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Chapter 17

RSM100Y1 Chapter Notes - Chapter 17: Chief Executive Officer, Inventory Turnover, Financial Statement


Department
Rotman Commerce
Course Code
RSM100Y1
Professor
John Oesch
Chapter
17

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Chapter 17: Financial Management
Overview
Basic functions that a business must perform:
1. The company must produce a good or service or contract with suppliers to produce a
good or service.
2. The firm must market its good or service to prospective customers.
3. A companys managers must ensure that the company has enough money to perform
its other tasks successfully, in both the present and the future, and that these funds are
invested properly.
oThe company must have enough funds to buy materials, equipment, and other
assets; pay bills; and compensate employees.
oFinance: The business function of planning, obtaining, and managing the
company’s funds to accomplish its objectives as effectively and efficiently as
possible.
An organization’s financial objectives include meeting expenses, investing in assets, and
maximizing its overall worth, which is often measured by the value of the firm’s common
shares.
oFinancial managers are responsible for the above tasks.
The Role of the Financial Manager
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.
oThey are among the most vital people on the corporate payroll.
The Financial Organization at a Typical Firm
1. Chief Executive Officer (CEO)
2. Chief Financial Officer (CFO)
oThe CFO usually reports directly to the company’s CEO or chief operating officer
(COO).
oIn some companies, the CFO is also a member of the board of directors.
oThe CFO and CEO must both certify the accuracy of the firm’s financial
statement.
3. Vice-President of Financial Planning/Management, Treasurer, Controller
oThese 3 senior managers often report directly to the CFO.
oThe vice-president of financial management/planning is responsible for preparing
financial forecasts and analyzing major investment decisions related to new
products, new production facilities, and acquisitions.
oThe treasurer is responsible for all of the companys financing activities, including
cash management, tax planning and preparation, and shareholder relations; also
works on the sale of new security issues to investors.
oThe controller is the chief accounting manager. The controller’s functions include
keeping the company’s books, preparing financial statements, and conducting
internal audits.
The growing importance of financial professionals is reflected in the number of CEOs
who have been promoted from financial positions and in CFOs’ salaries.
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Financial professionals continually balance risks with expected financial returns.
oRisk is the uncertainty of gain or loss; return is 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 their firm’s
shareholders by striking the right balance between risk and return.
oFinancial managers’ job.
Financial managers must adapt to changes in the financial system and to internal changes.
Financial Planning
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.
oOperating plans are short-term financial plans that focus on no more than a year
or two in the future.
oStrategic plans are financial plans that have a much longer time horizon, up to 5
or 10 years.
A financial plan is based on forecasts of several items: production costs, purchasing
needs, plant and equipment expenses, and sales activities for the period covered.
Financial managers use forecasts to decide on the specific amounts needed and the timing
of expenses and receipts. They build a financial plan based on the answers to 3 questions:
1. What funds will the firm require during the planning period?
2. When will the firm need additional funds?
3. Where will the firm obtain the necessary funds?
The financial plan must reflect both the amounts and timing of inflows and outflows of
funds.
Preparing a financial plan consists of 3 steps:
1. A forecast of sales or revenue over some future time period.
oKey variable
2. The CFO uses the sales forecast to decide on the expected level of profits for future
periods.
oThis long-term projection involves estimating expenses such as purchases,
employee compensation, and taxes.
3. The CFO needs to estimate how many additional assets the firm will need to support
the projected sales.
oAsset Intensity: Some businesses need more assets than other businesses to
support the same amount of sales.
oManufacturing is a more asset-intensive business than retailing.
One of the largest business expenses is employee compensations.
A good financial plan also includes Financial Control: the process of comparing actual
revenues, costs, and expenses with the forecasted amounts. This comparison may show
differences between projected and actual figures.
Managing Assets
Assets consist of what a firm owns and represent uses of funds.
Short-Term Assets
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oAKA current assets: consist of cash and assets that can be, or are expected to be,
converted into cash within a year, including, cash, marketable securities, accounts
receivable, and inventory.
oCash and Marketable Securities
Major purpose of cash is to pay for day-to-day expenses.
Most firms invest their excess cash in market securities, which are low-
risk securities that either have short maturities or can be easily sold in
secondary markets.
Money market instruments are popular choices for firms that have excess
cash.
The cash budget is one tool for managing cash and marketable securities.
It shows expected cash inflows and outflows for a period of time.
Critics of some companies’ budgeting practices argue that some firms
hoard cash.
oAccounts Receivable
They are uncollected credit sales, can represent a significant asset.
The financial manager’s job is to collect the funds owed to the firm as
quickly as possible, while still offering sufficient credit to customers to
attract and generate increased sales.
A more liberal credit policy means higher sales but also increased
collection expenses, higher levels of bad debt, and a higher investment in
accounts receivable.
Management of accounts receivable is composed of 2 functions: deciding
on an overall credit policy and deciding which customers will be offered
credit. The overall credit policy is often the result of competitive pressures
or general industry practices.
One simple tool for assessing how well receivables are being managed is
to calculate the accounts receivable turnover over two or more time
periods in a row.
Shows signs of slowing, then credit customers are paying later.
oInventory Management
For many firms, such as retailers, inventory represents the largest single
asset.
Even for nonretailers, inventory is an important asset.
The cost of inventory includes: cost of acquiring goods, costs of ordering,
storing, insuring, and financing inventory.
Businesses take on the costs of stock-outs and the costs of lost sales due to
insufficient inventory.
Financial managers try to minimize the cost of inventory.
Inventory turnover ratio.
Capital Investment Analysis: The process financial mangers use when deciding whether
to invest in long-lived assets.
oLong-lived assets are expected to produce economic benefits for more than 1 year,
involved large amounts of money.
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