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Wilfrid Laurier University
Leanne Hagarty

Sidra Khans Final Notes April 11 2012 Finance and CVP 24 marks Chapter 12(16) Managing the Firms Finances 4 marks The Role of Finance and the Financial Manager Financial Management: The art and science of managing a firms money so that it can meet its goals Closely related to accounting Roles include the following Plan and monitor firms cash flows to ensure cash is available when needed by focusing on cash flows Track day to day operational data such as cash collection and disbursement to ensure company has enough cash Accountants* main function is to collect and present financial data, then financial managers use the statements and info prepared by the accountants to make financial decisions Responsibilities and Activities include Financial planning preparing financial plan, which project revenues, expenditure and financing Investment investing the firms fund in project and securities for high returns Financing obtaining funding for the firms operations and investments and seeking best balance between debt and equity The Goal: maximize the value of the firm to its owner consider both short and long-term consequences Financial planning, and How organizations use funds FINANCIAL PLANNING Forecasting Short term forecasts (operating plans): project revenues, cost of goods sold, and operating expenses over a one year period Long term forecasts (strategic plans): cover a period that is longer than a year, typically 2-10 years and take a broader view of the firms financial activities. Budgets Cash Budget: Forecast the firms cash inflows and outflows, and help the firm plan for cash surpluses and shortages. Capital budget: Forecast outlays for fixed assets. They usually cover a period of several years and ensure the business has enough money to buy the plant and equipment it needs Operating Budget: Combing sales and forecasts with estimates of production costs and operating expenses to forecast profits MANAGING FUNDS Short term Expenses aka operating expenses, outlays used to support current selling and production activities Cash Management: Assuring liquidity: The process of making sure that a firm has enough cash on and to pay bills as they are due, and to meet unexpected expenses o Companies will try to keep current account balance low due to low interest, so financial managers invest in low- risk marketable securities o Financial managers look for low risk investment that offer high returns, most popular securities; treasury bills, certificates of deposits and commercial papers o Also tries to shorten the time between purchase of inventory or service and collection of cash flows Manage A/R: Managers goal is to collect A/R as fast as possible while offering credit terms attractive enough to increase sales o Involves setting credit policies, guidelines on offering credit and credit terms balancing act Inventory: Purchase of inventory needed by the firm o Want least inventory possible without harming production efficiency or sales, must work closely with production to balance conflicting goals Long Term Expenditures Capital Expenditure: Investments in long lived assets that are expected to provide benefits extending past one year. These include Building, Land, Equipment and machinery o Why? To expand and to replace or renew fixed assets and to develop new products; o Capital budgeting: process of analyzing long term project and selecting those that offer best returns Obtaining short-term financing, and Raising long-term financing Unsecured Short-term Loans : Loans for which the borrower does not have to pledge specific assets as security Trade Credit: The extension of credit by the seller to the buyer between the time the buyer receives the goods or service and when they pay for them. Buyer enters the books as A/P Bank loans: usually used to finance seasonal businesses o Line of Credit: An agreement between a bank and a business or an individual specifying maximum amount of short term borrowing available to the firm or individual o Revolving Credit Agreement: Allows the borrower to continue to have access to funds as long as the maximum has not been exceeded Sidra Khans Final Notes April 11 2012 Commercial Paper: Unsecured sort-term debt issued by a financially strong corporation. Issued in multiples of $100,000 for anywhere from 3-270 days Secured Loans: Loans for which the borrower is required to pledge assets as collateral or security Factoring - A firm sells its A/R outright to a factor, a financial institution (usually a chartered bank or commercial finance company) that buys accounts receivable at a discount Raising Long-Term Financing Debt versus Equity Financing Debt Financing : Advantage deductibility of interest expense for income tax purposes, overall lowers cost Disadvantage financial risk; if firm is unable to make scheduled interest and principle payment Equity: form of permanent financing that places few restrictions on the firm, firm not required to pay dividends or repay the investment gives common shareholders voting rights that provide them with voice in management, more costly than debt Differences Debt Financing Equity Financing Voice in Management Creditors typically have none, unless borrowers Common shareholders have voting rights default on payments. Creditors may be able to place restraints on management in event of default Claim on income and Debt holders rank ahead of equity holders. Equity owners have residual claim on income assets Payment of interest and principle is a contractual (dividends are paid only after interest and any obligation of the firm scheduled principle payments are paid and assets) The firm has no obligation to pay dividends. Maturity Debt has stated maturity and requires repayment The company is not required to repay the equity of principle by a specified maturity date which has no maturity date Tax Treatment Interest is a tax-deductible expense Dividends are not tax-deductible and are paid from after-tax income. Trends CFO Role continues to expand beyond ordinary finance responsibilities, joined top management in developing and implementing firms strategic direction. More highly visible and active in companies than ever before Weighing the Risks more companies consider enterprise risk management (ERM) approach to identifying, monitoring, and managing all components of a companys risk. o Credit Risk: Exposure to a loss as a result of default on a financial transaction, or a reduction is a securities market value due to decline in the credit quality of the debt issuer o Market Risk: Risk Resulting from adverse movements in the level or volatility of market prices of securities, commodities, and currencies o Operational Risk : Risk of unexpected losses arising from deficiencies in a firms management systems and procedures Lecture Ratio Analysis (not including liquidity) and CVP 20 marks Debt to equity short answer, but thinking applies to stability rations When to use this tool: measures the relationship between the amount of debt financing (borrowing) and the amount of equity financing (owners fund) How to use it: calculated by dividing total liabilities by owners equity What does it mean: indicates how much debt in ratio with equity, ratio above 100% means firm has more debt than equity therefore lenders are providing more financing than the owners Rule of thumb: <1:1 investors or shareholders? Have to pay off debtors, investors only get liquidation priority Stability, profitability, and marketability ratios problems Stability Ratios Measure a companys ability to meet it long-term obligations by measuring the relationship between components of a firms capital structure - Shows a long term viability -Shows the results of the financial decisions that are made capital structure = long term liabilities + owners equity finance through equity or debt Sidra Khans Final Notes April 11 2012 Leverage When to use this tool: Measures degree of which a company has locked itself into fixed financial costs implies that given change in sales will result in a greater change in profit How to use it: What does it mean: Implies that given change in sales results in greater chance of profit The Rule of thumb: <5:1 low - Lower risk but higher cost of capital = lower return 5:1 1:1 average >1:1 high - Higher risk but lower cost of capital = higher return Advantage: Long term debt is cheapest source of capital because interest is tax deductible, and dividends are not Higher return Disadvantage: - long term debt = higher interest payments which i
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