Ch 20 - Finance and Risk - Pearson Education Canada

Report
CHAPTER 20
Financial Decisions and
Risk Management
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-2
Learning Objectives
Describe the responsibilities of a financial
manager.
Distinguish between short-term (operating) and
long-term (capital) expenditures.
Identify four sources of short-term financing for
businesses.
Distinguish among the various sources of
long-term financing and explain the risks
involved in each.
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-3
More Learning Objectives
Discuss some key issues in financial
management for businesses
Explain how risk affects business operations
and identify the five steps in the
risk-management process.
Explain the distinction between insurable and
uninsurable risks
Distinguish among the different types of
insurance purchased by businesses.
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-4
Financial Managers
Responsible for planning & overseeing
the financial resources of a firm including
Cash flow management
Financial control
Financial planning
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-5
Cash Flow Management
Managing the pattern of cash inflows
(revenues) and outflows (debt payments)
Investing funds that are not needed to
service debt
Funds must either be committed to
maintaining the firm, or earning interest,
not sitting idle
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-6
Financial Control
Checking actual performance against
strategic plans to ensure that desired
goals are achieved
Making adjustments as required when plans
change, or do not work as intended
Preparing budgets to ensure that
sufficient cash is on hand to meet
operational & debt service needs
Actual results that vary from the budget need
explanation and adjustment
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-7
Financial Planning
A plan for achieving a desired financial
status in the future
Projections of revenue flows
Sources & planned uses of funds
Timing of when funds will be required
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-8
Short-Term (Operating) Expenses
Accounts payable
 unpaid bills, wages, taxes due within the year
 main source of short-term debt
Accounts receivable
 funds due from customers who bought on credit
 estimation of cash inflow
 development of a policy to ensure timely payment
Inventory
 goods awaiting sale for future revenue
 raw materials (basic supplies, unassembled product)
 work-in-progress (goods being manufactured)
 finished goods (goods completed and awaiting sale)
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-9
Long-Term (Capital) Expenditures
Funding fixed assets that have a long life
and a lasting value
land, buildings, machinery
not normally sold or converted to cash
acquisition requires a large investment
ties up the firm’s resources
for a long period of time
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-10
Short-Term Sources of Funds
Allows firms to cover operational
expenses and implement short-term plans
Trade credit
Secured and unsecured loans
Commercial paper
Factoring accounts receivable
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-11
Trade Credit
The granting of credit by a selling firm to a buying firm
Open book credit
sellers simply ship goods on credit, expecting
that payment will follow
Promissory note
buyers sign a promise-to-pay agreement
before merchandise is shipped
Trade draft
buyers sign a statement of payment terms
attached to merchandise by the seller
once signed it is called a “trade acceptance”
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-12
Secured Short-Term Loans
A short-term loan for which the borrower is
required to put up collateral
 If the borrower defaults, the collateral is seized
 inventories and accounts receivable often used as collateral
 Excessive administrative burden of such loans
 Interest rates are usually lower than for unsecured
loans
 Appeals to firms whose credit rating is not sufficient (or
who are too new) to qualify for unsecured loans
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-13
Unsecured Short-Term Loans (1 of 3)
Line of Credit
A specified amount made available to the
borrower for a short-term unsecured loan
The borrower draws on funds as they are
needed
Banks do not agree that the funds will always
be available as needed
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-14
Unsecured Short-Term Loans (2 of 3)
Revolving Credit Agreements
 guaranteed line of credit
 the firm pays the bank interest on borrowed funds, as
well as a fee for extending the line of credit
 banks guarantee availability of the funds
 the firm does not have to borrow funds if it doesn’t need
them
The bank charges a “commitment fee” for
keeping the line of credit open for the firm
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-15
Unsecured Short-Term Loans (3 of 3)
Commercial Paper
a firm sells unsecured notes for less than their face
value, then repurchases them in 30 to 270 days for
the face value
Investors make money on the spread between the
face value and purchase price
As an unsecured note, only creditworthy firms are
able to sell them successfully
The cost of commercial paper to the borrowing firm is
usually less than prevailing interest rates
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-16
Sources of Long-Term Funds
Debt financing
seeking long-term funds through borrowing
from external sources
Equity financing
seeking long-term funds through internal
financing
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-17
Debt Financing
Long-term loans
borrowing money for 3 to 10 years
at a fixed or floating rate
 loans are quick to process and do not require
divulging business plans or the purpose for the loan
Corporate bonds
 a promise by the borrower to pay the lender an
amount of money on the maturity date
 usually large amounts over long periods (10 to 30 years)
 interest payments are received in the interim
 assets may be pledged against the bond
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-18
Equity Financing
Common stock
a firm sells ownership rights by issuing shares
investors buy the stock hoping that it will
appreciate
Retained earnings
financing by retaining profits in the firm and
not paying dividends to shareholders
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-19
Hybrid Financing: Preferred Stock
Preferred shares
 require fixed payments as do bonds
 unlike bonds, they do not have a maturity date
 shareholders receive a dividend if the firm can afford it
 preferred shareholders get paid first when dividends
become available
Preferred shareholders have no voting rights, so
the control of the firm is not affected
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-20
Comparing
Debt and Equity Financing
Debt Financing
Fixed deadline
Yes, regular and
fixed.
In liquidation,
creditors come first.
No
Bond interest is tax
deductible.
Yes, many
constraints.
Considerations
When must it be paid?
Will it make claims on
income?
Will it have claims on
assets?
Will it affect
management control?
How are taxes affected?
Will it affect
management flexibility?
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Equity Financing
No limit.
Only residual claim.
In liquidation,
shareholders must wait
until creditors are paid
and preferred equity
precedes common
equity.
May cause challenge for
corporation control.
Dividends are not tax
deductible.
No, few constraints.
Copyright © 2008 Pearson Education Canada
20-21
The Risk-Return Relationship
High
Size of
financial
returns
to attract
investors
Lower quality common stocks
Corporate bonds with low credit ratings
High quality, common stocks
Moderate
Aggressive
Medium quality, preferred stocks
High quality, stable common stocks
High grade corporate bonds, commercial paper
Conservative
Short-term Treasury Bills and bank GIC's (risk free)
Low
Low
(No risk)
High
(Big risk)
Uncertainty about financial returns on investments
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-22
Financial Management for Small
Business
Small business owners must strive to get
credit, manage it well, build their credit
rating, and manage cash flow in order to
obtain financing at start-up and beyond
arrange lines of credit
organize trade credit
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-23
Venture Capital
External equity funding
provided in return for part ownership
in the borrowing firm
Venture capital firms actively seek investment
opportunities
 Favour firms with rapid growth potential
Failure rates in new ventures are high,
particularly those with rapid growth;
therefore, investors demand
high returns for their money
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-24
Risk Management
Conserving a firm’s financial power or assets
by minimizing the financial effect of accidental losses
Risk: uncertainty about future events
Speculative risk: the chance for gain or loss
Pure risk: only the chance of loss
Chance of a warehouse fire
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-25
The Risk-Management Process
1. Identify risks
Speculative Risk
Pure Risk
2. Measure impact on firm.
3. Evaluate Alternatives
Risk
Avoidance
Risk
Control
Risk
Retention
Risk
Transfer
4. Implement Program
5. Monitor Results
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-26
Risk Management Alternatives
Risk avoidance
 refusing to participate in risky ventures
Risk control
 techniques to prevent losses, or minimize their impact
Risk retention
 covering a firm’s unavoidable losses with its own funds
Risk transfer
 transferring risk to another firm, or individual, often by
contract
 for a premium, an insurance company issues an insurance
policy to pay for losses, less the deductible
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-27
Insurance
Insurance companies return policyholders
to their financial position before the loss
Insurable risk criteria include:
Predictability
Casualty
Unconnectedness
Verifiability
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-28
Liability Insurance
Insurance that covers losses resulting from
damage to people or property
when the insured party is judged liable
Employers are required to provide workers’
compensation coverage for workers who are
permanently, or temporarily, disabled by jobrelated accidents or disease
Approximately $10 to $15 of every $100
paid in premiums goes to cover
losses due to fraud
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-29
Property Insurance
Covers losses
resulting from physical damage
to real estate or personal property
Fire and allied lines: damage to
property by fire, lightning, theft
Marine: transportation insurance
covering the act of transportation
(water, land, or air) and the good
being transported
Others: title, business interruption,
credit, co-insurance
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-30
Life Insurance
Pays benefits to the survivors of the
policyholder
Beneficiary
person to whom the benefits of a life insurance
policy are paid
Most companies buy group life insurance
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
20-31
Special Forms of Business Insurance
Key Person Insurance
insurance taken out by a firm on important
staff members
covers losses due to their death, or other
departure
Business Continuation Agreements
agreement whereby owners make plans to buy
the ownership interest of a deceased associate
from his/her heirs
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada

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