Financial Management and Debt Financing Flashcards
Financial Management
Planning for a firm’s money needs and managing the allocation and spending of funds
Risk/Return Trade-Off
the balance of potential risks against potential rewards
What are the goals and activities of a financial manager?
Goal: To maximize SHV
Key Activities:
- Financial Planning (budgeting)
- Investments (spending money)
- Financing ( raising money)
Leverage
the technique of increasing the rate of return on an investment by financing it with borrowed funds
Capital Structure
A firm’s mix of debt and equity financing
Debt Financing
Arranging funding by borrowing money.
- No voting rights
- Obligatory payments (interest)
- Fixed life/Maturity (must be repaid)
- Interest is a tax-deductible expense
Equity Financing
Arranging funding by selling ownership shares in the company, publicly or privately
- Voting rights
- Discretionary payments (dividends)
- Permanent Capital (principal never repaid)
- Dividends are not tax-deductible (Paid with after-tax income)
When a firm is unable to fund growth internally, outside investors are needed. What are the two sources of external financing?
- Debt (financing provided by lenders/creditors)
- Banks
- Long Term Loans/Bonds
- Equity (financing provided by shareholders/stockholders)
- Preferred stockholders
- Common stockholders
Short-Term Financing
Financing used to cover current expenses (generally repaid within a year)
Long-term Financing
Financing used to cover long-term expenses such as assets (generally repaid over a period of more than one year)
Credit Scoring: Character
This aspect includes not only the personal and professional character of the company owners but also their experience and qualifications to run the type of business for which they plan to use the loan proceeds
Credit Scoring: Capacity
To judge the company’s capacity or ability to repay the loan, lenders scrutinize debt ratios, liquidity ratios, and other measures of financial health. For small businesses, the owners’ personal finances are also evaluated
Credit Scoring: Capital
Lenders want to know how well capitalized the company is (aka whether is has enough capital to succeed). For small-business loans in particular, lenders want to know how much money the owners themselves have already invested in the business
Credit Scoring: Conditions
Lenders look at the overall condition of the economy as well as conditions within the applicant’s specific industry to determine whether they are comfortable with the business’s plans and capabilities
Credit Scoring: Collateral
Long-term loans are usually secured with collateral of some kind. Lenders expect to be repaid form the borrower’s cash flow, but in case that is inadequate, they look for assets that could be used to repay the loan, such as real estate or equipment
