Over a longer time horizon, the manager will thoroughly study whether and when the company should open a new manufacturing facility. Then they choose the best sources to obtain the required funding.įor example, a financial manager will track day-to-day operational data such as cash collections and disbursements to ensure that the company has enough cash to meet its obligations. They work with the firm’s other department managers to determine how available funds will be used and how much money is needed. Financial managers must track how money is flowing into and out of the firm (see Exhibit 17.1). But money from sales does not always come in when it is needed to pay the bills. Revenue from sales of the firm’s products should be the chief source of funding. The head of the IT department will need to justify any requests for new computer systems or employee laptops. If you are a sales representative, for example, the company’s credit and collection policies will affect your ability to make sales. Managers in all departments must work closely with financial personnel. All business decisions have financial consequences. It may not be as visible as marketing or production, but management of a firm’s finances is just as key to the firm’s success.įinancial management- the art and science of managing a firm’s money so that it can meet its goals - is not just the responsibility of the finance department. Therefore, finance is critical to the success of all companies. To make money, it must first spend money - on inventory and supplies, equipment and facilities, and employee wages and salaries. However, too much debt can result in dangerously high leverage levels, forcing the company to pay higher interest rates to offset the higher default risk.How Do Finance and the Financial Manager affect the Business’s Overall Strategy?Īny company, whether it is a small town bakery or Tim Hortons, needs money to operate. Debt financing is more tax-efficient than equity financing since interest expenses are tax-deductible and dividends on common shares are paid with after-tax dollars. This is the cost of capital that would be used to discount future cash flows from potential projects and other opportunities to estimate their net present value (NPV) and ability to generate value.Ĭompanies strive to attain the optimal financing mix based on the cost of capital for various funding sources. The firm’s overall cost of capital is based on the weighted average of these costs.įor example, consider an enterprise with a capital structure consisting of 70% equity and 30% debt its cost of equity is 10% and the after-tax cost of debt is 7%. Cost of Debt + Cost of Equity = Overall Cost of Capital The assumption is that a private firm's beta will become the same as the industry average beta. Analysts may refine this beta by calculating it on an after-tax basis. For private companies, a beta is estimated based on the average beta among a group of similar public companies. C A PM ( Cost of equity ) = R f + β ( R m − R f ) where: R f = risk-free rate of return R m = market rate of return īeta is used in the CAPM formula to estimate risk, and the formula would require a public company's own stock beta. However, since interest expense is tax-deductible, the debt is calculated on an after-tax basis as follows: The cost of debt is merely the interest rate paid by the company on its debt. Less-established companies with limited operating histories will pay a higher cost for capital than older companies with solid track records. The cost of capital becomes a factor in deciding which financing track to follow: debt, equity, or a combination of the two.Įarly-stage companies rarely have sizable assets to pledge as collateral for loans, so equity financing becomes the default mode of funding.
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