Finance is the business function involving a firm’s day to day financial activities and decisions about a firm’s long-term
investments and how to obtain those funds to pay for them
Finance is broken into two major areas
–Corporate finance
•How companies obtain and use funds
–Investments
•Analysis of financial securities including how they are valued
•Process of raising the funds for companies (can be considered under corporate finance)
•The two pieces are linked and build on the
existence and efficient functioning of capital markets (to be discussed next class)
Some Finance-Related Careers
•Managers, CEOs, CFOs
–Works inside the organization
–Makes decision that will best bring in sustaining future profits for firm
•Traders
–Conducts trades for client firms to help meet their financial goals
–more short-term focused
•Analysts (CFAs)
–evaluates investments and makes buy, sell, and hold recommendations on securities
•Financial planners (CFPs)
–assists individuals/firms in achieving long-term financial goals by setting up investing programs to do so
Responsibilities of a Financial Manager:
1.Financial Control
2.Financial Planning
3.Cash Flow Management
Financial Control
•Checking actual performance against strategic plans to ensure that desired goals are achieved
•Making adjustments as required when plans change, or do not work as intended
•Preparing budgets to ensure that sufficient cash is on hand to meet operational & debt service needs
•Actual results that vary from the budget need explanation and adjustment
Financial Planning
•A plan for achieving a desired financial status in the future
–Projections of revenue flows
–Sources & planned uses of funds
–Timing of when funds will be required
Cash Flow Management
•Managing the pattern of cash inflows (revenues) and outflows (debt payments)
•Investing funds that are not needed to service debt
•Funds must either be committed to maintaining the firm, or earning interest, not sitting idle
The Cash Flow Cycle
Order materials, purchase on credit
Stock arrives
Apply labour and build inventories
Pay for materials and labour on borrowed funds in necessary
Sell goods on credits
Collect cash on sales, repay borrowed funds
Financing required during this period
Finance Requirement
•Between paying suppliers and receiving the cash from customers, a company needs financing to keep up with operating and
selling expenses
•An adequate amount of cash is needed to maintain daily operations and to pay bills on time
Short-Term Sources of Funds
•Allows firms to cover operational expenses and implement short-term plans
1.Trade credit (Accounts Payables)
2.Secured and unsecured loans
3.Commercial paper
1. Trade Credit
•Open book credit
–sellers simply ship goods on credit, expecting that payment will follow
•Promissory note
–buyers sign a promise-to-pay agreement before merchandise is shipped
2. Secured Short-Term Loans
•A short-term loan for which the borrower is required to put up collateral (i.e.; a valuable asset)
•If the borrower defaults, the collateral is seized
•Interest rates are usually lower than for unsecured loans
•Appeal to firms whose credit rating is not sufficient (or who are too new) to qualify for unsecured loans
2. Unsecured Short-Term Loans
•Line of Credit
–A specified amount made available to the borrower for a short-term unsecured loan
–The borrower draws on funds as they are needed
–Usually offered by Banks who do not necessarily agree that the funds will always be available as needed
•Revolving Credit Agreements
–guaranteed line of credit
–the firm pays the bank interest on borrowed funds, as well as a fee for extending the line of credit
–banks guarantee availability of the funds
–the firm does not have to borrow funds if it doesn’t need them
•The bank charges a “commitment fee” for keeping the line of credit open for the firm
3. Commercial Paper
•a firm sells unsecured notes for less than their face value, then repurchases them in 30 to 270 days for the face value
•Investors make money on the spread between the face value and purchase price
•As an unsecured note, only creditworthy firms are able to sell them successfully
•The cost of commercial paper to the borrowing firm is usually less than prevailing interest rates
Sources of Long-Term Funds
•Debt financing
–seeking long-term funds through borrowing from external sources
•Equity financing
–seeking long-term funds through internal financing