Unit 11: Financial Management Flashcards
Compare personal financial management with managing finances for a business Explain the use of forecasts, budgets, and financial controls in financial planning for a business Describe the importance of managing cash flow in a business Identify the need for funds in a business and the various funding sources available
what are some financial concepts
- Marketing; break-even analysis to consider various price points for a product to evaluate profitability
- Entrepreneurship; capital (funding) available to start a business (personal savings, bank loans, angel investors, venture capitalists, etc.)
what should you know about your own finances
- Have a good sense of money inflows and outflows
- Knowing sources of income and plans to save or spend can help manage finances for the lifestyle you want now and in the future
what are questions to get you to think about your finances
- What are your sources of income
- What are your expenses
- What debt do you have
- What are your financial goals
what are potential sources of income and how should they be allocated
- Earnings can be from a part-time, co-op, or full-time job
- Money can be earned from scholarships and bursaries
- If any earnings were put into saving accounts or investments, can also get investment income
- Should plan based on your lifestyle and long-term goals to know how to allocate money towards education, entertainment, emergency funds, retirement
what could be your expenses & how can you track and monitor them
- Spending habits?
- Living expenses, costs for school, entertainment can all be expenses
- Impulsive buyer?
- Try to spend consciously
- Set aside a percent of income each month to spend, while the rest is used to save
what should you know about debts
- Plan to manage debts (can also build strong financial reputation)
- Are credit card debt, student loans, car loans, mortgage payments paid in a timely manner?
- Can affect credit score
what is a credit score & what is the point of having a good score
- an assessment of your financial track record and reputation
- Usually range from 300-900, and 800 is considered good
- Higher credit score = you’re less likely to have issues repaying a loan
- Can help you qualify for future borrowing, and have lower interest rates
- Credit scores include payment history, how much debt you have, and how long you’ve been using credit
how to build your credit score
- Pay your bills on time
- At least pay the minimum required payment each month, even if you can’t pay in full
- Avoid going over credit limit
how to meet your financial goals
Budget spending and savings to fund the lifestyle you want to have
what is time value of money
Recognizes the investment potential of money received today compared to receiving it in the future
Ex. $100 today is worth more than $100 in the future
what is compound interest
- When the interest made from the principle earns interest
- Larger the balance, bigger the interest earned
what is financial literacy
Having the knowledge, skills, and confidence to make informed financial decisions
why is it good to be financially literate
helps Canadians manage money and debt wisely, plan and save for the future, and prevent and protect against fraud and financial abuse
what finances does businesses need to manage
like personal finances, also needs to manage sources of income, expenses, debts, and financial goals
what is financial management like for companies
- involves managing funds to achieve company goals
- Looks at how they acquire and manage money to support day-to-day operations and to plan for the future
- Planning includes forecasts and budgets
in terms of finance, how does a company ensure they are making progress towards their goals
financial controls can be established to manage cash flows, cost/spending, and safeguard assets
what are responsibilities like in a large company? in smaller companies?
- In a large company, responsibilities can be divided into various teams that manage specific tasks
- In smaller companies, responsibilities are combined into only a couple of people
what does a company want to do with their finances
build a good credit score and a strong financial reputation
how to determine the creditworthiness for a business
4 C’s of credit
- credit; ex. company size, location, # of years in the business, business structure, media coverage
- capacity; ex. cash flow, ability to pay bills & existing debt
- capital; ex. resources available to repay any debts
- conditions; external factors that can impact the business, ex. industry growth rate, political factors, currency rates
what is financial planning
- Ensures company can manage day-to-day operations and plan for the future
- Involves analyzing cash inflows and outflows in the short & long-term
- Goals is to optimize profitability
what are some questions to ask regarding financial wellness
- Have control over day-to-day expenses?
- Have ability to absorb financial shock?
- Progress towards financial goals?
- Financial freedom to make choices to enjoy life?
what are the 3 steps of planning
- Developing forecasts
- Developing budgets
- Establishing financial controls
what is done in step 1 of financial planning
developing forecasts
- Help make informed predictions on future revenues and expenses
- Based on forecasted future sales volumes, a company can plan their production schedule and manage their resources to avoid supply chain shortages
- Forecasts can show expectations of future sales and expenses when looking for external financing
- Can demonstrate credibility through their accurate forecasts
what are long-term forecasts
- Predicts revenue and expenses beyond one year
- Used to plan for large investments and purchases
- The further the forecasting is done, the less accurate it is
Ex. Forecasting the next 10 years is less accurate than forecasting the next 2 years
what are short-term forecasts
- Predicts revenue and expenses for a period of one year or less
- Forecasts the next month, quarter, or year
- Cash flow forecast can also be prepared to predicted related cash flows
what information can help prepare forecasts
- Past performance (ex. Past sales numbers)
- New sales contracts or contracts that might not be renewed
- Product offerings and customer growth & predictions in changes in the market or economy that could impact sales
- Changes to key expenses (ex. Labour, materials)
why are long-term forecasts less accurate
because the business environment can quickly change (ex. Competition, politics), causing you to work with more estimates
what is done in step 2 of financial planning
developing budgets
- Budgets allocate money for day-to-day operations
- Can also plan for large purchases or investments in the future
- Choosing which specific resources to use based on expectations for revenue (forecasts)
what is done after forecasts
- budgets are made to manage financial resources
- Forecasts impact how budgets are prepared
what are common budgets
- operating budget
- cash budget
- capital budget
what is an operating budget
- Allocation for ongoing operating expenses in the year
Ex. salaries, supplies, advertising, rent
what is a cash budget
- Planning cash inflows and outflows for the period
- Borrow if funds will run low
- Make investments if there would be excess cash
what is a capital budget
- Planning to purchase major assets
- Considers a period longer than a year
Ex. planning to buy equipment over the course of multiple years
who contributes to the budget development
- The finance department
- each key business function (ex. Marketing, HR)
- product line
- geographic unit
ex. marketing manager can submit a budget request to the finance department to approve plans for specific expenses they will incur to work towards company goals (ex. Promotion campaign costs)
who is held accountable to stay within the approved budget & connect with the finance department if there are any changes to determine next steps
department managers
what is done in step 3 of financial planning
establishing financial controls
- Comparing actual performance to forecasts and budgets to see if plans are being achieved
- Allows a company to assess their progress and make appropriate adjustments to stay on track towards meeting their plans
what is financial control
- Comparing actual results to what was projected to identify any differences (variances)
- process can be different depending on the nature/size of the business
ex. some hold weekly meetings to identify variances from plan to ensure end of month goals/targets can be met, other companies assess variances month to month
what are some potential causes of increased operational costs
- Increase in cost of raw materials
- Increase in labour costs (ex. Additional overtime from increased production)
- Increase in the quantity produced (ex. Increased demand from unanticipated interest)
- Quality issues (ex. Problem with production process that led to defects or wasted resources)
why do companies want to manage cash flow
- Companies want to ensure they always have cash on hand to maintain daily operations and to pay off their bills
- Most common way small businesses fail is from undercapitalization and poor management of cash flow
what happens after discovering the causes of increased costs
- leads to the recommended courses of action
- Like adjusting the production process (ex. Finding cheaper raw materials)
- Or changing the forecasts/budgets (ex. To factor what was previously unaccounted for)
what is one of the largest costs for many organizations
employees
less employees = less capital
what type of business requires less capital
Service businesses may require less capital than manufacturers (they don’t need to spend money on raw materials and equipment)
what is undercapitalization
- Not having enough capital to support a business’ operations
- Common and problematic for small businesses
- Large start up costs before revenue is earned from sale of products/service
- Insufficient capital can cause issues for funding day-to-day operations
- Proper business and financial planning can help the first few years of operations
- Can also help if companies are being careful with their spending
what is cash management
- Proper cash management ensures that money is always immediately available
- Should not spend all available cash on fixed assets or inventories
- Because you won’t be able to sell them fast enough to pay the bills immediately
a new boutique sunglasses maker receives a large order from a multinational department store, but doesn’t have capacity to fill the order. what are the possible reasons for this
- Inadequate planning for customer demand
- Unexpected increase in operating expenses
- Not collecting cash from customers in a timely manner
- Lack of emergency funds
what is a company considered if they can’t pay their bills or debt
insolvent
what are some tips for a business to have more available cash
- Should also make sure that customers are paying in a timely manner (ensures company will have cash)
- To maintain control over cash flow, should manage the timing of cash collections (from customers) and cash payments (what you owe to others)
what should companies do when collecting from customers
- Be proactive in collecting what is owed from sales to customers
- Want customers to pay you as fast as possible
- Many business-to-business (BS) businesses provide products/services to their customers then invoice for them to pay at a later date
what are some things companies can do to get customers to pay faster
- invoice immediately; Billing customers as soon as product/service is provided, Clearly state the amount due and payment terms Ex. due within 30 days
- Follow up; Send email reminders of amounts owing before they’re due, Connect with any customers that have overdue amounts
- Reward early payment; Longer money is owed, higher the risk of collection (will they end of giving you the money), To encourage faster payments, companies offers discounts for those that pay early Ex. 2/10 net 30 is noted on the invoice (2% discount if paid within 10 days, Otherwise the payment is due within 30 days)
what should companies do when paying suppliers
- Company’s strategically pay their bills as late as possible (latest they can without incurring any penalties or missing out on any discounts from early payment)
- Allows company to hold onto cash for longer
- Can use the cash in operations before using it to pay the bulls
- To maximize cash flow available for use in operations, companies want to collect cash from sales as quickly as possible, and pay their expenses as late as possible
- Can be helpful for start-ups and small businesses to survive in the first few years & ensure a positive cash flow
why does a business need to manage funds
to support day-to-day operations & plan for the future
what are capital expenditures
- Company would want to buy resources that can help generate additional revenues and cash flows if they want to grow
- Can involve dedicating money for long-term assets (ex. Additional equipment to increase production capacity)
what do companies consider about financing for their day-to-day operations
- Is there enough money on hand to manage regular ongoing needs?
- Includes paying for raw materials, paying employees, paying monthly bills (utilities, electricity, internet, etc.)
- Companies should also set aside additional money for unanticipated emergencies
what should be done before purchasing (investing) in capital
- forecasts are done to see if this asset would help generate more profits if bought
- If it won’t, other strategies for growth are considered
what should a company consider in terms of capital expenditure
- Large purchases can significantly impact immediate cash flows
- To reduce impact, companies need to consider how to obtain additional funds (ex. Take on debt, or sell more shares)
- Also should consider the costs to obtain additional funds (ex. Interest, loss in ownership)
- Companies should develop a plan to repay any borrowed money
what are common sources of funding
- operations; Profits generated from operations that are retained in the business, Used the cash that is generated to invest in ongoing or future operations that can help expand the business
- debt financing; Obtaining funds from creditors (banks), Debts are liabilities for the company & needs to be repaid within specified timeframes
- equity financing; Funds can be raised through the sale of ownership in the company, Sale of company shares
what are things a company can do when they earn net income
- Keep it in the company to maintain and grow operations
- Provide a return to owners (ex. dividends)
- Use it to pay debts
what are start-ups most likely to do with their profits from operations & why
- reinvest them into the company to maintain and grow operations
- can be reinvested to support expanded production or growth of the team
- Can be more difficult for new companies to obtain funds from other sources of financing (ex. banks), as a new company is viewed as a high risk to lend to
what is the benefit of using a company’s own money
no added costs (interest)
why might a business in the growth stage find other ways besides using their own money to finance the business
may not be enough money generated from operations
how do banks assess the risks of a business
- Lower risk - business around for many years, predictable cash flow, valuable assets (to secure loan)
- Higher risk - great idea with business plan, no revenue, no assets
why do banks assess the risks of a business
- to determine how likely they’ll get their money back
- helps determine:
- whether they’ll finance
- type of financing
- cost to finance
what is principal
The original amount borrowed on a loan
what is interest
- % of the principal amount borrowed
- Interest can be fixed at a specific rate or variable (fluctuates with any changes to the benchmark interest rate)
what is term
The time period of a loan
what is short term
Loan that is borrowed and repaid within 1 year
what is long term
Loan that is borrowed for more than 1 year and typically repaid over time with regular ongoing monthly payments
what is a secured loan
Loan that is backed by assets (personal or business assets) that a borrow puts up as collateral, so in the event that the loan is not repaid, the lender can take ownership of the collateral
what is an unsecured loan
- Loan that is not backed by collateral, so it is only granted to customers with strong financial history
- Can also include higher interest rates or shorter repayment terms as the lender is taking on additional risk
what are covenants
- An agreed upon condition that must be maintained
- Can be financial (ex. Maintain a minimum cash balance or certain financial ratios) or non-financial (ex. Requirements to report audited financial statements to the lender annually)
- If the borrower at anytime doesn’t meet the conditions in the covenant, the lender can demand that the loan is paid back immediately in full
what is the security of a loan
A loan that can be secured or unsecured
what are common debt financing options
- credit cards
- line of credit
- term loan
what is a line of credit
- When a lender provides access (a “line”) to a pre-approved amount of money which can be accessed and repaid at anytime
- Interest is only charged on amounts that are used
- Interest is charged from the time the cash is taken out from the line of credit until it is repaid in full
Ex. if there is a $20,000 line of credit, and only $5,000 is used, the $5,000 has interest until it is paid
how are credit cards a debt financing option
- Provides the company with an interest-free period (time between original purchase, when the credit card bill is received, and the due date to pay the bill)
- If the credit card balance is paid off in full by the due date, there are no additional fees
- There is an annual interest rate applied on any amount that isn’t paid by the due date
- On average, the annual interest rate for a credit card is about 20%
- The high interest rate is an incentive for companies to pay on time and in full
what is a term loan
- An amount borrowed from a lender and paid off at fixed intervals (ex. Weekly, bi-weekly, monthly) over a specified period of time (term)
- Longer term loans has higher risk that they might not be paid back, so there may be the need for collateral, higher interest rates, set a covenant, or request a personal guarantee (a promise by an individual to pay any debts a business is unable to pay
what are bonds
- Loans issued by a corporation that must be repaid
- Bonds are an IOU to those they borrow from with a promise to repay by a specific date
what are the two components of bonds
- A promise to pay back the principal (face/par value of a bond) at a specific time (maturity date); Each bond is usually worth $1,000
- A promise of interest (coupon rate); Regular interest payments are required to be paid during the term of the bond
who issues bonds & which has lower risk
- companies
- canadian government
Government bonds are lower risk investments since they are guaranteed by the government (risk-free investment)
how is the risk of bonds rated
- Rated on a scale from AAA to D
- AAA is the highest credit quality
- D is a bankrupt company that can’t pay back their debts
- Higher risk bonds usually have higher interest rates to compensate for the risk that the bond may not be paid back
who rates the risk of bonds
bond rating organizations (ex. Dominion Bond Rating Services (DBRS))
what can bonds also be
- secured to unsecured
- Unsecured bonds (debenture bonds) are not backed by any security, and only include the reputation of the company
what is equity financing
- Selling ownership in the company through the sale of shares as an additional source of funding
- Shareholders get a % of ownership of the company when they purchase a share (give funding to the company)
what is an initial public offering (IPO)
When shares are sold to the public for the first time
what is prospectus
- A document that summarizes details about the business, financial information, and details on the shares being offered
- Issued before an IPO to potential investors
what are preferred shares
Class of shares that don’t include voting rights, but instead provides priority to dividends over common shareholders
what are common shares
- Class of shares that grant shareholders with the right to vote on issues that may impact the future direction of the company
- A company will say if one or more votes are granted per share owned
which shareholders have priority
- If dividends are declared, preferred shareholders are paid first
- If the company is forced out of business, preferred shareholders also get priority to the liquidated assets
what are venture capitalists
Individuals or companies that invest in already established businesses by purchasing shares
what do shareholders expect when they invest into a company
- Shareholders expect a return on investment
- They want to see a growth in their share price so they can sell them for profit (selling for more than they originally bought them for)
- Or they want dividends that might be declared
what do companies provide to their shareholders if they do well
- If a company performs well, the board of directors can declare dividends
- Dividends can be cash payments or more shares
what are the disadvantages of choosing debt over equity
- Companies that have increasing amount of debt is more risky in the eyes of lenders and investors
- Principle and interest parts of the debt must be paid by a specific date; If not planned for property, can cause cash flow issues
- Interest is a legal obligation, dividends are optional (only when the company is profitable)
- Company needs to have collateral or owners may need personal guarantees to get debt financing
what are the advantages of choosing debt over equity
- Lenders don’t gain ownership of the company, only repayment of debts
- With equity, shareholders have voting rights based on how many shares they hold, which dilutes ownership position of the company
