Chapter 11 - financial management
• finance is the function in a business that acquires funds for the firm and manages those funds within the firm. Finance
activities include preparing budgets; doing cash flow analysis; and planning for the expenditure of unds on such assets as
plant, equipment, and machinery.
• Financial management is the job of managing a firm's resources so it can meet its goals and objectives. The y examine the
financial data prepared by accountants and make recommendations to top executives regarding strategies for improving the
health (financial strength) of the firm.
• a key responsibility of a financial manager is to obtain money and then control the use of that money effectively. They are
responsible for seeing that the company pays its bills. They also buy merchandise on credit (accounts payable) and collecting
payment from customers (accounts receivables). They make sure that the company doesn't lose money to bad debts.
• firms fail because of undercapitalization (lacking funds to start and run the business), poor control over cash flow, and
inadequate expense control.
• financial planning is a key responsibility of the financial manager in a business. This involves analyzing short-term and long-
term money flows to and from the firm. It involves three steps: (1) forecasting short-term and long-term financial needs, (2)
developing budgets to meet those needs, and (3) establishing financial control to see how well the company is doing what it
set out to do.
• FORECASTING s important for a financial plan.
o short-term forecasting predicts revenues, costs, and expenses for a period of one year or less. This forecast is the
foundation of other financial plans. Accuracy is critical.
o short-term forecast is in the form of a cash-flow forecast. This predicts the cash inflows and outflows in future periods
(months or quarters). The inflows and outflows are based on expected sales and various costs and expenses
o long-term financing predicts revenues, costs, and expenses for a period longer than one year, and sometimes as far
as five or ten years into the future. This is needed for the long-term strategic plan. It gives management some sense
of the income or profit potential possible with different strategic plans. Budgets are good for this process.
• A 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 balance sheet, income statement and cash flow statement form the basis for the
• budgets are compiled from short term and long term financial forecasts.
• There are three types of budgets:
o operating (master) budget: ties together all of the firm's other budgets and summarizes the business's proposed
o a capital budget: concerns itself with the purchase of assets like property, buildings and equipment. THings that
require large sums of money.
o cash budget: 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. This assists managers in anticipating borrowing, debt repayment,
operating expenses, and short term investments.
• financial control is a process in which a firm periodically compares its actual revenues, costs, and expenses with its budget. It
provides feedback to help reveal which accounts, which departments and which people are varying from the financial plans.
Funds • Managing day-to-day needs: If workers expect to be paid on Friday, they don't want to have to wait till Monday for their
cheques. Efficient cash management is particularly important to small firms in conducting their daily operations because their
access to capital is generally more limited than that of a larger business. Financial management is to see that funds are
available to meet the daily cash needs. money has what is called a TIME VALUE.
• Controlling credit operations: 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 (AR). Financial managers have to develop efficient collection procedures.
Like..businesses often provide cash or quantity discounts to buyers who pay their accounts by a certain time. Finance
managers carefully scrutinize old and new credit customers to see if they have a favourable history of meeting their credit
obligations on time. A firm's credit policy reflects its financial position and its desire to expand into new markets. One way to
decrease the time and expense involved in collecting accounts receivables is to accept bank credit cards like a Mastercard of
• Acquiring inventory: to satisfy customers, businesses must maintain inventories that often involve a sizable expenditure of
funds. An inventory policy assists in managing the firm's available funds and maximizing profitability. Innvations such as just-in-
time inventory help reduces the amounts of funds a firm must tie up in inventory.
• Making capital expenditures: are major investments in either tangible long-term assets such as land, buildingsm and
equipment or intangible assets such as patents, trademarks and copyrights. It is ciritical that companies weigh all possible
options before committing a large portion of their available resources. Long-term financing could be used, as this type of
expenditure should benefit a business for many years to come.
• Alternative sources of funds: finance if the function in a business that is responsiblefor acquiring and managing funds within
the firm. A firm can seek to raise capital through borrowing money (debt), selling ownership (equity), or earning profits
o debt financing refers to funds raised through various forms of borrowing that must be repaid
o equity financing is money raised from within the firm (from operations) or through the sale of ownership in the firm.
o short-term financing refers to funds needed for one year or less.
o long-term financing refers to funds needed for a period longer than one year. (2-10 years)
Short-term financing Long-term financing
Trade credit Debt financing: lending institutions (ex: loan), and selling bonds
Promissory notes Equity financing: Retained earnings, venture capital, selling stock
Family and friends
Financial institutions (ex: line of credit)
Obtaining Short-Term Financing
• Firms need to borrow short-term funds to puurchase additional inventory or to meet bills that come due.
• TRADE CREDIT: the practice of buying goods or services now and paying for them later. When a firm buys merchandise, it
receives an invoice (receipt). Some suppliers hesitate to give trade credit to organizations with a poor credit rating, no credit
history, or a history of slow payment. A PROMISSORY NOTE is a written contract with a promise to pay a supplier a specific
sum of money at a definite time. • FAMILYAND FRIENDS: many small firms obtain short-term funds by borrowing money from family and friends. Entrepreneurs
today are doing this less. If they do then they have to agree on specific loan agreements, put it in writing and arrange for
repayment in the same way as a bank loan.
• COMMERCIAL BANKS AND FINANCIAL INSTITUTIONS: borrowing from banks. Banks would be reluctant to lend money to
small businesses. Businesses do this a lot and repayment depends on the kind of business it is and how quickly the
merchandise prchased with a bank loan can be resold or used to generate funds.
• DIFFERENT FORMS OF SHORT TERM LOANS:
o secured loan: a loan that's backed by something valuable like property. If the borrower fails to pay the loan, the lender
may take possession of the collateral (the item of value). accounts reveivables are assets that are often used by
businesses as collateral for a loan; this process is called pledging. Raw materials, buildings, machinery, and
company-owned stocks/bonds are also collateral.
o unsecured loan: doesn't require a borrower to offer the lending institution any collateral to obtain the loan. The loan
isn't backed by any assets. A lender in this case will give a loan to highly regarded customers that seen as less risky.
o line of credit: this happens when a business develops a good relationship with a bank, the bank may open a line of
credit for the firm. This is a given amount of unsecured funds a bank will lend to a business. The primary purpose of a
line of credit is to spee the borrowing process so that a firm a doesn't have to go through the process of applying for a
new loan every time it needs funds.
o As businesses mature and become more financially secure, the amount of credit is increased, much like the credit
limit on your credit card. In this case, some firms will apply for a REVOLVING CREDIT AGREEMENT: which is a line
of credit that's guaranteed. Banks will charge a fee for guaranteeing such an agreement. This is a good source of
funds for unexpected cash needs.
o if a business is unable to secure a short-term loan from a bank, a financial manager may obtain funds from
COMMERCIAL FINANCE COMPANIES. These non-deposit-type organizations (non-banks) make