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AFM 131 (171)
Chapter 17

Chapter 17 Finance Textbook Notes

6 Pages
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Department
Accounting & Financial Management
Course Code
AFM 131
Professor
Robert Sproule

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Description
Chapter17-Finance Role of Finance and Finance Managers  Finance: function in a business that acquires funds for the firm and manages them within the firm o Activities include:  Preparing budgets  Doing cash flow analysis  Obtaining of funds for long-lived assets o Important for both for profit and non-profit businesses, large and small  Financial Management: job of managing a firm’s resources to meet its goals and objectives  Financial Managers: examine the financial data prepared by accountants and recommend strategies for improving the financial performance of the firm o Must also understand basic accounting principles Value of Understanding Finance  Three most common ways for firms to fail financially: o Undercapitalization - insufficient funds to start o Poor control over cash flows - matching cash inflows to cash outflows o Inadequate expense control - expenses too high in relation to revenues What is Financial Management  Other concerns to financial managers: o Taxes and their minimization o Internal audit of the preparing of financial statements o Safeguarding of company cash  The general public is only aware of a very small percentage of the actual theft of cash which invariably is done by employees o To minimize theft: keep little cash on hand, segregation of duties, and preparing bank reconciliations Financial Planning  Analyzing short-term and long-term money flows to and from a firm Forecasting Financial Needs  Short-term Forecast: forecast that predicts revenue, costs, and expenses for a period of one year or less o Based on expected sales and various costs and expenses incurred o Using past financial statements as a basis for projecting the numbers  Cash Flow Forecast: forecast that predicts the cash inflows and outflows in future periods, usually months or quarters  Long-term Forecast: forecast that predicts revenue, costs, and expenses for a period longer than one year, sometimes five to ten years o Plays part in firm’s long term strategic plan Working with the Budget Process  Budget: financial plan that sets forth management’s expectations and allocates the use of specific resources throughout the firm o Depends on the accuracy of financial statements o Becomes primary guide for the firm’s financial operations and financial needs  Operating Budget: ties together all of a firm’s other budgets and summarizes the business’s proposed financial activities o Prepared by the respective managers and approved by the company's Board o Most the time, firms prepare monthly operating budgets o Entire process can take month to be approved  Capital Budget: highlights a firm’s spending plans for major assets purchases that often require large sums of money; like PPE o Cash inflows and outflows are calculated for the expected life of the capital asset and then present valued  Cash Budget: estimates a firm’s cash inflows and outflows for each department/division over a 12 month period by month o Cash vs. credit sales, will not get payment in at least a month; needs to be taken into consideration o Maintaining a minimum cash balance for safety in case of unplanned need for cash Establishing Financial Control  Financial Control: process win which a firm periodically compares actual performance on a monthly basis with its projected ones o Help to identify variances, may require corrective action The Need for Funds Managing Day-to-Day Needs of a Business  Must ensure funds are available to meet daily cash needs without compromising the firm’s opportunities to invest for its future o Ex: paying employees, taxes to governments, loans to banks  Consider the time value of money through collecting early and paying late Controlling Credit Operations  Need to develop efficient collection procedures  Using bank credit cards reduces risk, but also some fees Acquiring Needed Inventory  Use of JIT and evaluating inventory turnover ratios o Process for converting inventory to cash though credit sales o Including calculating days to sell average inventory and days to collect average receivables Making Capital Expenditures  Definition: major investments in either tangible long-term assets or intangible assets o Land for buildings, buildings for production, equipment for production o Patents, trademarks and copyrights Alternative Sources of Funds  Equity Financing: funds raised from operations within the firm or through the sale of ownership of the firm  Debt Financing: funds raised through various forms of borrowing that must be repaid  Short-term is one year or less vs. long-term, typically two to ten years Obtaining Short-Term Financing Trade Credit  Definition: practice of buying goods and services now and paying for them later o Most widely used, cheapest, and convenient o Usual terms, 2/10, net 30 (discount for early payment) o Promissory note required when credit rating low  Promissory Note: written contract with a promise to pay  Low rating: no credit history or late payments in the past Family and Friends  Often parties don't understand cash flow or don't properly negotiate: terms, interest rate or document the loan o Can lead to ugly disputes Commercial Banks  Prefer to lend to established businesses, sensitive to risk  Ability to assess risk and determine needs for different types of business/industries  Keep in close contact with lenders, constant analysis of financial statements Different Forms of Short-Term Loans  Secured Loans: a loan backed by collateral o Reduces risk o Collateral and taking possession if loan not paid o Could also pledge A/R as collateral, fund forwarded to lender once payment is collected  Unsecured Loan: loan that does not require any collateral o Given only to long-standing businesses considered financially stable  Lines of Credit: given amount of unsecured funds a bank will lend to a business o Needs good relationship with lender o Speeds up borrowing process, does not need to reapply o Amount increases as businesses grows  Revolving Credit Agreement: line of credit that is guaranteed but usually comes with a fee o Good sources of funds for unexpected cash needs  Commercial Finance Companies: organizations that make short-term loans to borrowers who offer tangible assets as collateral o Usually used of last resort o Charges higher interest
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