Finance Function Management Quiz

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Questions and Answers

What is primarily involved in the finance function of a business?

Procurement and administration of funds (correct)

Developing human resources

Manufacturing products

Following marketing strategies

Which of the following is NOT a specific requirement for determining fund requirements?

Financing the purchase of inventory

Financing daily operations

Financing advertising campaigns (correct)

Financing the firm's credit services

What is essential to finance regarding daily operations?

Research and development costs

Payment of wages and salaries (correct)

Expansion into new markets

Investment in new technology

When firms extend credit to customers, what challenge arises?

Financing the credit arrangement until payment is received Signup and view all the answers

Why is maintaining adequate inventory crucial for many firms?

To meet customer demand promptly Signup and view all the answers

Where does the financing for the purchase of major assets usually come from?

Long-term sources Signup and view all the answers

Which of the following is a common source of cash inflow for a business?

Cash sales from products or services Signup and view all the answers

Which of the following expenses is NOT typically included in financing daily operations?

Research and development Signup and view all the answers

What type of financial institutions finance inventory and equipment for businesses?

Business finance companies Signup and view all the answers

Which of the following is NOT considered a long-term source of funds?

Commercial paper Signup and view all the answers

What is a key characteristic of common stocks as a source of funds?

They are cheaper and more stable Signup and view all the answers

What is one of the advantages of term loans?

They can be generated quickly Signup and view all the answers

What is a characteristic of short-term credits?

They tend to mature more frequently. Signup and view all the answers

Which of the following is NOT a source of short-term financing?

Investment banks Signup and view all the answers

Which of the following factors is NOT recommended for determining the best source of financing?

Market conditions Signup and view all the answers

What type of credit allows a customer to pay for goods delivered over a specified number of days?

Open-book credit Signup and view all the answers

What is retained earnings in a corporate context?

Earnings not paid out as dividends Signup and view all the answers

Which type of risk is insurable and involves a chance of loss only?

Pure risk Signup and view all the answers

Which source of funds allows firms to assume complete accounting responsibilities?

Factors Signup and view all the answers

Which factor can be a disadvantage of short-term financing?

It is generally more expensive than long-term financing. Signup and view all the answers

What type of short-term loan does NOT require collateral?

Unsecured loan Signup and view all the answers

What is the primary purpose of risk management?

To choose methods for dealing with risk for economic survival Signup and view all the answers

What is a characteristic of bonds as a source of funding?

They are certificates of indebtedness Signup and view all the answers

What instrument represents an unconditional promise to pay on demand?

Promissory note Signup and view all the answers

Which of the following is an example of risk shifting?

Hedging investments Signup and view all the answers

What does planned risk retention refer to?

Deliberately assuming a known risk Signup and view all the answers

Which of the following accurately describes trade creditors?

They extend credit for use in manufacturing and processing. Signup and view all the answers

Commercial paper houses primarily assist businesses with what?

Borrowing on the money market. Signup and view all the answers

Which method of dealing with risk involves reducing the potential impact of losses?

Loss reduction Signup and view all the answers

What is unplanned risk retention?

Failure to recognize and address a risk Signup and view all the answers

What is one significant advantage of short-term fund sources compared to long-term sources?

They provide more flexibility. Signup and view all the answers

What does risk refer to in the context of financing?

The chance of adverse effects from financing decisions. Signup and view all the answers

Which of the following is NOT typically considered a method for dealing with risk?

Speculation Signup and view all the answers

Which factor is NOT listed as a consideration for determining the best source of funds?

Market demand. Signup and view all the answers

What does incorporating a business achieve in terms of risk management?

Transfers responsibility for business debts Signup and view all the answers

What potential drawback may occur when new owners are introduced to a firm?

Loss of control for current owners. Signup and view all the answers

Why is it important for a firm to generate enough income when borrowing?

To meet repayment obligations and ensure profitability. Signup and view all the answers

Which of the following is NOT one of the basic financial statements?

Cash flow statement. Signup and view all the answers

What is the main objective of engineering firms?

To make profits for the owners. Signup and view all the answers

Which of the following represents a type of exposure to risk that engineers should be aware of?

Fire. Signup and view all the answers

Study Notes

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.

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Description

Test your understanding of the finance function and its critical role in managing a business's funds and operations. This quiz covers topics such as fund requirements, credit financing, and inventory management, essential for achieving corporate objectives.