rsm100 chapter 20.docx

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University of Toronto St. George
Rotman Commerce
John Oesch

Chapter 20  Financial managers: managers responsible for planning and overseeing the financial resources of a firm  Finance (or corporate finance): the business activity known as finance typically involves o Determining a firm’s long-term investments o Obtaining funds to pay for those investments o Conducting the firm’s everyday financial activities o Helping to manage the risks that the firm takes  Financial managers collect funds, pay debts, establish trade credit, obtain loans, control cash balances, and plan for future financial needs  Overall objective of financial manager is to increase a firm’s value and thus stockholders’ wealth  In corporation, profits translate into an increase in the value of common stock  Cash flow management: managing the pattern in which cash flows in to the firm in the form of revenues and out of the firm in the form of debt payments o Financial managers must ensure that the firm has enough funds on hand to purchase materials and human resources needed to produce goods and service, and invest the rest of the funds that are not needed  Financial control: process of checking actual performance against plans to ensure that the desired financial status occurs o Control involves monitoring revenue inflows and making appropriate financial adjustments o The budget provides the “measuring stick” against which performance is evaluated as cash flows, debts, and assets of each department and the whole company are compared against budgeted amounts  Financial plan: describes a firm’s strategies for reaching some future financial position; includes projections for sources and uses of funds  Short-term (operating) expenditures: a firm makes short term expenditures regularly in its everyday business activities o Accounts payable is the largest category of short term debt and to plan for funding flows, financial managers need to know in advance the amounts of new accounts payable as well as when they must be repaid o Financial managers must also know the amounts of accounts receivable as well as when they will be received o Credit policy: rules governing a firm’s extension of credit to customers  This policy sets standards as to which buyers are eligible for what type of credit  Credit policy also sets payments terms (i.e. credit terms of 2/10, net 30 means you get a 2% discount if you pay up in 10 day, but regular price after 10 days and must pay within 30 days) o Inventory: materials and goods that the company will sell within a year  Too little inventory can lead to less sales, while too much inventory can mean that funds are tied up and cannot be used elsewhere  Raw materials inventory: portion of a firm’s inventory consisting of basic supplies used to manufacture products for sale  Work-in process inventory: portion of firm’s inventory consisting of goods partway through the production process  Finished goods inventory: portion of a firm’s inventory consisting of completed goods ready for sale o Working capital: difference between a firm’s current assets and current liabilities  It is the liquid asset out of which current debts can be paid  A company calculates its working capital by adding up inventories and accounts receivable minus accounts payable  Firms will try to reduce working capital as having less working capital means that the money is not tied up in working capital and thus can be used elsewhere  Long-term (capital) expenditures: companies also need funds to cover long term expenditures for fixed assets like land, buildings, and machinery o Long term expenditures differ from short term outlays in the sense that they often require a very large investment, they represent a binding commitment of company funds that continues long into the future, and unlike short term assets, long term assets normally cannot be converted into cash  Accounts payable are not merely expenditures as they are a source of funds to the company, until it has to pay the bill  Trade credit: granting of credit by one firm to another (effectively a short term loan) o Open-book credit: most common form of trade credit, in which sellers ship merchandise on faith that payment will be forthcoming (known as gentlemen’s agreement) o Promissory notes: form of trade credit in which buyers sign promise-to-pay agreements before merchandise is shipped o Trade draft: form of trade credit in which buyers must sign statements of payment terms attached to merchandise by sellers (states promised date and amount of payment due)  To take possession of the merchandise, the buyer must sign the draft  Once the buyer signs the trade draft, it becomes a trade acceptance o Trade credit insurance is available for sellers who are concerned that buyers may not pay their bills  Secured loans: a short term loan for which the borrower is required to put up collateral (i.e. bank loans) o Collateral: assets that the bank can seize if loan payments are not made as promised o Secured loans allow borrowers to get funds when they might not qualify for unsecured credit o Inventory is more attractive as collateral as it can be readily converted into cash o Pledging accounts receivable: using accounts receivable as collateral for a loan (often occurs for service companies that do not maintain inventories)  Unsecured loan: a short term loan for which the borrower does not have to put up collateral o However, banks require the borrower to maintain a compensating balance, that is, the borrower must keep a portion of the loan amount on deposit with the bank in a non- interest bearing account o Terms of the loan (amount, duration, interest rate, etc) are negotiated between the bank and the borrower o To receive unsecured loan, a firm must have a good banking relationship with the lender o Once an agreement is made, a promissory note will be executed o Line of credit: a standing agreement with a bank to lend a firm a maximum amount of funds on request (the bank does not guarantee that the funds will be available when requested) o Revolving credit agreements: a guaranteed line of credit for which the firm pays the bank interest on funds borrowed as well as a fee for extending the line of credit (called commitment fee) o Commercial paper: a method of short run fundraising in which a firm sells unsecured notes for less than the face value and then repurchases them at face value within 270 days; buyers profits are the difference between the original price paid and the face value  Works only for the largest and most creditworthy firms as commercial paper is back solely by the issuing firm’s promise to pay  Factoring: selling the firm’s accounts receivable o The purchaser of the receivables, usually a financial institution, is known as the factor  Sources of long term funds o Debt financing: raising money to meet long term expenditures by borrowing from outside the company’ usually takes the form of long term loans or sale of corporate bonds  Most corporations get their long term loans from a chartered bank, usually one with which the firm has developed a long standing relationship  Long term loans are attractive to borrowers because  The number of parties involved is limited ad so loans can be arranged quickly  Firm does not have to make public disclosure of its business plans or
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