Cash
8 16-8 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 costsavings 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.
9 16-9 Investing Idle Cash (cont.) Commercial Certificates of Deposit (CDs) 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 Paper A written promise from one company to another to pay a specific amount of money Eurodollar Market A market centered in London for trading U.S. dollars in foreign countries
10 16-10 Idle Cash Individuals and companies can invest their idle cash in marketable securities as U.S. Treasury bills, commercial paper, and eurodollar deposits
11 16-11 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
12 16-12 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
13 16-13 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
14 16-14 Accounts Payable Averting a cash shortfall with short-term funds Accounts Payable Trade Credit is credit extended by suppliers for the purchase of their goods and services 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
15 16-15 Bank Loans Most organizations obtain short-term funds from banks Line of Credit Secured Loans Unsecured Loans An arrangement by which a bank agrees to lend a specified amount of money to an organization upon request Loans backed by collateral that the bank can claim if the borrowers do not repay them Loans backed only by the borrowers good reputation and previous credit rating Prime Rate The interest rate that commercial banks charge their best customers (usually large corporations) for short-term loans
16 16-16 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 o Other nonbank liabilities include: taxes owed to the government and wages owed to employees Taxes and employees wages represent debt obligations and the financial manager must plan to meet them as they come due
17 16-17 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
18 16-18 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
19 16-19 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 Lowest Risk Repair Old Machinery Buy New Equipment for Established Market Add to a Product Line
20 16-20 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
21 16-21 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
22 16-22 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
23 16-23 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
24 16-24 Bonds: Corporate IOUs Bonds Debt instruments that larger companies sell to raise long-term funds o o o Bondholders enter into a contract, or indenture, with the bond issuer Bondholders receive regular interest payments and the face value of the bond on or before the maturity date The annual interest rate (often called coupon rate) is the percentage of face value the company pays yearly
25 16-25 Types of Bonds Unsecured Bonds Secured Bonds Serial Bonds Floating-Rate Bonds Junk Bonds Debentures, or bonds that are not backed by specific collateral Bonds backed by specific collateral that must be forfeited in the event the issuing firm defaults A sequence of small bond issues of progressively longer maturity Bonds with interest rates that change with current interest rates otherwise available in the economy A special type of high interest-rate bond that carries higher inherent risks
26 16-26 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
27 16-27 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 o Spreads out the risk so the failure of one company will not lead to enormous losses 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
28 16-28 A Basic Stock Quote
29 16-29 Estimated Common Stock Price-Earnings Ratios and Dividends for Selected Companies Dividend Yield The dividend per share divided by the stock price
30 16-30 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
31 16-31 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.
32 16-32 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
33 16-33 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
34 16-34 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
35 16-35 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
36 16-36 The 30 Stocks in the Dow Jones Industrial Average
37 16-37 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
38 16-38 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
39 16-39 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?
40 16-40 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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