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Lecture 9

AFM 131 Lecture 9: Financial Management Notes

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University of Waterloo
Accounting & Financial Management
AFM 131
David H A

Financial Management The Role of Finance and Financial Managers: • Finance – the function in a business that acquires funds for the firm and manages them within the firm • Finance activities – preparing budgets, completing cash flow analysis, and planning for the expenditure of funds on assets such as plant, equipment, and machinery • Financial Management – the job of managing a firm’s resources to meet its goals and objectives • Financial Managers – managers who examine the financial data prepared by accountants and recommend strategies for improving the financial performance of the firm The Value of Understanding Finance: • Common reasons a firm fails financially are: o Undercapitalization (insufficient funds to run a business) o Poor control over cash flow o Inadequate expense control What is Financial Management? • Financial managers are responsible for paying a company’s bills at appropriate time and for collecting overdue payments to make sure the company does not lose too much money to bad debts (people or firms that do not pay their bills) • Vital to all types of businesses, they are particularly critical to small and medium-sized businesses, which typically have small cash or credit cushions than large corporations • Financial managers must analyze the tax implications of managerial decisions to minimize the taxes the business must pay • Internal Auditors makes sure business transactions follow IFRS Financial Planning: • Financial Planning – analyzing short-term and long-term money flows to and from a firm • Overall objective – to optimize the firm’s profitability and make the best use of its money • Three Steps: 1. Forecasting Short-Term and Long-Term Financial Needs 2. Developing budgets to meet those needs 3. Establishing financial control to see whether the company is achieving its goals Forecasting Short-Term and Long-Term Financial Needs: • Short-Term Forecast – forecast that predicts revenues, costs, and expenses for a period or one year or less • Cash Flow Forecast – forecast that predicts the cash inflows and outflows in future periods, usually months or quarters • Inflows and outflows are based on expected sales revenues and on various costs and expenses incurred, as well as when they are due for payment • Sales Forecast – firm’s projected sales for a particular period • Past financial statements used as a basis for projection • Long-Term Forecast – forecast that predicts revenues, costs, and expenses for a period longer than one year, and sometimes as far as five or ten years into the future • Long-Term forecast plays a crucial part in the company’s long-term strategic plan • Also, provides sense of the income or profit of different strategic plans and helps in preparing company budgets Working with the Budget Process: • Budget – a financial plan that sets forth management’s expectations, and, on the basis of those expectations, allocates the use of specific resources throughout the firm • Depends heavily on the accuracy of a firm’s balance sheet, income statement, statement of cash flows, and short-term and long-term financial forecasts • Capital Budget – a budget that highlights a firm’s spending plans for major asset purchases that often require large sums of money like property, buildings, and equipment • Cash Budget – a budget that estimates a firm’s cash inflows and outflows during a particular period (e.g. monthly or quarterly) • Operating (Master) Budget – the budget that ties together all of a firm’s other budgets and summarizes the business’s proposed financial activities Establishing Financial Controls: • Financial Control – a process in which a firm periodically compares it actual revenues, costs, ad expenses with its projected ones Financial Management in Trying Times: • Collapse of financial markets in ’08 • Poor investment decisions and risky financial dealings caused financial markets to suffer their worst fall • Requirements of financial institutions become more stringent • Investors saw long-standing financial firms disappear and their invested funds disappear with them The Need for Operating Funds: • Funds needed for key areas: o Managing day-to-day needs of the business o Controlling credit operations o Acquiring needed inventory o Making capital expenditures Managing Day-to-Day Needs of a Business: • Financial managers must ensure that funds are available to meet daily cash needs without compromising the firm’s opportunities to invest money for its future • More beneficial to get $200 today rather than in one year • Financial managers often to minimize cash expenditures to free up funds for investment in interest-bearing accounts • Suggest pay a bill as late as possible unless a cash discount is available for early payment • Advise companies to try to collect what is owed to them as fast as possible in order to maximize the investment potential for firm’s funds • However, collecting funds as fast as possible is challenging • Efficient cash management is particularly important to small firms since their access to capital is much more limited than that of larger business Controlling Credit Operations: • Financial managers know that making credit available helps keep current customers happy and attracts new ones • Selling on credit could be tied up in its credit accounts (accounts receivable) • Forces firm to use its own funds to pay for goods and services • Offer cash or quantity discount to buyers who pay by a certain date • They scrutinize old and new credit customers to see whether they have a history their credit obligations on time • One convenient way to decrease time and expense of collecting accounts receivable is to accept bank credit cards. Business must pay a fee to accept credit cards but fees offset by benefits • Many businesses beginning to expect mobile payments through services like Square and Level Up • Mobile payments are quick, simple, and cheaper than traditional credit card companies Acquiring Needed Inventory: • Effective marketing requires focusing on the customer and providing high-quality service and readily available goods • Carefully constructed inventory policy helps manage firm’s available funds and maximize profitability • Just-in-time inventory control reduce funds a firm must tie up in inventory • Careful evaluation of inventory turnover ratio help a firm control the outflow of cash for inventory Making Capital Expenditures: • Capital Expenditures – major investment in either tangible long-term assets, such as land, buildings, and equipment, or intangible assets such as patents, trademarks, and copyrights • Expanding into new markets can be expensive and no guarantee of success • Critical for companies to weigh all possible options before a large portion of available resources Alternative Sources of Funds: • Debt Financing – funds raised through various forms of borrowing that must be repaid • Equity Financing – funds raised from operations within the firm or through the sale of ownership in the firm • Short-Term Financing – borrowed funds that are needed for one year or less • Long-Term Financing – borrowed funds that are needed for a period more than one year • Short-Term Funds: Monthly expenses, unanticipated emergencies, cash flow problems, expansion of current inventory, temporary promotional programs • Long-Term Funds: New-product development, replacement of capital equipment, mergers or acquisitions, expansion into new markets (domestic or global), new facilities Obtaining Short-Term Financing: • Needs to secure short-term funds when its cash reserves are low Trade Credit: • Trade credit – practice of buying goods and services now and paying for them later • Widely used source of short-term funding, least expensive, most convenient • When a firm buys merchandise, it receives an invoice (a bill) like the one you receive when you buy something with a credit card • 2/10, net 30 – 2% off if paid within 10 days or total net due in 30 days • Promissory Note – a written contract with a promise to pay Family and Friends: • Important that both parties: 1. Agree to specific loan terms 2. Put the agreement in writing 3. Arrange for repayment in the same way they would for a bank loan • Keeps family relationships intact Commercial Banks: • How much it borrows and for how long de
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