Internet Education

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Introduction to Business
Chapter 19
Financial Management

General: Most businesses fail because they  simply run out of money.  Their bills exceed their bank balance and other resources ad they  have to close their doors. Understanding what it takes to control your business finances and to understand and use the tools available to assist you is a basic element of it.

Financial planning must be a one of the portions of the firm's overall planning process   Here's the figure from the text that summarizes the process As you can see the formal plans are presented as budgets so that it is possible to compare actual performance to plans as time progresses. Without this information, it would be impossible to verify actual progress and identify  areas that need adjustment or changes.  It may be necessary to completely change your plans if it proves impossible or impractical to carry them out.

Terminology: Before you can get a handle on the overall process, it is important that you understand the numerous terms associated with it. Some of the basic terms follow:

1. Short-term or working capital which is money spent on business operations covering a period of a year or less.
2. Long term or fixed capital which is the fixed assets which are long lived and which are used to produce goods and services for more than a year.

1. Promissory Notes
2. Drafts
3. Commercial Paper
4. Checks
5. a. Cashier's check
6. b. Certified check (passé')

1. Trade Credit - credit your suppliers provide between the time you receive the goods and you are expected to pay for them. This is the major source of financing for businesses.
2. Commercial Banks which provide a line of credit, or some form of revolving credit against which you a firm is required to maintain an offsetting balance.
3. Commercial finance companies which finance inventory and equipment and may lend money against a firm's accounts receivable.
4. Factoring companies which buy a firm's credit accounts giving it immediate cash and taking over collection of them for a (factored) fee.
5. Sales finance companies who finance credit sales so the firm can receive immediate payment and avoid maintaining a collection service and related accounting functions. .
6. Consumer finance companies which provide loans to customers to buy products without directly involving the firm.

The mechanics of securities sales are usually handled by investment bankers who arrange the sale of stocks on the open market. They, in essence, act as a wholesaler by buying the issue of stock from the corporation and then selling it to the general public. Also involved are register and transfer agents who keep track of the buy and sell transactions of a stock to insure that the trail of ownership is properly kept. At one time they actually issued new stock certificates each time a transaction took places destroying the old ones. In this day and age, computers keep track of the transactions and you receive a document that looks much like a bank statement that lists your holdings. Some small firms that only trade in over the counter markets still issue stock certificates in the traditional way but it is expensive and is a disappearing practice.

There are a variety of types of stock. The "ordinary" type is called common stock. It is a share of ownership in a firm and your percentage of ownership is related to the total number os shares of stock sold by the firm. Owning a share of common stock provides you the right to vote for a board of directors who oversee the management of the organization and also gives you the right to share in the profits of the firm by receiving dividends. Should the firm choose to issue more shares of stock, you have the preemptive right to purchase enough of the new shares to maintain your percentage of ownership.

A firm may also choose to sell preferred stock. Usually this means that the owner of the stock gets first priority on any dividends that are derived from profits of the corporation. The variety of forms of preferred stock are too numerous to be described here. The company issuing the stock attempts to offer a set of benefits that will encourage the purchase of the stock when the company wishes to raise long term money.

Another method of raising long term money is through the issuance of bonds. Here again, there are a number of varieties of types of bonds but they are all borrowing instruments which offer some rate of interest to the lender in exchange for the use of the money over some period of time. Bond issues don't effect ownership as does selling stock and are often used to support purchase of specific items such plants and manufacturing equipment. As a rule, bonds are issued through investment bankers much as stocks are. To retire or pay off bonds, the corporation is often required to create a sinking fund which is simply a savings account into which the business places funds to pay off (retire) the bonds when they become due or mature.

Securities are, for the most part, traded through stock exchanges. These exchanges grew out of the old farmer's animal auctions (stock exchanges) as early entrepreneurs often went to the wealthy farmers and landowners to sell stock or bonds to finance their fledgling companies. Although highly sophisticated computers form the backbone of the record keeping, the 300 to 400 Million shares of stock traded in the exchanges on any given trading day are still done through brokers who literally auction off the stocks they have been authorized to sell much as cattle were auctioned in the old days. The floor of the exchange is also called the "pit" in honor of the design of cattle exchanges and perhaps also as a reference to the organized chaos that takes place there. The stock exchanges handle the bulk of stock transactions. But far more companies, usually but not necessarily, small are traded through the over-the-counter market which simply means that brokers call each other directly or communicate through computers to arrange the buying and selling of stock or bonds.

Venture capitalists may be a source of long term financing. If you can convince them that your business has long term chance for success, through proven performance and a well thought out business plan, you may be successful. It comes with a cost however as they will insist on a seat on the Board of Directors and substantial stock ownership. Venture capitalist risk their money on the expectation that they will make a substantial profit. They do this when the value of the stock rises to a point where its value will meet their goals and they will sell the stock. In  the meantime, they will take an active interest in the way your business is being run.

The truth is that small, start up companies will rarely have these resources available. Most funds for start up come from family and friends. The biggest financial resource available to most small businesses is the willingness of suppliers to sell to you pm credit. Normally, a supplier will provide you goods and then expect to be paid in thirty days or so. Exact terms may be based on industry practices or simply terms you are able to negotiate with the supplier.  Do not neglect your suppliers as they are able to put you out of business simply by demanding immediate payment and refusing to provide any more supplies.

Banks may be a source of funds after you have been in business for a while and you can prove that your business plan is working. Taking the time to learn who your bank's managers and loan officers are and taking the time to explain what your business is all about (invite them to visit you) is a good idea even if you know that  it may be quite a long time before your business is performing well enough to be elligible for loans.

There are no "magic" solutions here. What is required is careful planning and good management of your resources.  

 Chapter 19 VIdeo, Financial Planning

Chapter 19 Video, Financial Planning Cbl/DSL

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