Management of the Enterprise
Chapter 17: Financial Management
The Role of Finance and Financial Managers
- Finance the function in a business that acquires funds for the firm and manages those funds
within the firm.
- Financial Management the job of managing a firm’s resources so it can meet its goals and
- A financial manager of a business is the doctor who interprets the report and makes
recommendations to the patient regarding changes that will improve the patient’s health.
- Financial manager’s managers who make recommendations to top executives regarding
strategies for improving the financial strength of a firm.
Can make sound financial decisions only if they understand accounting
Responsible for seeing that the company pays its bills.
Buying merchandise on credit (accounts payable) and collecting
payment from customers (accounts receivables) are responsibilities.
- In large and medium-sized organizations, both the accounting and the finance functions are
generally under the control of a chief financial office or a vice-president or finance.
- The following are three of the most common ways for a firm to fail financially:
Undercapitalization (lacking funds to start and run the business)
Poor control over cash flow
Inadequate expenses control.
The Importance of Understanding Finance
- You do not have to pursue finance as a career to understand finance, which is important to
anyone who wants to start a small business, invest in stocks and bonds, or plan a retirement
- It’s vital that financial managers in any business stay abreast of changes or opportunities in
finance and prepares to adjust to them.
- Financial managers must also carefully analyze the tax implications of various managerial
decisions in an attempt to minimize the taxes paid by the business.
- Another responsibility of the firm’s finance department, internal audit, checks on the journals,
ledgers, and financial statements prepared by the accounting department.
- Another purpose of an internal audit is to safeguard assets, including cash. Financial Planning
- Financial planning is a key responsibility of the financial manager in a business.
- Financial planning involves analyzing short-term and long-term money flows to and from the
- Overall objective is to optimize the firm’s profitability and make the best use of its money.
- Financial planning involves 3 steps:
Forecasting both short-term and long-term financial needs.
Developing budgets to meet those needs
Establishing financial control to see how well the company is doing what it set
out to do.
Forecasting Financial Needs
- 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.
- The inflows and outflows of cash recorded in the cahs flow forecast are based on expected sales
revenues and on various costs and expenses incurred and when the cash will be collected and
costs will need to be paid.
- Long-term forecast the 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.
Gives top management, as well as operations managers, some sense of the
income or profit potential possible with different strategic plans.
Working with the Budget Process
- Budget sets forth management’s expectations for revenues, and, on the basis of those
expectations, allocates the use of specific resources throughout the firm.
- The key financial statements (balance sheet, income statement, and the cash flow statement)
form the basis for the budgeting process.
- There are usually several types of budgets established in a firm’s financial plan:
An operating (master) budget
A capital budget
A cash budget
- The Operating (master budget) the budget that ties together all of a firm’s other budgets; it
is the projection of dollar allocations to various costs and expenses needed to run or operate the
business, given projected revenues. - Capital Budget a budget that highlights a firm’s spending plans for major asset purchases
that often require large sums of money.
- Cash budget a budget that estimates a firm’s projected cash inflows and outflows tha the
firm can use to plan for any cash shortage or surpluses during a given period.
Establishing Financial Controls
- Financial Control a process in which a firm periodically compares its actual revenues, costs,
and expenses with its budget.
- Most companies hold at least monthly financial reviews as a way to ensure financial control.
- Help managers identify variances to the financial plan and allow them to take corrective action if
- Provide feedback to help reveal which accounts, which departments, and which people are
varying from the financial plans.
The Need for Funds
- Key areas such as:
Managing day-to-day needs of the business
Controlling credit operations
Acquiring needed inventory
Making capital expenditures
Managing day-to-day needs of the business
- Time value the interest gained on the firm’s investments is important in maximizing the
profit the company will gain.
- It’s also not unusual for finance managers to suggest that a company pay its bill as late as
possible (unless a cash discount is available) but try to collect what’s owed to it as fast as
- Efficient gash management is particularly important to small firms in conducting their daily
operations because their access to capital is generally much more limited than that of larger
Controlling Credit Operations
- Financial managers know that making credit available helps keep current customers happy and
attracts new customers. - 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) and at the same time needs
to pay the costs incurred for the making or provision of goods or services already sold to
customers who bought on credit.
- One way to decrease the time, and therefore expense, involved in collecting accouts receivable
is to accept bank credit cards such as MasterCard or Visa.
- Clear customer orientation means that high-quality service and availability of goods are vital if a
business expects to prosper in today’s markets.
- Although it’s true that firms expect to recapture their investment in inventory through sales to
customers, a carefully constructed inventory policy assists in managing the firm’s available funds
and maximizing profitability.
- Innovations such as just-in-time inventory help reduce the amount of funds a firm must tie up in
Making Capital Expenditures
- Capital expenditures major investments in either tangible long-term assets such as land,
buildings, and equipment, or intangible assets such as patents, trademarks, and copyrights.
- Expansion into new markets can cost large sums of money with no guarantee that the expansion
will be commercially successful.
Alternative Sources of Funds
- 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 longer period than one year.
- Trade Credit the practice of buying goods and services now and paying for them later.
- It is common for business invoices to contain items such as 2/10, net 30. This means that the
buyer can take a 2 percent discount if the invoice is paid within 10 days. - Promissory note a written contract with a promise to pay a supplier a specific sum of money
at a definite time.
Family and Friends
- Because such funds for small companies are needed for periods of less than a year, friends or
relatives are sometimes willing to help and the normal steps to obtain this type of funding are
- If an entrepreneur does decide to ask family or friends for financial assistance, it’s important
that both parties:
Agree on specific loan terms
Put the agreement in writing
Arrange for repayment in the same way they would for a bank loan.
Obtaining Short-term financing
- Firms need to borrow short-term funds to purchase additional inventory or to meet bills that
- Most small businesses are primarily concerned with just staying afloat until they are able to
build capital and creditworthiness.
Commercial Banks and Other Financial Institutions
- If a business is able to get such a loan, a small or medium sized business should have the person
in charge of the finance function keep in close touch with the bank.
- By anticipating times when many bills will come due, a business can begin early to seek funds or
sell other assets to prepare for a possible financial crunch.
- An experienced banker may spot cash flow problems early or be more willing to lend money in a
crisis if a business person has established a strong, friendly, relationship build on openness,
trust, and sound management practices.
Different forms of Short-Term Loans
- Secured loan a loan backed by something valuable, such as property.
- The item of value is often called a collateral.
- Account receivables are assets that are often used by businesses as collateral for a loan; the
process is called pledging. - Inventory such as raw materials (ex. Coal, steel) can also be used as collateral or security for a
- Unsecured loan a loan that’s not backed by any specific asset.
- Line of credit a given amount of unsecured funds a bank will lend to a business.
- Primary purpose of a line of credit 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.
- As business mature and become more financially secure, the amount of credit often is
increased, much like the credit limit on your credit card.
- Revolving credit agreement a line of credit that is guaranteed by he bank.
- Commercial Finance companies organizations that make short-term loans to borrowers who
offer tangible assets as collateral.