Chapter 18 – Financial Management
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PPT 18–48
Lessons of the Financial Crisis
PPT 18–49
Progress Assessment
1. A company could issue and sell bonds or it could
borrow from financial institutions and individuals.
2. The primary difference between debt financing and
equity financing is that debt must be repaid at ma-
turity while there is no obligation to repay equity
financing. Interest must be paid on debt, while the
company is under no obligation to issue dividends
on equity financing. The interest paid is tax deduct-
ible, while dividends are not. Finally, debt holders
do not have the right to vote on company matters,
while equity holders usually do have voting rights.
3. A business can obtain equity financing from the
sale of company stock, from retained earnings, or
from venture capital firms.
4. Leverage is borrowing funds to invest in expansion,
major asset purchases, or research and develop-
ment. Firms use leverage in an effort to increase the
firm’s profit.
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lecture
links
“True genius resides in the capacity for evaluation of uncertain, hazardous, and
conflicting information.”
Winston Churchill
“Careful planning is no substitute for dumb luck.”
Dunn’s Law
“Money is made by discounting the obvious and betting on the unexpected.”
George Soros
lecture link 18-1
LEARNVEST TEACHES THE FINANCIAL BASICS
Although women’s average salary still falls short of men’s in the United States, in some major
U.S. cities young women are significantly outearning males. For 20-something women in Dallas, the pay
gap stretches to as much as 20%. As it is for any ambitious person, responsible personal finance manage-
ment is a must in order to sustain that success. However, some women reached the highest levels of busi-
ness only to realize they didn’t know enough about what to do with their money.
Such was the case for Alexa von Tobel. A Harvard graduate, von Tobel landed a job with Morgan
Stanley shortly after finishing college. As she spent the day managing huge sums of cash and pulling in a
healthy salary, von Tobel became unnerved at how little she knew about tending to her own financial
needs. After all, how could she broker million-dollar deals every day, but lack the knowledge to plan for
her own retirement or pay down her debt? Drawing on a wealth of resources and her valuable education,
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she needs to be a strategist, communicator, dealmaker, and financier as well as an expert in information
technology and risk management. CFOs increasingly step outside the accounting role and focus on bigger
issues, and they are gaining more power and respect.
crease. One expert calls the new technology “CFO-in–a-box.”
At Oracle Corporation, a leading innovator in enterprise software itself, expense reports are filed
on the company’s intranet, eliminating paperwork and labor costs. It allows reimbursements to be paid
directly into bank accounts a week faster than was possible back when it used old-fashioned forms.
Another traditional CFO task that is being revolutionized is the reporting of a company’s finan-
spected enough to be given a voice in journals or on television shows, they aren’t infallible. The business
world is a volatile and ever-changing entity that defies the expectations of even the industry’s brightest
minds. So when it comes to investing, seeking expert advice is a must, but potential investors also have to
be careful not to follow their financial advisors blindly.
For instance, from the mid-1980s up until the eve of the financial crisis, Yale’s endowment man-
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lecture link 18-4
THE NUMBERS SPEAK WHEN DEALING WITH YOUR BANKER
With a few quick calculations, a banker can tell a lot about your company’s financial health. If
you’re in the market for a bank loan, you’d better pay close attention to what your financial statements are
telling prospective lenders. Do you have enough cash to repay the loan if sales start to drop? Are you
overleveraged? The answers are all there in black and red. By evaluating some key financial ratios from
1. Does the loan meet the bank’s market focus and lending policies?
2. What size loan and repayment term are being requested?
3. What is the proposed use of the funds?
4. What is the company’s capacity to repay the funds?
5. What is the default risk of this loan?
6. How can the risks be controlled?
7. What loan terms, if any, should we offer?
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CURRENT RATIO
This figure tells bankers whether your company has enough liquid assets to repay a short–
term loan, which generally must be repaid in one year. The ratio is calculated by dividing current
assets (cash, accounts receivable, and inventory) by current liabilities (debts and obligations due
within one year). The standard for the current ratio often is set at 2:1. The higher your ratio, the
greater your chances of receiving a short-term loan.
QUICK RATIO
Again, a quick ratio of more than 1:1 boosts your chances of getting a loan. But remember,
other factors may come into play as well. Consider the Smith Jones Law Firm, which recently re-
quested a loan to upgrade its computer equipment and thereby increase efficiency. The law firm’s
quick ratio is a positive 1:5. Yet, when the banker looks at its assets more closely, he finds that
the firm has only two major clients.
This issue, called “business concentration,” frequently arises with start-ups and other rela-
tively young companies. It can present a great risk for the bank, even if a company’s financial ra-
tios are favorable. Could the law firm, for example, repay the loan if one of its clients sought le-
gal counsel elsewhere or started dragging out its payments? Quite possibly, the firm may be able
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Though ABC’s initial cash flow ratios look promising, its current debt demands could af-
fect its ability to repay a loan and still have sufficient cash for operations. Although the banker
could try to make the loan work by changing the amount or the terms, the truth is that it may not
your loan. In the end, he or she wants to see more than ratios and financial statements; the banker
also wants to know that you understand how your business makes money, how it will grow, and
how you’ll manage future hurdles. With the sensitivity analysis, a banker might decide to control
its risk by securing the loan with collateral, asking for guarantors, or seeking the participation of a
third party such as the SBA.
MAKING PAYMENTS OVERSEAS
Businesses going global face many difficulties, including cultural differences, currency fluctua-
tions, and tariffs and quotas. Many small businesses also have difficulties making payments for products
bought from foreign suppliers. Asian manufacturers typically require either payment in advance or a letter
of credit from a bank. Neither option is great for the businesses’ cash flow.
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Crosetto’s payment arrangements are relatively rare. He has succeeded through a carefully or-
chestrated process. To build credibility, Crosetto usually offers to pay first time suppliers half of the bal-
1. Venture capitalists want to take control of a company. While most venture capital
2. Venture capitalists load their deals with unfair terms. Though some terms may
3. Venture capitalists have unrealistic performance expectations. High expecta-
4. Venture capitalists won’t invest in small deals. Smaller deals can always get fi-
nanced if you look in the right places and have a solid business plan.
5. Venture capitalists are too quick to pull the plug. It’s in the best interest of the VC
6. Venture capitalists are impossible to talk to. Somewhat true. Venture capitalists
would much prefer entrepreneurs send them a business plan they can absorb. They will
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lecture link 18-7
AMERICA’S DANGEROUS LACK OF FINANCIAL FACTS
When the credit crunch came to a head in 2008, not even the financial world’s leading experts
instance, a number of banks have not been able to foreclose on some defaulted mortgages because they do
not possess the proof of ownership. Before the real estate bubble popped banks failed to record the names
of the mortgage owners, favoring instead to pool a bunch of mortgages together and trade them as securi-
ties. About 60% of the country’s residential mortgages are listed as owned by a company called MERS, a
shell company used to streamline trading of the mortgages. Now banks that have collected billions in tax-
Some of the nation’s largest banks have begun to pay back their federal bailout money, leading
some to believe that the financial world has already experienced the worst of the recession. While this
may be true for the big banks on Wall Street, it’s a different story for small regional banks across the na-
tion. Before the recession, regional banks lacked the clout or capital to diversify into stocks and bonds
like their multinational colleagues. As a result, regional banks turned to local commercial real estate to
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Regional banks will also have a tougher time shedding the yoke of governmental control than
their Wall Street brethren. Since the big banks have far larger revenue streams and can amass capital
quicker, they’ve had an easier time obtaining federal permission to repay bailout funds. With cash flow
BUDGETARY CONTROL
The Weinstein Manufacturing Company prepared a budget for its production department as fol-
lows. At the end of the first month, the production manager compared actual results with budgeted
amounts and found that some were over and some were under. An expenditure is considered exceptional
if it varies by more than 10% from the budgeted amount.
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1. Which of the budget items should be investigated?
2. What could be causing the difference?
3. What are some suggestions for improvement?
1. Which of the budget items should be investigated?
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The second item that needs to be investigated is the expenditure for raw materials. Spending here
is 12% below budget. Students may argue that this is good news—why question it? However, the reasons
for the decrease need to be identified. Has the cost of raw materials declined? If so, the budget needs to be
modified. Are workers using a more efficient production method that uses fewer raw materials? If so, the
2. What could be causing the difference?
The increased labor costs may be due to an increase in the number of workers or an increase in
the amount paid each worker. In other words, has the workforce increased or have individual worker earn-
ings increased? The production department may be relying more on expensive overtime, increasing costs.
Or the company may have added additional workers to meet seasonal increases in demand. A critical fi-
nancial element is missing here—what is the total revenue earned for this period? This budget overage
3. What are some suggestions for improvement?
How can workers be used more efficiently? Are there ways to increase productivity? Is automa-
tion an option? If the increase is seasonal, how can the company even out the fluctuations? Perhaps the
1. Why would you not sell on credit in the first place?
2. Why do you think the lack of credit caused some shoppers not to buy from you?
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3. What alternatives for offering credit can you and your partners suggest? Which alternative do you
recommend? Justify your answer.
1. Why would you not sell on credit in the first place?
2. Why do you think the lack of credit caused some shoppers not to buy from you?
3. What alternatives for offering credit can you and your partners suggest? Which alternative do
you recommend? Justify your answer.
1. Follow the website links to the “interest rate roundup.” For each of the following types of loans,
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2. Use the “compare rates” tab to compare interest rates in your local area. The site does not specifi-
cally give rates for business loans. Use “personal loans” to see similar interest rates. List three
3. Follow the website links to find the subpage giving the prime rate.
a. What is the prime rate this week?
b. What was the prime rate a month ago?
c. What was the prime rate a year ago?
4. Use the rate calculator to calculate the monthly payment for 30- and 25-year loans. Again, busi-
ness loans are not specifically listed. Use the “mortgage payment calculator” to view sample loan
payments.
a. If your company wanted to get a 30-year loan for $165,000 at 7% interest, what would the
monthly payments be?
b. For a $165,000 loan at 7% interest over 15 years?
c. For a 15-year loan for $165,000 at 10% interest?
d. For a 15-year loan for $500,000 at 7% interest?
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e. For a 30-year loan for $500,000 at 7% interest?
f. For a 30-year loan for $500,000 at 10% interest?
5. If your company was considering taking out a $165,000 bank loan:
a. Would you advise that it borrow the money this week or wait two months? Why?
b. Would you advise using a 15-year loan or a 30-year loan? Why?
1. What are your financing alternatives?
2. Would you consider selling bonds if you had to pay 12% interest? Why or why not?
3. What are the major advantages of issuing bonds?
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4. A venture capital firm has agreed to invest the money you need. In return, the firm will own 75%
of the business. You will be replaced as board chair and CEO, though you’ll retain the title of
company founder and president. The VC firm will hire a new CEO. Would you be willing to take
the money but lose control of your business? Why or why not?
1. Your company needs a new copy machine quickly. The high-volume, multifeatured model you
2. Your firm has a large payment that needs to be made by next week. The company doesn’t have
the cash available at this time. You already have large outstanding loans, so you don’t want to go
3. You own a dry cleaning store near an apartment complex. The store attracts a growing number of
young patrons who find it convenient to drop off their garments on the way back and forth to
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1. Your company needs a new copy machine quickly. The high-volume, multifeatured model you
want costs $3,000, but your small business doesn’t have that much cash on hand right now and
2. Your firm has a large payment that needs to be made by next week. The company doesn’t have the
cash available at this time. You already have large outstanding loans, so you don’t want to go to
the bank. Your stockholders don’t want you to sell more stock because it would dilute their con-
3. You own a dry cleaning store near an apartment complex. The store attracts a growing number of
young patrons who find it convenient to drop off their garments on the way back and forth to
work. In fact, business is doing so well, your tiny store is starting to feel cramped. Your next-door
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bonus
case
bonus case 18–1
Rob.
They bought an abandoned veterinary clinic with a three-quarter-acre plot of land on the major
thoroughfare. The clinic, a sturdy 2,000-square-foot cinderblock structure, had been constructed in 1950
and needed major renovations. Rob and Janet were still paying off $45,000 in student loans and had no
savings to draw on. However, Janet’s parents agreed to deed them a house and tract of land to get started.
south. Clients going to exam rooms, animals being weighed, vets heading to treatment rooms, staff going
to the break room all had to go down same central hallway. The partners always knew that they eventual-
ly wanted to build a new “ideal” clinic. Janet kept a notebook full of ideas and possible floor plans that
they dubbed their “five-year plan.”
Then in April 2005 a line of severe thunderstorms passed through the city. It was a Wednesday
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Within two weeks, the partners were back in business, operating out of a doublewide trailer set up
on the north side of the parking lot. They hired a cleanup service to start the long process of recovery. The
cleaning crew soon realized the extent of the damage and told the partners that the cleanup would be very
1. Are there other options that have not been considered? Explain.
2. How should the renovations or rebuilding be financed—debt or equity financing? Why?
3. What would you advise the veterinary partners to do? Why?
4. If the Wardston area suffered a major economic blow, what risks would the partnership face?
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1. Are there other options that have not been considered? Explain.
2. How should the renovations or rebuilding be financed—debt or equity financing? Why?
3. What would you advise the veterinary partners to do? Why?
4. If the Wardston area suffered a major economic blow, what risks would the partnership face?
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endnotes
i Source: Dan Macsai, “A Source of Their Own,” Fast Company, October 2010.
ii Sources: Marcia Vickers, “Up from Bean Counter,” BusinessWeek, August 28, 2000, pp 118–120; Joseph Goedert,
“The CFO’s Role in IT Negotiations,” Health Data Management, June 1, 2006.
iii Source: Michael McDonald, “Paying the Price for Following Yale,” Bloomberg Businessweek, September 30,
2010.
iv Sources: Emily Barker, “Global Trade, Zero Angst,” Inc. Magazine, July 2001; Nadine Heintz, “Breaking Away:
Set Your Employees Free⎯with Paid Sabbaticals,” Inc. Magazine, October 2004; Michael Tobin, “Debunking the