Financial Management Flashcards
(36 cards)
Financial Management 5 Functions
- Financing—Raising capital to fund the business
- Capital budgeting—Selecting the best long-term projects based on risk and return
- Financial management—Managing cash flow so that funds are available when needed at
the lowest cost - Corporate governance—Ensuring behavior by managers that is ethical and in the best
interests of shareholders - Risk management—Identifying and managing the firm’s exposure to all types of risk
Working Capital Management - Inventory conversion period (ICP)
The average number of days required to convert inventory
to sales
• ICP = Average inventory / Cost of sales per day
• Average inventory = (Beginning inventory + Ending inventory) / 2
• Assume 365 days in a year unless told otherwise
Working Capital Management - Receivables collection period (RCP)
The average number of days required to collect accounts
receivable
• RCP = Average receivables / Credit sales per day
Working Capital Management - Payables deferral period (PDP)
The average number of days between the purchase of inventory
(including materials and labor for a manufacturing entity) and payment for them
• PDP = Average payables / Purchases per day
Working Capital Management - Cash conversion cycle (CCC)
The average number of days between the payment of cash to
suppliers of material and labor and cash inflows from customers
• CCC = ICP + RCP – PDP
Cash Balances are maintained for
- Operations—To pay ordinary expenses
- Compensating balances—To receive various bank services, fee waivers, and loans
- Trade discounts—Quick payment of bills for early payment discounts
- Speculative balances—Funds to take advantage of special business opportunities
- Precautionary balances—Amounts that may be needed in emergency situations
Float
refers to the time it takes for checks to be mailed, processed, and reflected in accounts.
Management techniques try to maximize float on payments and minimize it on receipts.
• Zero-balance accounts—The firm is notified each day of checks presented for payment
and transfers only the funds needed to cover them.
• Lockbox system—Customers send payments directly to bank to speed up deposits.
• Concentration banking—Customers pay to local branches instead of main offices.
• Electronic funds transfers—Customers pay electronically for fastest processing.
Private debt
Loans obtained from banks and other financial institutions or from syndicates of
lenders. Virtually all such loans have variable interest rates that are tied to an index:
Private Debt - Prime Rate
This is the rate that the lender charges its most creditworthy customers.
Loans to other customers would include a fixed amount above this (e.g., prime plus 2%).
Private Debt - LIBOR (London Interbank Offered Rate)
When the borrower and lender are in different
countries, the base used will typically be the LIBOR rather than the prime rate.
Public debt
To bypass institutional lenders, a corporation may sell bonds directly to investors
as a means of borrowing, with fixed interest rates and maturity dates for the securities, which can
then trade on the open market.
SEC registered bonds
To be sold on U.S. markets, bonds must satisfy the stringent
registration and disclosure requirements of the SEC.
Eurobonds
Bonds denominated in U.S. dollars can be sold on the European exchanges,
which have less stringent requirements.
Debt Covenants - Positive
- Providing annual audited financial statements to the lender
- Maintaining minimum ratios of current assets to current liabilities or financial measures
- Maintaining life insurance policies on key officers or employees of the company
Debt Covenants - Negative
- Not borrowing additional sums during the time period from other lenders
- Not selling certain assets of the business
- Not paying dividends to shareholders
- Not exceeding certain compensation limits for executives
Secured and Unsecured Bonds
Debt obligations may be secured by certain collateral or may specifically be placed behind other
forms of debt in the priority of repayment. In roughly declining order of safety (and increasing order
of interest rate), there are:
Order of Bond Safety
• Mortgage bonds—Secured by certain real estate owned by the borrower
• Collateral trust bonds—Secured by financial assets of the firm
• Debentures—Unsecured bonds
• Subordinated debentures—Unsecured bonds that will be repaid after all other creditors
in the event of a liquidation of the corporation
• Income bonds—Bonds whose interest payments will be made only out of earnings of the
corporation
Term bonds
Principal will be repaid on a single maturity date.
Serial bonds
Principal repayment will occur in installments
Sinking funds
Regular deposits will be made by the borrower into an account from
which repayment of the bonds will be made.
Convertible bonds
The bondholder may convert the bonds to the common stock of the company as a form of repayment instead of holding them to maturity for cash.
Redeemable bonds
The bondholder may be able to demand repayment of the bonds in advance of the normal maturity date should certain events occur (such as the buyout of
the company by another firm).
Callable bonds
The borrowing firm may force the bondholders to redeem the bonds before their normal maturity date (usually there is a set premium above the normal redemption price to compensate them for this forced liquidation).
