- THE ROLE OF FINANCE.
- COMPARING THE
ACCOUNTANT AND THE FINANCIAL MANAGER.
- The role of an
ACCOUNTANT is like a skilled technician who takes measures of a
companyís health and writes a report.
MANAGERS examine the data
prepared by accountants and make recommendations to top management
regarding STRATEGIES FOR IMPROVING THE COMPANYíS FINANCIAL
- A manager cannot
make sound financial decisions without understanding accounting
- The need for
careful financial management remains an ongoing challenge in a business
throughout its life.
- The MOST COMMON
WAYS FOR FIRMS TO FAIL FINANCIALLY are:
or not enough funds to start with.
- POOR CASH FLOW,
or cash in minus cash out.
- THE IMPORTANCE OF
- The text describes
a small organization called Parsley Patch, begun on a shoestring budget.
- When the owners
expanded into the health-food market, sales took off.
Neither woman understood cash flow
procedures or how to
control expenses, and profits did not materialize.
- They eventually
hired a CPA and an experienced financial manager, and soon they earned a
comfortable margin on operations.
understanding is important to anyone who wants to invest in stocks and bonds
or plan a retirement fund.
- WHAT IS
is the function in a business responsible for acquiring funds for the firm,
managing funds within the firm, and planning for the expenditure of funds on
- Without a carefully
calculated business plan, the firm has little chance for survival.
MANAGEMENT is the job of
managing a firmís resources so it can meet its goals and objectives.
organizations will designate a manager in charge of financial
operations, generally the CHIEF FINANCIAL OFFICER (CFO.)
management could also be put in the hands of the company TREASURER
or vice president of finance.
- A COMPTROLLER
is the chief accounting officer.
- The fundamental
task is to obtain money and then plan, use, and control that money
- Both CREDIT
and COLLECTIONS are important responsibilities of financial managers.
- Financial managers
are responsible for collecting overdue payments and minimizing bad debts.
- These functions are
particularly critical to small and medium-size businesses, which have
smaller cash or credit cushions.
- Financial managers
also handle TAX MANAGEMENT, the analyzing of tax implications of
various managerial decisions in an attempt to minimize the taxes paid by the
- As tax laws change,
finance specialists must carefully analyze the tax implications of various
decisions in an attempt to minimize taxes paid.
- Businesses of all
sizes must concern themselves with managing taxes.
- It is the INTERNAL
AUDITOR, usually a member of the firmís finance department, who checks
on the financial statements to make sure that all transactions are
- Without such
audits, accounting statements would be less reliable.
- It is important
that internal auditors be objective and critical of any improprieties or
- Accounting and
finance are MUTUALLY SUPPORTIVE functions in a firm.
- Financial planning
involves analyzing short-term and long-term money flows to and from the
- The major objective
of financial planning is TO OPTIMIZE PROFITS AND MAKE THE BEST USE OF
- The steps involved
in FINANCIAL PLANNING are:
- The steps
involved in FINANCIAL PLANNING are:
BUDGETS to meet those needs.
FINANCIAL CONTROL to see how
well the company is following the financial plans.
- A SHORT-TERM
FORECAST is a prediction of revenues, costs, and expenses for a period
of one year or less.
- A CASH FLOW
FORECAST is a prediction of cash inflows and outflows in future
periods, usually months or quarters.
- The inflows and
outflows of cash are based on expected sales revenues and on various
costs and expenses.
- A firm often uses
its past financial statements as a basis for projecting expected sales
and various costs and expenses.
FORECAST is a prediction of
revenues, costs, and expenses for a period longer than 1 year, sometimes
extending 5 or 10 years into the future.
- This forecast
plays a crucial part in the companyís long-term strategic plan.
- The long-term
financial forecast gives managers an idea of the income or profit
potential with different strategic plans.
- WORKING WITH THE
- A BUDGET is
a financial plan.
- A budget becomes
the primary basis and guide for the firmís financial operations.
- Most firms
compile yearly budgets from short-term and long-term financial
- There are
SEVERAL BUDGETS IN A COMPANY:
- The CAPITAL
BUDGET highlights a firmís spending plans for major assets purchased
that required large sums of money.
- The CASH
BUDGET estimates a firmís projected cash balance at the end of given
- The OPERATING
BUDGET, or MASTER BUDGET, ties together all of a firmís other
budgets; it is the projection of dollar allocations to various costs and
expenses needed to run the business.
- Financial planning
- What long-term
investments are made.
- When specific
funds will be needed.
- How the funds
will be generated.
CONTROL is a
proces in which a firm periodically compares
its actual revenues, costs, and expenses to those projected.
- Most companies hold
at least monthly financial reviews as a way to ensure financial control.
- Such controls
provide feedback to help reveal which accounts are varying from the
- Some financial
adjustments to the plan may be made.
- THE NEED FOR
- In business, the need
for operating funds never seems to cease.
- Continuous sound
financial management is essential because the CAPITAL NEEDS OF
BUSINESS CHANGE OVER TIME.
- Funds must be
available to finance specific operational needs.
- MANAGING DAILY
- Funds must be made
available to meet these daily cash expenditures without compromising the
investment potential of the firmís money.
- Money has TIME
VALUEó$200 today is more valuable that $200 a year from today.
- Financial managers
often try to keep cash expenditures to a minimum to free funds for
investment in interest-bearing accounts.
- Efficient cash
management is particularly important to small firms.
- MANAGING ACCOUNTS
- Making credit
available helps keep current customers happy and attracts new ones.
- The major problem
with credit purchasing is that as much as 25% OF A COMPANYíS ASSETS CAN BE
TIED UP IN ACCOUNTS RECEIVABLE.
- The firm needs to
use some of its available funds to pay for the goods or services already
given to customers.
- In order to collect
this money as soon as possible, financial managers offer such
INCENTIVES as cash or quantity discounts to purchasers who pay their
account by a certain time.
- One way to decrease
the time and expense of collecting accounts receivable is to ACCEPT
BANK CREDIT CARDS such as MasterCard or Visa.
- OBTAINING NEEDED
- To satisfy
customers, businesses must maintain INVENTORIES that involve a
sizable expenditure of funds.
- A carefully
constructed inventory policy assists in managing the use of the firmís
available funds and maximizing profitability.
INVENTORY may help reduce the
funds companies must use to maintain inventories.
- MAJOR CAPITAL
EXPENDITURES are major
investments in long-term assets such as land, buildings, equipment, or
purchase of major assets require huge
- It is critical
that the firm weigh all possible options before it commits a large
portion of its available resources.
managers must evaluate the appropriateness of capital expenditures.
- ALTERNATIVE SOURCES
- SHORT-TERM VERSUS
FINANCING refers to borrowed
capital that will be repaid within one year and helps finance current
FINANCING refers to borrowed
capital for major purchases that will be repaid over a specific time
period longer than one year.
- METHODS OF RAISING
- DEBT CAPITAL
refer to funds raised through various forms of
borrowing that must be repaid.
is money raised from within the firm or through the sale of ownership in
- OBTAINING SHORT-TERM
- Everyday operation of
the firm calls for careful management of short-term financial needs.
- TRADE CREDIT.
- The most widely
used source of short-term funding, trade credit, is the least expensive
and most convenient form of short-term financing.
- TRADE CREDIT
is the practice of buying
goods now and paying for them later or paying for them early and getting a
- Terms such as
"2/10, net 30" means that the buyer can take a 2 percent discount for
paying within 10 days, and the total bill is due in 30 days if the
discount is not taken.
- PROMISSORY NOTES.
- For organizations
with a poor credit rating or history of slow payment, the supplier may
insist that the customer sign a promissory note.
- A PROMISSORY
NOTE is a written contract with a promise to pay.
- FAMILY AND FRIENDS.
- It is better not to
borrow from friends and relatives.
- Entrepreneurs have
come to rely less and less on family and friends for funding.
- If you borrow from
family or friends it is best to:
- AGREE ON
SPECIFIC LOAN TERMS AT THE BEGINNING.
- PUT THE
AGREEMENT IN WRITING.
- ARRANGE FOR
REPAYMENT IN THE SAME WAY YOU WOULD A BANK LOAN.
- COMMERCIAL BANKS
AND OTHER FINANCIAL INSTITUTIONS.
- Banks are highly
sensitive to risk and often reluctant to loan money to small business.
- The most
promising ventures are sometimes able to get bank loans.
- The person in
charge of finance should keep in close touch with the bank and see the
- How much a
business borrows and for how long depend on:
- The kind of
business it is.
- How quickly the
merchandise purchased with a bank loan can be resold or used to
- Sometimes a
business gets so far into debt that the bank refuses to lend it more
- Often the
- This result can
be chalked up to cash flow problems.
- By anticipating
times when many bills will come due, a business can begin early to seek
funds and prepare for the crunch.
- A bankerís advice
at this point can help the firm.
- DIFFERENT FORMS OF
- A SECURED LOAN
is a loan thatís backed by something valuable, such as property.
- The item of value
is called COLLATERAL.
receivable can be quickly converted into cash, and are often used as
- The process of
using accounts receivable or other assets as collateral for a loan is
is the process of using inventory such as raw materials as
collateral for a loan.
- UNSECURED LOANS,
loans that are not backed by collateral, are the most difficult to
getóonly highly regarded customers are approved.
- LINE OF CREDIT
means that bank will lend the business a given amount of unsecured
short-term funds, provided the bank has the funds available.
- A line of credit
is not guaranteed.
- The purpose of a
line of credit is to speed the borrowing process.
- As businesses
mature and become more financially secure, the amount of credit often is
CREDIT AGREEMENT is a line
of credit that is guaranteed.
FINANCE COMPANIES make
short-term loans to borrowers that offer tangible assets as collateral.
finance companies are willing to accept higher degrees of risk than
- Interest rates
charged are usually higher than banks.
the process of selling accounts receivable for cash, is relatively
- A FACTOR is
a market intermediary that agrees to buy the accounts receivable from the
firm at a discount for cash.
- The factor then
collects and keeps the money that was owed the firm.
- Factoring is very
popular among small businesses.
- Factoring is not a
loanóit is the sale of an asset.
- Factoring charges
are much lower if the company assumes the risk of those accounts
who donít pay at all.
- COMMERCIAL PAPER.
- COMMERCIAL PAPER
consists of unsecured promissory notes in amounts of $25,000 and up that
mature in 270 days or less.
- Commercial paper is
unsecured and is sold at a public sale, so ONLY FINANCIALLY STABLE
FIRMS are able to sell it.
- Some large
companies are considering selling commercial paper over the Internet.
- It is an investment
opportunity for buyers who can put up cash for short periods.
- OBTAINING LONG-TERM
- The FINANCIAL PLAN
specifies the amount of funding that the firm will need over various time
periods and the most appropriate sources of those funds.
- In setting
long-term financing objectives, the firm generally asks three major
are the organizationís long-term GOALS AND
- What are the
FINANCIAL REQUIREMENTS needed to achieve these goals and objectives?
- What SOURCES
of long-term capital are available, and which best fit our needs?
CAPITAL is used to buy fixed
assets such as plant and equipment and to finance any expansions of the
- Long-term financing
usually comes from two sources: DEBT CAPITAL or
- DEBT FINANCING.
- DEBT CAPITAL
are funds that come to the firm from borrowing
through lending institutions or from the sale of bonds.
- With debt
financing, the firm has a legal obligation to repay the amount
- Long-term loans
are usually repaid within 3 to 7 years, but may extend to 15 or 20
- A TERM-LOAN
AGREEMENT is a promissory note that requires the borrower to repay
the loan in specified installments.
- A major advantage
is that interest paid on a long-term debt is tax deductible.
- LONG-TERM LOANS
are often more expensive than short-term loans because larger amounts of
capital are borrowed and the repayment date is less secure.
- Most long-term
loans require some form of COLLATERAL.
- Lenders will also
often require certain RESTRICTIONS on a firmís operations.
- The greater risk
a lender takes, the higher rate of interest it requires, known as the
- If an organization
is unable to obtain its long-term financing needs from a lending
institution, it may decide to issue bonds.
- A BOND is
a company IOU, a binding contract through which an organization agrees
to specific terms with investors in return for investors lending money
to the company.
TERMS are the terms of
agreement in a bond.
- SECURED AND
- A BOND is a
long-term debt obligation of a corporation or government.
- Investors in bonds
measure the RISK involves in purchasing a bond with the RETURN
(interest) the bond promises to pay.
- SECURED BONDS
are issued with some form of collateral, such as real estate, equipment,
or other pledged collateral, such as real estate, equipment, or other
- UNSECURED BONDS
are bonds backed only by the reputation of the organization and
bondholdersí trust in the issuer.
- EQUITY FINANCING.
- EQUITY FINANCING
comes from the owners of the firm.
- It involves selling
ownership in the firm in the form of stock, or using retained earnings the
firm has reinvested in the business.
- A business can also
seek equity financing from venture capital.
- SELLING STOCK.
- One way to obtain
need funds is to sell OWNERSHIP SHARES (STOCK) in the firm to the
- Purchasers of stock
become OWNERS in the organization.
- Shares of stock the
company decides not to offer for sale are known as
UNISSUED STOCK, or TREASURY STOCK.
- Companies can only
issue stock for public purchase if they meet requirements set by the
Security and Exchange Commission (SEC.)
- The terminology and
intricacies of selling stock to raise funds is discussed in the next
- RETAINED EARNINGS
is the profit the company keeps and reinvests in the firm.
- This is often a
MAJOR SOURCE OF LONG-TERM FUNDS.
- Retained earnings
are usually the most favored source of meeting long-term capital needs
- The company saves
interest payments, dividends, and underwriting fees.
- There is no
dilution of ownership.
- The major problem
is that many organizations do not have sufficient retained earnings.
- The hardest time
for a business to raise money is when it is just starting.
- Venture capital
firms are one of the sources of start-up capital for new companies.
- VENTURE CAPITAL
MONEY is invested in new
companies with great profit potential.
- The venture capital
industry began about 50 years ago as an alternative investment vehicle for
- The venture
capital industry grew significantly in the 1980s.
- In the 1990s,
venture capital investment increased, especially in high-tech centers.
capitalist investments have recently reached into international markets.
- Venture capitalist
investments have recently reached into international markets.
- The search for
venture capital begins with a good business plan.
- Financing a firmís
long-term needs clearly involves a high degree of risk.
- MAKING DECISIONS
ON USING LEVERAGE.
is raising needed funds through borrowing to increase the rate of return.
- While debt
increases the risk of the firm, it also enhances the firmís profitability.
- If the firmís
earnings are larger than the interest payments on the funds borrowed,
stockholders earn a higher rate of return than if equity financing were
- It is up to each
firm to determine exactly what is a proper balance
between debt and equity financing.
- The average debt of
a large industrial corporation ranges between 33 and 40% of its total
- The next chapter
looks at stocks and bonds and other investment topics.