INTRODUCTION TO BUSINESS

PREPARED BY: SHAFAYET ULLAH

SECTION: A3 AND A4

Financial ManagementChapter 18, Part 1

Defining Finance

The study of money within the firm.

The functional area with the responsibility of:

Finding funds for the firm Managing funds of the firm Determining best uses of the firm’s funds

The Financial Manager

Individual who is responsible for the finance function

Effective, financial manager must develop and follow a financial plan.

Role of the Financial Manager

Projecting month-by-month flow of funds into and out of the business

Comparing monthly inflows to monthly outflowsFinding ways to generate revenue from excess

fundsAdjusting inflows and or outflows and looking for

other funding sources ( in case of fund shortage)Analyzing alternate sources of funds and finding

the most efficient source ( in case new funds are required)

Monitoring and evaluating results of the financial plan.

Month-by-Month Outward Flow of Funds

Represents the firm’s use of fundsCost of daily operations: Rent, utilities, wages,

interest expense, taxes.Cost of credit service: Most firms cannot do

business strictly on cash basis, so they provide customers with some form of credit to encourage larger purchases and gain new customers.

Cost of inventory: To survive in a competitive environment firms must provide for customer needs and cannot afford to be out of product that customer demands. ( Further complicated by demand fluctuation).

Month-by-Month Outward Flow of Funds

Purchase of major assets: Land, buildings, equipment (Must be periodically replaced and upgraded) Expansion also requires additional assets.

Debt payment: Payment of interest and principal

Dividend payment: Made to the shareholder as form of earnings on their stocks. Most firms pay dividends to keep their stock attractive to potential investors.

Month-by-Month Inward Flow of Funds

From revenue generated by the business

Can be projected by estimating sales volume

Where credit sales are involved, rate of payment on accounts receivable must be estimated

Interest income expected from investment of cash reserves and other excess funds.

Monthly Inflow to Monthly Outflow: Comparison

Three possible outcomes:

Perfect matching: No action required ( Unlikely)

Expected expenditure for the month greater than expected income ( Additional funds must be found to cover shortfall)

Expected income for the month greater than expected expenditure: Company has excess funds.

Generating Revenue from Excess Funds: Expansion

Applicable for companies with substantial excess funds

Achieved by: Increase in production capacity

Addition of new sales outlets

Acquiring another firm.

Generating Revenue from Excess Funds: High Liquidity Investments

Most popular placement for excess funds: Marketable securities ( Easily converted into cash, pay relatively high interest rates)

Three most commonly used marketable securities:

U.S. Treasury Bills: • Issued each week to the highest bidder• Maturity Dates: Three or six months ( Date on which principal

must be repaid to the purchaser)• Often called T bills• Virtually risk free• One of the most popular marketable securities• Issued in amounts of $ 10,000/more ( not for a small

investor).

Generating Revenue from Excess Funds: High Liquidity Investments

Commercial paper:

• Short term note ( Represents a loan to a major corporation with a high credit standing)

• Maturity date: Three days to nine months• Riskier than T bills, not as liquid• Purchaser paid a higher rate of interest• Normally issued in amounts of $25,000 to

100,000.

Generating Revenue from Excess Funds: High Liquidity Investments

Certificates of deposit/CDs:

• Notes issued by a commercial bank/ brokerage firm

• Size runs from $100 to 100,000• Maturity dates: Range from 24 hours to 10

years• Issued for 7 days to 42 months• CDs issued by banks: Early redeeming

possible (Substantial interest penalty).

Financial ManagementChapter 18, Part 1

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