Financial Careers Lesson

1

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

1

Chapter 16

Mastering Financial
Management

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

2

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives

Once you complete this chapter, you will be able to:

16-1

Explain why financial management is important in today’s competitive economy.

16-2

Identify a firm’s short- and long-term financial needs.

16-3

Summarize the process of planning for financial management.

16-4

Identify the services provided by banks and financial institutions for their business
customers.

16-5

Describe the advantages and disadvantages of different methods of short-term debt
financing.

16-6

Evaluate the advantages and disadvantages of equity financing.

16-7

Evaluate the advantages and disadvantages of long-term debt financing.

3

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

3

16-1

Why Financial Management?

4

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Figure 16-1 Business Bankruptcies

in the United States

Note: At the time of publication, 2020 was the most recent year for which complete statistics were available

5

Multiple Choice

The management of money and financial decisions for a person or family including budgeting, investments, retirement planning and investments is...

1

Investment

2

Personal Finance

3

Economics

4

Savings

6

Multiple Choice

The process of budgeting, saving, investing, spending or otherwise supervising the use of money by an individual or group is ...

1

Money Management

2

Savings Account

3

Checking Account

4

Investment

7

Multiple Choice

Market value of shares are decided by

1

the respective companies

2

the investment market

3

the government

4

the shareholders

8

Multiple Choice

Wealth in the form of money or other assets owned by a person or organization or available or contributed for a particular purpose such as starting a company or investing.

1

Consumer

2

Seller

3

Capital

4

Demand

9

5

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-1 Why Financial Management? (1 of 2)

The Need for Financial Management

• Financial management*: All the activities concerned with obtaining money and using it

effectively

• Proper financial management must ensure that:

− Funds are available when needed both now and in the future, obtained at the lowest possible cost,

and used as efficiently as possible

− Financing priorities are established in line with organizational goals and objectives

− Spending is planned and controlled

− A firm’s credit customers pay their bills on time, and the number of past due accounts is reduced

− Bills are paid promptly to protect the firm’s credit rating and its ability to borrow money

− The funds required for paying the firm’s taxes are available when needed to meet tax deadlines

− Excess cash is invested in certificates of deposit (CDs), government securities, or conservative,

marketable securities

*Words accompanied by an asterisk are key terms from the chapter.

10

6

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-1 Why Financial Management? (2 of 2)

Careers in Finance

• Managers and employees in the finance area must:

− Be honest

− Have a strong background in finance, accounting, or mathematics

− Know how to use a computer to analyze data

− Be an expert at both written and oral communication

• Typical job titles in finance include:

Chief

Financial

Officer

Vice

President of

Finance

Bank Officer

Consumer

Credit
Officer

Financial
Analyst

Financial
Planner

Loan Officer

Insurance

Analyst

Investment

Account
Executive

11

Multiple Choice

The system of recording financial activity is called

1

Accounting

2

Finance

3

banking

4

Audit

12

Multiple Choice

The Formal examination of a company's financial records is called

1

accounting

2

budget

3

audit

4

assets

13

Multiple Choice

What is one difference between an accountant and an auditor?

1

Accountants assist auditors in recording financial transactions

2

Auditors speed up the process of collection money owed to the firm

3

Accountants work for auditors to help them verify financial records

4

Auditors assess the accuracy of the firm's financial statements

14

Multiple Choice

John works buying and selling stocks and bonds for his customers. John's job is an example of which type of career?

1

Accounting

2

Finance

3

Budgeting

4

Banking

15

Multiple Choice

Checking the company financial records for accuracy, writing monthly paychecks for employees, and preparing an Income Statement are classified as which type of activity?

1

Accounting

2

Banking

3

Budgeting

4

Finance

16

Multiple Choice

Bernice has a job sending bills to customers and recording their payments. Bernice's job is an example of which type of career?

1

Budgeting

2

Finance

3

Banking

4

Accounting

17

Multiple Choice

A savings and loan branch manager is an example of which type of career?

1

Finance

2

Accounting

3

Budgeting

4

Banking

18

Multiple Choice

Managing a customer's investment portfolio and giving business advice about its investments are classified as which type of activity?

1

Banking

2

Accounting

3

Finance

4

Budgeting

19

Multiple Choice

Counseling customers who want to buy corporate bonds, selling life insurance, and analyzing company spending and savings plans are classified as which type of activity?

1

Accounting

2

Banking

3

Budgeting

4

Finance

20

Multiple Choice

Accepting money that customers put in their savings accounts, counting cash to give to customers who have requested it, and processing a car loan request are classified as which type of activity?

1

Finance

2

Budgeting

3

Accounting

4

Banking

21

Multiple Choice

What is one difference between an accountant and a CPA?

1

Accountants must pass a national exam

2

CPAs usually receive a lower salary

3

CPAs must pass a national exam

4

Accountants must have more education

22

Multiple Choice

Recording payments made on account, preparing balance sheets, and preparing a quarterly income tax report are classified as which type of activity?

1

Finance

2

Budgeting

3

Banking

4

Accounting

23

7

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Polling Activity

Many financial managers and corporate officers have been criticized for poor
decisions, lack of ethical behavior, large salaries, lucrative severance packages
worth millions of dollars, and extravagant lifestyles.

Is this criticism justified?

24

8

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

8

16-2

The Need for Financing

25

9

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-2 The Need for Financing

• Short-term financing*: Money that will be used for one year or less

− Cash flow*: The movement of money into and out of an organization

− Speculative production*: The production of goods which is followed by a time lag before

the actual sale of those goods

• Long-term financing*: Money that will be used for longer than one year

• Risk–return ratio*: A ratio based on the principle that a high-risk decision

should generate higher financial returns for a business and more conservative
decisions often generate lower returns

*Words accompanied by an asterisk are key terms from the chapter.

26

Multiple Choice

Select the reasons for short term financing.

1

Cash flow problems

2

Speculative productions

3

Increase inventory

4

All of the above

27

Multiple Choice

Long term financing is the money that will be used for longer than one year.

1

True

2

False

28

Multiple Choice

Select the steps involved in financial planning

1

Establishing organizational goals and objectives

2

Budgeting for financial needs

3

Identify sources of funds

4

All of the above

29

Multiple Choice

Short term funds include:

1

Hybrid financing, debt financing, long term finance

2

Trade credit, debt financing, equity financing

3

Debt financing, equity financing, hybrid financing

4

Trade credit, secured term loan and unsecured term loan

30

10

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Table 16-1 Comparison of Short- and

Long-Term Financing

Short-Term Financing Needs

Long-Term Financing Needs

Cash-flow problems

Business start-up costs

Speculative production

Mergers and acquisitions

Current inventory needs

New product development

Monthly expenses

Long-term marketing activities

Short-term promotional needs

Replacement of equipment

Unexpected emergencies

Expansion of facilities

31

11

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Figure 16-2 Cash Flow for a Manufacturing Business

32

12

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

12

16-3

Planning—The Basis of Sound

Financial Management

33

13

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Figure 16-3 The Three Steps of Financial Planning

• Financial plan*: A plan for

obtaining and using the
money needed to
implement an
organization’s goals and
objectives

*Words accompanied by

an asterisk are key terms from the

chapter.

34

14

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Figure 16-4 Cash Budget for

Stars and Stripes Clothing

35

15

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-3 Planning—The Basis of Sound

Financial Management (1 of 3)

Developing the Financial Plan

ESTABLISHING ORGANIZATIONAL GOALS AND OBJECTIVES

• Goal: An end result that an organization expects to achieve over a one- to ten-year period

• Objective: A specific statement detailing what an organization intends to accomplish over a

shorter period of time

BUDGETING FOR FINANCIAL NEEDS

• Budget*: A financial statement that projects income, expenditures, or both over a specified

future period

− Process usually begins with the construction of departmental budgets for sales and various types of

expenses

− Cash budget*: A financial statement that estimates cash receipts and cash expenditures over a

specified period

*Words accompanied by an asterisk are key terms from the chapter.

36

Multiple Choice

What is the name of the document which is used to show future income and expenditure for a business?

1

Cash budget

2

Cash statement

3

Income statement

4

Income budget

37

Multiple Choice

What is NOT a benefit of preparing a cash budget?

1

helps determine profits for owners and shareholders

2

ensures there will be enough cash to pay employees and suppliers

3

will help business plan when to invest in new equipment

4

helps to plan a bank overdraft or additional funding in advance of when needed

38

Multiple Choice

What name is given to the situation of having excess cash expected at the end of next month?

1

Cash surplus

2

Cash deficit

3

Cash profit

4

Cash loss

39

Multiple Choice

What name is given to the situation of having a negative cash balance expected at the end of next month?

1

Cash surplus

2

Cash deficit

3

Cash profit

4

Cash loss

40

Multiple Choice

Identify the action below which would NOT help a cash deficit situation?

1

Implement tighter inventory control and reduce wastage

2

Negotiate a temporary overdraft with the bank

3

Sell unwanted assets

4

Award bonuses to staff to help motivate them

41

Multiple Choice

A business may prepare for a cash deficit by:

1

reducing planned profits

2

reducing planned cash payments

3

reducing capital contributions

4

increasing loan payments

42

16

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-3 Planning—The Basis of Sound

Financial Management (2 of 3)

BUDGETING FOR FINANCIAL NEEDS (continued)

• Traditional approach: A budgeting approach in which each new budget is based on the dollar

amounts contained in the budget for the preceding year, the amounts are modified to reflect any
revised goals, and managers are required to justify only new expenditures

• Zero-base budgeting*: A budgeting approach in which every expense in every budget must be

justified

• Capital budget*: A financial statement that estimates a firm’s expenditures for major assets and

its long-term financing needs

− To develop a plan for long-term financing needs, managers often construct a capital budget.

*Words accompanied by an asterisk are key terms from the chapter.

43

17

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-3 Planning—The Basis of Sound

Financial Management (3 of 3)

IDENTIFYING SOURCES OF FUNDS

• Sales revenue

• Equity capital*: Money received from the owners or from the sale of shares of ownership in a

business

• Debt capital*: Borrowed money obtained through loans of various types

• Proceeds from the sale of assets

Monitoring and Evaluating Financial Performance

• It is important to ensure that financial plans are implemented properly and to catch potential

problems before they become major ones.

*Words accompanied by an asterisk are key terms from the chapter.

44

18

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Group Activity

Working as a team, complete the following activity:

1.

Revisit Figure 16-4 from the perspective of Stars and Stripes Clothing’s financial manager.

2.

Decide what you would do with the excess cash that the firm expects in the second, third, and
fourth quarters.

45

19

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Group Activity Debrief

What would you do with Stars and Stripes Clothing’s excess cash expected in the
second, third, and fourth quarters?

46

20

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

20

16-4

Financial Services Provided by Banks and

Other Financial Institutions

47

21

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-4 Financial Services Provided by Banks and

Other Financial Institutions (1 of 5)

Traditional Banking Services for Business Clients

SAVINGS AND CHECKING ACCOUNTS

• Provide a safe place to store money a business doesn’t immediately need

• Certificate of deposit (CD)*: A document stating that the bank will pay the

depositor a guaranteed interest rate on money left on deposit for a specified
period of time

− A business with excess cash can earn a higher rate of interest

• Business firms also deposit money in checking accounts so that they can write

checks to pay for purchases.

*Words accompanied by an asterisk are key terms from the chapter.

48

22

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-4 Financial Services Provided by Banks and

Other Financial Institutions (2 of 5)

BUSINESS LOANS

• Short-term business loans: Must be repaid within one year or less

− Line of credit*: A loan that is approved before the money is actually needed

− Revolving credit agreement*: A guaranteed line of credit

• Long-term business loans: Are repaid over a period of years

− Collateral*: Real estate or property pledged as security for a loan

− Most lenders require some type of collateral for long-term loans.

*Words accompanied by an asterisk are key terms from the chapter.

49

23

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-4 Financial Services Provided by Banks and

Other Financial Institutions (3 of 5)

THE BASICS OF GETTING A LOAN

• Know potential lenders before requesting a loan.

• Check your firm’s credit rating with a national credit bureau.

• Fill out a loan application and provide current business plan, explaining how

much funding you require to accomplish your goals and how the loan will be
repaid.

• Submit current financial statements that have been prepared by an independent

certified public accountant.

• Compile a list of references that includes your suppliers, other lenders, or the

professionals with whom you are associated.

50

24

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Table 16-2 Consumer Payment Options

Payment Option

Percentage of People Who Prefer This Option

Debit cards

30 percent

Cash

26 percent

Credit cards

24 percent

Electronic payments

11 percent

Checks

5 percent

51

25

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-4 Financial Services Provided by Banks and

Other Financial Institutions (4 of 5)

Debit and Credit Card Transactions and Mobile Pay

• Debit card*: A card that electronically subtracts the amount of a purchase from

a customer’s bank account at the moment the purchase is made

• Mobile payment*: Payment for a product or service which is made using an

electronic device or an app

Electronic Banking Services

• Electronic funds transfer (EFT) system*: A means of performing financial

transactions through a computer terminal

− Automatic teller machines (ATMs), automated clearinghouses (ACHs), point-of-sale (POS)

terminals, and electronic check conversion (ECC)

*Words accompanied by an asterisk are key terms from the chapter.

52

26

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-4 Financial Services Provided by Banks and

Other Financial Institutions (5 of 5)

International Banking Services

• Letter of credit*: A legal document issued by a bank or other financial

institution guaranteeing to pay a seller a stated amount for a specified period of
time if certain conditions or requirements are met

− Conditions, such as delivery of merchandise, may be specified before payment is made.

• Banker’s acceptance*: A written order for a bank to pay a third party a stated

amount of money on a specific date

− No conditions are specified; it is simply an order to pay without any strings attached.

• Both a letter of credit and a banker’s acceptance are popular methods of paying

for import and export transactions.

*Words accompanied by an asterisk are key terms from the chapter.

53

27

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

27

16-5

Sources of Short-Term Debt Financing

54

28

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-5 Sources of Short-Term Debt Financing (1 of 5)

Sources of Unsecured Short-Term Financing

• Short-term debt financing is usually easier to obtain than long-term debt

financing for three reasons:

− For the lender, the shorter repayment period means less risk of nonpayment.

− The dollar amounts of short-term loans are usually smaller than those of long-term loans.

− A close working relationship normally exists between the short-term borrower and the

lender.

• Unsecured financing*: Financing that is not backed by collateral

− Most lenders do not require collateral for short-term financing.

*Words accompanied by an asterisk are key terms from the chapter.

55

29

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-5 Sources of Short-Term Debt Financing (2 of 5)

TRADE CREDIT

• Trade credit*: A type of short-term financing extended by a seller who does not

require immediate payment after delivery of merchandise

− The most popular form of short-term financing because most manufacturers and

wholesalers do not charge interest for trade credit

PROMISSORY NOTES ISSUED TO SUPPLIERS

• Promissory note*: A written pledge by a borrower to pay a certain sum of

money to a creditor at a specified future date

− Usually requires the borrower to pay interest
− Offers two important advantages to the firm extending the credit:

▪ A promissory note is legally binding and an enforceable contract.

▪ A promissory note is a negotiable instrument.

*Words accompanied by an asterisk are key terms from the chapter.

56

30

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-5 Sources of Short-Term Debt Financing (3 of 5)

UNSECURED BANK LOANS

• Prime interest rate*: The lowest rate charged by a bank for a short-term loan

− A bank may require that a compensating balance be kept on deposit and that every

commercial borrower clean up (pay off completely) its short-term loans at least once a year
and not use short-term borrowing again for a period of 30 to 60 days.

COMMERCIAL PAPER

• Commercial paper*: A short-term promissory note issued by a large

corporation

− The interest rate a corporation pays when it sells commercial paper is tied to its credit rating

and its ability to repay the commercial paper.

*Words accompanied by an asterisk are key terms from the chapter.

57

31

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Knowledge Check Activity

Which of the following is the most popular and inexpensive form of short-term
financing?

a) Factoring

b) Promissory notes

c) Commercial paper

d) Unsecured bank notes

e) Trade credit

58

32

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Figure 16-5 Average Prime Interest Rate Paid by

U.S. Businesses, 1990–March 2021

59

33

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-5 Sources of Short-Term Debt Financing (4 of 5)

Sources of Secured Short-Term Financing

LOANS SECURED BY INVENTORY

• Finished goods, raw materials, and work-in-process inventories may be pledged

as collateral for short-term loans.

LOANS SECURED BY RECEIVABLES

• A firm can pledge its accounts receivable (amounts owed to a firm by its

customers) as collateral to obtain short-term financing.

60

34

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-5 Sources of Short-Term Debt Financing (5 of 5)

Factoring Accounts Receivable

• Factor*: A firm that specializes in buying other firms’ accounts receivable

− Accounts receivable may be used to help raise short-term financing by being sold to a

factoring company

− Firm selling its accounts receivable gets less than face value, but receives cash immediately

− Shifts both the task of collecting and the risk of nonpayment to the factor

Cost Comparisons

• Trade credit is the least expensive short-term financing method.

• Secured loans and factoring of accounts receivable are typically the highest-

cost methods.

*Words accompanied by an asterisk are key terms from the chapter.

61

35

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Table 16-3 Comparison of Short-Term

Financing Methods

Type of
Financing

Cost

Repayment
Method

Business That May Use It

Comments

Trade credit

Low, if any

30–60 days

All businesses with good credit

Usually no finance charge

Promissory note
issued to suppliers

Moderate

One year or less

All businesses

Usually unsecured but requires
legal document

Unsecured
bank loan

Moderate

One year or less

All businesses

Promissory note is required and
compensating balance may be
required

Commercial paper

Moderate

270 days or less

Large corporations with high
credit ratings

Usually available only to large
firms

Secured loan

High

One year or less

Firms with questionable credit
ratings

Inventory or accounts receivable
often used as collateral

Factoring

High

None

Firms that have large numbers
of credit customers

Accounts receivable sold to a
factor

62

36

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Discussion Activity 1

Why would a lender offer unsecured short-term loans when it could demand
collateral?

63

37

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Discussion Activity 1 Debrief

Why would a lender offer unsecured short-term loans when it could demand
collateral?

64

38

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

38

16-6

Sources of Equity Financing

65

39

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-6 Sources of Equity Financing (1 of 5)

Selling Stock

INITIAL PUBLIC OFFERING AND THE PRIMARY MARKET

• Initial public offering (IPO)*: Occurs when a corporation sells common stock to

the general public for the first time

• Primary market*: A market in which an investor purchases financial securities

(via an investment bank) directly from the issuer of those securities

− When a corporation uses an IPO to raise capital, the stock is sold in the primary market.

• Investment banking firm*: An organization that assists corporations in raising

funds, usually by helping to sell new issues of stocks, bonds, or other financial
securities

*Words accompanied by an asterisk are key terms from the chapter.

66

40

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Figure 16-6 The All-Time Largest Initial Public

Offerings for U.S. Companies

67

41

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-6 Sources of Equity Financing (2 of 5)

THE SECONDARY MARKET

• Secondary market*: A market for existing financial securities that are traded

between investors

• Secondary-market transactions are usually completed through a securities

exchange or the over-the-counter (OTC) market.

− Securities exchange*: A marketplace where member brokers meet to buy and sell

securities

− Over-the-counter (OTC) market*: A network of dealers who buy and sell the stocks of

corporations that are not listed on a securities exchange

*Words accompanied by an asterisk are key terms from the chapter.

68

42

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-6 Sources of Equity Financing (3 of 5)

COMMON STOCK

• Common stock*: The most basic form of corporate ownership and whose

owners may vote on corporate policies

PREFERRED STOCK

• Preferred stock: Stock whose owners usually do not have voting rights but

whose claims on dividends and assets are paid before those of common-stock
owners

*Words accompanied by an asterisk are key terms from the chapter.

69

43

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-6 Sources of Equity Financing (4 of 5)

Retained Earnings

• Retained earnings*: The portion of a corporation’s profits not distributed to

stockholders

• Because they are undistributed profits, retained earnings are considered a form

of equity financing.

• The amount of retained earnings in any year is determined by corporate

management and approved by the board of directors.

*Words accompanied by an asterisk are key terms from the chapter.

70

44

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-6 Sources of Equity Financing (5 of 5)

Venture Capital, Angel Investors, and Private Placements

• Venture capital: Money invested in small (and sometimes struggling) firms that have the

potential to become very successful

− In return for financing, investors generally receive an equity or ownership position in the business and

share in its profits.

• Angel investor*: A wealthy investor who provides financial backing for small business start-ups

or entrepreneurs

− Focused on helping a business or entrepreneur succeed rather than earning huge profits; often

provide more favorable financial terms than venture capitalists and financial institutions

• Private placement*: Occurs when stock and other corporate securities are sold directly to

wealthy investors, banks and financial firms, insurance companies, pension funds, large
institutional investors, or mutual funds

*Words accompanied by an asterisk are key terms from the chapter.

71

45

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

45

16-7

Sources of Long-Term Debt Financing

72

46

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-7 Sources of Long-Term Debt Financing (1 of 5)

• Financial leverage*: The use of borrowed funds to increase the return on

owners’ equity

− Works as long as earnings are larger than the interest charged for the borrowed money

• For a small business, long-term debt financing is generally limited to loans.

• Large corporations have the additional option of issuing corporate bonds.

*Words accompanied by an asterisk are key terms from the chapter.

73

47

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Table 16-4 Analysis of the Effect of Additional Capital

from Debt or Equity

Additional Debt

Calculation

Owners’ equity

$500,000

Additional equity

+ 0

Total owner’s equity

$500,000

Loan (@ 7%)

+ 100,000

Total capital

$600,000

Year-End Earnings

Calculation

Gross profit

$ 95,000

Less loan interest

– 7,000

Profit

$ 88,000

Return on owners’ equity

17.6%

($88,000 ÷ $500,000)

Additional Equity

Calculation

Owners’ equity

$500,000

Additional equity

+ 100,000

Total owner’s equity

$600,000

Loan (@ 7%)

+ 0

Total capital

$600,000

Year-End Earnings

Calculation

Gross profit

$ 95,000

No interest

– 0

Profit

$ 95,000

Return on owners’ equity

15.8%

($95,000 ÷ $600,000)

74

48

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-7 Sources of Long-Term Debt Financing (2 of 5)

Long-Term Loans

TERM-LOAN AGREEMENTS

• Term-loan agreement*: A promissory note that requires a borrower to repay a

loan in monthly, quarterly, semiannual, or annual installments

• Interest rate and repayment terms often are based on factors such as reasons

for borrowing, borrowing firm’s credit rating, and value of collateral.

− The lender usually requires some type of collateral.

• Lenders may also require that borrowers maintain a minimum amount of

working capital.

*Words accompanied by an asterisk are key terms from the chapter.

75

49

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-7 Sources of Long-Term Debt Financing (3 of 5)

Corporate Bonds

• Corporate bond*: A corporation’s written pledge that it will repay a specified

amount of money with interest

− Interest rates vary with the financial health of the company issuing the bond.

• Registered bond*: A bond registered in the owner’s name by the issuing

company

− Most corporate bonds are registered bonds.

• Maturity date*: The date on which a corporation is to repay borrowed money

*Words accompanied by an asterisk are key terms from the chapter.

76

50

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Figure 16-7 The Risk–Return Ratio for Corporate

Bond Investors

77

51

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-7 Sources of Long-Term Debt Financing (4 of 5)

TYPES OF BONDS

• Debenture bond*: A bond backed only by the reputation of the issuing

corporation

• Mortgage bond*: A corporate bond secured by various assets of the issuing

firm

• Convertible bond*: A bond that can be exchanged, at the owner’s option, for a

specified number of shares of the corporation’s common stock

*Words accompanied by an asterisk are key terms from the chapter.

78

52

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

16-7 Sources of Long-Term Debt Financing (5 of 5)

REPAYMENT PROVISIONS FOR CORPORATE BONDS

• Bond indenture*: A legal document that details all the conditions relating to a

bond issue

• A corporation may use one of three methods to ensure it has sufficient funds

available to redeem a bond issue:

− It can issue the bonds as serial bonds*: Bonds of a single issue that mature on different

dates

− It can establish a sinking fund*: A sum of money to which deposits are made each year for

the purpose of redeeming a bond issue

− It can pay off an old bond issue by selling new bonds

• Trustee*: An individual or an independent firm that acts as a bond owner’s

representative

*Words accompanied by an asterisk are key terms from the chapter.

79

53

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Table 16-5 Comparison of Long-Term Financing Methods

Type of
Financing

Repayment

Repayment
Period

Cost/Dividends/Interest

Businesses That May Use It

Equity

Common stock

No

None

High initial cost; low ongoing costs
because dividends not required

All corporations that sell stock
to investors

Preferred stock

No

None

Dividends not required but must be paid
before common stockholders receive
any dividends

Large corporations that have
an established investor base
of common stockholders

Debt

Long-term loan

Yes

Usually 3–7
years

Interest rates between 3 and 12 percent
depending on economic conditions, the
financial stability of the company
requesting the loan, and the amount of
the loan

All firms that can meet the
lender’s repayment and
collateral requirements

Corporate bond

Yes

Usually 1–
30 years

Interest rates between 1.25 and 8
percent depending on the financial
stability of the company issuing the
bonds and economic conditions

Large corporations that are
financially healthy

80

54

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Discussion Activity 2

How can a business owner or corporate manager use financial leverage to
improve the firm’s profits and return on owners’ equity?

Is there a potential danger of using financial leverage?

81

55

Pride, Hughes, and Kapoor, Foundations of Business, 7th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.

Discussion Activity 2 Debrief

How can a business owner or corporate manager use financial leverage to
improve the firm’s profits and return on owners’ equity?

Is there a potential danger of using financial leverage?

Financial Careers

Similar Resources on Wayground

Popular Resources on Wayground

Discover more resources for Computers