Managing The Finance Function PDF

Managin g The Finance Function ENGR. MARY KAYE PAQUIBOT WHAT IS THE FINANCE FUNCTION? The Finance Function deals with the "procurement and administration of funds with the view of achieving the objectives of business....

Managin g The Finance Function ENGR. MARY KAYE PAQUIBOT WHAT IS THE FINANCE FUNCTION? The Finance Function deals with the "procurement and administration of funds with the view of achieving the objectives of business. The finance function is one of the three basic management functions. The other two are production and marketing.  THE DETERMINATION OF FUND The following specific requirements: REQUIREMENTS 1. to finance daily operations 2. to finance the firm's credit services 3. to finance the purchase of inventory Financing Daily Operations Money must be made available for the payment of the following: 1. wages and salaries 2. rent 3. taxes 4. power and light 5. Marketing expenses like those for advertising, entertainment, travel expenses, telephone and telegraph, stationery and printing, postage, etc. 6. Administrative expenses like those for auditing, Financing the Firm's CreditIt Services is oftentimes unavoidable for firms to extend credit to customers. Construction firms will have to finance the construction of government projects that will be paid many months later. A new problem will be created, i.e., how the credit arrangement will be financed. Financing the Purchase of Inventory The maintenance of adequate inventory is crucial to many firms. Raw materials, supplies, and parts are needed to be kept in storage so they will be available when needed. The purchase of adequate inventory will require sufficient funding and this must be secured. Financing the Purchase of Major Asset Companies, at times, need to purchase major assets. When top management decides on expansion, there will be a need to make investments in capital assets. It is obvious that the financing of the purchase of major assets must come from long-term sources.  THE SOURCES OF Various sources of cash inflows: SUMMARY: FUNDS 1. Cash sales – from products or services. 2. —Collection Engineering of activities need to Accounts be managed and Receivables – from settling engineers are sometimes placed in positions where of extended they have to credit from. learn management skills. 3. — Loans andmanagers Successful Credits become – from possible borrowing. only if 4. those having the ability and motivation are given Sale of assets - from the sale of the company's the opportunity to manage. assets. 5. Ownership contribution – from owners of the firm. 6. Advances from customers – from cash advances. Short-Term Sources of Funds Loans and credits may be classified as short-term, medium-term, or long-term. Advantages of Short-Term Credits 1. They are easier to obtain. 2. Short-term financing is often less costly. 3. Short-term financing offers flexibility to the borrower. Disadvantages of Short-Term Credits 1. Short-term credits mature more frequently. 2. Short-term debts may, at times, be more costly than long-term debts.  SUPPLIES OF SHORT-TERM FUNDS Short-term financing is provided by: 1. trade creditors 2. commercial banks 3. commercial paper houses 4. finance companies 5. factors 6. insurance companies  Trade Creditors - refer to suppliers extending credit to a buyer for use in manufacturing, processing, or reselling goods for profit. The instruments used: 1. open-book credit 2. trade acceptance 3. promissory notes Open-book Credit is unsecured and permits the customer to pay for goods delivered to him in a specified number of days. Trade Acceptance is a time draft drawn by a seller upon a purchase payable to the seller as payee, and accepted by the purchaser as evidence that the goods shipped are satisfactory and that the price is due and payable. Promissory Note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay, on demand. COMMERCIAL BANKS - are institutions which individuals or firms may tap as source of short-term financing. Two types of short-term loans: 1. those which require collateral 2. those which do not require collateral COMMERCIAL PAPER HOUSES - are those that help business firms in borrowing funds from the money market. The business firm in need of funds issues a commercial paper and issued by large, established firms. BUSINESS FINANCE COMPANIES - are financial institutions that finance inventory and equipment of almost all types and sizes of business firms. FACTORS - are institutions that buy the accounts receivables of firms, assuming complete accounting and collection responsibilities. INSURANCE COMPANIES - are also possible sources of short-term funds. Philippines regularly make investments in: 1. short-term commercial papers 2. promissory notes  LONG-TERM SOURCES OF FUNDS Classified as follows: 1. long-term debts 2. common stocks 3. retained earnings Long-term debts are sub-classified into: 1. term loans 2. bonds TERM LOANS - is a "commercial or industrial loan from a commercial bank, commonly used for plant and equipment, working capital, or debt repayment.“ - Maturities of 2 to 30 years. The advantages of term loans : 1. Funds can be generated more quickly than other long-term sources. 2. They are flexible, i.e., they can be easily tailored to the needs of the borrower. 3. The cost of issuance is low compared to other long- term sources. BONDS - is a certificate of indebtedness issued by a corporation to a lender. - It is a marketable security that the firm sells to raise funds. COMMON STOCKS - The third source of long-term funds consists of the issuance of common stocks. - Common stocks can be cheaper and more stable sources of long-term funds. - Common stocks do not have maturity and repayment dates. RETAINED EARNINGS - refer to corporate earnings not paid out as dividends. - earnings that are due to the stock- holders of a corporation are reinvested.  THE BEST SOURCE OF To determine the best source, Schall and Haley FINANCING recommends that the following factors must be considered: 1. Flexibility 2. Risk 3. Income 4. Control 5. Timing 6. Other factors like collateral values, flotation costs, speed, and exposure. FLEXIBILITY - Some fund sources impose certain restrictions on the activities of the borrowers. - As some fund sources are less restrictive, the flexibility factor must be considered. - Short-term fund sources offer more flexibility than long- term sources. RISK - refers to the chance that the company will be affected adversely when a particular source of financing is chosen. - Short-term debt "subjects the borrowing firm to more risk than does financing with long-term debt.“ INCOME - When the firm borrows, it must generate enough income to cover the cost of borrowing and still be left with sufficient returns for the owners. CONTROL - When new owners are taken in because of the need for additional capital, the current group of owners may lose control of the firm. TIMING - There are times when certain means of financing provide better benefits than at other times.  Other Factors Factors considered in determining the best source of SUMMARY: funds: — Engineering activities need to be managed and 1. Collateral values: Are there assets available as engineers are sometimes placed in positions where collateral? they have to learn management skills. 2. — Flotation Successful cost: Howbecome managers much possible will it cost only to if issue bonds those having the ability and motivation are given or stocks? the opportunity to manage. 3. Speed: How fast can the funds required be raised? 4. Exposure: To what extent will the firm be exposed to other parties?  THE FIRM'S FINANCIAL The objectives of engineering firms are as follows: HEALTH 1. to make profits for the owners; 2. to satisfy creditors with the repayment of loans plus interest; 3. to maintain the viability of the firm so that customers will be assured of a continuous supply of products or services, employees will be assured of employment, suppliers will be assured of a market, etc.  INDICATORS OF FINANCIAL Three basic financial statements: 1. HEALTH Balance sheet —also called statement of financial position; 2. Income statement - also called statement of operations; 3. Statement of changes in financial position. RISK MANAGEMENT AND Risk is a very important concept that the engineer INSURANCE manager must be familiar with. Risk refers to the uncertainty concerning loss or injury. List of exposure to risks: 1. Fire 2. Theft 3. Floods 4. Accidents 5. Nonpayment of bills by customers (bad debts) 6. Disability and death 7. Damage claim from other parties.  Types of Risk Risks may be classified as either pure or speculative. Pure risk is one in which "there is only a chance of loss.“ Pure risks are insurable and may be covered by insurance. Speculative risk is one in which there is a chance of either loss or gain. This type of risk is not insurable. WHAT IS THE RISK MANAGEMENT? Risk management is "an organized strategy for protecting and conserving assets and people." The purpose of risk management is “to choose intelligently from among all the available methods of dealing with risk in order to secure the economic survival of the firm" Methods of Dealing with Risk: 1. the risk may be avoided 2. the risk may be retained 3. the hazard may be reduced 4. the losses may be reduced 5. the risk may be shifted RISK RETENTION - is a method of handling risk wherein the management assumes the risk. A planned risk retention, also called self- insurance, is a conscious and deliberate assumption of a recognized risk. Unplanned risk retention exists when management does not recognize that a risk exists and unwisely believes that no loss could occur. Examples of efforts on loss reduction are as follows: 1. using fireproof materials on interior building construction; 2. storing inventory in several locations to minimize losses in cases of fire and theft; 3. maintaining duplicate records to reduce accounts receivable losses; 4. transporting goods in separate vehicles instead of concentrating high values in single shipments; 5. Limiting legal liability by forming several separate corporations.  Examples of Risk Shifting The following risk shifting: 1. Hedging 2. Subcontracting 3. Incorporation 4. Insurance Hedging refers to making commitments on both sides of a transaction so the risks offset each other. A stockholder is able to make profits out of his investments but without individual responsibility for whatever errors in decisions are made by the management.