Finance Function Management Quiz

Managing the Finance Function

• The finance function involves the procurement and administration of funds to achieve business objectives.
• It is one of three fundamental management functions, alongside production and marketing.

Determination of Fund Requirements

• Specific requirements include financing daily operations, firm's credit services, inventory purchases, and major purchases.
• Daily operations financing covers wages, salaries, rent, taxes, power, light, marketing expenses (advertising, entertainment, travel, phone, telegraph, stationary, printing, postage), and administrative expenses (auditing).

Financing the Firm's Credit

• Firms often need to extend credit to customers.
• This is especially true in construction, where government projects may take months to pay.
• Financing these longer-term credit arrangements creates a new challenge.

Financing the Purchase of Inventory

• Maintaining adequate inventory is crucial for many firms.
• Raw materials, supplies, and parts must be stored for availability when needed.
• Sufficient funding is necessary to acquire the needed inventory.

Financing the Purchase of Major Assets

• Companies sometimes require major asset purchases.
• Major asset investments are often prompted by expansion decisions made by top management.
• Long-term funding sources are typically needed for these purchases.

The Sources of Funds

• Cash inflows come from various sources: cash sales, collecting accounts receivables, loans and credits, selling assets, owners' contributions, and advances from customers.

Short-Term Sources of Funds

• Short-term loans and credits are easier to obtain and often less costly.
• They offer flexibility to borrowers.
• However, short-term debts can sometimes be more expensive than long-term ones due to their frequent repayment schedules.
• Short-term financing sources include trade creditors, commercial banks, commercial paper houses, finance companies, factors, and insurance companies.

Trade Creditors

• Suppliers granting credit to buyers for manufacturing, processing, or reselling goods.
• Instruments used in trade credit include open-book credit, trade acceptance, and promissory notes.
• Open-book credit operates without collateral, allowing the buyer to pay within a certain timeframe.
• Trade acceptance is a form of credit whereby payment or the promise thereof is transferred to the seller.
• Promissory notes are written promises made by one party to another promising payment in the future.

Commercial Banks

• Banks are institutions that individuals and firms can use for short-term financing.
• Types of short-term loans from banks include those requiring collateral and those not requiring collateral.

Commercial Paper Houses

• These intermediaries facilitate businesses borrowing money from the money market.
• Large, established companies issue commercial papers to assist firms needing funds.

Business Finance Companies

• Financial institutions financing inventory and equipment for businesses of all types and sizes.

Factors

• Firms that purchase accounts receivables for businesses, handling accounting and collection responsibilities.

Insurance Companies

• Insurance companies can also be sources of short-term funds.
• Philippine insurance companies invest in short-term commercial papers and promissory notes.

Long-Term Sources of Funds

• Long-term funding sources include long-term debts, common stocks, and retained earnings.
• Long-term debts are categorized into term loans and bonds.

Term Loans

• Term loans are commercial or industrial loans from banks, often used for plant and equipment or debt repayment.
• Term loans typically mature in 2 to 30 years.
• They offer quicker generation of funds, flexibility, and cost-effectiveness compared to other long-term sources.

Bonds

• Bonds are certificates of indebtedness issued by a corporation to a lender.
• They are marketable securities that raise funds for the corporation.
• Types of bonds include debentures, mortgage bonds, collateral trust bonds, guaranteed bonds, subordinated debentures, convertible bonds, bonds with warrants, and income bonds. Bond characteristics differentiate them.

Common Stocks

• One source of long-term funds is the issuance of common stock.
• Common stock offers potential affordability and stability as a long-term financing option.
• Importantly, common stocks lack fixed maturity and repayment dates.

Retained Earnings

• Retained earnings are reinvested corporate profits that are not paid out as dividends.

The Best Source of Financing

• Determining the best source of financing requires a consideration of factors like flexibility, risk, income, control, and timing, as well as other factors like collateral values, flotation costs, speed and exposure.

Flexibility

• Some financing sources place restrictions on a borrower's actions.
• Short-term funds often provide more flexibility compared to long-term options.

Risk

• Risk relates to potential adverse effects when choosing a particular financing source.
• Short-term debt usually poses more risk to borrowers than long-term debt.

Income

• Borrowers must ensure sufficient income generation to cover financing costs while maintaining returns for owners.

Control

• New owners may dilute the control of current owners if new investors are introduced due to a need for capital.

Timing

• Specific financing methods can yield advantages under particular circumstances.
• The optimal time for using particular financing methods depends on market conditions.

Other Factors

• Crucial factors in choosing the best funding source include available collateral values.
• Costs for issuing bonds or stocks, the speed of fund raising, and the level of exposure to other parties.

The Firm's Financial Health

• Engineering firms aim for profit maximization, creditor satisfaction, and consistent operations.

Indicators of Financial Health

• Financial health assessments hinge on the evaluation of three crucial statements—the balance sheet (or statement of financial position), the income statement (or statement of operations), and the statement of changes in financial position.

Risk Management

• Risk management structures strategies for protecting and conserving assets and personnel.
• Managing risk involves intelligently choosing among various methods for dealing with risks.

Types of Risk

• Risks are classified as pure or speculative.
• Pure risks entail only a potential for loss, and speculative ones have possibilities for both loss and gain.

Risk Retention

• Risk retention is the firm's decision to take on the risk itself.
• Planned risk retention (self insurance) involves consciously and deliberately assuming the risk, whereas unplanned retention arises from failing to recognize and accept the risk.

Risk Reduction Efforts

• Loss reduction practices include using fireproof building materials, storing inventory in multiple locations, maintaining multiple records, transporting goods in separate vehicles, and limiting liability by employing different corporations.

Risk Shifting

• Risk shifting techniques include hedging, subcontracting, incorporation, and insurance.