Part 6
Financing the
Enterprise
© 2015 McGraw-Hill Education.
16-2
CHAPTER 14
Accounting and Financial Statements
CHAPTER 15
Money and the Financial System
CHAPTER 16
Financial Management and Securities Markets
16-3
Learning Objectives
LO 16-1 Describe some common methods of managing current
assets.
LO 16-2 Identify some sources of short-term financing (current
liabilities).
LO 16-3 Summarize the importance of long-term assets and
capital budgeting.
LO 16-4 Specify how companies finance their operations and
manage fixed assets with long-term liabilities,
particularly bonds.
LO 16-5 Discuss how corporations can use equity financing by
issuing stock through an investment banker.
LO 16-6 Describe the various securities markets in the United
States.
16-4
Managing Current Assets and Liabilities
Working Capital Management
• The managing of short-term assets and liabilities
 Since short-term assets and liabilities continually flow
through an organization, they are said to be “working”
 The terms current and short-term are used
interchangeably
 Current assets: cash, investments, accounts receivable
and inventory – goal is maximize return on these assets
 Current liabilities: accounts payable, accrued salaries,
accrued taxes and short-term bank loans
16-5
Managing Current Assets
Idle cash does not make money and managers try to
keep just enough to pay bills as they fall due
Transaction Balances
• Cash kept on hand by a firm to pay normal daily
expenses, such as employee wages and bills for
supplies and utilities
Lockbox
• An address, usually a commercial bank, at which a
company receives payments in order to speed
collections from customers
16-6
Managing Current Assets
Sometimes cash comes in faster than needed to pay bills
Marketable Securities
• Temporary investment of “extra” cash by organizations
for up to one year in U.S. Treasury bills, certificates of
deposit, commercial paper, or Eurodollar loans
Treasury Bills (T-Bills)
• Short-term debt obligations the U.S. government
sells to raise money
T-bills are considered risk free
16-7
Short-Term Investment Possibilities
for Idle Cash
16-8
Method Is a Green Company in
More Ways than One

Method sells eco-friendly household supplies and also
generates more that $100 million in annual revenues.

Thanks to companies such as Method, finance executives
are beginning to realize the financial benefits of going
green.

Method aligns its environmental objectives with its costsavings goals.

The operations and finance departments
routinely work together to look at what
ingredients and processes would save money
while reducing Method’s environmental
impact.
16-9
Managing Current Assets
Commercial Certificates of Deposit (CDs)
• Certificates of deposit issued by commercial banks and
brokerage companies, available in minimum amounts of
$100,000 which may be traded prior to maturity
Commercial Paper
• A written promise from one company to another to pay a
specific amount of money
Eurodollar Market
• A market centered in London for trading U.S. dollars in foreign
countries
16-10
Managing Current Assets
 Many businesses make a majority of sales on
credit, so managing receivables is important
 Discounts for early payment and extending
credit comes at the cost of lowered profits
 Credit ratings can be provided by credit
bureaus, credit-rating agencies such as Dun
and Bradstreet and industry trade groups
16-11
Managing Current Assets
 Financial managers have to coordinate
inventory purchases to manage cash flows
 Optimal inventory levels are determined
mainly by method of production
 Excess inventory ties up money
unnecessarily but inventory shortages could
drive a customer to a competitor – forever
16-12
Managing Current Liabilities
Averting a cash shortfall with short-term funds
Accounts
Payable
• Trade Credit is extended by
suppliers for the purchase of
their goods and services
Most suppliers offer discounts for early
payment, offered as “1/10 net 30,” meaning a
1% discount if given is paid in 10 days and
the full amount is due in 30 days
16-13
Managing Current Liabilities
Most organizations obtain short-term funds from banks
Line of
Credit
Secured
Loans
• An arrangement by which a bank agrees to lend a specified
amount of money to an organization upon request
• Loans backed by collateral the bank can claim if the
borrowers do not repay them
Unsecured
Loans
• Loans backed only by the borrowers’ good reputation and
previous credit rating
Prime Rate
• The interest rate commercial banks charge their best
customers (usually large corporations) for short-term loans
16-14
Managing Current Liabilities
Banks are not the only source of short-term funds
Factor
• A finance company to which businesses sell their
accounts receivable – usually for a percentage of the
total face value
o Other nonbank liabilities include: taxes owed to the
government and wages owed to employees
o Taxes and employees’ wages represent debt
obligations and the financial manager must plan to
meet them as they come due
16-15
Managing Fixed Assets
Long-Term (Fixed) Assets
• Production facilities (plants), offices, and equipment
– all of which are expected to last for many years
 Modern facilities and equipment are
expensive, requiring long-term financing
 Options include capital leases and
operating leases, where a company
pays a fee for usage rather than owning
an asset
16-16
Managing Fixed Assets
Capital Budgeting
• The process of analyzing the needs of the business
and selecting the assets that will maximize its value
 This process continues after
purchase as all assets and projects
must be continually reevaluated
against the company’s needs
 Budgeting is not an exact process
and managers must be flexible
16-17
Assessing Risk
Highest Risk
Introduce a New
Product in
Foreign Markets
Expand into a
New Market
Introduce a New
Product in a
Familiar Market
Buy New
Equipment for
Established
Market
Add to a Product
Line
Lowest Risk
Repair Old
Machinery
16-18
Assessing Risk
Pharmaceutical
companies spend
millions of dollars
developing new drugs
without knowing if the
drug will pass FDA
approval and have a
significant margin of risk
16-19
Assessing Risk
Every investment carries some risk
» The longer a project or asset is
expect to last, the greater its
potential risk as it may become
obsolete or wear out prematurely
» Risk is also affected by the stability
and competitive nature of the
marketplace and the world economy
16-20
Pricing Long-Term Money
 Returns from any project must cover not only operating
costs but interest expenses on the debt used to finance
the project
 The most efficient and profitable companies attract the
lowest-cost funds because they typically offer
reasonable returns for low relative risk
 New companies have a strong motivator to use financial
resources wisely because they will, over time, reduce
the costs of their funds and increase profit
16-21
Financing with Long-Term Liabilities
Two common sources for long-term funds:
Attracting new owners (equity financing)
Long-term liabilities (debt financing)
Long-Term Liabilities
• Debts that will be repaid over a number of years,
such as long-term loans and bond issues


These take many different forms but the in the end, the
key word is debt
Heavily indebted companies may not make it through a
recession and be forced into bankruptcy
16-22
Financing with Long-Term Liabilities
Bonds
• Debt instruments that larger companies
sell to raise long-term funds
o Bondholders enter into a contract, or
indenture, with the bond issuer
o Bondholders receive regular interest payments and the
face value of the bond on or before the maturity date
o The annual interest rate (often called coupon rate) is
the percentage of face value the company pays yearly
16-23
Types of Bonds
Unsecured
Bonds
• Debentures, or bonds that are not backed by
specific collateral
Secured
Bonds
• Bonds backed by specific collateral that must be
forfeited in the event the issuing firm defaults
Serial Bonds
• A sequence of small bond issues of progressively
longer maturity
Floating-Rate
Bonds
• Bonds with interest rates that change with current
interest rates otherwise available in the economy
Junk Bonds
• A special type of high interest-rate bond that
carries higher inherent risks
16-24
Financing with Owners’ Equity
Corporate owners own shares of the company and
stockholders’ equity includes common stock, preferred
stock and retained earnings
Retained Earnings
• Earning after expenses and taxes that are
reinvested in the assets of the firm and belong to
the owners in the form of equity
Retained earnings are the only long-term funds the
company can generate internally
16-25
Venture Firm Focuses on Smaller Cleantech
Investments
Robert Fenwick-Smith prefers smaller clean-tech companies
that are capital efficient, can reach profitability more quickly,
and yield smaller but still profitable returns.

He founded the venture capital firm Aravaipa Ventures in
2008 to invest in several smaller firms
 Invests in four key areas: transportation efficiency, building
efficiency, water efficiency, and location efficiency

Spreads out the risk so the failure of one company will not lead
to enormous losses
 Invests only in firms that need no more than $5 million in
funding and have the ability to generate revenue within the
next year and a half

Won the Governor’s Award for Excellence in Cleantech
Leadership in 2012
16-26
A Basic Stock Quote
16-27
Estimated Common Stock Price-Earnings Ratios
and Dividends for Selected Companies
Dividend
Yield
The
dividend
per share
divided by
the stock
price
16-28
Investment Banking
Primary Market
• The market
where firms
raise financial
capital
Secondary
Markets
• Stock
exchanges and
over-the-counter
markets where
investors can
trade their
securities with
others
Investment
Banking
• The sale of
stocks and
bonds for
corporations
16-29
High Frequency Trading
High Frequency Trading has become popular over the last
several years and has dramatically changed the
landscape of the securities markets.

High frequency trading is made possible by proprietary
algorithms created to allow computers to automatically
trade stocks and securities in a matter of seconds.

Since the advent of this method, there have been severe
crashes in the market due to failure of the technology or
mistakes made by the computers.
 These mistakes are usually corrected just as quickly as they
occur, however, it does make some wonder if replacing a
human trader with an automated one is worth the risk.
SOURCE: Richard Finger. “High Frequency Trading: Is it A Dark Force Against Ordinary Human Traders and Investors?”. www.forbes.com.
September 30, 2013.
16-30
Securities Markets
Securities Markets
• The mechanism for buying and selling
securities
» In the broadest sense,
stocks and bonds
markets are providers of
liquidity
» Without liquid securities
markets, investors would
not risk their savings on
securities
16-31
Stock Markets
 Stock markets exist around the world; the two



MayU.S.
lead to stock markets are the New York Stock
biggest
inflation – a
Exchange
and the NASDAQ market
continuing(NYSE)
rise
in prices
Both exchanges
are now publicly traded
organizations, no longer not-for-profit
May lead to
Electronic
trading
is faster and less expensive than
recession
–a
decline in
floor trading
and now accounts for most of the stock
production,
employment
trading done
worldwide
and income
NASDAQ was traditionally an electronic market and
the NYSE was traditionally a floor-traded market
16-32
Social Media Companies Face Obstacles
Going Public
 Facebook made a major debut as a public company
with an initial offering of $38 a share.
 Within four months its stock had slid 45%, leading to a
number of investor lawsuits claiming that they had been
misled about Facebook’s future growth prospects.

The social gaming company Zynga saw its stock drop
70% in less than a year.
?
?
Why might a company’s stock be overvalued?
Why are these social media companies performing poorly
compared to their original hype?
16-33
Securities Markets
Over-The-Counter (OTC) Market
• A network of dealers all over the country linked by
computers, telephones and Teletype machines
 Most corporate bonds and all
U.S. securities are traded over
the counter
 Therefore, the OTC accounts for
the largest total dollar value of
all the secondary markets
16-34
Measuring Market Performance
 Investors and financial managers need to know
how a companies’ securities are performing
compared with competitors’
 Performance measures – averages and indexes –
are very important to many different people
 An index compares current stock prices with
those in a specified base period
 An average is the average of certain stock prices
and some are weighted averages
16-35
The 30 Stocks in the Dow Jones
Industrial Average
16-36
Measuring Market Performance
 The Dow Jones Industrial Average gained 10
times from August 1982 to the beginning of 2000
 This was the Internet bubble and they are difficult
to see until they burst
 Before the housing bubble burst in October 2007,
the Dow Jones hit an all time high
 For investors to make sound financial decisions, it
is important that they stay in touch with business
news, markets and indexes
16-37
Discussion
?
?
How can companies
use equity to finance
their operations and
long-term growth?
What were some of
the principle causes of
the most recent
recession?