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Chapter 17

RSM100Y1 Chapter Notes - Chapter 17: Financial Plan, Investment, Commercial Paper


Department
Rotman Commerce
Course Code
RSM100Y1
Professor
M.Khan
Chapter
17

Page:
of 6
Chapter 17 Financial Management
17.1 The Role of the Financial Manager
-Finance: business function of planning, obtaining, and managing the company’s funds to accomplish
its objective as effectively and efficiently as possible
-Financial managers: executives who develop and carry out their firm’s financial plan and decide on
the most appropriate sources and uses of funds
-Vice-president of financial planning: prepares financial forecasts and analyzes major investment
decisions related to new products, new production facilities, and acquisitions
-Treasurer: responsible for all of the company’s financing activities, including cash management, tax
planning and preparation, and shareholder relations; also works on the sale of new security issues to
investors
-Controller: chief accounting manager; keeping the company’s books, preparing financial statements,
and conducting internal audits
-Risk-return trade-off: process of maximizing the wealth of the firm’s shareholders by striking the right
balance between risk and return
- The more money a firm borrows, the greater the risk to shareholders
- Firms that fail to invest their surplus funds in an income-earning asset, such as securities, reduce their
potential return or profitability
17.2 Financial Planning
-Financial plan: 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) and strategic plans (long-term)
-> Based on forecasts of production costs, purchasing needs, plant and equipment expenses, and
sales activities for the period covered
- A financial plan consists of three steps
1) Forecast of sales or revenue over some future time period
2) CFO uses sales forecast to decide on the expected level of profits for future periods; involves
estimating expenses such as purchases, employee compensation, and taxes
3) Estimation of how many additional assets the firm will need to support the projected sales
- One of the largest business expenses is employee compensation
-Financial control: process of comparing actual revenues, costs, and expenses with the forecasted
amounts; may show differences between projected and actual figures
17.3 Managing Assets
- Short-Term Assets
-> Also called current assets; consist of cash and assets that can be converted into cash within a year
-> Major current assets = cash, marketable securities, accounts receivable, and inventory
-> Cash and Marketable Securities
-> Marketable securities: low-risk securities that either have short maturities or can be easily
sold in
secondary markets; can easily be converted into cash
-> Accounts Receivable
-> Accounts receivable are uncollected credit sales
-> Decides on an overall credit policy -> will the firm offer credit and, if so, what terms of credit
to offer
-> Decides which customers will be offered credit -> consider customer’s repayment history
-> Inventory Management
-> Inventory represents the largest single asset
-> Cost of inventory includes cost of acquiring goods, ordering, storing, insuring, and financing
inventory
-> Businesses take on the costs of stock-outs and the costs of lost sales due to insufficient
inventory
- Capital Investment Analysis
-> The process financial managers use when deciding whether to invest in long-lived assets
-> Two types of capital investment decisions: expansion and replacement
-> Expansion -> Ex. Target taking over Zellers
-> Replacement: involves upgrading assets by substituting new assets for older assets
- One of the most important challenges in dealing with managing international assets is dealing with
exchange rates
17.4 Sources of Funds and Capital Structure
-Assets = Liabilities + Owners’ equity
-Debt capital: consists of funds obtained through borrowing
-Equity capital: consists of 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 from
outside vendors
-Capital structure: mix of a firm’s debt and equity capital
- Debt is frequently the least costly method of raising additional financing dollars
- Leverage and Capital Structure Decisions
-> Leverage: increasing the rate of return on funds invested by borrowing funds
-> Key to managing leverage is to ensure that a company’s earnings remain larger than its interest
payments
-> Problem with heavy reliance on borrowed funds is a reduction in management’s flexibility in future
financing decisions
-> Equity capital = more expensive; dividends paid to shareholders are not tax-deductible
- Mixing Short-Term and Long-Term Funds
-> Short-term funds = current liabilities; less expensive but more risk
-> Need to be renewed frequently and interest rates = unstable
-> Long-term funds = long-term debt and equity;
-> Long-term funds used to finance both long-term and short-term assets
- Dividend Policy
-> Dividend: periodic cash payments to shareholders; not reinvested in the firm and doesn’t contribute
to equity capital
-> Regular dividend: paid quarterly and most common type
-> Company considers firms investment opportunities
-> Numerous investment opportunities = little/no dividends (finance through equity funding)
-> Limited investment opportunities = more earnings in dividends
-> Share buy-backs raise the market value of remaining shares; benefits shareholders
17.5 Short-Term Funding Options
- Short-term funds repaid within one year
- Trade Credit
-> Trade credit: extended by suppliers when a firm receives goods or services and agrees to pay for
them at a later date
-> Easy availability
- Short-Term Loans
-> Commercial banks = large source
-> Two types of short-term bank loans
-> Lines of credit: max amount firm can borrow over a period of time; bank has no obligation to
lend
-> Revolving credit agreement: guaranteed line of credit; guarantees available funds when
needed