Chapter 16 Business

banker’s acceptance

a written order for a bank to pay a third party a stated amount of money on a specific state

bond indenture

a legal document that details all the conditions relating to a bond issue

budget

a financial statement that projects income, expenditures, or both over a specified future period

capital budget

a financial statement that estimates a firm’s expenditures for major assets and its long-term financing needs

cash budget

a financial statement that estimates cash receipts and cash expenditures over a specified period

cash flow

the movement of money into and out of an organization

certificate of deposit (CD)

A document stating that the bank will pay the depositor a guaranteed interest rate on money left on deposit for a specified period of time

check

a written order for a bank or other financial institution to pay a stated dollar amount to the business or person indicated on the face of the check

chief financial officer (CFO)

a high-level corporate executive who manages a firm’s finances and reports directly to the company’s chief executive officer or president

collateral

real estate or property pledged as security for a loan

commercial paper

a short-term promissory note issued by a large corporation.

common stock

stock whose owners may vote on corporate matters but whose claims on profits and assets are subordinate to the claims of others

convertible bond

a bond that can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock

corporate bond

a corporation’s written pledge that it will repay a specified amount of money with interest

debenture bond

a bond backed only by the reputation of the issuing corporation

debit card

a card that electronically subtracts the amount of a customer’s purchase from her or his bank account at the moment the purchase is made

debt capital

borrowed money obtained through loans of various types

electronic funds transfer (EFT) system

a means of performing financial transactions through a computer terminal or telephone hookup

equity capital

money received from the owners or from the sale of shares of ownership in a business

factor

a firm that specializes in buying other firms’ accounts receivable

financial leverage

the use of borrowed funds to increase the return on owners’ equity

financial management

all the activities concerned with obtaining money and using it effectively

financial plan

a plan for obtaining and using the money needed to implement an organization’s goals and objectives

initial public offering (IPO)

occurs when a corporation sells common stock to the general public for the first time

investment banking firm

an organization that assists corporations in raising funds, usually by helping to sell new issues of stocks, bonds, or other financial securities

an organization that assists corporations in raising funds, usually by helping to sell new issues of stocks, bonds, or other financial securities

a legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time.

line of credit

a loan that is approved before the money is actually needed

long-term financing

money that will be used for longer than one year

maturity date

the date on which a corporation is to repay borrowed money

mortgage bond

a corporate bond secured by various assets of the issuing firm

over-the-counter (OTC) market

a network of dealers who buy and sell the stocks of corporations that are not listed on a securities exchange

preferred stock

stock whose owners usually do not have voting rights but whose claims on dividends and assets are paid before those of common-stock owners

primary market

a market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities

prime interest rate

the lowest rate charged by a bank for a short-term loan

private placement

occurs when stock and other corporate securities are sold directly to insurance companies, pension funds, or large institutional investors

promissory note

a written pledge by a borrower to pay a certain sum of money to a creditor at a specified future date

registered bond

a bond registered in the owner’s name by the issuing company

retained earnings

the portion of a corporation’s profits not distributed to stockholders

revolving credit agreement

a guaranteed line of credit

risk-return ratio

a ratio based on the principle that a high-risk decision should generate higher financial returns for a business and more conservative decisions often generate lower returns

secondary market

a market for existing financial securities that are traded between investors

securities exchange

a marketplace where member brokers meet to buy and sell securities

serial bonds

bonds of a single issue that mature on different dates

short-term financing

money that will be used for one year or less

sinking fund

a sum of money to which deposits are made each year for the purpose of redeeming a bond issue

speculative production

the time lag between the actual production of goods and when the goods are sold

term-loan agreement

a promissory note that requires a borrower to repay a loan in monthly, quarterly, semiannual, or annual installments

trade credit

a type of short-term financing extended by a seller who does not require immediate payment after delivery of merchandise

trustee

an individual or an independent firm that acts as a bond owner’s representative

unsecured financing

financing that is not backed by collateral; unsecured short-term financing offers several options

zero-base budgeting

a budgeting approach in which every expense in every budget must be justified

1. What is financial management?

Financial management refers to the efficient and effective management of money (funds) in such a manner as to accomplish the objectives of the organization. It is the specialized function directly associated with the top management.

2. What is the risk-return ratio?

A ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns.

3. What are some short-term financing needs for a corporation?

Short term business finance facilitates businesses and financiers to seize quick business opportunities that require transactions to be completed in short time.

4. What are some long-term financing needs for a corporation?

Businesses need long-term financing for acquiring new equipment, R&D, cash flow enhancement and company expansion.

5. What are the steps to effective financial planning?

choosing a financial planner and establishing a relationship, gather your financial information and establish goals, analyzes your financial status and makes recommendations., You review and consider the recommendations, Put the plan into motion. Benchmark your progress against the goals in your financial plan.

a. Cash budget:

An estimation of the cash inflows and outflows for a business or individual for a specific period of time

b. Capital budget

nvestment appraisal, is the planning process used to determine whether an organization’s long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding of cash through the firm’s capitalization structure

7. What is equity capital and debt capital?

Debt capital refers to funds that are borrowed and must be repaid at a later date. equity capital typically comes from funds invested by shareholders, the cost of equity capital is slightly more complex. While equity funds need not be repaid, there is a level of return on investment that shareholders can reasonably expect based on the performance of the market in general and the volatility of the stock in question.

8. What are traditional banking services for business?

aning of bank A banker or bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money. It is an institution for receiving, keeping, and lending money.

9. What are some sources for short-term financing?

which is the use of credit with maturity of one year or less.

10. What are sources of equity financing?

Equity is cash paid into the business—either the owner’s own cash or cash contributed by one or more investors. Equity investments are certified by issuing shares in the company.

11. What is an IPO or initial public offering?

is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it’s known as an IPO. Companies fall into two broad categories: private and public.

12. What is the difference between common and preferred stock?

This means that when the company must liquidate and pay all creditors and bondholders, common stockholders will not receive any money until after the preferred shareholders are paid out. Second, the dividends of preferred stocks are different from and generally greater than those of common stock.

13. What are dividends?

a sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits

14. Who elects board of directors?

A private company or nonprofit corporation may be structured to have members, rather than shareholders. Some or all of the members can have responsibility for electing directors. The members can choose directors from within the organization’s membership or from a larger pool.

15. How does a corporate bond work?

Companies issue bonds, known as corporate bonds, to raise money to finance their business activities. Investors that buy the bonds normally receive regular interest payments from the issuing company throughout the pre-determined lifetime of the bonds.

Financial Management

Activities concerned with obtaining money and using it effectively

The Need for Financial Management

Uses of funds dictate the type of financing needed by a business Activities a business can undertake are determined by the types of financing available

Financial Reform
After the Economic Crisis

President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010 New regulations will protect American families from unfair, abusive financial and banking practices

Financial Reform
After the Economic Crisis
Goals

Hold Wall Street firms accountable for their actions End taxpayer bailouts Tighten regulations for major financial firms Increase government oversight

Financial Reform
After the Economic Crisis
Debate

Limiting executive pay and bonuses Limiting the size of the largest firms Curbing previously used speculative investment techniques

Chief financial officer (CFO):

High-level corporate executive who manages firm’s finances and reports directly to the company’s chief executive officer

Managers and employees in the finance area must:

Have a strong background in accounting or mathematics Know how to use a computer to analyze data Be an expert at both written and oral communication

Cash flow:

Movement of money into and out of an organization

Speculative production:

Time lag between production and the selling of goods

Long-Term Financing

Money that will be used for longer than one year Involves large amounts of money

The Risk-Return Ratio

High risk decision should generate higher financial returns for a business More conservative decisions generate lower returns

Financial Plan

Plan for obtaining and using the money needed to implement an organization’s goals and objectives

Budget:

Financial statement that projects income and/or expenditures over a specified future period

Cash budget:

Financial statement that estimates cash receipts and cash expenditures over a specified period

Zero-base budgeting:

Budgeting approach in which every expense in every budget must be justified

Capital budget:

Estimates a firm’s expenditures for major assets and its long-term financing needs

Equity capital:

Money received from the owners or from the sale of shares of ownership in a business

Debt capital:

Borrowed money obtained through loans of various types

Monitoring and
Evaluating Financial Performance

Financial plans are implemented properly Prevents minor problems from becoming major ones Interim budgets may be prepared for comparison purposes

Savings and Checking Accounts

Provide a safe place to store money Conservative means of investing

Certificate of deposit (CD):

A document stating that the bank will pay the depositor a guaranteed interest rate on money left on deposit for a specified period of time

Check:

Written order for a bank or other financial institution to pay a stated dollar amount to the business or person indicated on the face of the check

Line of credit:

Loan approved before the money is actually needed

Revolving credit agreement:

Guaranteed line of credit

Collateral:

Real estate or property pledged as security for a loan

Basics of getting a loan

Know potential lenders Fill out an application; submit a business plan and financial statements; compile references Meet with loan officer If denied, determine why

Why Has the Use of Credit
Transactions Increased?

For the merchant, credit and debit card transactions can be converted to cash and improve a firm’s cash flow.

Debit card:

Electronically subtracts the amount of a purchase from bank account when the purchase is made

Electronic Funds Transfer

Means of performing financial transactions through computer terminal Automated teller machines (ATMs) Automated clearinghouses (ACHs) Point-of-sale (POS) terminals Electronic check conversion (ECC)

Letter of credit:

Legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time

Banker’s acceptance:

Written order for a bank to pay a third party a stated amount of money on a specific date

Sources of Short-Term Debt Financing

Short-term debt financing is easier to obtain than long-term Shorter repayment period means less risk of nonpayment Amounts of short-term loans are smaller than long-term loans A close working relationship normally exists between borrower and lender

Unsecured financing:

Financing not backed by collateral

Trade credit:

Financing extended by a seller who does not require immediate payment

Promissory notes:

written pledge by a borrower to pay a certain sum of money to a creditor at a specified future date

Unsecured bank loans

Interest rates vary with each borrower’s credit rating

Prime interest rate:

Lowest rate charged by a bank for a short-term loan

Compensating balance –

10 to 20 percent of the borrowed funds

Commercial paper

Short-term promissory note issued by a large corporation Interest rates are usually below that charged by banks for short-term loans

Loans secured by inventory –

Inventory is pledged as collateral

Loans secured by receivables –

Amounts owed to a firm by its customers are pledged as collateral

Factor:

Firm that specializes in buying other firms’ accounts receivable Buys accounts receivable for less than their face value

For sole proprietorships or partnerships

Owner or partners invest money in the business Venture capital

For corporations

Sale of stock Use of profits not distributed to owners Venture capital

Initial public offering:

When a corporation sells common stock to the general public for the first time

Primary market:

Investors purchase financial securities directly from the issuer of the securities.

Investment banking firm:

Assists corporations in raising funds usually by helping to sell new issues of stocks, bonds, or other financial securities

Secondary market

is for existing financial securities that are traded between investors Securities exchange market Over-the-counter (OTC) market

Common stock:

Stock whose owners may vote on corporate matters Claims on profits and assets are subordinate to the claims of others Stockholders are also asked to approve or disapprove of major corporate actions

Preferred stock:

Stock whose owners usually do not have voting rights Claims on dividends and assets are paid before those of common-stock owners

Retained Earnings

The portion of a corporation’s profits not distributed to stockholders Form of equity financing Amount is determined by corporate management and approved by the board of directors

Venture capital –

Money invested in small firms that have the potential to become very successful and extremely profitable Investors receive an equity or ownership position in the business and share in its profits

Private placement:

Stock and other corporate securities are sold directly to: Insurance companies Pension funds Large institutional investors

Financial leverage:

use of borrowed funds to increase the return on owners’ equity As the firm’s earnings are larger than the interest charged for the borrowed money, there is a positive effect on return on owners’ equity

Term-loan agreement:

Promissory note that requires a borrower to repay a loan in monthly, quarterly, semiannual, or annual installments Interest rate and repayment terms are based on: Reasons for borrowing firm’s credit rating Value of collateral

Corporate Bonds

A corporation’s written pledge that it will repay a specified amount of money with interest

Maturity date:

Date on which a corporation is to repay borrowed money

Registered bond:

Bond registered in the owner’s name by the issuing company

Debenture bond:

Bond backed only by the reputation of the issuing corporation

Mortgage bond:

Bond secured by various assets of issuing firm

Convertible bond:

Bond that can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock

Bond indenture:

Legal document that details all the conditions relating to a bond issue

Serial bonds:

Bonds of a single issue that mature on different dates

Sinking fund:

Sum of money to which deposits are made each year for the purpose of redeeming a bond issue

Trustee:

Individual or an independent firm that acts as a bond owner’s representative