Chapter 12 Flashcards
This function is an important management responsibility that deals with the procurement and administration of funds with the view of achieving the
objectives of business.
finance
the three basic management functions
finance, production, marketing
Process Flow of the Finance Function
Determination of Fund Requirements
Procurement of Funds
Effective and Efficient Use of Funds
Any organization, including the engineering firm, will need funds for the following specific requirements:
- to finance daily operations
- to finance the firm’s credit services
- to finance the purchase of inventory
- to finance the purchase of major assets
Money must be made available for the payment of the following:
- wages and salaries
- rent
- taxes
- power and light
- marketing expenses like those for advertising, entertainment, travel expenses, telephone and telegraph, stationery and printing, postage, etc.
- administrative expenses like those for auditing, legal, services, etc.
(Sources of Funds) To finance its various activities, the engineering firm will have to make use of its cash inflows coming from various sources, namely:
- Cash sales
- Collection of Accounts Receivables.
- Loans and Credits.
- Sale of assets.
- Ownership contribution.
- Advances from customers.
Cash is derived when the firm sells its products or services. Which source of funds is being described?
Cash Sales
Some engineering firms extend credit to customers. When these are settled, cash is made available. Which source of funds is being described?
Collection of Accounts Receivables
When other sources of financing are not enough, the firm will have to resort to borrowing. Which source of funds is being described?
Loans and Credits
Cash is sometimes obtained from the sale of the company’s assets. Which source of fund is being described?
Sale of assets
When cash is not enough, the firm may tap its owners to provide more money. Which source of funds is being described?
Ownership contribution
Sometimes, customers are required to pay cash advances on orders made. This helps the firm in financing its production activities. Which source of funds is being described?
Advances from customers
Loans and credits may be classified as:
short-term, medium-term, or long-term
_________ sources of funds are those with repayment schedules of less than one
year.
Short-term
Short-term financing is provided by the following:
- trade creditors
- commercial banks
- commercial paper houses
- finance companies
- factors
- insurance companies
This refer to suppliers extending credit to
a buyer for use in manufacturing, processing, or reselling goods for profit.
Trade creditors
The instruments used in trade credit
consist of the following:
- open-book credit
- trade acceptance
- promissory notes
This is unsecured and permits the customer to pay for goods delivered to him in a specified number of days.
open-book credit
This is a time draft drawn by a seller upon a purchase payable to the seller as payee, and accepted by the purchaser as evidence that the goods shipped are satisfactory and that the price is due and payable.
trade acceptance
This is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a certain sum of money to, or to the order of a specified person or to bearer.
promissory note
These are institutions which individuals or firms may tap as source of short-term financing.
Commercial banks
Commercial banks grant two types of short-term loans:
(1) those which require collateral
(2) those which do not require collateral
These are those that help business firms in borrowing funds from the money market.
Commercial paper houses
This is a short-term promissory note, generally unsecured, and issued by large, established firms.
commercial papers
These are financial institutions that finance inventory and equipment of almost all types and sizes of business firms.
Business finance companies
Examples of finance companies in the Philippines
Philacor Credit Corporation
Consolidated Orix Leasing and Finance Corporation
Examples of commercial banks granting short-term loans
City Trust
Premier Bank
Land Bank
These are institutions that buy the accounts receivables of firms, assuming complete accounting and collection responsibilities.
Factors
These are also possible sources of short-term funds. Industry reports indicate that these companies in the Philippines regularly make investments in short-term commercial papers and promissory notes.
Insurance companies
Engineering firms will have to tap this when expenditures for capital assets become necessary.
long-term sources of funds
Long-term sources of funds are classified as follows:
- long-term debts
- common stocks
- retained earnings
Long-term debts are sub-classified into:
term loans
bonds
This is a commercial or industrial loan from a commercial bank, commonly used for plant and equipment, working capital, or debt repayment.
term loan
Term loans have maturities of how many years?
2 to 30 years
This is a certificate of indebtedness issued by a corporation to a lender.
bond
It is a marketable security that the firm sells to raise funds.
bonds
These represent ownership of corporations.
common stocks
These refer to corporate earnings not paid out as dividends.
Retained earnings
Types of Bonds
- Debentures
- Mortgage bond
- Collateral trust bond
- Guaranteed bond
- Subordinated debentures
- Convertible bonds
- Bonds with warrants
- Income bonds
This type of bond has no collateral requirement.
Debentures
This type of bond is secured by real estate.
Mortgage bond
This type of bond is secured by stocks and bonds owned by the issuing corporation.
Collateral trust bond
The payment of interest or principal for this type of bond is guaranteed by one
or more individuals or corporations.
Guaranteed bond
This type of bond has an inferior claim over other debts.
Subordinated debentures
This type of bond are convertible into shares of common stock.
Convertible bonds
This is the type of bond at which warrants are options which permit the holder to buy stock of the issuing company at a stated price.
Bonds with warrants
This type of bond pays interest only when earned.
Income bonds
To determine the best source of financing, Schall and Haley recommends that the following factors must be considered:
- flexibility
- risk
- income
- control
- timing
- other factors like collateral values, flotation costs, speed, and exposure
This refers to the chance that the company will be affected adversely when a particular source of financing is chosen.
risk
This subjects the borrowing firm to more risk than does financing with long-term
debt.
short-term debt
In general, the objectives of engineering firms are as follows:
- to make profits for the owners;
- to satisfy creditors with the repayment of loans plus interest;
- to maintain the viability of the firm so that customers will be assured of a continuous supply products or services, employees will be assured of employment, suppliers will be assured of a market, etc.
(Indicators of Financial Health) The financial health of an engineering firm may be determined with the use of three basic financial statements. These are as follows:
- Balance sheet
- Income statement
- Statement of changes in financial position
also called statement of financial position
balance sheet
also called statement of operations
income statement
This refers to the uncertainty concerning loss or injury.
Risk
The engineering firm is faced with a long list of exposure to risks, some of which are as follows:
- fire
- theft
- floods
- accidents
- nonpayment of bills by customers (bad debts)
- disability and death
- damage claim from other parties
Risks may be classified as either __________ or __________.
pure or speculative
__________ is one in which there is only a chance of loss. This means that there is no way of making gains.
Pure risk
An example of this is the exposure to loss of the company’s motor car due to theft. These are insurable and may be covered by insurance.
pure risk
___________ is one in which there is a chance of either loss or gain. This type of risk is not insurable.
Speculative risk
An example of this is investment in common stocks. If one wants to make gains in the common stock market, the nuances and intricacies of investments must be learned and properly applied.
speculative risk
This is an organized strategy for protecting and conserving assets and people.
Risk management
The purpose of this is to choose intelligently from among all the available methods of dealing with risk in order to
secure the economic survival of the firm.
risk management
This is designed to deal with pure risks.
Risk management
The application of ____________ practices are directed towards speculative risks that are inherent and cannot be avoided.
sound management
There are various methods of dealing with risks. They are as follows:
- the risk may be avoided
- the risk may be retained
- the hazard may be reduced
- the losses may be reduced
- the risk may be shifted
This is a method of handling risk wherein the management assumes the risk.
Risk retention
A ____________, also called self-insurance, is a conscious and deliberate assumption of a recognized risk.
planned risk retention
Examples of __________ are hedging,
subcontracting, incorporation, and insurance.
risk shifting
This refers to making commitments on both sides of a transaction so the risks offset each other.
Hedging
