Business Chapter 14

Question 1

Financial management

Answer 1

Financial management is the art and science of obtaining enough finance for a business at the lowest cost, investing in assets earning a return greater than the cost of capital, and managing the profitability, liquidity and solvency of the business

Question 2

Capital budgeting

Answer 2

That is, the business’s long-term investment, the process of planning and managing a business’s long-term investments, so called capital budgeting, and which investment opportunities exist for the business

Question 3

Capital Structure

Answer 3

That is, the ways in which the business obtains and manages the long-term financing it needs to support its long-term investments. This includes the mixture of debt and equity that a business uses to finance its operations

Question 3

Working capital management

Answer 3

This is related to the short-term assets of the business, such as inventory, and short-term liabilities, such as money owed to suppliers

Question 4

Return of proceeds to shareholders

Answer 4

Paying dividends and retaining earnings to invest in new projects

Question 5

Financial function

Answer 5

The financial function is concerned with this flow of funds. In particular, it is concerned with the acquisition of funds (known as financing), the application of funds for the acquisition of assets (known as investment), and the administration of and reporting on financial matters (known as accounting

Question 6

Financial management

Answer 6

Financial management is responsible for the efficient management of all facets of the financial function. Within the broad framework of the strategies and plans of the business, its aim is to make the highest possible contribution to the objectives through the performance of the following tasks

Question 7

Which tasks does the financial management use

Answer 7

Financial analysis, reporting, planning and control
Management of the application of funds, also known as the management of the asset structure; and
Management of the acquisition of funds, also known as the management of the financing or capital structure.

Question 8

The statement of financial position

Answer 8

Allows the viewer to have an overall grasp of the financial position of a position, furnishes details about the manner in which the profit or loss for a particular period was arrived at and how it has been distributed.

Question 9

Asset side

Answer 9

Reflects all the possessions of the business, together with their respective values as at the date on which the statement was prepared, and therefore shows the mutual coherence between these possessions

Question 10

Non-current assets

Answer 10

such as land, buildings, machinery, vehicles and other equipment that will be used in a business for more than a year

Question 11

Current assets

Answer 11

such as cash in the bank, as well as other possessions of the business that will be converted into cash within one year during the normal course of business, such as
marketable securities, debtors and all inventories.

Question 12

Long-term funds

Answer 12

This is also known as non-current liabilities and comprises shareholders’ interest and long-term debt.

Question 13

Shareholders’ interest

Answer 13

is owners’ equity (made up of ordinary share capital, reserves, undistributed or retained profits) and, in some instances, preference-share capital.

Question 14

Long-term debt

Answer 14

is usually made up of debentures, mortgage bonds, secured loans and long-term credit

Question 15

Short-term funds

Answer 15

These are also referred to as current liabilities, They represent all debts or credit that are normally repayable within one year. They represent all debts or credit that are normally repayable within one year. The favorable difference between the current assets and the current liabilities represents the net working capital or that portion of the current assets that has been financed from long-term funds

Question 16

Capital

Answer 16

It is the accrued power of disposal over the products and services used by a business to generate a monetary return or profit
A business needs capital for investment in fixed assets(referred to as the need for fixed capital)and capital for investment in current assets(referred to as the need for working capital)
A business has a permanent need for a certain minimum portion of working capital. The remaining need for working capital will vary according to factors such as seasonal influences and contingencies that result in an increase or decrease in production activities

Question 17

Income

Answer 17

Income=units sold x price per unit
The income of a business consists primarily of receipts resulting from the sale of its products and/or services sold within that period, and the unit price for which they were sold

Question 18

Costs

Answer 18

Costs can be regarded as the monetary value sacrificed in the production of products and/or services produced for the purpose of resale

Question 19

Fixed cost

Answer 19

is that portion of total cost that remains unchanged (within the boundaries of a fixed production capacity) regardless of an increase or decrease in the quantity of products and/or services produced.

Question 20

Variable cost

Answer 20

Variable cost is that portion of the total costs that changes according to a change in the volume produced

Question 21

The total costs

Answer 21

Involved in the production of a specific number of products produced in a particular period consists of the total fixed costs and the total variable costs incurred in the production of those products

Question 22

Profit

Answer 22

Profit is regarded as the favorable difference between the income earned during a specific period and the costs incurred to earn that income
Profit/loss=Income-cost
Profit/loss=(pricexunits sold)-cost

Question 23

What is the long-term objective?

Answer 23

It should be to increase the value of the business. This may be accomplished by
Investing in assets that will add value to the business
Keeping the cost of capital of the business as low as possible

Question 24

Short-term financial objective

Answer 24

The short-term financial objective should be to ensure the profitability, liquidity and solvency of the business.

Question 25

Profitability

Answer 25

Profitability is the ability of the business to generate income that will exceed cost

Question 26

Liquidity

Answer 26

The ability of the business to satisfy its short-term obligations as they become due

Question 27

Solvency

Answer 27

Is the extent to which the assets of the business exceed its liabilities

Question 28

The risk-return

Answer 28

A tradeoff between risk and return .The greater the risk ,the greater the required rate of return will be

Question 29

The cost-benefit principle

Answer 29

A trade-off between cost and return. The greater the cost, the greater the benefit will be

Question 30

The time value of money principle

Answer 30

The time value of money principle means a person could increase the value of any amount of money by earning interest

Question 31

Cost-volume-profit relationships

Answer 31

the profitability of a business is determined by the unit selling price of its product, the costs (fixed and variable) of the product and the level of the activity of the business (the volume of production and sales). A change in any one of these three components will result in a change in the total profit made by the business

Question 32

Break-even analysis

Answer 32

Where the break-even point is reached when total costs are equal to total income. At the break-even point, no profit or loss is realized

Question 33

Financial analysis

Answer 33

Is necessary to monitor the general financial position of a business and, in the process, to limit the risk of financial failure of the business as far as possible

Question 34

To help it with its financial analyses, financial management has, among others, the following important aids at their disposal:

Answer 34

The statement of financial performance; The statement of financial position; and Financial ratios The flow of funds in a business

Question 35

The flow of funds

Answer 35

It is therefore necessary to conduct an analysis of how the capital of the business is employed and supplied The flow of funds of a firm is a continuous process

Question 36

Financial ratios

Answer 36

A financial ratio gives the relationship between two items (or groups of items) in the financial statements (especially the statement of financial performance and the statement of financial position). It also serves as a performance criterion to point out potential strengths and weaknesses of the business.

Question 37

Who uses financial ratio?

Answer 37

Financial management, with a view to internal control, planning and decision-making; *The suppliers of borrowed capital, to evaluate the ability of the business to pay its debt and interest; *Investment analysts, to evaluate the business as an investment opportunity; and *Labour unions, with a view to salary negotiations.

Question 38

Three types of comparisons are significant in this regard:

Answer 38

1.A comparison of the current financial ratios of the business with the corresponding ratios of the past and/ or expected future ratios with a view to revealing a tendency. 2.A comparison of the financial ratios of the business with those of other similar businesses. 3.A comparison of the financial ratios of the business with the norms for the particular industry as a whole.

Question 39

The focal points of budgets in a control system

Answer 39

Typically, responsibility is assigned to income, cost (expense), profit and/or investment centres Control systems are devised to ensure that a specified strategic business function or activity (for example, manufacturing or sales) is carried out properly

Question 40

Income centre

Answer 40

Outputs are measured in monetary terms, though the size of these outputs is not directly compared with the input costs

Question 41

Cost centre

Answer 41

Inputs are measured in monetary terms, though outputs are not. The reason for this is that the primary purpose of such a centre is not the generation of income

Question 42

Profit centre

Answer 42

Performance is measured by the monetary difference between income (outputs) and costs (inputs)

Question 43

Investment centre

Answer 43

The monetary value of inputs and outputs is again measured, but the profit is also assessed in terms of the assets(investment) employed to produce this profit

Question 44

An integrated budgeting system for a manufacturing business

Answer 44

1.Operating budgets 2.Financial budgets

Question 45

Operating budgets

Answer 45

1.Cost budgets. manufacturing-cost budgets and discretionary-cost budgets. Manufacturing-cost budgets are used where outputs can be measured accurately. Discretionary-cost budgets are used for cost centres in which output cannot be measured accurately (for example, administration and research) 2.Income budgets. These budgets are developed to measure marketing and sales effectiveness 3.The profit plan or profit budget. This budget combines cost and income budgets, and is used by managers who have responsibility for both the expenses and income of their units

Question 46

Financial budget

Answer 46

Are used by financial management for the execution of the financial planning and control task, consist of capital expenditure, cash, financing and balance-sheet budgets

Question 47

Financial budgets serve three major purposes:

Answer 47

1.They verify the viability of the operational planning (operating budgets). 2.They reveal the financial actions that the business must take to make the execution of its operating budgets possible. 3.They indicate how the operating plans of the business will affect its future financial actions and condition.

Question 48

The time value of money

Answer 48

Time value is based on time, the amount of money involved, and the return(interest)that could be earned if money is invested In principle ,the time value of money bears a direct relation to the opportunity of earning interest on an investment

Question 49

Asset management :current

Answer 49

Current assets include items such as cash ,marketable securities, debtors and inventory. These items are needed to ensure the continuous and smooth functioning of the business Keep in mind the consequences of having too much or too little invested in them

Question 50

The costs of holding cash are

Answer 50

Loss of interest Loss of purchasing power

Question 51

The costs of little or no cash are

Answer 51

Loss of goodwill Loss of opportunities Inability to claim discounts Cost of borrowing

Question 52

Why is cash management essential?

Answer 52

It is essential for obtaining the optimal trade-off between the liquidity risk and the cost of being too liquid. This is achieved by focusing on the cash budget and the cash cycle

Question 53

The management debtors accounts are

Answer 53

Credit policy Credit terms The collection policy

Question 54

Realistic credit standards revolve around the four Cs of credit:

Answer 54

Character-the customers integrity and willingness to pay Capacity-the customers ability to pay Capital-The customers financial resources Conditions-current economic or business conditions

Question 55

The costs of holding inventory stock

Answer 55

Lost interest Insurance costs Storage costs Obsolescence

Question 56

The costs of holding little or no inventory stocks

Answer 56

The loss of customer goodwill Loss of flexibility Production interrupt dislocation Re-order costs

Question 57

The importance of capital-investment projects is reflected by the following factors

Answer 57

The relative magnitude of the amounts involved The long-term nature of capital investment decisions The strategic nature of capital investment projects

Question 58

The relative magnitude of the amounts involved

Answer 58

The amounts involved in capital investment are much larger than those relating to, for example, decisions about the amount of credit to be extended or purchasing inventory

Question 59

The long-term nature of capital investment decisions

Answer 59

The benefits from capital-investment projects may accrue in periods varying from two or three years to as much as 30 or 40 years.

Question 60

The strategic nature of capital investment projects

Answer 60

Investment decisions of a strategic nature, such as the development of an entirely new product, the application of a new technology, the decision to diversify internationally or the decision to embark on rendering a strategic service could have a profound effect on the future development of a business

Question 61

Most common form of short-term financing

Answer 61

Trade credit Accruals Bank overdrafts Factoring

Question 62

Shareholders interest in a company is subdivided

Answer 62

Into owners' equity and preference-shareholders' capital

Question 63

Owners' equity

Answer 63

Consists of the funds made directly available by the legal owners(ordinary shareholders) in the form of share capital as well as indirect contributions in the form of profit retention as reserves and undistributed profits

Question 64

Preference-shareholders' capital

Answer 64

Fall somewhere between debentures and ordinary shares in terms of risk

Question 65

Long-term debt

Answer 65

Refers to debt that will mature(has to be repaid)in a year or more, and can usually be obtained into 2 ways: Through a loan Through credit

Question 66

Sources of financing for a small business

Answer 66

Personal funds, loans from relatives and friends, trade credit ,mortagage loans, selling shares, venture capital, taking in partners,loans or credit from equipment sellers, commercial bank loans,small business loans

Question 67

What is the cost of capital used for in capital investment decisions

Answer 67

To evaluate investment proposals. The cost of capital was assumed as given in the calculation of the net present value(NPV)

Question 68

Risk

Answer 68

2 components: The possible loss of the principal sum(the original amount invested) The possibility for the use of the capital(no interest or dividend payments)