MGM101H5 Lecture Notes - Unsecured Debt, Cash Flow, Revolving Credit

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5 Oct 2011

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Chapter 17 Outline
The Role of Finance and Financial Management
Financial activities include preparing budgets, doing cash flow analysis, and planning for
the expenditure of funds on assets.
Accountant records data, financial managers analyze data
Accountants need to know finance and vice versa. In large corporations, CFO is in
charge of both departments.
Financial managers examine financial data and make recommendations to top
executives on how to improve financial strength of firm
Most common ways for small businesses to fail are: undercapitalization, poor cash flow
control, and poor expense control.
The Importance to Understanding Finance
Financial managers have to be aware of changes in financial regulations such as tax
deductions etc.
Financial department is also responsible for internal auditing, which is a strategic
approach to checking the work of accountants.
Financial Planning
Objective is to optimize firm’s profitability and make the best use of its money. This is
done by analyzing past short-term and long-term money flows. Therefore, it is easier to
financially manage a old firm, which has had records and experience, than a new firm.
Three steps in financial planning are: (1) forecasting financial needs (2) budgeting and
(3) establishing financial controls (reflection and change).
Forecasting Financial Needs
A short-term forecast predicts revenues, costs, cash flow, and expenses for a period of
one year or less.
Long term forecast predicts revenues, costs, expenses and cash flow for a period longer
than one year.
Long-term forecast is crucial in budgeting and setting up company strategies.
Working with the Budget Process
A budget is a financial plan that allocates resources based on the forecast. The three
types are operating budget, capital budget, and cash budget.
An operating budget, or master budget, ties all the firm’s individual budgets together to
form a summary. Typically created annually; monthly budgets are created.
Ultimately, the firm’s board of directors have to approve all budgets and this can take a
lot of time.
A capital budget highlights the firm’s spending plans for major assets that require large
sums of money.
Cash budget estimates a firm’s projected inflows and outflows and is used to plan any
cash shortages or surpluses in a given period.
Establishing Financial Controls
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Financial control is a process where firms compare their budget with what actually
happened in terms of revenues, costs, and expenses. This is usually done on a monthly
basis. Financial control allows managers to take corrective action if necessary.
The Need for Funds
This section outlines the areas where firms need funds
Managing Day-to-Day Needs of the Business
Sound financial managements means that firms can meet daily cash needs such as tax
payments and wage payments.
Financial managers try to keep expenditures to a minimum to rack up on the time value
of money
On the same principle, financial managers attempt to pay bills as late as possible and
collect payments as soon as possible.
Controlling Credit Operations
Credit is important; customers like to pay on credit. But it creates the problem for the
firm to having to pay bills but having all of its money tied up in account receivables.
Therefore, companies have to (1) make sure to have enough available funds on hand (2)
set up efficient credit collection systems and (3) only sell to those with good credit
Accepting business from MasterCard or Visa holders is a solution because those who
can apply for these cards are guaranteed to have good credit history
Acquiring Inventory
Retail businesses are required to put a significant amount of funds in inventory. A
carefully constructed inventory policy like that of “Just in Time” works well.
A poorly managed inventory system can seriously affect cash flow and drain finances
It is important to not keep to much inventory because of opportunity cost (because of
time value of money)
Making Capital Expenditures
Capital expenditures are major investments in either tangible assets (land, building,
equipment) or intangible assets (patents, trademarks, copyrights)
Expansion into new markets is expensive without guarantee of return so businesses
have to carefully weigh out their options.
Obtaining Short-Term Financing
Short-term financing = funds needed for one year or less
Most small businesses can only do short-term financing, and need to offer collateral
before they can build enough credit-worthiness.
Trade Credit
The practice of buying goods and services now and paying for them later. This is the
least expensive and most convenient way of short-term financing.
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