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RSM100Y1 (431)
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Chapter 20

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Rotman Commerce
John Oesch

Financial Decisions & Risk Management [Chapter 20] The role of the financial manager  We have seen production managers are responsible for planning and controlling the output of goods and services  Marketing managers must plan and control the development and marketing of products  Financial manager: those managers responsible for planning and overseeing the financial resources of a firm  Business activity known as finance (or corporate finance): the business function involving decisions about: o Determining a firms long term investments o Obtaining the funds to pay for those investments o Conducting the firms everyday financial activities o Helping to manage the risks that the firm takes Objectives of the financial manager  Must collect funds, pay debt, establish trade credit, obtain loans, control cash balances, plan for future financial needs  Their overall objective is to increase a firms value- and thus a stockholders’ wealth  Must ensure the company’s earnings exceed its costs (profit) Responsibilities of the financial manager  To increase a firms wealth falls into 3 categories: cash flow management, financial control, financial planning o Cash flow management: managing the pattern in which cash flows in to the firm in the form of revenues and out of the firm in the form of debt payments  Must ensure that firm has enough funds on hand to purchase the materials and human resources that it needs to produce foods and services o Financial control: the process of checking actual performance against plans to ensure that the desired financial status is achieved  Involves monitoring revenue inflows and making appropriate financial adjustments o Financial planning: a financial plan that is a description of how a business will reach some financial position it seeks for the future, includes protection for sources and uses of funds  Must develop clear picture of why a firms needs funds Why do businesses need funds?  Financial managers must distinguish between 2 different kinds of financial outlays- short term expenditures (operating) and long term expenditures (capital) Short-term (operating) expenditures  Accounts payable: unpaid bills owed to suppliers + wages and taxes due within the upcoming year  Accounts receivable: funds due from customers who have bought on credit; requires managers to project accurately both how much credit is advanced to buyers and when they will make payments on their accounts o Credit policies: rules governing a firms extension of credit to customers; sets standards as to which buyers are eligible for what type of credit and is extended to those who have the ability to pay and who honor the obligations  Inventories: materials and goods currently held by the company that will be sold within the year o 3 basic types of inventories:  Raw materials inventory: that portion of a firms inventory consisting of basic supplies used to manufacture products for sale  Work in process inventory: that portion of a firms inventory consisting of goods partway through the production process  Finished goods inventory: that portion of a firms inventory consisting of completed goods ready for sale  Working capital: difference between a firms current assets and current liabilities; liquid asset with which current debts can be paid o Inventories- raw materials, work in process, finished goods on hand o Accounts receivable (minus accounts payable) Long-term (capital) expenditures  Companies need funds to cover long term expenditures for fixed assets (items that have a lasting use or value – like land, building machinery)  Differ in the following ways to short term: o Unlike inventories and other short term assets, they are not normally sold or converted into cash o Their acquisition requires a very large investment o They represent a binding commitment of company funds that continues long into the future Sources of short-term funds Trade credit  Is the granting of credit by a selling firm to a buying firm; the trade credit can take several forms: o Open book credit: most common, and is a form of trade credit in which sellers ship merchandise on faith that payment will be forthcoming o Promissory notes: buyers sign promise to pay agreements before merchandise is shipped o Trade draft: buyers must sign statements of payment terms attached to merchandise by sellers; once signed the document becomes a trade acceptance: trade draft that has been signed by the buyer Secured short-term loans  Secured loan: a short term loan for which the borrower is required to put up collateral (banks require this)  Collateral: any asset that a lender ha the right to seize if a borrower does not repay a loan  Inventory as collateral: when a loan is made with inventory as collateral, the lender loans the borrower some portion of the stated value of the inventory  Accounts receivable as collateral: this process is called pledging accounts receivable: using accounts receivable as collateral for a loan and in case of non payment form borrower, the lender may seize these receivables Unsecured short-term loans  Unsecured loan: a short term loan in which the borrower is not required to put up collateral  The bank requires the borrower to maintain a compensating balance though, which is the borrower must keep a portion of the loan amount on deposit with the bank in a non interest bearing account  Many of them take the form of lines of credit, revolving credit agreements, commercial paper o Lines of credit: a standing agreement between a bank and a firm in which the bank specifies the maximum amount it will make available to the borrower for a short term unsecured loan; the borrower can then draw on those funds, when available o Revolving credit agreement: a guaranteed line of credit for which the firm pays the bank interest on funds borrowed as well as a fee for extending the line of credit o Commercial paper: a method of short term fundraising in which a firm sells unsecured notes for less than the face value and then repurchases them at the face value within 270 days; buyers’ profits are the difference between the original price paid and the face value Factoring accounts receivable  A firm can raise funds by factoring- selling the firms accounts receivable (and the purchaser is known as the factor) which pays a percentage of the full amount of receivable; the seller gets money immediately  The profit depends on the quality of the receivables, the cost of collecting them, and interest rates Sources of long-term funds  Firms need long term funding to finance expenditures on fixed assets- the buildings and equipment necessary for conducting business  May seek them through debt financing (from outside the firm), equity financing (by drawing on internal sources) or hybrid financing (a middle group)  Must consider the risk return relationship Debt financing  Raising money to meet long term expenditures by borrowing from outside the company; usually takes the form of long term loans or the sale of corporate bonds  2 primary sources of such funding are long term loans and the sale of corporate bonds: o Long term loans: most get them from a chartered bank, credit companies, insurance companies, pension funds etc and are attractive to borrowers because:  Number of people involved in limited, often loans can be arrange very quickly  The firm does not need to make public disclosure of its business plans or purpose for which acquiring the loan  The duration of loan can be matched for borrowers needs  If firms need change, the terms of loan can be usually changed  Interest rates: are negotiated between the borrower and lender; may fluctuate or float because the prime
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