Chapter 11 Financing the Business Lecture Slides PDF

CHAPTER 11 Financing the Business INTRODUCTION TO BUSINESS Learning Objectives To differentiate between debt and equity financing To compare and contrast different sources of funding To analyze net present value and its relevance to a business’ finance operations To distinguish b...

CHAPTER 11 Financing the Business INTRODUCTION TO BUSINESS Learning Objectives To differentiate between debt and equity financing To compare and contrast different sources of funding To analyze net present value and its relevance to a business’ finance operations To distinguish between forecasting and drivers & draggers To describe break-even analysis and the time value of money To interpret asset allocation and risk management Where Does Financing Come From? (Sources) Sources can be divided into two types: Debt — an obligation, such as a loan or bond, that is paid back with interest Equity — providing a portion of the business in exchange for financing Where Does Financing Come From? Banks Small Business Corporate Administration Debt Financial intermediary Part of the US Commercial Federal paper or bonds Collateral & Line of government credit Where Does Financing Come From? (cont.) Partners Angel Investors and Equity Investments Venture Capital Invests their money Done by issuing into the business Angel investor stocks and takes on finances before others responsibility would Venture capital comes from another company Pros and Cons of Equity Investments Corporate Finance The role of corporate finance is to make sure that a business has the proper funding to undertake its activities. Corporate Finance Topics Financial Management Net Present Value Liquidity Forecasting Ethics Financial Management Part of financial management is to ensure the proper amount of funding is obtained at the lowest cost to the business The cash spent today could be used for some other purpose or it could be invested in stocks, bonds, or some other financial investment So how does the finance department determine the value of the cash spent or invested today and the cash that comes into the company 12 years from now? The answer is called net present value or NPV. Net Present Value Net present value is a method of bringing cash that happens in the future, such as revenues 12 years from now or an expense 10 years from now and making them equivalent to the present value of today’s money. By bringing all revenues and expenses into today’s value, different projects can be compared to see which is the best if a choice needs to be made between the two. NPV is also a valuable tool in comparing a project to doing nothing. Liquidity Liquidity is a measure of the current assets that are available to meet a business’ current liabilities, which are due in less than a year. Assets have a varying degree of liquidity. Cash is regarded as the most liquid of assets Stocks and bonds are also regarded as being very liquid Inventory is less liquid Forecasting One of the roles of the finance function is to establish forecasts for what is coming in the future and what will be required The first step in the forecasting process is establishing a baseline of what is currently happening. This forecasting model can then be analyzed to determine how much financing a business will need to get from a bank, how much debt they will issue through a corporate bond sale, or how much equity needs to be raised. Forecasting (cont.) It is important to identify the drivers and draggers of revenue Break-even Analysis To determine if the investment will be a good one is through break-even analysis. This analysis will find the quantity of sales that are needed so that revenues are greater than the expenses, making the investment a driver. Ethics All areas of a business and every employee have an ethical responsibility to conduct themselves in a respectable manner. For finance, there are additional responsibilities called fiduciary duties. In-class Recommended to add one of the activities suggested in the Financing Your Business activities file. exercise Personal Finances Snowballing Debt Happens when debt begins to increase. If you imagine a snowball going down a mountain, it starts off very small, but as it goes along it gets bigger and bigger in size. This can happen when paying a debt becomes a struggle or when an unexpected event, such as a car breaking down or unplanned medical expense, causes someone to build up too much credit card debt. Snowball Method Debt can also be controlled in the “snowball method” Snowball method created by Dave Ramsey Personal Finances: Investing for Retirement Time Value of Money Money is not a static thing because it can grow over time through the power of compounding interest If you were to put $1000 in the bank today and it earned 5% interest per year with the interest being paid monthly, you would have $1,283.36 in 5 years. Compounding interest is defined as the interest on a deposit or loan calculated based on the initial principal and the accumulated Personal Finances: Investing for Retirement (cont.) Risk vs. Reward As with most things in life nothing is free and the higher the reward, the higher the risk. Investments are no different Even if the risk seems appropriate for the return, not everyone is willing to take the same risks. Key: Figure out your risk tolerance Stock Markets The stock markets (The Dow Jones Industrial Average, S&P 500, and NASDAQ) in the US and international ones (FTSE – England, DAX – Germany, NIKKEI – Japan, and Shanghai – China) are where the shares of publicly traded companies are bought and sold. Bull and Bear Markets and Asset Allocation Stocks have more risk than other tools Bull and bear markets Investments for any portfolio need to have a mixture of different types of assets Asset allocation is the selecting of different investment types to balance risk Asset Allocation Based on Risk Tolerance  Once We Reviewed Different Issues, We Come Back to Retirement. How Much Does One Need to Retire? According to Forbes.com, that number may be over $2 million for someone graduating from college right now Don’t panic, we bring back compound interest The time and interest rate have an enormous impact on how much you need to save Do not delay too long in getting started for retirement Net Worth A measure of how much money a person has is called their net worth Calculated by adding up the total assets (value of a home minus the loan balance, checking and savings accounts, retirement accounts, etc.) minus total debt (credit cards, student and car loans, mortgage loan, etc.) Net worth is a partial picture of a person’s financial health