Business Essentials - Chapter 15 - Financial Decisions and Risk Management

Business Essentials Tenth Canadian Edition Chapter 15 Financial Decisions and Risk Management Copyright © 2023 Pearson Canada Inc. 15 - 1 Lear...

Business Essentials Tenth Canadian Edition Chapter 15 Financial Decisions and Risk Management Copyright © 2023 Pearson Canada Inc. 15 - 1 Learning Objectives (1 of 2) Describe the responsibilities of a financial manager. Distinguish between short-term (operating) and long-term (capital) expenditures. Identify three sources of short-term financing for businesses. Identify three sources of long-term financing for businesses. Discuss the value of common stock and preferred stock to shareholders and describe the secondary market for each type of security. Explain the process by which securities are bought and sold. Describe the investment opportunities offered by mutual funds, exchange-traded funds, hedge funds, and commodities. Explain how risk affects business operations and identify the five steps in the risk management process. Copyright © 2023 Pearson Canada Inc. 15 - 2 Learning Objectives (2 of 2) Njene/Shutterstock Copyright © 2023 Pearson Canada Inc. 15 - 3 The Role of the Financial Manager (LO 15.1) (1 of 5) Finance involves four key responsibilities: Determine a firm’s long- term investments Obtain funds to pay for those investments Conduct the firm’s Dragon Images/Shutterstock everyday financial activities Help manage the risks that a firm takes Copyright © 2023 Pearson Canada Inc. 15 - 4 The Role of the Financial Manager (L O 15.1) (2 of 5) The Financial Manager – responsible for planning and overseeing the financial resources of a firm ▪ cash-flow management ▪ financial planning ▪ financial control Copyright © 2023 Pearson Canada Inc. 15 - 5 The Role of the Financial Manager (LO 15.1) (3 of 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 Copyright © 2023 Pearson Canada Inc. 15 - 6 The Role of the Financial Manager (LO 15.1) (4 of 5) Financial Control Checking performance against strategic plans Making adjustments Preparing budgets to ensure that sufficient cash is on hand to meet operational and debt-service needs Copyright © 2023 Pearson Canada Inc. 15 - 7 The Role of the Financial Manager (LO 15.1) (5 of 5) Financial Planning a plan to achieve a desired financial status: – projections of revenue flows – sources and planned uses of funds to meet both short- and long-term goals – timing of when funds will be required Copyright © 2023 Pearson Canada Inc. 15 - 8 Why Do Businesses Need Funds? (LO 15.2) (1 of 2) Short-Term (Operating) Expenses accounts payable accounts receivable – credit policy inventory – raw materials – work in process This warehouse manager is checking inventory levels in a large warehouse. Wavebreakmedia/Shutterstock Copyright © 2023 Pearson Canada Inc. 15 - 9 Why Do Businesses Need Funds? (LO 15.2) (2 of 2) 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 Copyright © 2023 Pearson Canada Inc. 15 - 10 Sources of Short-Term Funds (LO 15.3) (1 of 4) Short-Term Funds – allows firms to cover operational expenses and implement short-term plans ▪ trade credit ▪ secured loans ▪ unsecured loans ▪ factoring accounts receivable Copyright © 2023 Pearson Canada Inc. 15 - 11 Sources of Short-Term Funds (LO 15.3) (2 of 4) Trade Credit – the granting of credit by a selling firm to a buying firm ▪ Open-book credit ▪ Promissory note ▪ Trade draft Copyright © 2023 Pearson Canada Inc. 15 - 12 Sources of Short-Term Funds (LO 15.3) (3 of 4) Secured Short-Term Loans – a short-term loan for which the borrower is required to put up collateral ▪ 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 Copyright © 2023 Pearson Canada Inc. 15 - 13 Sources of Short-Term Funds (LO 15.3) (4 of 4) Unsecured Short-Term Loans Line of Credit Revolving Credit Agreements Commercial Paper Copyright © 2023 Pearson Canada Inc. 15 - 14 Sources of Long-Term Funds (LO 15.4) (1 of 4) Debt Financing Equity Financing Hybrid Financing Risk-Return Relationship Jarretera/Shutterstock Copyright © 2023 Pearson Canada Inc. 15 - 15 Sources of Long-Term Funds (LO 15.4) (2 of 4) Debt Financing Long-Term Loans – borrowing money for 3 to 10 years at a fixed or floating rate Corporate Bonds – a promise by the borrower to pay the lender an amount of money on the maturity date Copyright © 2023 Pearson Canada Inc. 15 - 16 Sources of Long-Term Funds (LO 15.4) (3 of 4) Bonds Secured Unsecured (debentures) Registered bonds Bearer (coupon) bonds Corporations aren’t the only organizations that sell bonds. Government also sells bonds to finance its activities. StockstudioX/E+/Getty Images Copyright © 2023 Pearson Canada Inc. 15 - 17 Sources of Long-Term Funds (LO 15.4) (4 of 4) The Retirement of Bonds Callable Bonds – may be called at anytime, or after a minimum period of time, and paid off for a specified call price Serial Bonds – redemption rates are staggered so that the bond is paid off gradually over time Convertible Bonds – option of receiving common stock instead of cash Copyright © 2023 Pearson Canada Inc. 15 - 18 Equity Financing (LO 15.5) (1 of 4) Common Stock – a firm sells ownership rights by issuing shares – investors buy the stock hoping that it will appreciate Retained Earnings MDA’s Canadarm has been a key tool used by – financing by retaining astronauts on space missions since 1981. Stocktrek Images, Inc/Alamy Stock profits in the firm and not Photo paying dividends to shareholders Copyright © 2023 Pearson Canada Inc. 15 - 19 Equity Financing (LO 15.5) (2 of 4) Common Stock Market Value – current price of a share on the secondary securities market Book Value – shareholders’ equity divided by the number of shares Casimiro PT/Shutterstock outstanding Par Value – arbitrary value set by the company’s board of directors and stated on stock certificates Copyright © 2023 Pearson Canada Inc. 15 - 20 Equity Financing (LO 15.5) (3 of 4) Hybrid Financing: Preferred Stock Preferred Shares – require fixed payments, as do bonds – unlike bonds, they do not have a maturity date – have no voting rights, so control of the firm is not affected Copyright © 2023 Pearson Canada Inc. 15 - 21 Equity Financing (LO 15.5) (4 of 4) Choosing between Debt and Equity Financing – capital structure: the mix of debt versus equity ▪ financial plans usually include a target for the debt– equity mix ▪ equity is expensive, but the company has no formal obligations to the shareholders ▪ debt is cheaper, but the company may not be able to service the debt Copyright © 2023 Pearson Canada Inc. 15 - 22 Securities Markets (LO 15.5) (1 of 5) Primary Securities Market – sale and purchase of newly issued stocks or bonds Secondary Securities Market – sale and purchase of previously issued stocks and bonds Investment Bankers – financial specialists who issue new securities Copyright © 2023 Pearson Canada Inc. 15 - 23 Securities Markets (LO 15.5) (2 of 5) Stock Exchanges – provide a setting for members to buy and sell stock in accordance with the rules of the exchange Nearly 3600 stocks are traded on N ASDAQ including some of the top names in tech like: Apple, Intel and Zoom. E.J. Baumeister Jr./Alamy Stock Photo Copyright © 2023 Pearson Canada Inc. 15 - 24 Securities Markets (LO 15.5) (3 of 5) Stockbrokers – individuals licensed to buy and sell securities for customers in the secondary market ▪ Discount brokers ▪ Full-service brokers This meme-stock phenomenon was on the front ▪ Online trading pages during a very volatile period in early 2021. Fuelled by social media posts on Reddit (with groups like r/wallstreetbets) and Twitter, some unexpected companies saw tremendous interest and large stock price gains. TY Lim/Shutterstock Copyright © 2023 Pearson Canada Inc. 15 - 25 Securities Markets (LO 15.5) (4 of 5) Toronto Stock Exchange (TSX) – the largest exchange in Canada with 110 members – the securities of most major Canadian companies are listed here Foreign Exchanges – there are major exchanges around the world such as the: ▪ New York Stock Exchange ▪ London Stock Exchange Copyright © 2023 Pearson Canada Inc. 15 - 26 Securities Markets (LO 15.5) (5 of 5) The Over-the-Counter Market (OTC) – numerous dealers who trade among themselves for smaller firms and those not listed on exchanges – also trade all fixed-income securities (includes bonds and debentures) National Association of Securities Dealers Automated Quotation (NASDAQ) – the world’s first electronic stock market Copyright © 2023 Pearson Canada Inc. 15 - 27 Buying and Selling Securities (LO 15.6) (1 of 7) Stock Quotations Figure 15.4 How to read a daily stock quotation Company Volume High Low Close Change Shopify 92 1947.41 1871.01 1881.81 −62.97 Royal Bank 774 130.58 129.26 129.39 −0.56 Bombardier 7,239 1.96 1.87 1.92 −0.02 Magna Intl. 704 101.62 98.45 100.4 −1.22 Kinross Gold Corp. 1,988 7.6 7.42 7.52 −0.06 Spin Master Corp. 60 47.04 45.66 54.18 −0.25 Copyright © 2023 Pearson Canada Inc. 15 - 28 Buying and Selling Securities (LO 15.6) (2 of 7) Stock Magna International (Name of Company). Volume 704 (total number of shares traded on this date [in 100s]). High and Low During the trading day, the highest price was $101.62 and the lowest price was $98.45. Close At the close of trading on this date, the last price paid per share was $100.40. Net Change Difference between today’s closing price and the previous day’s closing price. Price decreased by $1.42 per share. Copyright © 2023 Pearson Canada Inc. 15 - 29 Buying and Selling Securities (LO 15.6) (3 of 7) Figure 15.5 How to read a bond quotation Copyright © 2023 Pearson Canada Inc. 15 - 30 Buying and Selling Securities (LO 15.6) (4 of 7) Market Indexes – summarize trends in the stock market and specific industries: ▪ Dow Jones Industrial Average (DJIA) ▪ S & P Composite Index (S&P 500) ▪ NASDAQ Composite ▪ S&P/TSX index Bear market – a period of falling stock prices Bull market – a period of rising stock prices Copyright © 2023 Pearson Canada Inc. 15 - 31 Buying and Selling Securities (LO 15.6) (5 of 7) Market order Limit order Stop order Round lot Odd lot Copyright © 2023 Pearson Canada Inc. 15 - 32 Buying and Selling Securities (LO 15.6) (6 of 7) Margin Trading – the investor makes a down payment on a portion of the price with the rest financed by the broker – the broker borrows the amount from the bank, secured by stock – the broker charges the investor a higher rate of interest than he/she pays the bank Copyright © 2023 Pearson Canada Inc. 15 - 33 Buying and Selling Securities (LO 15.6) (7 of 7) Short Sale – an investor “borrows” shares from the broker and sells them – the investor must purchase the equal number of shares later and return them to the broker Profit or Loss based on the spread between the selling price and the purchasing price Copyright © 2023 Pearson Canada Inc. 15 - 34 Other Investments (LO 15.7) (1 of 5) Mutual Fund – a company that pools the resources of many investors and uses funds to purchase various types of securities – investments are professionally managed – different funds have different goals (stability, growth, etc.) and different levels of risk ▪ No-load funds ▪ Load funds Copyright © 2023 Pearson Canada Inc. 15 - 35 Other Investments (LO 15.7) (2 of 5) Ethical Funds Stress socially responsible investing Focus on companies that produce safe and useful products (no cigarettes, weapons etc.) Emphasize good employee relations, environmental practices, and human rights Copyright © 2023 Pearson Canada Inc. 15 - 36 Other Investments (LO 15.7) (3 of 5) Exchange-Traded Funds (ETF) A bundle of stock and/or bonds that is in an index tracking the overall movement of a market ETFs can be traded throughout the day, like stocks, but not like bonds that are priced only at the end of each day ETFs have lower operating expenses Copyright © 2023 Pearson Canada Inc. 15 - 37 Other Investments (LO 15.7) (4 of 5) Hedge Funds – private pools of money that try to give positive returns, regardless of stock-market performance – sold to wealthy, knowledgeable investors – also sold as “principal-protected notes” ▪ original principal, but no extra return is guaranteed Commodities – undifferentiated products – futures contract ▪ agreement to purchase specific amounts of a commodity at a certain price on a set date in the future Copyright © 2023 Pearson Canada Inc. 15 - 38 Other Investments (LO 15.7) (5 of 5) Stock Options – Call option: the purchased right to buy a particular stock at a certain price until a specified date – Put option: the purchased right to sell a particular stock at a certain price until a specified date Daily prices of put and call options appear in the financial press Copyright © 2023 Pearson Canada Inc. 15 - 39 Securities Regulations (LO 15.7) Canadian Securities Regulations – Canada does not have federal securities legislation; regulation is primarily provincial – Blue-sky law ▪ laws regulating how firms back up securities – Prospectus ▪ detailed registration statement about a new stock filed with a provincial securities exchange Copyright © 2023 Pearson Canada Inc. 15 - 40 Financial Management for Small Business (LO 15.7) Small business owners must strive to get credit, manage it well, build their credit rating, and manage cash flow. – Establish bank credit and trade credit – The Venture Capital approach – Planning for cash flow Copyright © 2023 Pearson Canada Inc. 15 - 41 Risk Management (LO 15.8) (1 of 3) 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 Iaremenko Sergii/Shutterstock Pure risk only the chance of loss (a warehouse fire) Copyright © 2023 Pearson Canada Inc. 15 - 42 Risk Management (LO 15.8) (2 of 3) The Risk-Management Process 1. Identify risks and potential losses 2. Measure the frequency and severity of losses and their impact 3. Evaluate alternatives and choose the techniques that will best handle the losses 4. Implement the risk-management program 5. Monitor results Copyright © 2023 Pearson Canada Inc. 15 - 43 Risk Management (LO 15.8) (3 of 3) Risk-Management Alternatives risk avoidance risk control risk transfer risk retention Copyright © 2023 Pearson Canada Inc. 15 - 44 Quick-Check Questions (1 of 5) 1) Meagan is comparing her firm's actual quarterly results to the budget projection that was completed six months ago. When analyzing these documents, she discovers that sales were lower than the firm had anticipated. Meagan is involved in _____________. A) financial control B) cash flow management C) financial planning D) management accounting Copyright © 2023 Pearson Canada Inc. 15 - 45 Quick-Check Answer (1 of 5) 1) Meagan is comparing her firm's actual quarterly results to the budget projection that was completed six months ago. When analyzing these documents, she discovers that sales were lower than the firm had anticipated. Meagan is involved in _____________. A) financial control B) cash flow management C) financial planning D) management accounting Copyright © 2023 Pearson Canada Inc. 15 - 46 Quick-Check Questions (2 of 5) 2) Crystal, an owner of a travel agency, is beginning to worry that her cash flows are not going to cover her current operating expenses. With the cold weather approaching, Crystal knows that her cash inflows will pick up very quickly as people begin to book vacations to the sunny south. Crystal can resolve her current cash flow concerns by obtaining ________ financing. A) immediate B) short-term C) contingency D) long-term Copyright © 2023 Pearson Canada Inc. 15 - 47 Quick-Check Answer (2 of 5) 2) Crystal, an owner of a travel agency, is beginning to worry that her cash flows are not going to cover her current operating expenses. With the cold weather approaching, Crystal knows that her cash inflows will pick up very quickly as people begin to book vacations to the sunny south. Crystal can resolve her current cash flow concerns by obtaining ________ financing. A) immediate B) short-term C) contingency D) long-term Copyright © 2023 Pearson Canada Inc. 15 - 48 Quick-Check Questions (3 of 5) 3) Azim has been approved for a bank loan; however the bank manager requires Azim’s signature allowing the bank to seize his car if payment is not made as agreed. Azim’s car is being used as __________. A) security B) a promissory note C) equity D) collateral Copyright © 2023 Pearson Canada Inc. 15 - 49 Quick-Check Answer (3 of 5) 3) Azim has been approved for a bank loan; however the bank manager requires Azim’s signature allowing the bank to seize his car if payment is not made as agreed. Azim’s car is being used as __________. A) security B) a promissory note C) equity D) collateral Copyright © 2023 Pearson Canada Inc. 15 - 50 Quick-Check Questions (4 of 5) 4) Businesses may seek long-term financing from these major sources: A) debt, equity and insurance financing B) debt, equity and hybrid financing C) government funds and bank loans D) commercial paper and promissory notes Copyright © 2023 Pearson Canada Inc. 15 - 51 Quick-Check Answer (4 of 5) 4) Businesses may seek long-term financing from these major sources: A) debt, equity and insurance financing B) debt, equity and hybrid financing C) government funds and bank loans D) commercial paper and promissory notes Copyright © 2023 Pearson Canada Inc. 15 - 52 Quick-Check Questions (5 of 5) 5) Extended periods where most stock prices are increasing is characterized as a ________ market; periods where most prices are falling is characterized as a ________ market. A) growth; decline B) recovery; recession C) bull; bear D) bear; bull Copyright © 2023 Pearson Canada Inc. 15 - 53 Quick-Check Answer (5 of 5) 5) Extended periods where most stock prices are increasing is characterized as a ________ market; periods where most prices are falling is characterized as a ________ market. A) growth; decline B) recovery; recession C) bull; bear D) bear; bull Copyright © 2023 Pearson Canada Inc. 15 - 54