Chapter 18 – Financial Management
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PPT 18-33
Different Forms of Short-Term Loans
PPT 18-34
Factoring
PPT 18-35
Commercial Paper
1. The commercial paper market is an important
source of funding for financially stable companies.
2. During the financial crisis which started in 2008,
this important market completely shut down, forc-
ing the Federal Reserve to step in and assist many
companies with their short-term financing by pur-
chasing their commercial paper.
Chapter 18 – Financial Management
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PPT 18-36
Credit Cards
PPT 18-37
Ways to Raise Start-Up Capital
1. This slide profiles some of the unique methods
businesses can use to raise capital.
2. Trade credit and factoring are two of the oldest
methods of raising capital. To start a discussion
with students ask the advantages and disadvantages
of using each of these methods.
3. Peer–to-peer lending involves individuals loaning
money to other individuals or businesses thus by-
passing traditional lending outlets.
4. For more information on this new method use loan
statistics from www.lendingclub.com.
PPT 18-38
Progress Assessment
1. 2/10 net 30 means a firm can receive a 2% discount
if the bill is paid within 10 days. If they choose not
to take the discount, the net amount is due in 30
days.
2. Trade credit is buying goods and services now and
paying for them later, while a line of credit is a
given amount of unsecured short term funds a bank
will lend a business, provided the funds are readily
available.
3. A secured loan requires collateral, while an unse-
cured loan doesn’t not.
4. Factoring is the process of sell accounts receivable
for cash. Things to consider in establishing the dis-
count rate are: age of the accounts receivable, the
nature of the business, and the condition of the
economy.
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PPT 18-39
Setting Long-Term Financing
Objectives
PPT 18-40
The Five Cs of Credit
1. This slide highlights the 5 “C”s of credit that lend-
ers use to make decisions.
2. It is essential that lenders make good decisions
when deciding whether or not to loan capital to po-
tential borrowers.
3. Go through each of the C’s and have students eval-
uate how important each one is. Are they equally
important for the lenders to consider? Why or why
not?
4. Ask students: Can you think of any other things the
lenders should consider before loaning money?
(Note: these do not have to be words that start with
C)
PPT 18-41
Investing Domestically in the Middle
East
In 2012, Middle Eastern nations spent less on foreign in-
vestments than they had in years. Instead, they put their
money into improving infrastructure, education and salaries
for workers in their own nations.
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PPT 18-42
Using Long-Term Debt Financing
Lenders may also require certain restrictions to force the
firm to act responsibly.
PPT 18-43
Using Debt Financing by Issuing Bonds
1. It is critical that students understand bonds are a
form of debt issued by companies.
2. The terms debt, bond, and loan are all four letter
words and basically mean the same thing.
3. Students should walk away from this discussion
knowing that the government and private industry
compete insofar as the sale of bonds to the invest-
ing public. The issue of investor security can easily
be addressed here, as well as the differences in in-
terest rates paid on specific bonds depending on the
issuer. Students should understand that U.S. Gov-
ernment bonds are considered the safest investment
in the bond market. There is a high probability that
students will be familiar with U.S. Government
Savings Bonds, and may in fact have received such
a bond as a gift. They clearly need to understand
the difference between such bonds and issues in-
volving investments in corporate bonds.
PPT 18-44
Securing Equity Financing
Chapter 18 – Financial Management
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PPT 18-45
Want to Attract a Venture Capitalist?
1. This slide shows how venture capitalists assess the
many pitches they receive all year.
2. Venture capitalists want to ensure that not only will
they get their money back, but that they will also
earn more than their investment.
3. Why is a question like “Will it be worth our money
and effort?” important to venture capitalists? (VCs
want to make sure there is a large return on their
investment so they can make money and continue
investing in other companies.)
PPT 18-46
Differences between Debt and Equity
Financing
1. This slide is based on Figure 18.6.
2. Financial managers must evaluate the benefits of
issuing debt or equity and then weigh those bene-
fits with the drawbacks.
PPT 18-47
Using Leverage for Funding Needs
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 they
could borrow from financial institutions and indi-
viduals.
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 de-
ductible, while dividends are not. Finally, debt
holders do not have the right to vote on company
matters, while equity holders usually do have vot-
ing 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 expan-
sion, major asset purchases, or research and devel-
opment. Firms use leverage in an effort to increase
the firm’s profit.
Chapter 18 – Financial Management
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lecture
enhancers
“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 enhancer 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 management is a
must in order to sustain that success. However, some women reached the highest levels of business 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 re-
tirement or pay down her debt? Drawing on a wealth of resources and her valuable education, von Tobel even-
tually solved her financial quandary. However, her struggle made her think about all the other women out there
who were just as intelligent and career-minded, but were nonetheless clueless about personal finance.
Recognizing a niche, von Tobel left her big bank job to found LearnVest.com, a website aimed at
making financial literacy relevant and exciting for young women. In her mind female business gurus like Suze
Orman and their $25 advice tomes didn’t resonate with today’s professional females. LearnVest provides in-
formation on everything from mortgages to investing, all filtered through a female-oriented design meant to
echo the stylish pages of Vogue combined with a point-tracking program akin to Weight Watchers. The site
personalizes each user’s experience. The website first asks visitors about their financial goals. If they want to
be better savers, the site provides the fundamentals as well as a series of checklists so the users can track their
progress. After less than a year in operation, LearnVest is attracting a dedicated following. With 350,000 hits a
month, the site has also amassed $5.5 million in venture capital to expand the brand to the nation’s growing
number of career-minded women.i
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lecture enhancer 18-2
THE EXPANDING ROLE OF THE CFO
The role of chief financial officer (CFO) is changing, expanding to that of strategist, venture capi-
talist, and chief communicator. Bean counters need not apply. Today businesses need someone to fill a
much broader role than just supervising transactions and keeping tabs on employee expense reports. He or
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.
At many firms, the CFO is helping build new businesses from within, by acting as the company
venture capitalist. Increasingly, CFOs head up incubators and venture capital arms within their own com-
panies. Dell Computer’s former CFO Thomas Meredith recently became the managing director of Dell
Ventures, which has invested around $700 million in almost 90 companies.
Now that the Internet is reshaping how companies create value, investors are demanding more
and better information. As financial markets become more global, this skill becomes more important.
Today you can get a computer program to do a lot of the more mundane accounting tasks. That
frees up the CFO to become more involved in strategic planning and information. Enterprise Software
Products already has programs that allow many accounting and financial-modeling tasks to be performed
in a fraction of the time it took just a few years ago. The sophistication of these programs will only in-
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-
cials and periodic closing of the books. Ultimately, financial information will be available in real-time
fashion, making it possible to close the books almost instantaneously. Cisco Systems CFO Larry Carter
and CEO John T. Chambers are credited with developing the “virtual close.” Cisco is the first company to
generate hourly updates on revenues, product margins, discounts, and bookings. It takes Cisco just one
day to close its books, while it takes most companies five days and some companies as many as fourteen.
lecture enhancer 18-3
IVY LEAGUE ENDOWMENT DIFFICULTIES
From countless investment magazines to television personalities like Mad Money’s Jim Cramer,
Americans have plenty of places to turn for financial advice. But just because financial “experts” are re-
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-
ager David Swensen was the Ivy League’s investment guru. Over the course of more than two decades,
Swensen poured billions into real estate, private equity, hedge funds, and other nontraditional assets.
Swensen’s clever investing yielded substantial returns, expanding Yale’s endowment at an average annual
rate of 16.3% in the decade preceding the credit crunch. Dozens of other wealthy universities copied
Swensen’s investment strategy, especially Ivy rival Harvard, which boasted a $36.6 billion endowment at
the end of fiscal 2008.
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But the other shoe dropped with a resounding thud in October 2008. The stock market meltdown
left investment-centric colleges with billions tied up in various failing ventures but with little cash on
hand to actually run their schools. As a result, 15 wealthy colleges, Harvard and Yale among them, bor-
rowed $7.2 billion between 2008 and 2009. Harvard now spends $87.5 million a year on interest pay-
ments to debtors alone. As a result of Harvard’s 27.3% endowment nosedive, university officials cut costs
at the student level. School administrators nixed hot breakfasts from student dining halls, reduced shuttle
bus service, and offered buyouts to professors in an effort to close budget gaps.ii
lecture enhancer 18-4
CROWDFUNDING BEYOND KICKSTARTER
Crowdfunding websites like Kickstarter and Indiegogo have raised hundreds of millions of dollars for
businesspeople and artists looking for quick injections of cash. But what has it done for the people who actual-
ly contributed to these campaigns? While many crowdfunding drives offer prizes and gifts to their donors, they
don’t provide participants with ownership stakes like other methods of investment. That’s why a new wave of
crowdfunding platforms are coming on the scene to make this burgeoning financing strategy more like tradi-
tional equity purchases.
Microventures, for instance, serves as a kind of online marketplace for startups to hook up with
wealthy investors. Entrepreneurs create profiles and plead their cases on the social network just like they
would on Kickstarter. Unlike that site, however, backers receive an equity stake in the venture commensurate
with their investment. Although this is no different than the way startups already seek out seed cash, the digital
platform allows entrepreneurs to meet interested parties online without hopping from meeting to meeting. So
far the company has handled more than $8 million in investments through 25 different campaigns with six
more currently in development.
While Microventures is useful for established entrepreneurs, it fails to serve the up-and-coming indi-
viduals who normally utilize crowdfunding sites. Fortunately, that’s where Upstart comes in. This new crowd-
funding venture provides young entrepreneurs with sizable investments from reputable sources in exchange for
stakes in future profits. Unlike Kickstarter, which acts as a funding platform for ideas, Upstart is focused on
people. For example, Omri Mor graduated from the University of Wisconsin with just $182 in his bank ac-
count and an idea for an independent music marketplace in his mind. Through Upstart he received $50,000 to
spend on whatever he wanted. In return he would pay his backers a percentage of his future income over the
course of a decade. This method grants entrepreneurs the freedom to pursue their goals at their own pace with-
out fretting about that first failure. Investors, on the other hand, can receive a windfall if their wards manage
to hit it big.iii
lecture enhancer 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
your balance sheet and income statement, a banker can take your company’s financial pulse and deter-
mine whether it qualifies for the loan request.
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Financial ratios, which we studied in Chapter 17, allow bankers to weigh one part of your compa-
ny’s balance sheet against another, such as debt against equity or assets against liabilities. The resulting
figures might show that you’re carrying too much debt to take on another loan or that your cash flow isn’t
sufficient to meet the payment terms. The ratios also allow bankers to compare your company’s financial
status with that of others in your industry.
Of course, plain numbers never tell the whole story. As much as the loan review process seems
like an exact science to nonbankers, it isn’t. So even if your numbers aren’t perfect, other factors will play
a role in the overall decision to grant credit. In bank terms, loan requests are measured by the three Cs of
credit: namely, the character of the borrower, the collateral the company brings to the table, and its ca-
pacity to repay the loan.
Every banker uses both objective criteria and subjective judgment to evaluate these factors. At the
beginning of the loan review process, he or she is likely to ask these seven questions:
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?
With those questions in mind, a banker will turn to the numbers on your financial statements,
which can sometimes reveal as much about a company’s past and future as can its CEO. Here are some of
the financial ratios your banker may evaluate:
Leverage Ratio
This ratio tells bankers how much debt your company is carrying in relation to its capital.
In other words, the ratio measures how many dollars you have in the company versus how many
your creditors have. Assets, liabilities, and owners’ equity all are evaluated to determine whether
your company can survive bumps in the road and still repay the loan.
Obviously, if your company has more debt than its capital can meet—for example, a debt-
to-equity ratio of more than 2:1—your chances of receiving a loan may decrease greatly. Or, at
the very least, the bank may try to minimize the risk of making such a loan by asking for other
guarantors or requiring the participation of a third party, such as a municipal or state government
agency.
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
Like the current ratio, a quick ratio gives bankers a look at your company’s ability to pay
short-term debt. The difference is that the quick ratio doesn’t include inventory in its tally of
current assets. This helps bankers determine how much of the company could be converted into
cash immediately. The quick ratio is especially relevant for service companies, such as law firms
and personnel agencies, which don’t carry tangible inventory such as raw materials, lumber, or
sheet metal.
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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
to overcome this obstacle by providing evidence that its business is growing, perhaps in the form
of new contracts.
Cash Flow Analysis
By analyzing your company’s cash flow, a banker can see how it uses money and how
much, if any, it needs to borrow. The cash flow analysis includes a number of pieces, each of
which helps paint an overall picture of your ability to service new debt. Some of the key factors
reviewed:
• Funds from operations. This includes your company’s net income and noncash charges,
such as depreciation and amortization.
• Net operating capital. This is the amount your company spends or takes in to operate the
business during a given period. It can include increases—or decreases—in receivables, in-
ventories, accounts payable, accrued expenses, and the like.
• Net cash throw-off. This is the combined sum of your funds from operations and net op-
erating capital. The surplus or deficit shows how much cash the company has available for
its current needs.
• Other financing required. If your company’s net cash throw-off shows a deficit, you
may need other financing such as a short- or long-term loan or an equity investment. This
factor helps determine how much—and what type—of capital is needed.
Most important, the cash flow analysis shows bankers whether you have enough funds to
support a loan. Suppose, for example, that ABC Clothing Store requests a $100,000 loan to fi-
nance new clothing display equipment. The banker walks through the numbers and sees that ABC
has a surplus net cash throw-off. The problem: After accounting for financing from other lenders
and investors, ABC shows a net cash change, or remaining cash, of only $38,000.
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
be in ABC’s best interest to take on the debt. Too much debt can limit a company’s future busi-
ness options and hamper its ability to develop the type of positive financial history that banks
look for.
Sensitivity Ratio
This is not a formal financial ratio, but rather the banker’s subjective, gut-level judgment of
whether a loan should be made. But don’t take it lightly: In some cases, it’s the most important
factor at play because it encompasses a variety of vital issues, including the credibility of the
management team, the business’s ability to generate accurate numbers, and the risks inherent to
the industry.
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The sensitivity ratio becomes especially important when a banker is on the fence about
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.
In some cases, of course, there may not be an immediate solution. But if you’re turned down for a
loan, don’t give up. Good bankers want to develop long-term relationships, and they may be able to help
you pursue other financing solutions, such as nonbank lenders or equity investors. Or, the banker may
direct you to an accountant or business consultant who can help you focus the business and package a
loan request that will be more successful.
Finally, as tedious as it may be, the loan review process itself can help prepare a company for
some ups and downs by forcing it to look more closely at its strategies and better plan for the future. As a
result, your company may take its first steps toward financial health and open the doors to loans down the
road.
lecture enhancer 18-6
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
could make sense out of all the confusion. A jumble of credit default swaps (CDSs), derivatives, and
faulty mortgages cluttered the marketplace in multitrillion-dollar heaps. Banks didn’t know what they
owned, who owed them money, or how much they had lost.
According to the renowned economist Hernando de Soto, all this chaos could possibly have been
avoided if investors and regulators had access to genuine financial facts. For almost a century businesses
were required to keep all titles, balance sheets, and statements of accounts in a publically accessible
“memory system.” This way people knew exactly what assets a company held and just how well they
were performing. However, over the last two decades deregulation eroded many of these outlets for fi-
nancial facts, relying almost exclusively on the companies themselves to release the relevant data.
This unaccountability led to a series of massive miscommunications during the 2008 crash. For
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-
payer money to recover their assets aren’t even sure of which assets they actually own.
The economy also suffered thanks to a practice called off–balance-sheet accounting. In the 1990s
governments around the world allowed ailing companies to recorded their debts off public balance sheets
and on to less accessible ones called special purpose entities. These SPEs allowed companies to game the
system by keeping their losses off the public record, thus making them seem healthier to investors. The
Dodd-Frank financial reform bill does not address unaccountable mortgage holdings, SPEs, or a number
of other maladies limiting our knowledge of the economic system. According to de Soto, without all the
necessary facts the world is poised for another wide-scale financial failure.iv
Chapter 18 – Financial Management
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lecture enhancer 18-7
REAL ESTATE WOES FOR REGIONAL BANKS
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
expand their portfolios. But as commercial properties across the country continue to fall victim to de-
faults, regional banks have found themselves mired in a fiscal pickle that could keep them on government
support for a while.
In a study of the nation’s 35 largest regional banking institutions, lending for commercial proper-
ty like office parks and shopping malls made up for more than a third of all loans issued. Vacancies and
falling real estate prices have ravaged the values of these properties, ensuring that many banks will stay in
the red indefinitely. For example, Synovus, a Georgia-based financial services firm, has two-thirds of its
loans in commercial property and construction. The company has reported five consecutive quarterly
losses. Along with Synovus, eight other banks with more than a third of their holdings in commercial real
estate are projected to post steady losses.
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
stagnant and losses piling up, most regional banks will retain a government presence for years to come.
That being the case, regional banks will not be able to declare dividends or make stock repurchases with-
out government approval. These limitations could make regional banks seem less attractive to consumer
borrowers than national banks, effectively hamstringing their chances for regrowth. Meanwhile, commer-
cial real estate will keep getting more toxic.v
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critical
thinking exercises
Name: ___________________________
Date: ___________________________
critical thinking exercise 18-1
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.
Weinsten Manufacturing Company
Monthly Budgetary Control Worksheet
____________________________________________________________________________
Expense Budgeted Actual Difference
Category Amount Expenditure from Budget
____________________________________________________________________________
Labor $162,500 $195,000 _______________
Raw materials 172,500 151,500 _______________
Utilities 6,500 6,300 _______________
Maintenance 9,750 8,950 _______________
Other variable expenses 16,750 18,000 _______________
Fixed overhead expenses 25,000 25,000 _______________
Total Expenses $393,000 $404,750 _______________
___________________________________________________________________________________