Managing the Finance Function

Submitted By: Group 10 Sancha, Zaivil Sanchez, Vienna Marie Secreto, Cristine Joy Trijo, John Lexus Valdellon, Cammille dawn Valdez, Ronnajean Yapcenco,Fatricia HRDM 1-3

Submitted to: Mrs. Jennifer Zabala

Managing the Finance Function Business firms need funds to finance their operations. To be assured of adequate supply of funds, there is a need to manage properly the finance function. Explanation: -Business entities or firms need money for them to be able to finance their operation on a continuing basis. To be assured that they have enough funds they need to mange the finance function well because if they fail to do so they might not be able to go on with their business. What the Finance Function is? It is an important management responsibility that is concerned with the procurement and administration of funds with the view of achieving the objectives of business.

Explanation: If the manager is running the business as a whole he must be concern with the determination of the funds. He must know where the funds needed or it would be used, how to obtain these funds and how they can maximize the utilization of these funds so it would be used efficiently and effectively.

The Determination of Fund Requirements Business firms will need funds for the following specific requirements: 1. To finance daily operations 2. To finance the firms credit services 3. To finance the purchase of inventory; and 4. To finance the purchase of major assets Financing Daily Operations The day-to-day operations of the firm will require funds to take care of expenses as they come. Money must be available for the payment of the following: 1. Wages

2. Rent 3. Taxes 4. Power and light 5. Marketing expenses like those for advertising, entertainment, travel, telephone, stationery and printing, postage, and others. 6. Administrative expenses like those for auditing, legal services, consultancy and others. Explanation: So if the business fail on this it might result on negative things like the disruption of effective work flow of the company, the public might not believe the ability of the firm to operate for a long time. Or the creditors might refrain the company from credit extension.

Financing the Firms Credit Services The extension of credit to customers is, oftentimes unavoidable. The sales terms of manufacturing firm vary from cash to 90 day credit. Construction firms will have to finance the construction of government projects that will be paid many months later.

Explanation: The firm sometimes needs to offer credit extension for the customers to have longer time in settling their debts. They need to do this so they wont have so much difficulty in convincing customers about their product.

Financing the Purchase of Inventory The Maintenance of adequate inventory is crucial to many firms. Raw materials, supplies, and parts are needed to be kept in storage so they will be available when needed. The purchase of adequate inventory, however, will require sufficient funding and this must be secured. Sometimes, inventories unnecessarily tie-up large amounts of funds. The manager must devise some means to make sure this situation does not happen.

Explanation:

Firms experiencing delays in producing the needed materials in the production process. They will resort to buying or purchasing inventories so they can make it available when they need it. Availability of resources must secured for the production process to be efficient. Managers must allocate funds for this because it sometimes brings expenses for the company.

Financing the Purchase of Major Assets Companies, at times, need to purchase major assets. When top management decides on expansion, there will be a need to make investments in capital assets like land, plant, and equipment. Financing these major assets must come from long-term sources.

Explanation: If a company wants to expand their business they need to acquire additional equipments, land and plant which are capital assets. To finance these kinds of assets they must get funds from long term sources because sooner or in the future these assets will bring additional cost or expenditures in the company.

Sources of Funds To finance its various activities, the business firm will have to make use of its cash inflows consisting of the ff: 1. Cash Sales. Cash flows into the coffers of the firm when it is able to sell its products or services. 2. Collection of accounts receivables. Some business firms extend credit to customers. When these are settled by the customers, cash is made available to the firm. 3. Loans and credits. When other sources of financing are not enough, the firm will have to resort to borrowing and cash is made available to the firm. 4. Sales of assets. Cash is sometimes obtained from the sale of the companys assets. First to be sold are the companys idle assets. 5. Ownership contribution. When cash is not enough, the firm may tap its owners to invest more money.

6. Advances from customers. Sometimes, customers are required to pay cash advances on orders made. This helps the firm in financing its production activities. Short-Term Sources of Funds Loans and credits can be classified as short-term, medium-term or long-term. Short-Term sources of funds are those with repayments schedules of less than a year. Collaterals are sometimes required by short-term creditors.

Advantages of Short-Term Credits 1. They are easier to obtain. 2. Short-term financing is often less costly. 3. Short-term financing offers flexibility to the borrower. Disadvantages of Short-Term Credits 1. Short-term credits mature more frequently. 2. Short-term debts may, at times, be more costly than long-term debts. Suppliers of Short-Term Credits 1. Trade Creditors- are those suppliers extending credit to buyers engaged in manufacturing, processing, or reselling goods for profit. The instruments used in trade credit are: 1. Open-book credit- unsecured and permits the customer to pay for goods delivered to him within a specified number of days. 2. Trade acceptance- 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. Under the terms granted in the trade acceptance, the seller allows the buyer to pay within certain number of days. The arrangement provides the buyer some relief in financing his short-term requirements. 3. Promissory notes- 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 sum certain in money to, or to the order of, a specified person. Or to the bearer. 2. Commercial banks- are institutions which may be tapped as sources of short-term financing by individuals or firms. Two types of short-term loans made available by commercial banks: 1. Those which require collateral. 2. Those which do not require collateral. 3. Commercial paper houses- are those assist business firms in borrowing funds from money market investors. Under this scheme, the business firm in need of funds issues commercial paper, w/c is actually a short-term promissory note, generally unsecured, and issued by large, established firms; the commercial paper is sold to investors trough the commercial paper house. 4. Business finance companies- are those financial institutions involved in financing inventory and equipment of almost all types and sizes of business firms. 5. Factors- are institutions that buy the accounts receivables of firms, assuming complete accounting and collection activities. 6. Insurance companies- are also possible sources of short-term funds. Industry reports indicate that insurance companies in the Phil. Regularly make investments in short-term commercial papers and promissory notes. Long-Term Sources of funds Explanation - this kind of funds are generally used to expand and/or to add more facilities to increase the production of the company. This funds are used for a long period of time. This source of funds are suitable for large company because they have that power to return and pay this debt.

Long-term sources of funds are classified as follows; 1. Long-term debts 2. Common stocks and, 3. Retained earnings Long term debts are sub classified into term loans and bonds.

Explanation- long term funds are funds that are usually used by the company to make or to add more resource and/or facilities to maintain or to increased their production rate. Term Loans A commercial or industrial loan from a commercial bank, commonly used for plant and equipment purchase, working capital, or debt repayment. Term loans have maturities of between 2-30 years.

Explanation- term loans are debt usually issued by the company in the banks to get or to have loans. This loans are used to expand the business and to buy additional equipment for the production process. Example, a company issued for a loan in a certain bank. This loan will be used by the company for the new facilities that they need in order to increase their production.

Advantage of term loans as long term source of funds 1. Funds can be generated more quickly than other long term sources. Explanation- one of the advantage of a term loan is that funds can be generated more quickly than other term loans, this advantage means that a term loan can provide funds more quickly due to the reason that money are lended by the banks and technically speaking, banks have that big amount of money to produce for the company rather than any kind of loans. 2. They are flexible,i.e.,they can be easily tailored to the needs of the borrower. Explanation- as long term loans are transaction usually made by the banks and other organization, money that are used in this kind of funds are flexible for the needs of the borrower. Money are distributed according to what they assigned of or in what field will they be used. 3. The cost of issuance is low, compared to other long term sources.

Explanation- due to the fact that money being borrowed by the company from an organization or banks, it has an issuance cost but banks around the world have a low amount of issuance cost compare to the other source of funds.

Bonds A certificate of indebtedness issued by a corporation to a lender. It is marketable security that a firm sells to raise funds. Since the ownership of bond can be transferred to another person, investors are attracted to buy them.

Explanation- bonds are the secured kind of loan where in coupons are made within the agreement to tell what amount of interest are being added to the original amount of money that the issuer borrow.

TYPE OF BOND

FEATURE

1. Debentures 2. Mortgage bond 3. Collateral trust Bond 4. Guaranteed bond

No collateral requirement Secured by real estate Secured by stocks and bond owned by the issuing corporation Payment of interest or principal is guaranteed by one or more individuals or corporations With an inferior claim over other debts Convertible into shares of common stocks Warrants are options which permit the holder to buy stock of the issuing company at a stated price Pays interest only when earned

5. Subordinated debentures 6. Convertible bonds 7. Bonds with warranty

8. Income bonds

Explanation1. Debenture bonds are unsecured bond that gives the lender the power to collect all the asset of the borrower in case that the borrower cannot pay the exact amount of money that he/she borrow from the lender. 2. Mortgage bond are bond that gives the power to a bond holder a security to an assets in cased of bankruptcy. 3. the lender of the money have the security for a collateral like house or any assets. 4. In this kind of bond, the issuer have someone who will guaranty that the issuer will pay the amount of money that he will borrow to a lender or to an organization that makes a deal with the companies regarding the loans. 5. This bonds are unsecured due to the fact that money that the lender produced will be paid after all the holder have collected their shares and other assets.

6. This kind of bonds give the power to a lender to make change their money into shares of the company. 7. This kind of bonds have an agreement in which lender will choose if their money that are being lend to the company will generate or turn out to be the stocks of the company. 8. This kind of bonds give the issuer the opportunity to gain income in order to pay for the amount of money that the company have borrowed to a certain organization or banks.

Common Stocks The third source of long term funds comes with the issuance of common stocks. Since stocks represent ownership of corporations, many investors are placing their money in them.

Explanation- this source of finance means that the stocks of the company are being sold to raise funds. In case that the company is in private, company will change into public for them to raise the amount of funds that they want in order to add more facilities. Retained Earnings Corporate earnings not paid out as dividends. This simply means that whatever earnings that are due to the stockholders are reinvested.

Explanation- the earnings of the stockholders are being reinvested to raise funds for the addition of facilities and/or production. The Best Source of Financing In determining the best source of financing the ff. Factors must be considered; 1. Flexibility 2. Risk 3. Income 4. Control

5. Timing, and 6. Other factors like collateral values, flotation costs, speed, and exposure.

Flexibility Some fund sources impose certain restrictions on the activities of the borrowers. An example of a restriction is the prohibition on the issuance of additional debt instruments by the borrower. As some funds sources are less restrictive, the flexibility factor must be considered. Short term sources offer more flexibility than long term sources. This is so because after settling the debt, short term borrowers are given this opportunity only after a longer period of waiting.

Explanation- flexibility must be consider in choosing the source of finance because, flexibility of the funds are needed to make sure that the funds are generated on the exact time that they need it. Risk Refers to the chance that the company will be affected adversely when a particular source of financing is chosen. Generally, short term debt subjects the borrowing firm to more risk than does financing with long term debt. This happen because of two reasons; 1. Short term debts may not be renewed with the same terms as the previous one, if they can be renewed at all. 2. Since repayments are done more often, the risk of defaulting is greater. Income When the firm borrows, it must generate enough income to cover cost of borrowing and still be left with sufficient returns for the owners.

Control

When new owners are taken in because of the need for additional capital, the current group of owners may lose control of the firms management. If the current owners do not want this to happen, they must consider other means of financing.

Timing The financial market has its ups and downs. This means that there are times when certain means of financing provide better benefits than other times. The manager must, therefore, choose the best time for borrowing or selling.

Other Factors There are other factors considered in determining the best source of financing. They are the ff.: 1. Collateral values: Are there assets available as collateral? 2. Flotation costs: How much will it cost to issue bonds or stocks? 3. Speed: How fast the funds required to be raised? 4. Exposure: To what extent will the firm be exposed to other parties? The Firms financial Health In general, the objectives of business firms are as follows: 1. To make profits for the owners 2. To satisfy creditors with the repayment of loans with interest; and 3. To maintain the viability of the firm so that customers will be assured of a continuous supply of products or services, employees will be assured of employment, suppliers will be assured of a market, and others. Indicators of Financial Health This can be determined with the use of three basic financial statements. These are the ff.: 1. The balance sheet- also called statement of financial position 2. The income statement- also called statement of operations, and

3. The statements of changes in financial position. Risk Management and Insurance Risk Refers to the uncertainty concerning loss or injury. The business firm faced with the long list of exposure to risks, some of which are as follows: 1. Fire 2. Theft 3. Floods 4. Accidents 5. Non-payment of bills by customers(Bad Debts) 6. Disability and death; and 7. Damage claim from other parties

Types of Risk Pure risk One which there is only a chance of loss. This means that there is no way of making gains with pure risks. These are insurable and may be covered by insurance.

Speculative risk One which there is a chance of either loss or gain. This type of risk is not insurable.

What is risk management? Risk management is an organized strategy for protecting and conserving assets and people. The purpose of risk management is to choose intelligently form among all the available methods of dealing with risk in order to secure the economic survival of the firm.

Risk management is designed to deal with pure risks, while of sound management application practices is directed towards speculative risks that are inherent to the business and cannot be avoided.

Methods of Dealing with Risk 1. The risk may be avoided A person who wants to avoid the risk of losing property like house can do so by simply avoiding the ownership of one.

2. The risk may be retained Risk retention is a method of handling risk wherein the management assumes the risk. The planned risk retention is called self-insurance where there is a conscious and deliberate assumption of a recognized risk. On the other hand Unplanned risk retention exist when management does not recognize that a risk exists and unwisely believe that no loss could incur.

3. The hazard may be reduced Hazards may be reduced by simply instituting appropriate measures in a variety of business activities.

4. The losses may be reduced. May be limited by way of reducing concentration of exposures.

5. The risk may be shifted Shifting the risk to another party. Examples of this are hedging, subcontracting, incorporation and insurance.

Hedging refers to making commitments on both sides of a transaction so the risks offset each other. When a contractor is confronted with a contract bigger than his companys capabilities, he may invite subcontractors so that some of the risks may be shifted to them. In a corporation, a stockholder is able to make profits out of his investments but w/o individual responsibility for whatever errors in decisions are made by management. The liability of the stockholder is limited to his capital contribution.

To shift risk to another party, the company buys insurance when a loss occurs, the company is reimbursed by the insurer for the loss incurred subject to the terms of insurance policy.