AFM 132 - Chp 11: financial management

Question 1

define compound interest

Answer 1

the principle where the interest also earn interest

Question 2

define financial literacy

Answer 2

having the knowledge, skills, and confidence to make informed financial decision

Question 3

what are the 4 “C”s in creditworthiness for a business

Answer 3

Character - company size, location, business structure, media coverage, number of year in the business

Capacity - cash flow + ability to pay bills/existing debt

capital - resources available to repay any debts

conditions = external factors that may impact the business (industry growth rates, political factors, currency rates)

Question 4

why is financial planning important for a company?

Answer 4

to ensure that they can mange day-to-day operations and plan for the future

Question 5

what are the 3 steps in financial planning?

Answer 5

1. developing forecasts
2. developing budgets
3. establishing financial controls

Question 6

what’s the importance in developing forecasts?

Answer 6

aim to make informed predictions on future revenue + expenses - brings clarity to future sales volumes = help a company plan their production schedule to manage their resources + avoid supply chain shortages

Question 7

what info is needed to prepare forecasts

Answer 7

past performance
new sales contracts or contracts that might not be renewed
product offerings + customer growth, along with prediction for changes in the market or economy that could impact sales
changes to key expenses

Question 8

define short-term forecasts

Answer 8

predict revenue + expenses for a period of 1 year or less

Question 9

define a long-term forcast

Answer 9

aims to predict revenue = expenses beyond 1 year - used to plan for large investments + purchases

Question 10

what’s a caveat to long-term forecast?

Answer 10

forecast accuracy drops further into the future you try to project since the business environment can quickly change

Question 11

what’s the importance of budgets?

Answer 11

allocate money for the day-to-day operations + can also plan for large purchases or investment in the future - they take into account management’s expectation for revenue and then allocate the use of specific resources in the company

Question 12

define operating budget

Answer 12

includes operating expenses in a year = make allocations for ongoing expenses (salaries, supplies, advertising, rent)

Question 13

define cash budget

Answer 13

anticipates planned cash inflows/outflows for a period = a company can plan to borrow if they will run low on funds in a period or can make investments if they anticipate that they’ll have excess cash

Question 14

define capital budget

Answer 14

considers a period longer than a year to play for major asset purchases (new equipment)

Question 15

which departments are involved in the budgeting process?

Answer 15

finance, each key business function, product line, or geographic unit of a company may contribute to budget development

Question 16

define financial control

Answer 16

process of comparing actual results to what was projected to identify any differences (variances)

Question 17

what may be some reasons for discrepancies in financial controls?

Answer 17

change in the cost of raw materials, labour costs, quantity produced or quality issues

Question 18

what are 2 common ways for small businesses to fail

Answer 18

1. undercapitalization
2. poor management of cash flow

Question 19

define undercapitlization

Answer 19

not having enough capital to support its operations

Question 20

what does it mean to have proper cash management

Answer 20

ensures that money is always immediately available - money is not completely tied up in fixed assets or inventories

Question 21

what are some strategies that businesses use to manage how quickly they can get customers to pay those bills

Answer 21

1. invoice immediately - billing customers as soon as a product or service is provided
   2, follow-up - send email reminders of amounts owing before they’re due
2. reward early payment - offer discounts to the customers if paid early

Question 22

what’s the companies strategy when it comes time ot pay their bills

Answer 22

strategically pay as late as possible without incurring any penalties or missing out on any discounts for early payment

Question 23

effective cash management traditionally involves;

Answer 23

speeding up cash collection and slowing down cash payments

Question 24

what are some day-to-day operations that companies have to pay for?

Answer 24

salaries, utilities, raw materials needed in production

Question 25

what are some capital expenditures for a company?

Answer 25

equipment,

Question 26

why do companies need to manage funds?

Answer 26

to support day to day operations and to plan for the future

Question 27

what are some common sources of funding? other than savings + borrowing form friends + family

Answer 27

operations = when a company generates profits + retains it in the business
debt financing - obtaining funds from creditors - liabilities that must be repaid within a specified timeframe
equity financing = funds raised through the sale of ownership in the company

Question 28

what can a business do with profit?

Answer 28

keep it in the company to maintain + grow operations
provide a return to owners (dividends)
use it to pay down debts

Question 29

in what phase of the business is the expansion in the business supported by the reinvestment of profits?

Answer 29

at the start-up phase of the business

Question 30

in what phase of the business is the expansion in the business not supported by the reinvestment of profits?

Answer 30

in the growth phase

Question 31

define principal for a loan

Answer 31

the original amount borrowed on a loan

Question 32

define interest on a loan

Answer 32

a charge on the principal amount borrowed - fixed at a specific rate or variable

Question 33

define term on a loan

Answer 33

the time period for a loan - short term (paid within 1 year) or long term (paid in more than 1 year)

Question 34

define security of a loan

Answer 34

secured loan = backed by asset that a borrower puts up as collateral - in case of default, lender can take ownership of the collateral

unsecured loan = not backed up by asset, so typically granted to highly regarded customers that have a strong financial history - have higher interest rates or shorter repayment terms (as lender is taking an additional risk)

Question 35

define covenants

Answer 35

an agreed upon condition that must be maintained - can be financial or non-financial

if the borrower at an time does not meet the conditions of the covenant, the lender can demand that the loan be paid back in full immediately

Question 36

what are some common debt financing options

Answer 36

credit cards, line of credit, term of loan

Question 37

pros + cons to credit cards

Answer 37

they have an interest free period, average annual interest rate is 20%

Question 38

pros + cons to line of credit

Answer 38

can be accessed + repaid at any time, interest = only charged on amounts access + charged from the time cash is taken out from the line of credit until it is repaid in full

Question 39

define a term loan

Answer 39

an amount borrowed from a lender + paid off at fixed intervals over a specified period of time - may ask for collateral in a for longer term loans

Question 40

define line of credit

Answer 40

when a lender provides access to a pre-approved amount of money that can be accessed + repaid at any time

Question 41

are issuing bonds considered debt financing?

Answer 41

yes, as bonds are loans issued by a corporate that must be repaid and essentially grants an IOU to those they borrow form with a promise to repay by a specific date

Question 42

what are the 2 components to a bond?

Answer 42

1. a promise to pay back the principal at a specific date
2. a promise of interest

Question 43

why are bonds seen as less risky investments

Answer 43

they have the financial guarantee of the Canadian governments

Question 44

which is more riskier; bonds from government or corporate bonds

Answer 44

corporate bonds

Question 45

the risk rating for bonds is evaluated by

Answer 45

bond rating organization - e.g. Dominion bond rating services (DBRS)

Question 46

how are bonds rated/.

Answer 46

AAA(higheest credit quality) to D (a bankrupt company that can’t meet its debt obligations)

Question 47

higher risk bonds traditionally offer ____ interest rate to _____ stakeholders for taking a _____ risk

Answer 47

higher, compensate, additional

Question 48

can bonds be secured or unsecrued?

Answer 48

yes

Question 49

what are unsecured bonds called

Answer 49

debenture bonds

Question 50

define an IPO

Answer 50

an initial public offering - the first time shares are sold to the public

Question 51

before an IPO, a company will issue _______ to potential investors

Answer 51

a prospectus

Question 52

define a prospectus

Answer 52

a document that summarizes details about their business, financial info, and details on the shares being offered

Question 53

define common shares

Answer 53

a class of shares that grant shareholders with a right to vote on issues that may impact the future direction of the company

Question 54

common shares vs preferred shares

Answer 54

preferred shares do not typically include voting rights as they are given priority to dividends over common shareholders

Question 55

most companies will use a combination of ___ and ___ financing over the life of the business

Answer 55

debt. equity

Question 56

what the pros + cons of choosing debt over equity financing?

Answer 56

pros: lender do not become owner in the company, and are just entitled to repayment of debts - with equity, shareholders may have voting rights depending on the share they hold, which dilutes ownership position in the company

cons:
1. companies that carry increasing levels of debt can be seen as more risky by lenders + investors
2. principal + interest portions of debt must be paid by a specific date, the repayment could cause cash flow issues if not planned for
3. interest is a legal obligation - where dividends are optional when a company is profitable
4. the company may need to pledge assets as collateral, or the owners may have to make personal guarantees to obtain debt financing