Understanding Canadian Business - Chapter 17: Mining Financial Management

Understanding Canadian Business - Chapter 17: Mining Financial Management

Learning Objectives

  • Explain the role and responsibilities of financial managers.
  • Outline the financial planning process, and explain the three key budgets in the financial plan.
  • Explain why firms need operating funds.
  • Identify and describe different sources of short-term financing.
  • Identify and describe different sources of long-term financing.

Finance and Managers

  • Finance:

    • Definition: The business function that acquires funds for the firm and manages them within the firm.

  • Financial Management:

    • Definition: The job of managing a firm’s resources to meet its goals and objectives.

  • Role of Financial Managers:

    • Examine financial data prepared by accountants.
    • Recommend strategies for improving the financial performance of the firm.

What Financial Managers Do

  • Acquire funds and control their effective use.
  • Ensure the company pays its bills on time.

The Value of Understanding Finance

  • Financial managers must stay updated on changes and opportunities in finance and adjust strategies accordingly.
  • Analyze tax implications of managerial decisions to minimize taxes paid by the business.

Common Reasons for Financial Failure

  1. Undercapitalization:
    • Insufficient funds to run a business.
  2. Poor control over cash flow.
  3. Inadequate expense control.

Financial Planning Process

  • Forecasting Financial Needs:
    • Short-term Forecasting:
    • Predicts revenues, costs, and expenses for a period of one year or less.
    • Includes cash flow forecasting, predicting future cash inflows and outflows (monthly/quarterly).
    • Long-term Forecasting:
    • Predicts revenues, costs, and expenses for more than one year, up to five or ten years.
    • Crucial for the company's long-term strategic planning.
Budgets Established in Financial Planning
  1. Operating (Master) Budget:
    • Ties together all of a firm’s budgets and summarizes proposed financial activities.
    • Usually the most detailed budget.
  2. Capital Budget:
    • Highlights spending plans for major asset purchases requiring large sums of money.
  3. Cash Budget:
    • Estimates projected cash inflows and outflows, helping to plan for cash shortages or surpluses.
    • Assists managers in anticipating borrowing, debt repayments, operating expenses, and short-term investments.
Establishing Financial Controls
  • Financial Control:
    • Process of regularly comparing actual revenues, costs, and expenses with the budget.
    • Monthly financial reviews are common to ensure financial control.

Need for Operating Funds

  • Key areas requiring funds include:
    1. Managing day-to-day needs of the business.
    2. Controlling credit operations.
    3. Acquiring needed inventory.
    4. Making capital expenditures.
Managing Day-to-day Needs
  • Ensure availability of funds to meet daily cash needs.
  • Time Value of Money: Money available now is worth more than the same amount in the future.
Controlling Credit Operations
  • Selling on credit ties up a significant amount of business assets in accounts receivable.
Acquiring Needed Inventory
  • Effective marketing requires maintaining inventories, which can involve significant expenditures.
  • Poorly managed inventory systems can negatively impact cash flow and financial health.
Making Capital Expenditures
  • Definition: Major investments in tangible long-term assets (e.g., land, buildings, equipment) and intangible assets (e.g., patents, trademarks).
  • These expenditures often require substantial funding.
Obtaining Funds for Operations
  • Considerations include:
    • Requirements for long-term or short-term funds.
    • The cost (interest rate) of obtaining these funds.
    • Sources of funds (internal vs. external).

Alternative Sources of Funds

Short-Term Funds
  1. Monthly expenses
  2. Unanticipated emergencies
  3. Cash flow problems
  4. Temporary promotional programs
Long-Term Funds
  1. New-product development
  2. Replacement of capital equipment
  3. Mergers or acquisitions
  4. Expansion into new markets (domestic or global)
  5. New facilities

Short-term Financing

  • Trade Credit:
    • Purchasing goods/services now and paying later.
    • Typical invoice terms may state: 2/10, net 30 (2% discount if paid within 10 days, otherwise due in 30 days).
Other Sources of Short-term Financing

  • Promissory Note: A written contract promising to pay a supplier a specific amount at a set time.

  • Family and Friends: Often used by small firms for short-term needs due to minimal formalities.

  • Commercial Banks and Financial Institutions:

    • Banks may be risk-averse and hesitant to lend to newer businesses.
    • Secured Loan: Backed by collateral (property); failure to repay allows lender to seize collateral.
    • Unsecured Loan: Does not require collateral; often more difficult to obtain.

  • Line of Credit:

    • An unsecured amount of credit a bank is willing to lend, often increasing over time with maturity.

  • Commercial Finance Companies:

    • Short-term loans for borrowers offering tangible assets as collateral.
The 4 Cs of Credit
  1. Character
  2. Capacity
  3. Capital
  4. Conditions
Factoring Accounts Receivable
  • Selling accounts receivable for cash as a relatively expensive option for short-term funding.
Commercial Paper
  • Unsecured promissory notes of $100,000 or more, maturing within 365 days, used by large corporations to secure short-term funds at lower interest rates.

Long-term Financing

Determining Long-term Financing Needs
  • Financial managers consider three major questions:
    1. Organization’s long-term goals and objectives.
    2. Required funds to achieve these objectives.
    3. Available sources of long-term funding that best meet needs.
Debt Financing
  • Involves borrowing funds with a legal obligation to repay.
  • Can be obtained through loans or issuing bonds.
Term-loan Agreement
  • A promissory note requiring repayment in specified installments, typically offering tax-deductible interest rates.
Debt Financing by Issuing Bonds
  • Definition: A long-term debt obligation requiring regular interest payments and repayment of principal by the maturity date.
Equity Financing
  • Involves selling ownership in the firm (stock) or using retained earnings for reinvestment.
  • Can also include venture capital investment.
Initial Public Offering (IPO)
  • The first sale of new stock to the general public, decided by the organization’s board of directors.
Stock Certificate
  • Document representing ownership in a corporation, detailing the company name, number of shares, and stock type.
Dividends
  • Distribution of profits to shareholders, either as cash or additional shares.
  • Common Stock: Basic ownership form; must be issued if only one type exists.
  • Preferred Stock: Holders receive dividend preference and priority on asset claims if the company liquidates.

Differences Between Debt and Equity Financing

Leverage
  • Raising funds through borrowing increases the firm's rate of return, creating financial risk through obligatory repayments but enhancing profit potential.
Comparison Factors

  • Management Influence:

    • Debt financing usually does not influence management unless specified.
    • Common shareholders possess voting rights.

  • Repayment Obligations:

    • Debt financing has maturity dates and must be repaid.
    • Equity has no maturity date or obligatory repayment.

  • Yearly Obligations:

    • Interest on debt is a contractual obligation; dividends are not legally required.

  • Tax Benefits:

    • Interest is tax-deductible; dividends are paid from after-tax income and are not deductible.

Venture Capital

  • Source of funding for startups with high profit potential, especially relevant for businesses lacking assets for significant bank loans.
Retained Earnings
  • Major source of long-term funds for small businesses, which have fewer financing options compared to larger firms.

Career Prospects in Finance

  • Career paths may include analyst positions, management roles, financial consulting, investment banking, and executive positions like Chief Information Officer (CIO).

Chapter Summary

  • Overview of the role and responsibilities of financial managers.
  • Understanding of financial planning processes, including three key budgets.
  • Knowledge of why firms require operating funds and the sources available.
  • Identification of types of short-term and long-term financing.