Chapter 10 Textbook Notes

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10 Nov 2010
MGTA04 / 01
Chapter 10: Financial Decisions
financial assets
- the business activity known as finance (or corporate finance) typically involves four
responsibilities: a) determining a ILUP¶VORQJ-term investments
b) obtaining funds to pay for those investments
d) helping to manage the risks that the firm takes
Objectives of the Financial Manager
- Financial managers collect funds, pay debts, establish trade credit, obtain loans, control
decisions for improving that status
- 3URILWVWUDQVODWHVWRDQLQFUHDVHLQRZQHU¶VZHDOWK for sole proprietorships/partners; profits
translates to an increase in the value of common stock for corporations
Responsibilities of the Financial Manager
general categories: cash flow management, financial control, and financial planning
Cash Flow Management
- Financial managers must ensure that it always has enough funds on hand to purchase the
materials and human resources that it needs to produce goods and services
- Funds that are not needed immediately should be invested to earn more money for the firm
- Cash flow management is managing the pattern in which cash flows into the firm in the
form of revenues and out of the firm in the form of debt payments
- Firms are learning to put their idle funds/cash to work in order to gain additional income
and avoid having to borrow from outside sources (savings on interest payments)
Financial Control
- Financial control is the process of checking actual performance against plans to ensure
that the desired financial status is achieved
- E.g. planned revenues based on forecasts usually turn out to be higher or lower than actual
o Higher: cash can be deposited in short-term interest-bearing accounts or used to
pay off short-term debt
o Lower: may necessitate short-term borrowing to meet current debt obligations
Financial Planning
- A financial plan is a description of how a business will reach some financial position it
seeks for the future; includes projections for sources and uses of funds
- When constructing a plan, the financial manager must ask several questions:
o What amount of funds does the company need to meet immediate plans?
o When will it need more funds?
o Where can it get the funds to meet both its short-term and its long-term needs?
- The financial manager must develop a clear picture of why a firm needs funds
The Role of the Financial Manager (pg. 221 ± 223)
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MGTA04 / 02
- The financial manager must distinguish between two different kinds of financial outlays:
short-term (operating) expenditures and long-term (capital) expenditures
Short-Term (Operating) Expenditures
- Firms incurs short-term expenditures regularly in its everyday business activities
- Pays attention to accounts payable, accounts receivable, and to inventories
Accounts Payable
- Accounts payable are unpaid bills owed to suppliers plus wages and taxes due within the
upcoming year
- To plan for funding flows, financial managers want to know in advance the amounts of
new accounts payable as well as when they must be repaid
Accounts Receivable
- Accounts receivable consists of funds due from customers who have bought on credit
- A sound financial plan requires financial managers to project accurately both how much
credit is advanced to buyers and when they will make payments on their accounts
Credit Policies
- Predicting payment schedules is a function of credit policy UXOHVJRYHUQLQJDILUP¶V
extension of credit to customers)
- Typically, credit is extended to customers who have the ability to pay and who honour
their obligations, credit is denied to firms with poor payment histories
- Credit policy also sets payment terms (e.g. 2/10, net 30; selling company offers a 2%
discount if the customer pays within 10 days, customer has 30 days to pay regular price
- The higher the discount, the more incentive buyers have to pay early
- Inventories are materials and goods currently held by the company that will be sold within
the year. While holding inventory, the firm ties up their funds in it
- Failure to manage inventory can have grave financial consequences
o Too little inventory: unable to make potential sales
o Too much inventory: ties up the firms funds which cannot be used elsewhere
- There are three basic types of inventories:
o Raw materials inventory ± SRUWLRQRIWKHILUP¶VLQYHQtory consisting of basic
supplies used to manufacture products for sale (e.g. Levi, huge rolls of denim)
partway through the production process (e.g. cut-out but not-yet-sewn jeans)
goods ready for sale (e.g. completed blue jeans ready for shipment to dealers)
Working Capital
- Company calculates working capital by adding up inventories (raw materials, work-in-
process, and finished goods) and accounts receivable (minus accounts payable)
- Large companies typically devote 20 cents of every sales dollar to working capital
- Benefit of reducing working capital:
o Every dollar that is not tied up in working capital becomes a dollar of useful cash flow
o Reduction in working capital raises earnings permanently
o Since borrowing money is costly, able reduce the amount of interest payment needed
Why Do Businesses Need Funds? (pg. 223 ± 224)
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