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Financial Management-mgm.docx

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Gill Parveen

Financial Management The Role of Finance and Financial Managers  Finance: the function in a business that acquires funds for the firm and managers those funds within the firm.  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.  Financial managers are responsible for paying the company’s bills at the appropriate time and for collecting overdue accounts receivable to make sure that the company does not lose too much money to bad debts  Top 3 ways a firm to fail financially: 1. Undercapitalization (lacking funds to start and run the business) 2. Poor control over cash flow 3. Inadequate expense control –firms in a growth mode can often find themselves with large increases in their working capital as accounts receivable and inventory grow Financial Planning  Financial planning involves 3 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 Forecasting Financial Needs  Short-term forecast: forecast that predicts revenues, costs and expenses for a period of one year or less  The forecast is the foundation for most other financial plans  Part of the short-term forecast may be in the form of a cash flow forecast  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 cash 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: 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.  The company’s sales forecast estimates the firm’s projected sales for a particular period. Working with the Budget Process  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  Budgeting is tied to forecasting, financial managers must take forecasting responsibilities seriously  Types of budgets established in a firm’s financial plan: o An operating (master) budget o A capital budget o A cash budget  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. –Primarily concerns itself with the purchase of such assets as property, buildings, and equipment  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 Establishing Financial Controls  Financial Control: a process in which a firm periodically compares its actual revenues, costs and expenses with its projected ones Need for Funds  Managing day to day needs of the business –take money today (invest + interest)  Controlling credit operations  Acquiring needed inventory  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. Alternative Sources of Funds  Determining the amount of money needed and finding out the most appropriate sources from which to obtain these funds are fundamental steps in sound financial management  Debt Financing: funds raised through various forms of borrowing that most be repaid  Equity Financing: funds raised from operations within the firm or through the sale of ownership in the firm.  Short-term financing: refers to funds needed for one year or less  Long-term financing: refers to funds needed for a period longer than one year (2-10 years) Obtaining Short-Term Financing – TRADE  Trade credit: the practice of buying goods and services now and paying for them later (account payable)  Promissory note: a written contract with a promise to pay a supplier a specific sum of money at a definite time Different Forms of Short-Term Loans  Secured loan: a loan backed by something valuable such as property –the item of value is called collateral –if the borrower fails to pay the loan, the lender may take possession of the collateral  Accounts receivable are assets that are often used by businesses as collateral for a loan; the process is called pledging  Unsecured Loan: a load that’s not backed by any specific assets –doesn’t require a borrower to offer the lending institution any collateral to obtain the loan  Line of Credit: a given amount of unsecured funds a bank will lend to a business –primary purpose of 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  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 Accounts Receivable  Factoring: the process of selling accounts receivable for cash –factoring is not a loan, it is a sale of an asset (accounts receivable) Commercial Paper  Commercial Paper: unsecured promissory notes of $100,00 and up that mature (come due) in 365 days or less –commercial paper states a fixed amount of money that the business agrees to repay to the lender (investor) on a specific date Obtaining Long-Term Financing  In setting long-term financing objectives, financial managers generally ask 3 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?  In business, long term capital is used to buy capital assets such as plant and equipment, to develop new products and to finance expansion of the organization  Debt financing, and equity financing Debt Financing  Involves borrowing money that the company has a legal obligation to repay  Firms can’t borrow funds by either getting a loan from a lending institution or issuing bonds Debt Financing by Borrowing Money from Lending Institutions  Long term loans are usually repaid within 3 to 7 years but may extend to 15 or 20 years  For such loans, a business must sign what is called a term-loan agreement  Term-loan agreement: is a promissory note that requires the borrower to repay the loan in specified installments –major advantage of a business using this tye of financing is that the interest paid on the long term debt is tax deductible  The interest rate for long term loans is based on the collateral, firms’ credit rating and the general level of market interest rates.  Risk/return trade off: the principle that the greater the risk a lender takes in making a loan, the higher the interest rate required. Debt Financing By Issuing Bonds  Bond: a corporate certificate
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