Chapter 10: Financial Decisions
The Role of the Financial Manager
Financial managers: those managers responsible for planning and overseeing the financial resources of a firm.
Finance (corporate finance): the business function involving decisions about a firm’s long-term investments and
obtaining the funds necessary to pay for those investments. Finance typically involves:
Determining a firm’s long-term investments
Obtaining funds to pay for those investments.
Conducting the firm’s everyday financial activities.
Helping to manage the risks that the firm takes.
Objectives of the Financial Manager:
Financial managers do the following:
Establish trade credit
Control cash balances
Plan for future financial needs
The financial manager’s overall objective is to increase a firm’s value – thus stockholder’s wealth.
In all words, financial managers must ensure that a company’s earnings exceed its costs – in other words, that it
makes a profit.
In sole proprietorships and partnerships, profits represent an increase in the owner’s wealth.
In a corporation, profits translate into an increase in the value of common stock.
Responsibilities of the Financial Manager:
Cash flow management: managing the pattern in which cash flows into the firm in the form of revenues and out of
the firm in the form of debt payments.
Financial control: the process of checking actual performance against plans to ensure that the desired financial
status is achieved.
Financial plan: a description of how a business will reach some financial position it seeks for the future; includes
projections for sources and uses of funds.
Why do Business need Funds?
Short-term (operating) Expenditures:
Accounts payable: unpaid bills owed to suppliers plus wages and taxes due within the next year.
Accounts receivable: consists of funds due from customers who have bought on credit.
Credit policy: rules governing a firm’s extension of credit from customers.
Inventory: materials and goods currently held by the company that will be sold within the year.
Raw materials inventory: that portion of a firm’s inventory consisting of basic supplies used to manufacture
products for sale. Work-in-process inventory: that portion of a firm’s inventory consisting of goods partway through the production
Finished goods inventory: that portion of a firm’s inventory consisting of completed goods ready for sale.
Working capital is the difference between a firm’s current assets and current liabilities.
It is a liquid asset out of which current debts can be paid.
A company calculates its working capital by adding up the following:
Inventories – raw materials, working in process and finished goods on hands
Accounts receivable (minus accounts payable)
The benefits of reducing sums in working capital are:
Every dollar that is not tied up in working capital becomes a dollar of more useful cash flow.
Reduction of working capital raises earnings permanently.
The second advantage results from the fact that money costs money (in interest payments and the like).
Reducing working capital, therefore, means saving money.
Long-term (capital) expenditures:
Long term expenditures are usually more carefully planned out than short term outlays because they pose special
They differ from short-term outlays in the following ways, all of which influence the ways that long-term outlays
Unlike inventories and other short-term assets, they are not normally sold or converted into cash.
They represent a binding commitment of company funds that continues long into the future.