Long Term Finance for Companies - USA

The corporate lending world can, in its simplest form, be divided into two different
approaches: the asset-based credit market and the cash flow-based credit market.
In ABL transactions, the lender’s interest is secured by the borrower’s assets, which then
forms the basis for determining how much credit the borrower can access. In contrast, the
cash flow method of determining credit capacity is principally based on an analysis of
the borrower’s enterprise value.


Asset-based lenders have generally found that, over time, the valuation of a borrower’s
assets is remarkably stable over a variety of business and economic cycles. This makes
calculating a borrower’s credit capacity based on asset values a highly predictable way
of providing capital to clients.


Cash flow-based loans, while also usually a secured form of financing, often use EBITDA
(or a company’s earnings before interest, taxes, depreciation and amortization) along with
a multiplier to determine credit capacity, rather than the value of the underlying collateral
assets. The level of EBITDA can change and the multiplier applied can change significantly during business and economic cycles. During an economic downturn, most companies will see their EBITDA decline, both on a relative and absolute basis. Often, the multiplier being used by lenders will shrink at the same time; this combination of declining EBITDA and a shrinking multiplier can result in a significant decline in available credit capacity at what could be the exact time a company most needs access to capital.

Typical uses

Frequent uses of ABLs

For higher quality, large-corporate borrowers, ABLs are often used simply for financing working capital. These companies will often access the public or private capital markets for long-term forms of financing for the majority of their overall capitalization. They will then use ABLs to fund seasonal changes in working capital, for shareholder value-creating actions such as share repurchase programs, dividends or distributions, and for opportunistic acquisitions.


For midsized companies, in addition to providing working capital financing, ABLs often incorporate
term loans, which are secured by longer-term assets such as machinery and real estate, to provide incremental credit capacity.

ABLs also tend to play a key role in the financing of companies facing cyclical or operating
performance headwinds that have caused their credit profile to deteriorate. They need
patient capital to attempt to execute on their business turnaround or restructuring
plans, or just to weather the current environment, including the possibility of bankruptcy
reorganization. Often, an ABL is “transitional” capital for these companies; for a time it
provides incremental liquidity and structural flexibility characteristics that help owners
and managers reposition the company. Once that is completed, these companies often
refinance again in the cash flow credit market.

There are also times when companies use an ABL as transitional capital only to later
realize that many of the characteristics of ABLs fit their business well. They may see that
both the discipline and freedom associated with these loans can enhance the way they
execute their plans. These companies often never go back to the cash flow loan market.
In fact, there are several Fortune 500 companies that have opted to used ABLs.

Qualifying companies


Manufacturers, wholesale distributors, retailers, and some forms of service companies
are prime candidates for ABLs. Solid ABL candidates will usually have tangible asset-rich
balance sheets, often with at least half of their total assets in working capital assets,
such as accounts receivable and inventory.

Like all lenders, asset-based loan providers look for companies with solid management
teams and a history of being able to effectively manage their businesses, even when
facing difficult circumstances. They also look for companies with excellent financial
accounting information systems that can provide reliable data about both operating and
asset performance.

Does company size matter in qualifying for an ABL?

No. Companies of all sizes can qualify for an ABL as long as their business is a good match
for the characteristics that asset-based lenders look for. For midsized companies, annual
revenues between $35 million and $250 million are typical of today’s borrowers. But ABLs
are also delivered just as easily to multibillion-dollar revenue companies.

What about credit ratings?
Since asset-based lending is always secured, its target market is non-investment grade
companies (companies with an actual or equivalent S&P rating of BB+ and below, or a
Moody’s rating of Ba1 and below). External credit ratings are not required to issue an ABL.

Which assets qualify as collateral under ABL structures?
Accounts receivable and inventory—assets that have a high degree of market liquidity
and can be easily valued and monitored—head the list of qualifying assets. Long-term
assets such as equipment and real estate are often used as additional collateral when
the ABL is structured as a term loan with a fixed amortization schedule.
Some proportion of even the most liquid of asset classes are typically ineligible in ABLs.
Examples include substantially past due accounts receivable, some types of work-inprocess
inventory or assets held for sale not in the ordinary course of business.

http://corp.bankofamerica.com/documents/10157/67594/Frequently_Asked_Questions_about_Asset_Based_Lending.pdf





Project Finance
Project Finance can be characterised in a variety of ways and there is no universally adopted definition
but as a financing technique, the author’s definition is:
 “the raising of finance on a Limited Recourse basis, for the purposes of developing a large capitalintensive
infrastructure project, where the borrower is a special purpose vehicle and repayment of the
financing by the borrower will be dependent on the internally generated cashflows of the project”
The terms ‘Project Finance’ and ‘Limited Recourse Finance’ are typically used interchangeably and
should be viewed as one in the same. Indeed, it is debatable the extent to which a financing where the
Lenders have significant collateral with (or other form of contractual remedy against) the project
shareholders of the borrower can be truly regarded as a project financing. The ‘limited’ recourse that
financiers have to a project’s shareholders in a true project financing is a major motivation for
corporates adopting this approach to infrastructure investment.
Project financing is largely an exercise in the equitable allocation of a project’s risks between the
various stakeholders of the project.
https://www.hsbcnet.com/gbm/attachments/products-services/financing/project-finance.pdf


MBA Core Management Knowledge - One Year Revision Schedule

Role of Finance Managers in Enterprise Risk Management

Companies should be managed so that they do not go into financial distress. Benjamin Graham tells conservative investors not to invest in a company that made a loss in the last ten years.

Financial distress is associated with having operating cash flows fall below minimum required levels. Risk management can reduce the likelihood of low cash flows and hence of financial distress.



Risk management meant buying insurance against fire, theft, and liability losses sometime back. Now finance managers have more alternatives.

 In an article in CFO, Scott Lange, who was head of Microsoft Risk at the time the article appeared, identified these 12 major sources of risk:


1. Business partners (interdependency, confidentiality, cultural conflict, contractual risks).
2. Competition (market share, price wars, industrial espionage, antitrust allegations).
3. Customers (product liability, credit risk, poor market timing, inadequate customer support).
4. Distribution systems (transportation, service availability, cost, dependence on distributors).
5. Financial (foreign exchange, portfolio, cash, interest rate, stock market).
6. Operations (facilities, contractual risks, natural hazards, internal processes and control).
7. People (employees, independent contractors, training, staffing inadequacy).
8. Political (civil unrest, war, terrorism, enforcement of intellectual property rights, change in leadership,
revised economic policies).
9. Regulatory and legislative (antitrust, export licensing, jurisdiction, reporting and compliance, environmental).
10. Reputations (corporate image, brands, reputations of key employees).
11. Strategic (mergers and acquisitions, joint ventures and alliances, resource allocation and planning, organizational agility).
12. Technological (complexity, obsolescence, workforce skill sets).

 Lange defined the role of finance in risk management: The role of finance is to put on paper all of
the risks that can be identified and to try to quantify them. When possible, use a number—one number perhaps or a probability distribution. For example, what is the probability of losing $1 million on a product? $10 million?


MBA Core Management Knowledge - One Year Revision Schedule

Market Development for New Products, Processes and System

Market development is the last mile of  any innovation.  The authors proposed  two very
different kinds of market development. Accelerating adoption applies to individual products, services, and business models, while creating new markets is a more fundamental process that supports the success of revolutionary business ideas.

Accelerating Adoption

For introducing a single innovation to the marketplace, firms often rely on proven techniques such as
advertising, public relations, and trade shows to persuade potential customers that the new products or services are worth paying attention to. One of the reasons for the increased sophistication required for breakthrough innovations is that their users make fundamental change to how they function or how they behave, changes that involve switching costs incurred by the end user to make use of the new product or service. This cost is the most significant factor in new product adoption and may inhibit the adoption.



The development of principles in this area  has been significantly influenced by Everett Rogers, a Stanford professor whose book "Diffusion of Innovations" pioneered the study of the critical relationship between innovations and the customers who adopt them. Rogers showed that the rate
of new product adadoption commonly follows a bell curve, and defined different groups within a total population according to how quickly or slowly they tended to adopt innovations. He also explored issues such as opinion leadership, diffusion networks, change agents, and innovation in
organizations, all of which are significant factors in market development. Consultant Geoffrey Moore subsequently applied Rogers’ ideas in a model that has become widely used in high tech industries. Moore’s book, "Crossing the Chasm", explains how the adoption curve can be applied to
understand how and why new high tech products succeed or fail in the market. It also examines how differing psychological factors affect different groups of buyers, and therefore how marketing, advertising, and sales have to be adapted at each different phase of the adoption curve.
Moore identifies four groups of adopters: early adopters who in the technology world tend to be technology enthusiasts, and then visionaries, pragmatists, and conservatives. The mass market that is your goal begins with the pragmatists,  The important principle is that marketing communications have to be different for different groups. Hence the organization has to identify when the product is moving into the hands of the next group and change its marketing communications to create awareness first and then attract the persons in the target group to sample the product and then become advocates of the product.


Malcolm Gladwell’s concept of the “tipping point,” described in his book of the same name, also explores the factors underlying the adoption of new ideas and new products.   The book
shows how contagious behavior—like a fashion trend or the sudden emergence of a bestselling book—starts in an organic fashion and then suddenly takes off exponentially, much like a virus, without any central control or master plan. The idea from which the book takes its title is that moment in a
system’s development when a small change leads to a huge effect in a very rapid time frame, and spreads contagiously. For those who want to instigate rapid change, the principles of the
tipping point model are important.

The rapid growth is usually started by a handful of people who exhibit some kind of exceptional behavior. In the propagation of infectious diseases, some people, who by the nature of what they do or the lifestyle they lead, allow the growth of the disease to tip so that it becomes an epidemic.
The same can be said for many other trends—a small number of people (like skateboarders) have the ability to infect a large number of other people with a new idea (like a style of clothing or shoes). Gladwell suggests that there are three types of exceptional people whose disproportional influence can make a change tip and become a trend. They’re Connectors, Mavens and Salesmen.


Connectors are people who seem to know everyone. As information travels through networks it’s highly likely to come in contact with a connector, and if the information engages the connector’s interest, he or she will distribute it to a huge number of other individuals in a short period of time, creating a tipping point. Only a small number of connectors are needed in any system to propagate a new trend.

Mavens are information specialists. They’re the people who seem to know everything there is to know about a certain topic, and they have one additional characteristic that makes them different from ordinary experts: they love to share what they know with others. If somebody asks them, they ar willing to explain and share.  Mavens are important as tipping points because they’re on the leading edge of acquiring new information.


Salesmen are the quintessential persuaders who can get people to make decisions and take actions that they ordinarily wouldn’t take if left to themselves. They’re individuals who have the ability to persuade in part because they can get another person to root for them in the same way that an audience roots for a performer on stage. Their ability to persuade makes them strong carriers of infectious ideas, concepts, trends and changes.


Creating New Markets

When new markets or industries emerge, it’s often because someone has been able to catalyze the connectors, mavens, and salesmen in a community, although this doesn’t necessarily happen quickly.



If you look down the list of breakthrough technologies, you’ll notice that just about every breakthrough, and many of the new business models, was supported by focused market development efforts that articulated existing needs and defined new possibilities for meeting them.

Autos: Minivans
Computer: Personal Computers
Banking: ATMs
Food: Genetic Engineering (still an ongoing development process)
Airlines: Online reservations
Telecommunications: Cell phones
Health Care: MRI / CAT Scan
Retail: Bar codes
Office Supply: Post-it Notes
Media: BLOGs


Early adopters bought the first versions of nearly all these products, and gradually the value was proven as more and more users were satisfied. Mainstream buyers eventually became interested, leading to the development of a large customer base. All this was supported by advertising, and constant effort to gain favorable (and free) media publicity.


From Permanent Innovation - Langdon Morris

Permanent Innovation
The Definitive Guide to the Principles, Strategies, and Methods of
Successful Innovators
Langdon Morris

Langdon Morris is a co-founder and principal of InnovationLabs LLC and Senior Practice Scholar at the Ackoff Center of the University of Pennsylvania and Senior Fellow of the Economic Opportunities Program of the Aspen Institute.


MBA Core Management Knowledge - One Year Revision Schedule

Opportunities or Areas for Innovation

Every activity done by an organization provides an opportunity for innovation. Porter brought out this idea strongly in his value chain model of an organization. Every activity can become a differentiator and a differentiation in multiple activities becomes difficult for competitors to imitate because they will take time to understand.

Business structure


alliances & partnerships
capital formation



Administration

information flow
automation
insourcing / outsourcing services


Organization

structure type
facilities infrastructure
 IT infrastructure
employee / contractor mix
employee experience
decision making processes
facilities effectiveness
process to improve processes
 education & training


Customer experience

communication process
CRM
brand / image
 advertising
 feedback

Customer service

service process
communication

Supply chain

distribution system
manufacturing
communication
automation

Product

product offering
product availability
technology (hidden)
technology (evident)
manufacturing
R&D
user interface
packaging
functionality
life cycle model
sales model
sustainability
after-sale service
distribution
 style

Production Processes and Technology

Maintenance Processes

Inspection and Quality Control Processes

Pollution Control Process

Industrial Engineering


From Permanent Innovation - Langdon Morris

Permanent Innovation
The Definitive Guide to the Principles, Strategies, and Methods of
Successful Innovators
Langdon Morris

Langdon Morris is a co-founder and principal of InnovationLabs LLC and Senior Practice Scholar at the Ackoff Center of the University of Pennsylvania and Senior Fellow of the Economic Opportunities Program of the Aspen Institute.

MBA Core Management Knowledge - One Year Revision Schedule

Financial Management Aspects of Mergers and Acquisitions

An acquisition of a company or substantial portion of its shares is an investment. Financial managers have to appraise it to see whether return on such investment is higher than the cost of the capital for the company.

Financial managers and theorists have proposed many reasons for acquisitions and merger activity. The primary economic motives mentioned are:


Synergy

Synergistic effects can arise from four sources: (1) operating economies, which result from economies of scale in management, marketing, production, or distribution due to combining operations; (2) financial economies, including lower transactions costs and better coverage by security analysts; (3) differential efficiency, which implies that the management of one firm is more
efficient and  will increase the return from that the weaker firm’s assets after the acquisition or  merger; and (4) increased market power due to reduced competition.





Tax Considerations
Tax considerations have stimulated a number of mergers. For example, a profitable firm in the highest tax bracket could acquire a firm with large accumulated tax losses. These losses could then be turned into immediate tax savings rather than carried forward and used in the future. Thus excess cash can be used  as a way of minimizing taxes.

Purchase of Assets below Their Replacement Cost
Sometimes a firm acquires a company because the cost of replacing its assets is considerably higher than its market value. If the new management uses the assets appropriately, the market value will increase in the future.

Diversification
Managers contend that diversification helps stabilize a firm’s earnings and thus benefits its owners as risk premium of the company's comes down. Stabilization of earnings is certainly beneficial to employees, suppliers, and customers; but its value is less certain from the standpoint of stockholders. Stockholders also can buy the stock of both firms? Many studies find that diversified firms are worth significantly less than the sum of their individual parts as top managements cannot provide adequate managerial expertise to diversified businesses.

Breakup Value
 Recently, takeover specialists have identified breakup value as  a basis for
valuation. A company’s breakup value, is the value of the individual parts of the firm if they are sold off separately. If this value is higher than the firm’s current market value, a takeover specialist could acquire the firm at or even above its current market value, sell it off in pieces, and earn a substantial profit. Such a breakup value is mainly appearing in diversified companies.

Types of Mergers


Mergers are classified into four types:
(1) horizontal,
(2) vertical,
(3) congeneric, and
(4) conglomerate.


A horizontal merger occurs when one firm combines with another in its same line of business.
An example of a vertical merger is a steel producer’s acquisition of one of its own suppliers, such
as an iron or coal mining firm. Congeneric means “allied in nature or action”; There is a relationship but not producers of the same product (horizontal) or firms in a producer-supplier relationship (vertical). A clothing retailer may acquire a food retailer.  A conglomerate merger occurs when unrelated enterprises combine.

Vertical and horizontal mergers generally provide the greatest synergistic operating benefits

Financial Analysis

The acquiring firm performs an analysis to value the target company based on its expected cash flows and cost of capital applicable and then determines whether the target can be bought at that value or, preferably, for less than the estimated value.

The target company also makes an analysis of its cash flows and makes a valuation of them and will accept the offer if the price exceeds either its value if it continued to operate independently or the price it could receive from some other bidder.


MBA Core Management Knowledge - One Year Revision Schedule

Management of Cash and Marketable Securities

Sophistication is increasing  in cash management by corporations. The trend has been toward reducing cash—the firm’s most liquid asset—to a minimum.  and the funds are invested in interest earning securities or in earning assets. This trend can be attributed to rising interest rates on securities, which make the opportunity cost of holding cash more expensive, to innovations in cash management, and to economies of scale in cash management as corporations grow larger.

A number of methods have come into existence in recent years to speed up this collection process and maximize available cash. These methods helps cash management in the following ways:
(1) speed the mailing time of payments from customers to the firm;
(2 ) reduce the time during which payments received by the firm remain uncollected funds; and
(3) speed the movement of funds to disbursement banks.


Multiple Collection Centers

 Instead of a single collection center located at the company headquarters, multiple collec-
tion centers are established. The purpose is to shorten the period between the time a customer mails in his payment and the time when the company has the use of the funds. Customers in a particular geographic area are instructed to remit their payments to a collection center in that area.  When
payments are received, they are deposited in the collection center’s local bank. Surplus funds are then transferred from these local bank accounts to a concentration bank or banks. A bank of concentration is one with which the company has a major account—usually a disbursement account.


Bank Collection of Checks from Post Offices


Another means of accelerating the flow of funds is a lock-box arrangement. The purpose
of a lock-box arrangement is to eliminate the time between the receipt of remittances by the company and their deposit in the bank. The company rents a local post office box and authorizes its bank in
each of these cities to pick up remittances in the box. Customers are billed with instructions to mail their remittance to the lock box. The bank picks up the mail several times a day and deposits the checks in the company’s account. This procedure frees the company from handling and depositing the checks. The main advantage of a lock-box system is that checks are deposited at banks sooner and become collected balances sooner than if they were processed by the company prior to deposit. No doubt, the bank will take an extra fee for the service. But the service is utilized only when it is profitable for the company to employ it.


Frequently, firms give special attention to the handling of large remittances so that they may be deposited in a bank as quickly as possible. This special handling may involve personal pickup of these checks or the use of airmail or special delivery.. The firm should exercise tight control over interbank transfers of cash and transfers between various units of the company, such as divisions or subsidiaries. Excessive funds may be tied up in various divisions of the firm.

Some companies maintain too many bank accounts, thereby creating unnecessary pockets of idle funds. With less number of accounts also similar service can be provided at a lesser cost to the company.


MBA Core Management Knowledge - One Year Revision Schedule

Management of Investment in Accounts Receivable

Management of Accounts Receivable


Accounts receivable is a current asset that appears due to the extension of open-account credit
by one firm to other firms and to individuals. Credit has to be extended to generate sales.
Therefore, accounts receivable are necessary investment, but require careful analysis. Receivables can be managed efficiently so that the level of investment in them is optimal.

Credit policy involves a tradeoff between the profits on sales that give rise to receivables on one hand and the cost of carrying these receivables plus bad-debt losses on the other. Credit policy determines
the amount of credit risk  accepted. In turn, the risk accepted or taken affects the slowness of receivables as well as the amount of bad-debt losses. Collection procedures also affect these factors. Thus, proper the credit granting and collection procedures of the firm determine the success of the firm’s overall credit management and collection policies.

CREDIT AND COLLECTION POLICIES


The policy variables include the quality of the trade accounts accepted, the length of the credit period, the cash discount given, any special terms given, such as seasonal datings, and the collection program of the firm. Together, these elements largely determine the average collection period and the proportion of bad-debt losses.

Credit Standards

Credit policy can have a significant influence upon sales. If competitors extend credit liberally and if a firm does not, the policy may have a dampening effect upon the marketing effort. Trade credit is one of many factors that influence the demand for a firm’s product.  In theory, the firm can lower its quality standard for accounts accepted as long as the expected profitability of sales generated exceeds the added costs of the receivables. What are the costs of relaxing credit standards? The incremental cost comes from the increased probability of bad-debt losses. Also a slower average collection
period will occur.

To determine the profitability of a more liberal extension of credit, we must know the profitability of additional sales; the added demand for products arising from the relaxed credit standards; the increased slowness of the average collection period; and the required return on investment.


Suppose a firm’s product sells for $ 10 a unit, of which $7 represents variable costs before taxes, including credit department costs. Current annual sales are $2.4 million, represented entirely by credit sales, and the average total cost per unit at that volume is $9 before taxes. The firm is considering a more liberal extension of credit, which will result in a slowing in the average collection period from one to two months. This relaxation in credit standards is expected to produce a 25 per cent increase in sales, to $3 million annually.  With this percentage increase, the unit sales and total costs of the firm become:


Cost of Present sales  =  240,000 units X $9 = $2,160,000
Marginal cost of Additional sales =  60,000 units X $7 = 420,000
Total cost =  $2,580,000
The average cost per unit of sale at the new level of sales is
$2,580,000/300,000

Assume that the firm’s required return on investment is 20 per cent before taxes.

Inasmuch as the profitability on additional sales, $180,000 (60,000 * $3), exceeds the required return on the additional investment in accounts receivable, $50,000, the firm is advised to relax its credit standards. An optimal credit policy would involve extending trade credit more liberally until the marginal profitability on additional sales equals the required return on the additional investment in receivables necessary to generate those sales.


MBA Core Management Knowledge - One Year Revision Schedule