Chapter 18: Financial Management

Chapter 18: Financial Management

• Finance: The function within a business responsible for acquiring and managing funds. Core activities include preparing budgets, analyzing cash flow, and planning for expenditures.

Role of Finance and Financial Managers

• Financial Management: The process of managing a firm's resources to achieve its goals and objectives.
• Financial Managers: Analyze financial data and create strategies to improve financial performance.
• Accountants: Prepare financial reports about the company's health. Financial managers interpret these reports and make recommendations. Financial managers are responsible for obtaining funds and effectively using them.
• Financial Manager Duties (Figure 18.1): Planning, Auditing, Budgeting, Obtaining funds, Controlling funds (Cash management), Managing taxes, Advising top management on financial matters, Collecting funds (Credit management).

The Value of Understanding Finance

• Reasons for Business Failure: Undercapitalization, poor cash flow control, and inadequate expense control are common reasons firms fail financially.
• Financial Management's Role: Financial managers are responsible for paying bills, collecting overdue payments, and staying current with changes in finance (e.g., tax laws).

Financial Planning

• Overview: Analyzing short-term and long-term money flows into and out of the company.
• Key Steps:
  • Forecasting short-term and long-term financial needs.
  • Creating budgets to meet those needs.
  • Establishing financial controls to ensure the company meets its goals.
• Forecasting Financial Needs (Figure 18.7): Short-term forecasts cover one year or less, analyzing revenues, costs, and expenses; cash flow forecasts predict future cash movements (monthly or quarterly). Long-term forecasts are for periods longer than a year, sometimes up to five or ten years.

Working with the Budget Process

• Budgets: Management expectations and resource allocation within the firm. Budgets are linked to the balance sheet, income statement, cash flow statements, and financial forecasts.
• Budget Effectiveness: Accurate forecasts are crucial for effective budgets. Budgets guide financial operations and anticipated needs.

Establishing Financial Controls

• Financial Control: Regularly comparing actual revenues, costs, and expenses against the budget.
• Financial Reviews: Companies typically hold monthly financial reviews to identify variances and take corrective actions.

The Need for Operating Funds

• Key Needs: Managing daily business needs, meeting short-term obligations, controlling credit operations, handling deferred payments and credit cards, acquiring inventory (e.g., Just-in-Time inventory).
• Capital Expenditures: Major investments in tangible long-term assets (land, buildings, equipment) or intangible assets (patents, trademarks, copyrights).

Alternative Sources of Funds

• Equity Financing: Money raised within the firm from operations or through the sale of ownership (stock or venture capital).
• Debt Financing: Funds raised through borrowing; must be repaid. This includes short-term and long-term financing (funds needed for a year or less, and more than a year, respectively).

Obtaining Short-Term Financing

• Trade Credit: Buying goods and services now, paying later. Business often use terms like 2/10, net 30 (2% discount if paid within 10 days, net 30 days for full payment).
• Promissory Note: An agreement to pay a supplier a specific amount at a definite time. Can be sold to a bank at a discount.
• Family and Friends: Short-term financing from family or friends. Important to agree to specific terms, put the agreement in writing, and arrange repayment.
• Commercial Banks: Loans to larger established businesses; secured or unsecured loans based on collateral provided.
• Factoring Accounts Receivable: Selling accounts receivable for cash.

Obtaining Long-Term Financing

• Debt Financing (Borrowing): Long-term loans typically due within 3-7 years, potentially up to 15-20 years; term loan agreement specifying installments. Major advantage is tax-deductible interest. Risk/return trade-off.
• Debt Financing (Issuing Bonds): Like an IOU with a promise to repay the amount borrowed with interest on a specific date; secured bonds use collateral (real estate), unsecured bonds (debentures) depend on the issuer's reputation.
• Equity Financing:
  • Selling stock
  • Retained earnings
  • Venture capital (money invested in new or emerging companies).

Debt vs. Equity Financing (Figure 18.6)

• Debt: Management influence is usually limited; debt has a maturity date; the principal must be repaid; interest is a contractual obligation and tax-deductible.
• Equity: Common stockholders have voting rights; stock has no maturity date; the company isn't required to repay equity itself; the firm doesn't have legal liability to pay dividends but dividends are paid from after-tax income and not deductible.