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Chapter 14

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McMaster University
Rita Cossa

Chapter 14 Finance - The function in a business that acquires funds for the firm and manages those funds within the firm - Activities include preparing budgets, doing cash flow analysis, and planning for the expenditure of funds on assets Financial management - The job of managing a firm’s resources so it can meet its goals and objectives Financial managers - Managers who make recommendations to top executives regarding strategies for improving the financial strength of a firm Common ways a firm fail financially: 1. Undercaptialization (lacking funds to start and run the business) 2. Poor control over cash flow 3. Inadequate expense control Financial planning is a key responsibility of the financial manager in a business. It involves three steps: 1. Forecasting both short-term and long-term financial needs 2. Developing budgets to meet those needs 3. Establishing financial control to see how well the company is doing what it set out to do Short-term forecast - Forecast that predicts revenues, costs, and expenses for a period of one year or less Cash flow forecast - Forecast that predicts the cash inflows and outflows in future periods, usually months or quarters - Estimates the firm’s projected sales for a particular period Long-term forecast - Forecast that predicts revenues, costs, and expenses for a period longer than one year, and sometimes as far as five or ten years into the future Budget - A financial plan that sets forth management’s expectations, and, on the basis of those expectations, allocates the use of specific resources throughout the firm - The key financial statements – the balance sheet, income statement, and the cash flow statement –form the basis for the budgeting process - A budget becomes the primary guide for the firm’s financial operations and financial needs - There are usually several types of budgets established in a firm’s financial plan: 1. An operating budget  the budget that ties together all of a firm’s other budgets  the projection of dollar allocations to various costs and expenses needed to run or operate the business, given the projected revenues  most firms will prepare an operating budget on a monthly basis for the next 12 months 2. A capital budget  A budget that highlights a firm’s spending plans for major asset purchases that often require large sums of money  Concerns itself with the purchase of such assets as property, buildings, and equipment 3. A cash budget  A budget that estimates a firm’s projected cash inflows and outflows that the firm can use to plan for any cash shortages or surpluses during a given period Financial control - A process in which a firm periodically compares its actual revenues, costs, and expenses with its projected ones - Provide feedback to help reveal which accounts, which departments, and which people are varying from the financial plans In all organizaitons, there are certain needs for which funds must be available. Key areas include: • Managing day-to-day needs of the business o The challenge of sound financial management is to see that funds are available to meet these daily cash needs o Money has what is called a time value • Controlling credit operations o Financial managers know that making credit available helps keep current customers happy and attracts new customers o The major problem with selling on credit is that a large percentage of a non- retailer’s business assets could be tied up in its credit accounts (accounts receivable) • Acquiring needed inventory o Innovations such as just-in-time inventory help reduce the amount of funds a firm must tie up in inventory • Making capital expenditures o Capital expenditures  Major investments in either tangible long-term assets or intangible assets Debt financing - Funds raised through various forms of borrowing that must be repaid Equity financing - Funds raised from operations within the firm or through the sale of ownership in the firm Short-term financing - Borrowed funds that are needed for one year or less Long-term financing - Borrowed funds that are needed for a period longer than one year Trade credit - The practice of buying goods and services now and paying for them later Promissory note - A written contract with a promise to pay - Can be sold by the supplier to a bank at a discount If an entrepreneur does decide to ask family or friends for financial assistance, it’s important that both parties 1. Agree on specific loan terms 2. Put the agreement in writing 3. Arrange for repayment in the same way they would for a bank loan Secured loan - A loan backed by something valuable, such as property - If the borrower fails to pay the loan, the lender may take possession of the collateral Unsecured loan - A loan that’s not backed by any specific assets - Loan is not backed by any assets - Given to highly regarded customers Line of credit - A given amount of unsecured funds a bank will lend to a business - The purpose is to speed the borrowing process so that a firm does not have to go through the process of applying for a new loan every time it needs funds Revolving credit agreement - A line of credit that is guaranteed by the bank Commercial finance companies - Organizations that make short-term loans to borrowers who offer tangible assets as collateral Factoring - The process of selling accounts receivable for cash Commercial paper - Unsecured promissory notes of $100,000 and up that mature in 365 days or less - States a fixed amount that the business agrees to repay to the lender on a specific date - Only financially stable firms are able to sell commercial paper Credit cards provide a readily available line of credit to a business that can save time and the likely embarrassment of being rejected for a bank loan. Credit cards are an expensive way to borrow money and are probably best used as a last resort. In setting long-term financing objectives, financial managers generally ask three major questions: 1. What are the organization’s long-term goals and objectives? 2. What are the financial requirements needed to achieve these long-term goals and objectives? 3. What sources of long-term capital are available, and which will best fit our needs? Long-term funding comes from two major types of financing: Debt financing and equity financing Debt Financing - Involves borrowing money that the company has a legal obligation to repay - Firms can borrow funds by either getting a loan from a lending institution or issuing bonds Term-loan agreement - A promissory note that requires the borrower to repay the loan in specified instalments - A major advantage of a business using this type of financing is that intere
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