Arjun Nigam

Chapter 11 Notes – Financial Management

- Finance; function in business that acquires funds for firm and manages those funds within firm
o Preparing budgets
o Doing cash flow analysis
o Planning for expenditure of funds
- Financial Management; job of managing a firm’s resources so it can meet goals
o Without plan, firm has little chance of survival
- Financial Managers; managers who make recommendations to top execs regarding strategies for
improving financial strength of a firm
o Responsible for managing accounts payable and accounts receivable
- Financial Planning
o Forecasting both short-term and long-term financial needs
o Developing budgets to meet those needs
o Establishing financial control to see how well the company is doing what it set out to do

Forecasting Financial Needs

- Short-Term Forecast; forecasts that predicts revenues, costs, and expenses for period of one year or
less
- Cash-Flow Forecast; forecast that predicts cash inflows and outflows in future periods, usually
months or quarters
- Long-Term Forecast; forecast that predicts revenues, costs, and expenses for period longer than one
year, and sometimes as far as five or ten years into the future
- Budget; financial plan that sets forth management’s expectations, and on basis of those
expectations, allocates use of specific resources throughout firm
o Operating (master) budget; budget that ties together all of firm’s other budgets
 How much will the firm spend on supplies, travel, rent, research, salaries
 Most detailed and most used budget
 Mostly prepared on monthly basis for next 12 months
o Capital budget; budget that highlights firm’s spending plans for major asset purchases that
often require large sums of money
 Assets such as property, building, and equipment
o Cash budget; budget that estimates a firm’s projected cash inflows and outflows that firm
can use to plan for any cash shortages or surpluses during given period

Financial Control
- Financial Control; process in which firm periodically compares its actual revenues, costs, and
expenses with its budget
- At least one monthly financial review to ensure financial control
- Help managers identify variances to financial plan and allow them to take corrective action
- Provide feedback to help reveal which accounts, which departments, and which people are varying
from financial plans

Need for Funds

- Managing day-to-day needs of the business (page 265)
- Controlling credit operations
o Making credit available makes customers happy
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o Accepting credit cards (MasterCard and Visa) enhance sales and business no longer incurs
cost of running credit department
- Acquiring needed inventory
o Businesses must maintain inventories that often involve sizable expenditures of funds
- Making capital expenditures
o Capital Expenditures; major investments in either tangible long-term assets such as land,
buildings, and equipment, or intangible assets such as patents, trademarks, and copyrights
 Often require huge portion of organization’s funds

Alternate Sources of Funds (268)

- Debt financing; funds raised through various forms of borrowing that must be repaid
o Selling bonds
o Loans from banks
- Equity financing; funds raised from operations within the firm or through sale of ownership of firm
o Retained earnings
o Venture capital
o Selling stock
- Short-Term financing; borrowed funds that are needed for one year or less
o Trade Credit; practice of buying goods and services now and paying later
o Promissory note; written contract with promise to pay
o Secured loan; loan backed by something valuable, such as property
o Unsecured loan; loan that is not backed up by assets
o Line of Credit; given amount of unsecured funds a bank will lend to a business
o Revolving credit agreement; line of credit that is guaranteed by the bank
o Commercial finance companies; organization that make short-term loans to borrowers who
offer tangible assets as collateral
- Long-Term financing; borrowed funds that are needed for a period longer than one year
o Debt financing or equity financing
- Debt financing
o Involves borrowing money that must be repaid
o Lending Institutions
 Term-Loan Agreement; a promissory note that requires the borrower to repay the
loan in specified instalments
 Risk/Return trade-off; principle that the greater risk a lender takes in making loan,
the higher the interest rate required
 Bond; a corporate certificate indicating that a person has lent money to a firm
 Institutional investors; large organizations that invest their own funds or the funds
of others
 Interest; payment the issuer of the bond makes to the bondholders for use of
borrowed money
 Maturity Date; exact date the issuer of a bond must pay the principal to the
bondholder
o Advantages of Bonds
 Interest paid on bonds is tax deductible to the firm issuing the bond
 When bonds repaid, debt obligation is eliminated
 Management retains control over the firm’s operations
o Disadvantages of Bonds
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 Increase debt and affect market perception of the firm

 Paying interest is legal obligation
o Debenture Bonds; bonds that are unsecured
o Sinking Fund; reserve account in which issuer of bond periodically retires some part of bond
principal prior to maturity so that enough capital will be accumulated by maturity date to
pay off bond
- Equity financing
o Stock; shares of ownership in a company
o IPO; initial public offering of a corporation’s stock
o Venture Capital; money that is invested in new or emerging companies that are perceived
as having great profit potential
o Stock certificate; evidence of stock ownership that specifies name of company, number of
shares it represents and type of stock being issued
o Dividends; part of firm’s profits that may be distributed to shareholders as either cash
payments or additional shares of stock
o Advantages of issuing Stock
 Shareholders never have to be repaid
 No legal obligation to pay dividends to shareholders
 No risk since issuing stock creates no debt
o Disadvantages of issuing Stock
 Dividends are paid out of profit after taxes and are not tax deductible
 Management’s decisions can be affected by need to keep stockholders happy
o Common shares; most basic form of ownership, confers voting rights and right to share in
firm’s profits through dividends, offered by firm’s BOD
o Preferred shares; stock that gives owners preference in payment of dividends and earlier
claim on assets than common shareholders if company is going bankrupt