Financial Management PDF

Financial Management  After ending of this chapter you will be able to: Sl. No. Learning Outcomes CLO 1 Define finance and explain its role within the firm. CLO 3, 4 2 Identify the reasons firms need cash and why...

Financial Management  After ending of this chapter you will be able to: Sl. No. Learning Outcomes CLO 1 Define finance and explain its role within the firm. CLO 3, 4 2 Identify the reasons firms need cash and why financial CLO 3, 4 management is important. 3 Discuss the different sources of funds available to a firm. CLO 3, 4 4 Compare the different types of short and long-term CLO 3, 4 financing. 5 Identify the specific duties of the financial manager. CLO 3, 4 1-2  LO1 CLO3, 4 Defining Finance Finance is the study of money within the firm. It is also the functional area with responsibility for managing corporate funds. To function, the firm must have adequate funding, and the finance department manages these funds by developing and monitoring the firm’s financial plan. This plan should include balancing the monthly inflows and outflows of funds determining liquid investments for excess funds, finding efficient outside sources for funds, and properly monitoring and controlling the process.  LO2 CLO3, 4 Planning for Cash Flow Firms need cash to fund the cost of daily operations, to handle the cost of the firm’s credit service, to handle the cost of the firm’s inventory, to purchase major assets, to service the firm’s debt, and to pay dividends. Financial management is important to this process because the financial manager not only determines the future uses of funds but also identifies the most efficient sources of these funds. The financial manager makes it possible for the firm to function uninterrupted and efficiently.  LO3 CLO3, 4 Sources of Funds The firm has several sources of funds. The most obvious is the revenue generated from daily operations. When additional cash is needed, the firm should use short-term sources for short-term needs and long-term sources for long-term needs. Short-term sources of funds include debt capital: trade credit; family and friends; commercial bank loans (secured and un-secured), lines of credit, factoring of accounts receivable, and floor planning; commercial paper; and internal funds management. Long-term sources include long-term loans, bonds, and equity financing. Equity capital includes retained earnings, additional contributions of current owners, the sale of partnerships, and the sale of public stock issues.  LO4 CLO3, 4 Short-Term Financing For short-term financing, unsecured commercial bank loans may be preferred, but are often difficult to get. Many businesses must secure the loan with some form of collateral, a situation which ties up the property used as collateral until the loan is paid off. Loans from family and friends can be a problem, unless they are handled as a legal loan obligation complete with written and agreed-upon terms. Trade credit should always be used, since this is like an interest free loan, Commercial paper will generally only be available as an option to large companies. Factoring accounts receivable poses a danger because it is expensive and negatively impacts the reputation of the firm.  LO4 CLO3, 4 Long-Term Financing For long-term sources, long-term loans are perhaps the easiest to execute, although they may require relatively high rates of interest. For small amounts, they make sense. Bonds are better for larger amounts, due to the more favorable terms, although only larger firms can issue these. The firm needs to prepare for the date the bonds come due. Long- term debt financing also provides leverage. Equity financing has the advantage of not requiring interest or repayment; however, it reduces the return of profits to current owners and may require some sharing of ownership responsibility.  LO5 CLO3, 4 Duties of the Financial Manager The financial manager is responsible for maintaining the proper flow of funds. To accomplish this, he or she must manage uses of funds, help find sources of funds, find appropriate investments for excess cash, and manage the company’s working capital and capital budgeting processes. The financial manager must also develop appropriate financial controls. Questions for Discussion and Review 1. Why does a manager need to understand the concept of cash flow? 2. What is the difference between short-term and long-term financing? 3. What sources of funds would a new-business owner count on to sustain the business? 4. If you were opening a new business, what should you consider relative to needed start-up capital? be as specific as possible. 5. List the steps in the financial planning process. Explain why each of these steps is necessary. 6. Explain internal funds management. How can it be used to generate funds? Questions for Discussion and Review 7. What is a corporate bond? What are the different types of bonds discussed in the text? Are there any concerns a firm should have when it issues bonds? If so, what are they? 8. What are the responsibilities of the financial manager of the firm? 9. Name the different types of equity financing. What are the advantages or disadvantages of each? 10. Why would a lender decide to offer unsecured loans rather than demand collateral?