Business Chapter 14 Flashcards
Financial management
Financial management
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
Capital budgeting
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
Capital Structure
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
Working capital management
This is related to the short-term assets of the business, such as inventory, and short-term liabilities, such as money owed to suppliers
Return of proceeds to shareholders
Paying dividends and retaining earnings to invest in new projects
Financial function
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
Financial management
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
Which tasks does the financial management use
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.
The statement of financial position
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.
Asset side
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
Non-current assets
such as land, buildings, machinery, vehicles and other equipment that will be used in a business for more than a year
Current assets
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.
Long-term funds
This is also known as non-current liabilities and comprises shareholders’ interest and long-term debt.
Shareholders’ interest
is owners’ equity (made up of ordinary share capital, reserves, undistributed or retained profits) and, in some instances, preference-share capital.
Long-term debt
is usually made up of debentures, mortgage bonds, secured loans and long-term credit
Short-term funds
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
Capital
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
Income
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
Costs
Costs can be regarded as the monetary value sacrificed in the production of products and/or services produced for the purpose of resale
Fixed cost
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.
Variable cost
Variable cost is that portion of the total costs that changes according to a change in the volume produced
The total costs
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
Profit
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
What is the long-term objective?
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
Short-term financial objective
The short-term financial objective should be to ensure the profitability, liquidity and solvency of the business.
Profitability
Profitability is the ability of the business to generate income that will exceed cost
Liquidity
The ability of the business to satisfy its short-term obligations as they become due
Solvency
Is the extent to which the assets of the business exceed its liabilities
The risk-return
A tradeoff between risk and return .The greater the risk ,the greater the required rate of return will be
The cost-benefit principle
A trade-off between cost and return. The greater the cost, the greater the benefit will be
The time value of money principle
The time value of money principle means a person could increase the value of any amount of money by earning interest
Cost-volume-profit relationships
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
Break-even analysis
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
Financial analysis
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
To help it with its
financial analyses, financial management has, among others, the following important aids at
their disposal:
The statement of financial performance;
The statement of financial position; and
Financial ratios
The flow of funds in a business
The flow of funds
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
Financial ratios
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.
Who uses financial ratio?
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.
Three types of
comparisons are significant in this regard:
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.
The focal points of budgets in a control system
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
Income centre
Outputs are measured in monetary terms, though the size of these outputs is not directly compared with the input costs
Cost centre
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
Profit centre
Performance is measured by the monetary difference between income (outputs) and costs (inputs)
Investment centre
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
An integrated budgeting system for a manufacturing business
1.Operating budgets
2.Financial budgets
Operating budgets
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
Financial budget
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
Financial budgets serve three major purposes:
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.
The time value of money
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
Asset management :current
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
The costs of holding cash are
Loss of interest
Loss of purchasing power
The costs of little or no cash are
Loss of goodwill
Loss of opportunities
Inability to claim discounts
Cost of borrowing
Why is cash management essential?
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
The management debtors accounts are
Credit policy
Credit terms
The collection policy
Realistic credit standards revolve around the four Cs of credit:
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
The costs of holding inventory stock
Lost interest
Insurance costs
Storage costs
Obsolescence
The costs of holding little or no inventory stocks
The loss of customer goodwill
Loss of flexibility
Production interrupt dislocation
Re-order costs
The importance of capital-investment projects is reflected by the following factors
The relative magnitude of the amounts involved
The long-term nature of capital investment decisions
The strategic nature of capital investment projects
The relative magnitude of the amounts involved
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
The long-term nature of capital investment decisions
The benefits from capital-investment projects may accrue in periods varying from two or three years to as much as
30 or 40 years.
The strategic nature of capital investment projects
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
Most common form of short-term financing
Trade credit
Accruals
Bank overdrafts
Factoring
Shareholders interest in a company is subdivided
Into owners’ equity and preference-shareholders’ capital
Owners’ equity
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
Preference-shareholders’ capital
Fall somewhere between debentures and ordinary shares in terms of risk
Long-term debt
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
Sources of financing for a small business
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
What is the cost of capital used for in capital investment decisions
To evaluate investment proposals. The cost of capital was assumed as given in the calculation of the net present value(NPV)
Risk
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)
