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Chapter 20

RSM100Y1 Chapter Notes - Chapter 20: Promissory Note, Credit Risk, Commercial Paper

Rotman Commerce
Course Code
John Oesch

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RSM 100Y Chapter 20: Financial Decisions and Risk Management
Role of the Financial Manager
Managers responsible for the planning and controlling of the acquisition and
dispersal of the companies financial assets, with 4 duties:
- Determining a firm’s long-term investments
- Obtaining funds to pay for those investments
- Conducting the firm’s every day financial activities
- Helping to manage the risks that the firm takes
Objectives of the Financial Manager is to INCREASE a FIRM’S VALUE
Responsibilities of the Financial Managers
Cash Flow Management
Managers must ensure that it always has enough funds to purchase the
materials and human resources needed in production. Any cash that is not
needed immediately should be invested.
Financial Control
Process of checking actual performance against plans to ensure that the
desired financial status occurs (adjustments made daily to financial
Financial Planning
Firm’s strategies for reaching a future financial position, answering:
- What amount of funds does the company need for immediate plans?
- When will it need more funds?
- Where can it get the funds to meet short/long-term needs?
Short-Term Fund Needs (Operating Expenditures)
Accounts Payable
Unpaid bills, taxes due, wages All known before hand
Accounts Receivable
Customers who have bought on credit, must know their payment schedule
This prediction is a function of “Credit Policy”
Raw Materials, Work-in-process inventory (unfinished goods) and finished goods
Working Capital (= Current Assets – Current Liabilities)
20 cents of every sale is tied up into this; reducing Working Capital – saves cash
Long-Term Fund Needs (Capital Expenditures)
Used in the purchase of fixed assets like factories or machinery; differ from ST:
- Long-term assets are not normally sold or converted into cash
- Their acquisition requires large investment
- Binding commitment of company funds into the future
- Usually much more carefully planned than short-term expenditures
Sources of Short-Term Funds
Trade Credit
Credit extended to a buying firm from a selling firm (a short term loan)
- Open Book Credit (Most Common)
oBased on faith of payment, an invoice is shipped w/ credit terms
- Promissory Notes
oBuyers sign an agreement of payment
- Trade Draft (Used for international Transactions
oSimilar to promissory note, outlines date and amount due
oMust be signed before items can be received
oBecomes a “trade acceptance” once signed
Secured Short Term Loans
The borrower must put up collateral (seizable assets) in case of default.
Most short term loans secured by inventory or accounts rec.
Inventory Loans
Inventory is used as collateral, only useful if inventory is liquid
Accounts Receivable as Collateral
Known as pledging accounts receivable (Useful to service firms)
Factoring Accounts Receivable
Selling the firms accounts receivable, with the buyer being known
as a “factor” for a percentage of the total value of AR
Unsecured Short-Term Loans
No collateral needed, but sometimes banks require a compensating balance (a
portion of the loan) must remain in deposit with the bank at all times
Lines of Credit Agreement for a bank to lend a firm X$ at any time
Revolving Credit Similar to credit card, must pay interest and annual fees
Commercial paper Sells unsecured notes at discount, and rebuys at par
Usually 270 days, but can be less
Sources of Long-Term Funds
Debt Financing
Raising money by borrowing outside of company through loans & bonds
Long-Term Loans
Usually gotten from a chartered bank, attractive because
oFew parties involved allowing for quick loan arrangements
oNo need for public disclosure of financial standing (Bonds do)
oThe duration of the loan is flexible
oAs needs change, loan terms can usually change
Large borrows may find it hard to get a lender
May have restrictions placed on them as conditions
May have to pledge long-term assets as collateral
May agree to take on no more debt until loan is paid off
Interest Rates: Negotiated, usually @ Prime +1
Contract like Commercial Paper; it’s a promise to pay a certain
amount of money on a certain date, usually in 30 years
Bond Indenture
Terms of the corporate bond (rate, maturity, assets in collateral)
Equity Financing
Raising money through issuing common stock or retained earnings
Common Stock
Profits through appreciation and dividends (rare)
They have voting control usually for no dividends
Expensive because paying bond interest is cheaper than
paying dividends which are NOT TAX DEDUCTIBLE
Retained Earnings
These are profits not paid out in dividends, and can be used to
reinvest within the company to improve profits
Financial Burden on the Firm
Debt Financing is most appealing to firms who have predictable profits
and cash flow patterns. Otherwise, the fixed interest rate of bonds do not
offer flexibility that stocks do in bad economic times.