FHF

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

part

Financing the
Enterprise

CHAPTER 14 Accounting and Financial Statements

CHAPTER 15 Money and the Financial System
CHAPTER 16 Financial Management and Securities Markets

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Working Capital Management

The management of short-term assets
and liabilities
Current Assets: Short-term resources
Cash
Investments
Accounts receivable
Inventory
Current Liabilities: Short-term debts
Accounts payable
Accrued salaries
Accrued taxes
Short-term bank loans
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Transaction Balance

Cash kept on hand by a firm to pay

normal daily expenses such as
employee wages and bills for supplies
and utilities

]
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Lockbox

An address, usually a commercial

bank, at which a company receives
payments in order to speed collections
from customers

]
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Electronic Funds Transfer

Frequently used to speed up collections
Also being used to pay bills online
Companies want to collect bills quickly and pay
them slowly
Paying electronically increases the speed of collections
and disbursements to one day

Checks are the slowest way to pay bills (generally 3-4

days)

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Investing Idle Cash

Marketable Securities

Temporary investments of extra cash by organizations

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

Maturities between 1 week to 1 year

continued on next page

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Investing Idle Cash

Commercial Certificates of Deposit (CDs)
Issued by commercial banks and brokerages available in
minimum amounts of $100,000, typically $1 million, and
can be traded prior to maturity

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

Restricted only to the largest and most respected companies

Eurodollar Market
A market for trading U.S. dollars in foreign countries
Any U.S. dollar-denominated deposit in non-U.S. bank is called
eurodollar
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Short-Term
Investment for Idle Cash
Type of
Security

Maturity

Seller of
Security

Interest
Rate

Safety
Level

Treasury Bills

90 days

U.S.
government

.155%

Excellent

Treasury Bills

180 days

U.S.
government

.188%

Excellent

Commercial
Paper

30 days

Major
corporations

.22%

Very Good

CDs

90 days

U.S.
commercial
banks

.74%

Very Good

CDs

180 days

U.S.
commercial
banks

1.14 %

Very Good

Eurodollars

90 days

Foreign
commercial
banks

.28%

Very Good

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Accounts Receivable
and Inventory
Occurs on the balance sheet after cash and
marketable securities
Accounts Receivable
Money owed to a business by credit customers
Companies often offer discounts for early payment and
penalties for late payments

Optimizing Inventory
Objective is to minimize firms investment in inventory without
experiencing production cutbacks

Radio frequency identification (RFID) technology helps firms

track and optimize their inventories
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Managing Current Liabilities

Accounts Payable

Money an organization owes to suppliers for goods

and services
Trade Credit

Credit extended by suppliers for the purchase of

their goods and services

The most important account payable and most

widely used source of short-term financing

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Current Liabilities: Bank Loans

Line of Credit

An arrangement by which a bank agrees to lend a

specified amount of money to an
organization upon request

Similar to a credit card, but often for millions of dollars

Secured Loans

Loans backed by collateral that the bank can claim if

the borrowers do not repay the debt

continued on next page

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Current Liabilities: Bank Loans

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

Prime Rate
The interest rate that commercial banks charge their best
customers for short-term loans

Interest rates on commercial loans can be fixed or variable

(floating-rate loan)

Floating rate loans are appealing when interest rates are

falling, but not when they rise
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Microfinance
Some businesses are so small they

have difficulty obtaining bank loans

Loans particularly scarce in developing
countries
Microfinance provides resources

Headed by Mohammed Yunus

Bangladeshi Nobel Peace Prize winner
Grameen provides small loans to female entrepreneurs
98% loan repayment rate
Over 2 million borrowers
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Non-Bank Liabilities
Short-term loans from insurance companies,
pension funds, money market funds, or
finance companies
Factor

An organization that purchases accounts receivables

at a discount and assumes responsibility for
collecting the accounts
Taxes and Employees Wages

Debt obligations to the firm

Additional nonbank liabilities that must be efficiently
managed to ensure maximum profitability
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Managing Long-Term
(Fixed) Assets
Expected to last for many years
Production facilities (plants), offices and equipment

Tend to be high-cost, making financing critical

Organizations need the most high-tech, up-to-date facilities
and equipment they can afford in order to be competitive

Obtaining long-term financing can be difficult

Leasing is a way of obtaining assets without purchasing
them

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Capital Budgeting

The process of analyzing the needs of business

and selecting the assets that will maximize its value
Not an exact process

Managers must be flexible as new information

becomes available

Assets and projects must be continuously

reevaluated

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Assessing Budgeting Risk

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Pricing Long-Term Money

Factors to Consider:

How much cash will be generated

Cost of financing
Supply of funds available for investment
Accurately identifying opportunities with the greatest
potential for ROI

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Financing with
Long-Term Liabilities
Debts that will be repaid over a number of years
Long-term loans
Bond issues

Companies must raise money in the form of lines of

credit or loans

Relying too heavily on debt can be dangerous

Companies may not earn enough to cover interest payments

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Bonds
Common form of long-term debt
Sold by large companies to raise long-term funds
Like corporate IOUs
Bondholders basically loan the issuer cash

Indenture: The bond contract specifying all terms

of agreement between the bondholder and the
issuing organization

Specifies interest payments, maturity date,

repayment methods, etc.
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Types of Bonds
Unsecured Bonds

Debentures, or bonds, that are not backed by

specific collateral

Most common type

Secured Bonds

Bonds that are backed by specific collateral that must

be forfeited in the event the issuing firm defaults
Serial Bonds

A sequence of small bond issues of progressively

longer maturity
continued on next page

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Types of Bonds

Floating-Rate Bonds

Bonds with interest rates that change with current

interest rates otherwise available in the economy
Junk Bonds

Special type of high interest rate bond that carries

higher inherent risks

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A 30-Year Treasury Bond

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Financing with Owners Equity

Owners Equity is the owners investment in an

organization

All money and assets owners have brought into an

organization

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Common Stock
The most important source of capital for most
new companies

Gives stockholders voting and control rights

Par Value: The amount printed on the stock certificate
Market Value: The price at which the stock is trading
Capital in Excess of Par: The difference between the
market value and the par value

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Financing with Owners Equity

Preferred Stock

Gives the stockholder preference in distribution

of profits, but not voting and control rights

Is a safer investment than common stock

Retained Earnings

Earnings after expenses and taxes

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

The only long-term funds a company generates

internally
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When a Company Has Profits Left

Over

Retained Earnings

Reinvested in the assets of the firms

Dividend Yield

The dividend per share divided by the stock price

Not all companies pay dividends

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Financing Through Issuing Stock

Primary Market

New issue (first-time sale of stock) or initial public

offering (IPO when a company offers stock for sale
for the first time)

Raise cash for issuing corporation

Secondary Market

Stock exchanges and OTC markets

Investors trade securities with each other
Does not raise cash for corporation
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Investment Banking
Is the sale of stocks and bonds for corporations
Helps companies raise funds by matching people
and institutions who have money to invest with
corporations needing resources

A way for corporations to obtain financing

Many investment banks now offer other banking
services
One-stop shopping

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Securities Markets
Provide the mechanism for buying and
selling securities
The Stock Market
Dramatic shifts in structure of exchanges
NY Stock Exchange and NASDAQ now are for-profit businesses
Most exchanges are or are becoming electronic making
organized exchanges less centralized and faster

Over-the-Counter Market (OTC)

A network of dealers all over the country and world
No central location
Small stocks, illiquid bank stocks and penny stocks
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Measuring Market Performance

How are investments performing relative to
the whole market?

Performance measures make comparison possible

Index: Compares current stock prices with a base price
Average: The average of certain stock prices, usually
calculated with complicated formulas

Financial bubbles can be hard to recognize, even

with performance measures

Investors must stay well informed of business news

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The Dow Jones Industrial

Average

Source: Dow Jones Industrial Average (^DJI)," Yahoo Finance, http://finance.yahoo.comq/bc?s=^DJI&t=5y&l=on&z=m&q=l&c=

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