AFM 132 - Chp 11: financial management Flashcards
define compound interest
the principle where the interest also earn interest
define financial literacy
having the knowledge, skills, and confidence to make informed financial decision
what are the 4 “C”s in creditworthiness for a business
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)
why is financial planning important for a company?
to ensure that they can mange day-to-day operations and plan for the future
what are the 3 steps in financial planning?
- developing forecasts
- developing budgets
- establishing financial controls
what’s the importance in developing forecasts?
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
what info is needed to prepare forecasts
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
define short-term forecasts
predict revenue + expenses for a period of 1 year or less
define a long-term forcast
aims to predict revenue = expenses beyond 1 year - used to plan for large investments + purchases
what’s a caveat to long-term forecast?
forecast accuracy drops further into the future you try to project since the business environment can quickly change
what’s the importance of budgets?
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
define operating budget
includes operating expenses in a year = make allocations for ongoing expenses (salaries, supplies, advertising, rent)
define cash budget
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
define capital budget
considers a period longer than a year to play for major asset purchases (new equipment)
which departments are involved in the budgeting process?
finance, each key business function, product line, or geographic unit of a company may contribute to budget development
define financial control
process of comparing actual results to what was projected to identify any differences (variances)
what may be some reasons for discrepancies in financial controls?
change in the cost of raw materials, labour costs, quantity produced or quality issues
what are 2 common ways for small businesses to fail
- undercapitalization
- poor management of cash flow
define undercapitlization
not having enough capital to support its operations
what does it mean to have proper cash management
ensures that money is always immediately available - money is not completely tied up in fixed assets or inventories
what are some strategies that businesses use to manage how quickly they can get customers to pay those bills
- 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 - reward early payment - offer discounts to the customers if paid early
what’s the companies strategy when it comes time ot pay their bills
strategically pay as late as possible without incurring any penalties or missing out on any discounts for early payment
effective cash management traditionally involves;
speeding up cash collection and slowing down cash payments
what are some day-to-day operations that companies have to pay for?
salaries, utilities, raw materials needed in production
what are some capital expenditures for a company?
equipment,
why do companies need to manage funds?
to support day to day operations and to plan for the future
what are some common sources of funding? other than savings + borrowing form friends + family
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
what can a business do with profit?
keep it in the company to maintain + grow operations
provide a return to owners (dividends)
use it to pay down debts
in what phase of the business is the expansion in the business supported by the reinvestment of profits?
at the start-up phase of the business
in what phase of the business is the expansion in the business not supported by the reinvestment of profits?
in the growth phase
define principal for a loan
the original amount borrowed on a loan
define interest on a loan
a charge on the principal amount borrowed - fixed at a specific rate or variable
define term on a loan
the time period for a loan - short term (paid within 1 year) or long term (paid in more than 1 year)
define security of a loan
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)
define covenants
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
what are some common debt financing options
credit cards, line of credit, term of loan
pros + cons to credit cards
they have an interest free period, average annual interest rate is 20%
pros + cons to line of credit
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
define a term loan
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
define line of credit
when a lender provides access to a pre-approved amount of money that can be accessed + repaid at any time
are issuing bonds considered debt financing?
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
what are the 2 components to a bond?
- a promise to pay back the principal at a specific date
- a promise of interest
why are bonds seen as less risky investments
they have the financial guarantee of the Canadian governments
which is more riskier; bonds from government or corporate bonds
corporate bonds
the risk rating for bonds is evaluated by
bond rating organization - e.g. Dominion bond rating services (DBRS)
how are bonds rated/.
AAA(higheest credit quality) to D (a bankrupt company that can’t meet its debt obligations)
higher risk bonds traditionally offer ____ interest rate to _____ stakeholders for taking a _____ risk
higher, compensate, additional
can bonds be secured or unsecrued?
yes
what are unsecured bonds called
debenture bonds
define an IPO
an initial public offering - the first time shares are sold to the public
before an IPO, a company will issue _______ to potential investors
a prospectus
define a prospectus
a document that summarizes details about their business, financial info, and details on the shares being offered
define common shares
a class of shares that grant shareholders with a right to vote on issues that may impact the future direction of the company
common shares vs preferred shares
preferred shares do not typically include voting rights as they are given priority to dividends over common shareholders
most companies will use a combination of ___ and ___ financing over the life of the business
debt. equity
what the pros + cons of choosing debt over equity financing?
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
