Financial Issues for Managers

AuthorHoward Finch, Scott Droege

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One of the most critical aspects of management pertains to the finances of running a firm. Although there are numerous issues facing modern managers with respect to financial management, the following sections will address three of the most ubiquitous—acquisition of outside capital for start-up and growth, management of working capital and cash flow, and the construction and implementation of a capital budgeting process. Accessing the capital markets is fundamental for procuring funds that allow the firm to grow. Working capital involves managing the current assets

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and liabilities of the firm. Capital budgeting is the process of making long-term fixed asset investments.


In the initial start-up of any firm, management must procure the funds needed to get the business off the ground. These funds may come from a variety of sources, but managers should be aware that all assets are initially financed with either of two sources of capital—equity and debt. The capital markets represent the method by which external funds are made available to firms requiring outside capital infusions.


The equity markets are the means by which managers may raise capital by selling portions of the firm's ownership. The most common method is selling common stock in the firm. Outside investors provide the firm with new investment capital in exchange for ownership rights in the firm. As owners, stockholders receive voting rights and may participate in the financial success of the firm. In corporations, stockholders are protected by limited liability, meaning they are liable only for losses limited to the amount invested in the firm's stock; personal assets are protected against liability. Other sources of equity capital include contributions by the individual owner or owners from their own resources, and those made by family and friends of originators of the business.

Another method of raising equity capital involves the sale of preferred stock in the firm. Preferred stock promises to pay investors a stated dividend amount, and may also offer the opportunity for eventual conversion into common shares, commonly called convertible preferred stock. Preferred stock is particularly important for larger corporations as a source of funds because current tax law subsidizes the investment by one corporation in another corporation's preferred stock by exempting a portion of dividend income from taxation.

Other methods of equity capital attainment include the selling of warrants and rights. Warrants are securities that grant the holder the right to purchase a fixed number of common shares in the firm at a specified price for a specified period of time. Because warrants are stand-alone securities that may be traded among investors, the firm may raise new capital immediately through the sale of warrants while delaying the dilution of existing stockholders's interests until the warrants are exercised.

Rights are similar to warrants in that firms issue rights as a method of raising new equity capital. In a rights offering, the firm issues additional common stock to raise new capital. Rights are then issued to all outstanding shareholders, giving them the right to purchase shares in the new offering to avoid dilution of their pro-rata ownership in the firm. Through the use of rights, the firm is able to directly access the group of investors who are already interested in the firm's financial success, namely existing shareholders. Because rights have value in that they allow the purchase of new shares at a set subscription price, they are desired by shareholders and may be sold to others if the shareholder decides not to use the rights.


The other major market for outside capital is the debt market. The debt market is often vital to the financial success of a firm and managers must be familiar with, and have access to...

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