Chapter 18 Financial Management The Role of Finance and Financial Managers Finance the function in a business that acquires funds for the firm and manages those funds within the firm include preparing budgets doing cash flow analysis and planning for the expenditure of funds Financial management the job of managing a firm s resources so it can meet its goals and objectives Financial managers managers who examine financial data prepared by accountants and recommend strategies for improving the financial performance of the firm o Obtain funds effectively control the use of those funds o Buying merchandise on credit collecting payment from customers o Looking at taxes Common reasons a firm fails financially undercapitalization poor control over cash flow inadequate expense control Financial Planning Financial planning means analyzing short term and long term money flows to and from the firm objective is to optimize the firm s profitability and make the best use of its money 3 steps o 1 Forecasting financial needs Short term forecast forecast that predicts revenues costs and expenses for a period of one year or less Cash flow forecast forecast that predicts the cash inflows and outflows in future periods usually months or quarters Long term forecast forecast that predicts revenues costs and expenses for a period longer than 1 year and sometimes as far as 5 or 10 years into the future o 2 Developing budgets to meet the financial needs Budget a financial plan that sets forth management s expectations and on the basis of those expectations allocates the use of specific resources throughout the firm primary guide for the firm s financial operations expected financial needs Capital budget a budget that highlights a firm s spending plans for major asset purchases that often require large sums of money Cash budget a budget that estimates cash inflows and outflows during a particular period like a month or a quarter prepared last Operating master budget the budget that ties together the firm s other budgets and summarizes its proposed financial activities most detailed o 3 Establishing financial controls Financial control a process in which a firm periodically compares its actual revenues costs and expenses with its budget The Need for Operating Funds Managing day to day needs of the business financial managers must ensure that funds are available to meet daily cash needs cash has time value offered 200 today or in a year take it today Controlling credit operations financial managers know that making credit available keeps customers happy Acquiring needed inventory just in time inventory control inventory turnover rate Making capital expenditures o Capital expenditures major investments in either tangible long term assets such as land buildings and equipment or intangible assets such at patents trademarks and copyrights How do we obtain the funds for the 4 bullet points above o Sound financial management determines the amount of money needed and the most appropriate sources to obtain it a firm can raise money through borrowing debt selling ownership equity or earning profits retained earnings o Debt financing funds raised through various forms of borrowing that must be repaid o Equity financing money raised from within the firm from operations or through the sale of ownership in the firm stock o Short term financing funds needed for a year or less Monthly expenses unanticipated emergencies cash flow problems expansion of current inventory temporary promotional programs o Long term financing funds needed for more than a year usually 2 10 New product development replacement of capital equipment mergers acquisitions expansion into new markets new facilities Obtaining Short Term Financing Trade credit the practice of buying goods and services now and paying for them later most widely used source of short term funding least expensive most convenient o Invoice bill a company receives 2 10 net 30 means the buyer can take a 2 discount for paying the invoice within 10 days otherwise the bill is due in 30 days o Promissory note a written contract with a promise to pay a supplier a specific sum of money at a definite time From friends family From commercial banks o Secured loan a loan backed by collateral something valuable such as property if the borrower fails to pay the loan the lender may take possession of the collateral Accounts receivable are company assets used as collateral for a loan called pledging a of the value of a firm s accounts receivable pledged usually 75 is advanced to the borrowing firm as customers pay off their accounts the funds received are forwarded to the lender Unsecured loan a loan that doesn t require any collateral Line of credit a given amount of unsecured short term funds a bank will lend to a business provided the funds are readily available speeds up borrowing process b c a firm does not have to apply for a new loan every time it needs one Evolving credit agreement a line of credit that s guaranteed but usually comes with a fee From commercial finance companies organizations that make short term loans to borrowers who offer tangible assets as collateral From factoring the process of selling accounts receivable for cash o A firm sells its products on credit creating accounts receivable slow at paying back bills so company doesn t have cash a factor is a market intermediary that agrees to buy the firm s accounts receivable at a discount for cash factors charge more than banks loan rates but many small businesses don t qualify for bank loans Large businesses can get short term loans from commercial paper unsecured promissory notes of 100 000 and up that mature come due in 270 days or less states a fixed amount of money the business agrees to repay the lender on a specific date at a specified rate of interest Credit cards Obtaining Long Term Financing Debt financing by borrowing from lending institutions o Term long agreement a promissory note that requires the borrower to repay the loan with interest in specified monthly or annual installments advantage interest is tax deductible o Risk return trade off the principle that the greater the risk a lender takes in making a loan the higher the interest rate required Debt financing by issuing bonds o A bond is like an IOU with a promise to repay the amount borrowed which interest on a certain date o Indenture terms the terms of agreement in a bond issue o Secured bond a bond issued with some form of collateral o Unsecured
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