CHAPTER 12

MANAGING THE FINANCE

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FUNCTION

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WHAT THE FIANCE FUNCTION IS

The finance function is an important management

responsibility that deals with the “procurement and
administration of funds with the view of achieving
the objective of business” . If the engineer manager
is running the firm as a whole , he must be
concerned with the determination of the amount of
funds required, when they are needed, how to
procedure them, and how to effectively and
efficiently use them.

In the performance of his duties, the engineer

manager , at whatever management level he is,
must do his share in the achievement of the
financial objectives of the company.

the finance function is one of the three basic

management functions. The other two are
production and marketing.
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Determinati
on of fund
requirement

1. Short-term
2. Long-term

Procuremen
t of funds

1. Short-term
2. Long-term

Effective
and efficient
use of funds
1. Short-term
2. Long-term

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 THE DETERMINATION OF FUND
REQUIREMENT

Any organization, including the engineering firm, will

need funds for the following specific requirement:

1. to finance daily operations

2. to finance the firm’s credit services
3. to finance the purchase of inventory
4. to finance the purchase of major assets

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 FINANCING DAILY OPERATION

The day to day operation of the engineering firm will

require funds to take care of expenses as they come.
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
, stationary and printing , postage , etc.
6. administrative expenses like those for auditing ,legal ,
services, etc.

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FINANCING THE FIRM’S CREDIT SERVICES

It is oftentimes unavoidable for firms to extend credit to

customers. If the engineering firm manufactures products,
sales terms vary from cash to 90 days credit extensions to
customers. Construction firms will have to finance the
construction of government projects that

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.
Many firms cannot cope with delays in the availability of
the required material inputs in the production process, so
these must be kept ready whenever required.

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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 investment in capital assets like hand, plant,
and equipment

It is obvious that the financing of the purchase of major

assets must come from long-term sources.

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THE SOURCES OF FUNDS

To finance its various activities, the engineering firm will

have to make use of its cash inflows coming from various
sources, namely:

1. Cash sales . Cash is derived when the firm sells its

produces or services
2. Collection of Accounts Receivable. Some engineering
firms extend credit to customers . When these are
settled , cash is made available
3. Loans and credits. When other sources of financing are
not enough, the firm will have to resort to borrowing
4. Sale of assets. Cash is sometimes obtained form the
sale
of the company’s assets
5. Ownership contribution. When cash is not enough, the
firm may tap its owners to provide more money
6. Advances from customers. Sometimes, customers are
required to pay cash advances on orders made. This
helps
the firm in financing its production activities
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SHORT-TERM SOURCES OF FUNDS

Loans and credits may be classified as short-term,

medium-term, or long-term. Short-term sources of funds
are those with repayment schedules of less than one year.
Collaterals are sometimes required by short-term creditors.

Advantages of short-term credits. When the engineering

firm avails of short-term credits, the following advantages
may be derived:

1. They are easier to obtain. Creditors maintain the view

that the risk involved in shot-term lending is also
short-term. Thus, short-term credits are made easily
available to qualified borrowers
2. Short-term financing is often less costly. Since
short-term financing is favored by creditors, they make
it available at less cost.

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3. short-term financing offers flexibility to the borrower.
After the borrower has settled his short-term debt, he
may consider other means of financing , if he still
requires it. Long-term financing , in contrast,
eliminates this option. He is stuck with the long-term
funds even if he no longer requires it.

Disadvantages of short-term credits. Short-term

financing has also some disadvantage. They are as follows:

1. short-term credits mature more frequently. This may

place the engineering firm in a tight position more
often than necessary. When the frequently of the firm’s
cash inflows are more than twelve months apart, the firm
could be in serious trouble meeting its short-term
2. short-term debts may, at times, be more costly than
long-term debts. When short term expenditures, the
frequent renewals, adjustment of terms, and shopping
for
new sources may prove to be more costly
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 Supplies of short-term funds. Short-term financing is
provided by the following:

1. trade creditors- refer to suppliers extending credit to

a buyer for use in manufacturing , processing or
reselling goods for profit
2. commercial banks- are institutions which individuals or
firms may tap as source of short-term financing
3. commercial paper houses- are those that help business
firms in borrowing funds from the money market
4. finance companies- are financial institutions that
finance inventory and equipment of almost all types and
sizes of business firms
5. factors- are institutions that buy the accounts
receivable of firms, assuming complete accounting and
collection responsibilities
6. insurance companies- are also possible sources of
short-term funds

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LONG-TERM SOURCES OF FUNDS

There are instances when the engineering firm will have

to tap the long-term sources of funds. An example is when
expenditures for capital assets become necessary. After
the amount required is determined, a decision has to be
made on the type of sources to be used.

Long-term sources of funds are classified as follows:

1. long-term debts
2. common stocks, and
3. retained earnings.

Term loans . A term loan is a “ commercial or industrial

loan from a commercial bank, commonly used for plant
and equipment , working capital , or debt repayment. Term
loans have maturities of 2 to 30 years

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The advantages of term loans as a long-term source of
funds are as follows:

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 . A bond 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 stock

Retained earnings . Retained earnings refer to “ corporate

earnings not paid out as dividends. This simply means that
whatever earning that are due to the stock holders of a
corporation are reinvested.
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THE BEST SOURCES OF FINANCING

As there are various fund sources, the engineer

manager, or whoever is in charger, must determine which
source is the best available for the firm.

To determine the best source, schall and Haley

recommends that the following factors must be
considered.

1. flexibility- some fund sources impose certain

restrictions on the activities of the barrowers
2. risk- when applied to the determination of fund sources,
risk refers to the chance that the company will be
affected adversely when a particular source of financing
is chosen.
3. income- the various sources of funds, when availed of,
will have their own individual effects in the net income
of the engineering firm
4. 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
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5. timing- financing market has its ups and downs. This
means that there are times when certain means of
financing provide better benefits than at other times.
The engineer manager must , therefore, choose the best
time for borrowing or selling equity
6. other factors like collateral values , flotation cost,
speed , and exposure.
- collateral values: are there assets available as
collateral?
- Flotation cost: how much will it cost to issue bonds
or stocks?
- speed: how fast can the funds required be raised?
- Exposure: to what extent will the firm be exposed to
other parties

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THE FIRM’S FINANCIAL HEALTH

In general , the objectives of engineering firms are as

follows:

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,
employees will be assured of employment , suppliers will
be assured of a market, etc.

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INDICATORS OF FIANCIAL HEALTH

The financial health of an engineering firm may be

determined with the use of three basic financial statement.
These are as follows

1. Balance sheet- also called statement of financial

position

2. income statement- also called statement of operations;

3. statement of changes in financial position.

To be able to determine the financial health of a firm, the

appropriate financial analysis must be undertaken.

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RISK MANAGEMENT AND INSURANCE

the engineer manager , especially those at the top level, is

entrusted with the function of making profits for the
company . This will happen if losses brought by improper
management of risk are avoided.

Risk is a very important concept that the engineer

manager must be familiar with. Risks confront people
everyday. Companies are exposed to them. Newspapers
report on a daily basis the destruction of life and property.
Companies that could not cope with losses are forced to
shot down, according to reports.

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RISK DEFINED

Risk refers to the uncertainly concerning loss or injury . He

engineering firm is faced with a long list of exposure to
risks, some of which are as follows:

1. fire
2. theft
3. floods
4. accidents
5. nonpayment of bills by customers ( bed debts)
6. disability and death
7. damage claim from other parties

Types of risk

risk may be classified as either pure or speculative. Pure

risk is one in which “ there is only a chance of loss” . This
means that there is no way of making gains with pure
risks. An example of pure risk is the exposure to loss of the
company’s motor car due to theft. Pure risks are insurable
and may be covered by insurance
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What is 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

there are various methods of dealing with risks. they are

as follows.
1. the risk may be avoided
2. the risk may be retained
3. the hazard may be reduced
4. the losses ma be reduced
5. the risk may be shifted

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 A person who want to avoid the risk of losing a property
like a house can do so by simply avoiding the ownership of
one. There are instances ,however, when ownership cannot
be avoided like those for equipment , appliances, and
materials used in the production process. In this case,
other methods of handling risk must be considered.

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