Bus 201 ch 15

Chapter Overview

• This chapter discusses financial management principles in business, focusing on financial decision-making, risk management, and the role of the financial manager.

Learning Objectives

Learning Objectives (1 of 2)

• Describe the responsibilities of a financial manager.

• Distinguish between short-term (operating) and long-term (capital) expenditures.

• Identify three sources of short-term financing for businesses.

• Identify three sources of long-term financing for businesses.

Learning Objectives (2 of 2)

• Discuss the value of common stock and preferred stock to stockholders and describe the secondary market for each type of security.

• Explain the process by which securities are bought and sold.

• Describe the investment opportunities in mutual funds, hedge funds, commodities, and stock options.

• Explain how risk affects business operations and identify the five steps in the risk management process.

The Role of the Financial Manager (LO 15-1)

Key Responsibilities of a Financial Manager

• Finance responsibilities include:

  • Determining a firm's long-term investments.

  • Conducting the firm’s financial activities to manage risks.

  • Obtaining funds to pay for investments.

  • Managing the firm's everyday financial activities.

Detailed Responsibilities

• Cash-flow management:

  • Managing the pattern of cash inflows (revenues) and outflows (debt payments).

  • Investing funds that are not needed to service debt, ensuring idle funds earn interest rather than sit idle.

• Financial control:

  • Checking performance against strategic plans.

  • Making adjustments based on performance evaluations.

  • Preparing budgets to ensure sufficient cash is on hand to meet operational and debt service needs.

• Financial planning:

  • Developing a plan to achieve a desired financial status.

  • Projections of revenue flows.

  • Sources and planned uses of funds to meet both short- and long-term goals.

  • Timing of when funds will be required.

Why Do Businesses Need Funds? (LO 15-2)

Short-Term (Operating) Expenses

• Funds are required for various operating expenses including:

  • Accounts receivable and accounts payable as influenced by the company's credit policy.

  • Inventory:

  • Raw materials necessary for production.

  • Work in process that indicates items being produced.

Long-Term (Capital) Expenditures

• These involve funding fixed assets that have a long life and a lasting value.

  • Examples include:

  • Land, buildings, and machinery.

  • Characteristics of capital expenditures:

  • They are not normally sold or converted to cash, as their primary role is to support operational capabilities.

  • The acquisition requires a large investment and typically ties up the firm’s resources.

Financial Management for Small Business (LO 15-7)

• Small business owners must focus on:

  • Establishing and managing bank credit effectively.

  • Building trade credit relationships.

  • Planning for cash flow to stabilize finances.

Risk Management (LO 15-8)

Definition and Importance of Risk Management

• Risk:

  • Refers to uncertainty about future events.

• Types of Risk:

  • Speculative Risk: The chance for both gain or loss.

  • Pure Risk: Only the chance of loss (e.g., a warehouse fire).

Risk Management Process

1. Identify risks and potential losses.

2. Measure the frequency and severity of losses and their impact.

3. Evaluate alternatives and choose techniques to best handle the losses.

4. Implement the risk-management program.

5. Monitor results to ensure effective management.

Risk-Management Alternatives

• Risk avoidance: Taking steps to guarantee risks are eliminated.

• Risk control: Implementing measures to minimize risks.

• Risk transfer: Shifting risks to other parties, often through insurance.

• Risk retention: Accepting the risk and its potential consequences.