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Chapter 17

RSM100Y1 Chapter 17 Notes

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University of Toronto St. George
Rotman Commerce
Michael Khan

RSM100Y1 Textbook Notes Chapter 17  Finance: the business function of planning, obtaining, and managing the company’s funds to accomplish its objectives as effectively and efficiently as possible.  Financial managers: the executives who develop and carry out their firm’s financial plan and decide on the most appropriate sources and uses of funds.  Financial managers are responsible for meeting expenses, investing in assets, and increasing profits to shareholders. Chief Executive Officer (CEO) Chief Financial Officer (CFO) Vice-President of Financial Treasurer Controller Planning  The vice-president of financial planning/management is responsible for preparing financial forecasts and analyzing major investment decisions related to new products, new production facilities, and acquisitions.  The treasurer is responsible for all of the company’s financing activities, including cash management, tax planning and preparation, and shareholder relations and also works on the sale of new security issues to investors.  The controller is the chief accounting manager and is responsible for keeping the company’s books, preparing financial statements, and conducting internal audits.  Return: the gain or loss that results from an investment over a specified period of time.  Risk-return trade-off: the process of maximizing the wealth of the firm’s shareholders by striking the right balance between risk and return  Firms that fail to invest their surplus funds in an income-earning asset, reduce their potential return or profitability.  Financial plan: a document that specifies the funds needed by a firm for a period of time, the timing of cash inflows and outflows, and the most appropriate sources and uses of funds.  Operating plans: short-term financial plans that focus on no more than a year or two in the future.  Strategic plans: financial plans that have a much longer time horizon, up to 5 or 10 years.  A financial plan is based on forecasts of: o Production costs o Purchasing needs o Plant and equipment expenses o Sales activities for the period covered  The three steps in developing a financial plan are: o Forecast sales or revenue over some future time period  Without an accurate sales forecast, the firm will have difficulty accurately estimating other variables, such as production costs and purchasing needs.  CFO may look at the expected sales growth and any store openings/closings that will happen. o Forecast the expected level of profits for the future period  Involves estimating expenses such as purchases, employee compensation, and taxes.  CFO should also decide what portion of these profits will likely be paid to shareholders in the form of cash dividends. o Estimate how many additional assets the firm will need to support projected sales  I.e. an increase in sales may mean more inventory is needed.  Asset intensity: the need of more assets for one business than any other business to support the same amount of sales.  The financial plan tells the CFO how much money will be needed and when it will be needed.  One of the largest business expenses is employee compensation.  Financial control: the process of comparing actual revenues, costs, and expenses with the forecasted amounts.  Short-term (current) assets: assets that can be, or are expected to be, converted into cash within a year.  Marketable securities: low-risk securities that either have short maturities or can be easily sold in secondary markets.  The cash budget shows which months the firm will have surplus cash and will be able to invest in marketable securities and which months when it will need additional cash.  Accounts receivable (A/R): uncollected credit sales which must be collected by the financial manager.  A more liberal credit policy means higher sales but also increased collection expenses, higher levels of bad debt, and a higher investment in A/R.  Management of A/R consists of: o Deciding on an overall credit policy o Deciding which customers will be offered credit  A/R turnover is a simple way of assessing how well receivable are being managed.  The cost of inventory includes the costs of ordering, storing, insuring, and financing the inventory.  Production, marketing, and logistics play important roles in determining proper inventory levels.  The inventory turnover can give early warning signs of difficulties ahead.  Long-lived assets: assets that are expected to produce economic benefits for more than one year.  Capital investment analysis: the process financial managers use when deciding whether to invest in long-lived assets.  Firms make two basic types of capital investment decisions: o Expansion (i.e. Target expanding to Canada) o Replacement (i.e. Walmart upgrading stores to supercentres)  Financial managers must estimate all the costs and benefits of a proposed investment.  One of the most important challenges in managing foreign assets is the exchange rate of the two currencies.  Accounting equation: Assets = Liabilities + Owners Equity  Looking at the equation from a management perspective shows there are only two types of funding: o Debt capital: funds obtained through borrowing. o Equity capital: funds provided by the firm’s owners when they reinvest their earnings, make additional contributions, liquidate assets, issue shares to the general public, or raise capital.  Capital structure: the mix of a firm’s debt and equity capital.  Choosing more debt in the capital structure increases the fixed costs a company must pay, which makes a company more sensitive to any chan
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