Chapter 18 – Financial Management
18-31
a. The item of value is called COLLATERAL.
b. Accounts receivable are often used as col-
lateral for a loan—known as PLEDGING.
2. An UNSECURED LOAN is a loan that doesn’t
require any collateral.
a. These are the most difficult to get.
b. Only highly regarded customers are ap-
proved.
3. LINE OF CREDIT is a given amount of unse-
cured short-term funds a bank will lend to a
business, provided the funds are readily availa-
ble.
a. A line of credit is NOT GUARANTEED to a
business.
b. It can, however, speed the borrowing pro-
cess.
c. As businesses become more financially se-
cure, the amount of credit may be increased.
d. REVOLVING CREDIT AGREEMENT is a
line of credit that is guaranteed but usually
comes with a fee.
4. COMMERCIAL FINANCE COMPANIES are or-
ganizations that make short-term loans to bor-
rowers that offer tangible assets as collateral.
a. These NON-DEPOSIT–TYPE ORGANIZA-
TIONS (nonbanks) are willing to accept
higher degrees of risk than commercial
banks.
Chapter 18 – Financial Management
18-32
PPT 18-34
Different Forms of Short-Term
Loans
DIFFERENT FORMS of
SHORT-TERM LOANS
18-34
• Commercial banks offer short-term loans like:
– Secured Loans — Backed by collateral.
– Unsecured Loans — Don
’
t require collateral
from the borrower.
– Line of Credit — A given amount of money the
bank will provide so long as the funds are
available.
– Revolving Credit Agreement — A line of credit
that
’
s guaranteed but comes with a fee.
LO 18-4
critical thinking
exercise 18-3
FINDING THE COST OF BANK
LOANS
This Internet exercise asks students to go online and research
the actual cost of a bank loan. (See the complete exercise on
page 18.79 of this manual.)
lecture enhancer 18-5
THE NUMBERS SPEAK WHEN
DEALING WITH YOUR BANKER
Through ratio analysis the firm’s financial statement can tell a
banker a lot about the company’s financial health. (See the
complete lecture enhancer on page 18.69 of this manual.)
Chapter 18 – Financial Management
18-33
b. Interest rates charged are usually higher
than banks because they take greater risks.
F. FACTORING ACCOUNTS RECEIVABLE
1. FACTORING, the process of selling accounts
receivable for cash, is relatively expensive.
a. A FACTOR is a market intermediary that
agrees to buy the accounts receivable from
the firm at a discount for cash.
b. The factor then collects and keeps the mon-
ey that was owed the firm.
2. Despite the high cost, factoring is very popular
among small businesses, especially in the cloth-
ing and furniture businesses.
3. Factoring charges are much lower if the compa-
ny assumes the risk of those accounts who are
slow to pay or don’t pay at all.
4. Factoring is not a loan—it is the sale of an asset.
G. COMMERCIAL PAPER
1. COMMERCIAL PAPER consists of unsecured
promissory notes in amounts of $100,000 and
up that mature (come due) in 270 days or less.
2. Only financially stable firms are able to sell
commercial paper.
3. Companies can get short–term funds quickly and
at a lower interest rate than bank loans.
4. During the recent credit crisis the Federal Re-
serve stepped in to purchase commercial paper
Chapter 18 – Financial Management
18-34
PPT 18-35
Factoring
FACTORING
18-35
• Factoring — The process
of selling accounts
receivable for cash.
• Factors charge more than
banks, but many small
businesses don’t qualify
for loans.
LO 18-4
PPT 18-36
Commercial Paper
COMMERCIAL PAPER
18-36
• Commercial Paper — Unsecured promissory notes
in amounts of $100,000+ that come due in 270 days
or less.
• Since commercial paper is unsecured, only
financially stable firms are able to sell it.
LO 18-4
Chapter 18 – Financial Management
18-35
to ease credit.
H. CREDIT CARDS
1. About half of all small businesses finance their
start-up with credit cards.
2. Credit cards provide a readily available line of
credit, but they are extremely risky and costly.
3. Because of their risk and cost, credit cards
should be used only as a last resort.
learning objective 5
Identify and describe several sources of long-term financing.
V. OBTAINING LONG-TERM FINANCING
A. The FINANCIAL PLAN specifies the amount of
funding that will be needed over various time peri-
ods and the most appropriate sources of those
funds.
1. In setting long-term financing objectives, the firm
generally asks THREE MAJOR QUESTIONS:
a. What are the organization’s long-term
GOALS AND OBJECTIVES?
b. What FUNDS are needed to achieve these
goals and objectives?
c. What SOURCES of long-term funding (capi-
tal) are available, and which best fit our
needs?
2. LONG-TERM CAPITAL is used to buy fixed as-
Chapter 18 – Financial Management
18-36
PPT 18-37
Credit Cards
CREDIT CARDS
18-37
PhotoCredi :RobertScoble
• Rates for small businesses
grew almost 30% after The
Credit Card Responsibility
Accountability and
Disclosure Act was passed.
• Credit cards are convenient
but costly for a small
business.
LO 18-4
PPT 18-38
Ways to Raise Start-Up Capital
WAYS to RAISE
START-UP CAPITAL
• Seek out a microloan from a microlender
• Use asset-based lending or factoring
Sources: St. Louis Small Business Monthly, January 2014 and Entrepreneur, www.entrepreneur.com, accessed November 2014. 18-38
• Turn to the web and seek
out peer-to-peer lending
• Research local banks
• Sweet-talk vendors you
want to do business with
LO 18-4
PPT 18-39
How Companies Fail to Raise Capi-
tal
HOW COMPANIES FAIL to
RAISE CAPITAL
Source: St. Louis Small Business Monthly, January 2014. 18-39
1. There is no formalized business plan to show
need.
2. The company does not know how much to
request from a lender.
3. Poor credit.
4. Management is unrealistic about growth.
LO 18-4
test
prep
PPT 18-40
Test Prep
TEST PREP
18-40
• What does an invoice containing the terms 2/10,
net 30 mean?
• What is the difference between trade credit and a
line of credit?
• What is the key difference between a secured and
an unsecured loan?
• What is factoring? What are some of the
considerations factors consider in establishing
their discount rate?
PPT 18-41
Setting Long-Term Financing
Objectives
SETTING LONG-TERM
FINANCING OBJECTIVES
18-41
• Three questions of financial managers in setting long-
term financing objectives:
1. What are the organization’s long-term goals and
objectives?
2. What funds do we need to achieve the firm’s long-term
goals and objectives?
3. What sources of long-term funding (capital) are
available, and which will best fit our needs?
LO 18-5
PPT 18-42
The Five Cs of Credit
The FIVE “C”s of CREDIT
18-42
1. The character of the borrow.
2. The borrower’s capacity to repay the loan.
3. The capital being invested in the business by
the borrower.
4. The conditions of the economy and the firm’s
industry.
5. The collateral the borrower has available to
secure the loan.
LO 18-5
Chapter 18 – Financial Management
18-37
sets such as plant and equipment and to finance
any expansions of the organization.
3. These financing decisions involve high-level
management.
4. Long–term financing comes from two sources:
DEBT FINANCING or EQUITY FINANCING.
B. DEBT FINANCING
1. DEBT FINANCING involves borrowing money,
which creates a legal obligation to repay the
amount borrowed.
2. DEBT FINANCING BY BORROWING MONEY
FROM LENDING INSTITUTIONS.
a. Long-term loans are usually repaid within 3
to 7 years, but may extend to 15 or 20 years.
i. A TERM-LOAN AGREEMENT is a
promissory note that requires the bor-
rower to repay the loan in specified in-
stallments.
ii. A major advantage is that interest paid
on a long-term debt is TAX DEDUCTI-
BLE.
b. LONG-TERM LOANS are often more ex-
pensive than short-term loans because larg-
er amounts of capital are borrowed and the
repayment date is less secure.
i. Most long-term loans require some form
of COLLATERAL.
ii. The greater the risk a lender takes, the
higher the rate of interest.
Chapter 18 – Financial Management
18-38
REACHING
BEYOND
our
borders
PPT 18-43
Are They He-
roes or Hus-
tlers?
ARE THEY HEROS or HUSTLERS?
18-43
• Rich nations place their excess incomes into
sovereign wealth funds (SWFs).
• SWFs are hailed as heroes when billions are
invested in distressed companies. However, some
grow concerned with the presence of foreign
governments.
• Much of that concern seems to be unfounded
because of investigations by the U.S.
government.
PPT 18-44
Using Long-Term Debt Financing
USING LONG-TERM
DEBT FINANCING
18-44
• Long-term financing loans generally come due
within 3 -7 years but may extend to 15 or 20
years.
• Term-Loan Agreement — A promissory note that
requires the borrower to repay the loan with interest in
specified monthly or annual installments.
• A major advantage of debt financing is the interest
the firm pays is tax deductible.
LO 18-5
bonus case 18-1
THE REBUILDING DECISION
A small veterinary clinic is hit by a tornado, ripping off the
roof. The partners must make a decision on how to recover.
(See the complete case, discussion questions, and suggested
answers beginning on page 18.84 of this manual.)
Chapter 18 – Financial Management
18-39
c. The cost of financing involves the RISK/
RETURN TRADE-OFF, the principle that the
greater the risk a lender takes in making a
loan, the higher the interest rate required.
d. Lenders will also often require certain RE-
STRICTIONS on a firm’s operations.
3. DEBT FINANCING BY ISSUING BONDS
a. If an organization can’t get long-term financ-
ing from a lending institution, it may issue
bonds.
i. A BOND is a company IOU, a binding
contract through which an organization
agrees to specific terms with investors in
return for investors lending money to the
company.
ii. INDENTURE TERMS are the terms of
agreement in a bond issue.
b. Investors in bonds measure the RISK in-
volved in purchasing a bond with the RE-
TURN (interest) the bond promises to pay.
c. A SECURED BOND is a bond issued with
some form of collateral such as real estate,
equipment, or other pledged assets.
d. An UNSECURED BOND is a bond backed
only by the reputation of the issuer; also
called a debenture bond.
C. EQUITY FINANCING
1. EQUITY FINANCING comes from the firm’s
Chapter 18 – Financial Management
18-40
PPT 18-45
Using Debt Financing by Issuing
Bonds
USING DEBT FINANCING
by ISSUING BONDS
18-45
• Indenture Terms — The terms
of agreement in a bond issue.
• Secured Bond — A bond
issued with some form of
collateral (i.e. real estate).
• Unsecured (Debenture)
Bond — A bond backed only by
the reputation of the issuing
company.
LO 18-5
PPT 18-46
Securing Equity Financing
• A company can secure equity financing by:
SECURING EQUITY FINANCING
18-46
– Selling shares of stock in the
company.
– Earning profits and using the
retained earnings as
reinvestments in the firm.
– Attracting Venture Capital —
Money that is invested in new or
emerging companies that some
investors believe have great
profit potential.
LO 18-5
Chapter 18 – Financial Management
18-41
owners.
a. It involves selling OWNERSHIP in the firm in
the form of stock, or using retained earnings
the firm has reinvested in the business.
b. A business can also seek equity financing
from venture capital.
2. EQUITY FINANCING BY SELLING STOCK
a. One way to obtain needed funds is to sell
OWNERSHIP SHARES (STOCK) in the firm
to the public.
b. Purchasers of stock become OWNERS.
c. The first time a company offers to sell its
stock to the general public is called an INI-
TIAL PUBLIC OFFERING (IPO).
d. Companies can issue stock for public pur-
chase only if they meet requirements set by
the Securities and Exchange Commission
(SEC).
3. EQUITY FINANCING FROM RETAINED
EARNINGS
a. The profits the company keeps and reinvests
in the firm are called RETAINED EARN-
INGS.
b. They are a MAJOR SOURCE OF LONG-
TERM FUNDS.
c. Retained earnings are the most popular type
of financing because:
Chapter 18 – Financial Management
18-42
critical thinking
exercise 18-4
FINANCING OPTIONS
A company needs $1,000 to expand its product line. Which
financing option should it use? (See the complete exercise on
page 18.81 of this manual.)
Chapter 18 – Financial Management
18-43
i. The company saves interest payments,
dividends, and underwriting fees.
ii. There is no new ownership created.
d. Many organizations can’t use this type of fi-
nancing because they don’t have enough re-
tained earnings.
4. EQUITY FINANCING FROM VENTURE CAPI-
TAL
a. The hardest time for a business to raise
money is when it is just starting or in the ear-
liest stages of expansion.
b. VENTURE CAPITAL (VC) is money that is
invested in new or emerging companies that
are perceived as having great profit poten-
tial.
c. The venture capital industry began as an al-
terative investment vehicle for wealthy fami-
lies.
i. Venture capital investment increased dur-
ing the 1990s, especially in high-tech cen-
ters.
ii. In the early 2000s problems in the econ-
omy and in the technology industry re-
sulting in a decrease in VC financing.
iii. As the economy began to grow again in
2011, venture capital returned to the
market.
Chapter 18 – Financial Management
18-44
PPT 18-47
Want to Attract a Venture Capital-
ist?
WANT to ATTRACT a
VENTURE CAPITALIST?
18-47
Source: Entrepreneur, www.entrepreneur.com, accessed November 2014.
1. Can the company
grow?
2. Will we get our money
back and more?
3. Will it be worth our
money and effort?
LO 18-5
Chapter 18 – Financial Management
18-45
D. COMPARING DEBT AND EQUITY FINANCING
1. LEVERAGE is raising needed funds through
borrowing to increase a firm’s rate of return.
2. While debt increases the risk of the firm, it also
enhances the firm’s profitability.
3. COST OF CAPITAL is the rate of return a com-
pany must earn in order to meet the demands of
its lenders and expectations of its equity holders.
4. If the firm earns more than the interest payments
on the funds borrowed, stockholders earn a
HIGHER RATE OF RETURN than if equity fi-
nancing were used.
5. It is up to each firm to determine exactly what a
PROPER BALANCE between debt and equity
financing is.
a. LEVERAGE RATIOS are a way to compare
leverage relative to other firms in the indus-
try.
b. The average debt of a large industrial corpo-
ration ranges between 33 and 40% of its to-
tal assets.
c. Small-business debt varies considerably.
E. LESSONS LEARNED FROM THE RECENT FI-
NANCIAL CRISIS
1. The collapse of financial markets in 2008 fo-
cused attention on the failure of financial man-
agement.
2. Credit tightened as financial institutions institut-