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AFM 132 > Unit 11: Financial Management > Flashcards

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

1
Q

what are some financial concepts

A
  • 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.)
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2
Q

what should you know about your own finances

A
  • 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
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3
Q

what are questions to get you to think about your finances

A
  • What are your sources of income
  • What are your expenses
  • What debt do you have
  • What are your financial goals
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4
Q

what are potential sources of income and how should they be allocated

A
  • 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
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5
Q

what could be your expenses & how can you track and monitor them

A
  • 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
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6
Q

what should you know about debts

A
  • 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
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7
Q

what is a credit score & what is the point of having a good score

A
  • 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
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8
Q

how to build your credit score

A
  • 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
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9
Q

how to meet your financial goals

A

Budget spending and savings to fund the lifestyle you want to have

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10
Q

what is time value of money

A

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

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11
Q

what is compound interest

A
  • When the interest made from the principle earns interest
  • Larger the balance, bigger the interest earned
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12
Q

what is financial literacy

A

Having the knowledge, skills, and confidence to make informed financial decisions

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13
Q

why is it good to be financially literate

A

helps Canadians manage money and debt wisely, plan and save for the future, and prevent and protect against fraud and financial abuse

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14
Q

what finances does businesses need to manage

A

like personal finances, also needs to manage sources of income, expenses, debts, and financial goals

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15
Q

what is financial management like for companies

A
  • 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
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16
Q

in terms of finance, how does a company ensure they are making progress towards their goals

A

financial controls can be established to manage cash flows, cost/spending, and safeguard assets

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17
Q

what are responsibilities like in a large company? in smaller companies?

A
  • 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
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18
Q

what does a company want to do with their finances

A

build a good credit score and a strong financial reputation

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19
Q

how to determine the creditworthiness for a business

A

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

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20
Q

what is financial planning

A
  • 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
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21
Q

what are some questions to ask regarding financial wellness

A
  • 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?
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22
Q

what are the 3 steps of planning

A
  1. Developing forecasts
  2. Developing budgets
  3. Establishing financial controls
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23
Q

what is done in step 1 of financial planning

A

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

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24
Q

what are long-term forecasts

A
  • 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
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24
Q

what are short-term forecasts

A
  • 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
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24
Q

what information can help prepare forecasts

A
  • 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)
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25
Q

why are long-term forecasts less accurate

A

because the business environment can quickly change (ex. Competition, politics), causing you to work with more estimates

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26
Q

what is done in step 2 of financial planning

A

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)

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27
Q

what is done after forecasts

A
  • budgets are made to manage financial resources
  • Forecasts impact how budgets are prepared
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28
Q

what are common budgets

A
  • operating budget
  • cash budget
  • capital budget
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29
Q

what is an operating budget

A
  • Allocation for ongoing operating expenses in the year
    Ex. salaries, supplies, advertising, rent
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30
Q

what is a cash budget

A
  • Planning cash inflows and outflows for the period
  • Borrow if funds will run low
  • Make investments if there would be excess cash
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31
Q

what is a capital budget

A
  • Planning to purchase major assets
  • Considers a period longer than a year
    Ex. planning to buy equipment over the course of multiple years
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32
Q

who contributes to the budget development

A
  • 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)
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33
Q

who is held accountable to stay within the approved budget & connect with the finance department if there are any changes to determine next steps

A

department managers

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34
Q

what is done in step 3 of financial planning

A

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

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35
Q

what is financial control

A
  • 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
36
Q

what are some potential causes of increased operational costs

A
  • 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)
37
Q

why do companies want to manage cash flow

A
  • 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
38
Q

what happens after discovering the causes of increased costs

A
  • 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)
39
Q

what is one of the largest costs for many organizations

A

employees
less employees = less capital

40
Q

what type of business requires less capital

A

Service businesses may require less capital than manufacturers (they don’t need to spend money on raw materials and equipment)

41
Q

what is undercapitalization

A
  • 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
42
Q

what is cash management

A
  • 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
43
Q

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

A
  • Inadequate planning for customer demand
  • Unexpected increase in operating expenses
  • Not collecting cash from customers in a timely manner
  • Lack of emergency funds
43
Q

what is a company considered if they can’t pay their bills or debt

A

insolvent

44
Q

what are some tips for a business to have more available cash

A
  • 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)
45
Q

what should companies do when collecting from customers

A
  • 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
46
Q

what are some things companies can do to get customers to pay faster

A
  • 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)
47
Q

what should companies do when paying suppliers

A
  • 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
48
Q

why does a business need to manage funds

A

to support day-to-day operations & plan for the future

49
Q

what are capital expenditures

A
  • 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)
49
Q

what do companies consider about financing for their day-to-day operations

A
  • 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
50
Q

what should be done before purchasing (investing) in capital

A
  • 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
51
Q

what should a company consider in terms of capital expenditure

A
  • 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
52
Q

what are common sources of funding

A
  • 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
53
Q

what are things a company can do when they earn net income

A
  • Keep it in the company to maintain and grow operations
  • Provide a return to owners (ex. dividends)
  • Use it to pay debts
54
Q

what are start-ups most likely to do with their profits from operations & why

A
  • 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
55
Q

what is the benefit of using a company’s own money

A

no added costs (interest)

56
Q

why might a business in the growth stage find other ways besides using their own money to finance the business

A

may not be enough money generated from operations

57
Q

how do banks assess the risks of a business

A
  • 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
58
Q

why do banks assess the risks of a business

A
  • to determine how likely they’ll get their money back
  • helps determine:
    • whether they’ll finance
    • type of financing
    • cost to finance
59
Q

what is principal

A

The original amount borrowed on a loan

60
Q

what is interest

A
  • % of the principal amount borrowed
  • Interest can be fixed at a specific rate or variable (fluctuates with any changes to the benchmark interest rate)
61
Q

what is term

A

The time period of a loan

62
Q

what is short term

A

Loan that is borrowed and repaid within 1 year

63
Q

what is long term

A

Loan that is borrowed for more than 1 year and typically repaid over time with regular ongoing monthly payments

64
Q

what is a secured loan

A

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

65
Q

what is an unsecured loan

A
  • 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
66
Q

what are covenants

A
  • 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
67
Q

what is the security of a loan

A

A loan that can be secured or unsecured

68
Q

what are common debt financing options

A
  • credit cards
  • line of credit
  • term loan
69
Q

what is a line of credit

A
  • 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
69
Q

how are credit cards a debt financing option

A
  • 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
70
Q

what is a term loan

A
  • 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
71
Q

what are bonds

A
  • 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
72
Q

what are the two components of bonds

A
  • 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
73
Q

who issues bonds & which has lower risk

A
  • companies
  • canadian government
    Government bonds are lower risk investments since they are guaranteed by the government (risk-free investment)
74
Q

how is the risk of bonds rated

A
  • 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
75
Q

who rates the risk of bonds

A

bond rating organizations (ex. Dominion Bond Rating Services (DBRS))

76
Q

what can bonds also be

A
  • secured to unsecured
  • Unsecured bonds (debenture bonds) are not backed by any security, and only include the reputation of the company
77
Q

what is equity financing

A
  • 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)
78
Q

what is an initial public offering (IPO)

A

When shares are sold to the public for the first time

79
Q

what is prospectus

A
  • A document that summarizes details about the business, financial information, and details on the shares being offered
  • Issued before an IPO to potential investors
80
Q

what are preferred shares

A

Class of shares that don’t include voting rights, but instead provides priority to dividends over common shareholders

81
Q

what are common shares

A
  • 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
82
Q

which shareholders have priority

A
  • 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
82
Q

what are venture capitalists

A

Individuals or companies that invest in already established businesses by purchasing shares

83
Q

what do shareholders expect when they invest into a company

A
  • 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
84
Q

what do companies provide to their shareholders if they do well

A
  • If a company performs well, the board of directors can declare dividends
  • Dividends can be cash payments or more shares
85
Q

what are the disadvantages of choosing debt over equity

A
  • 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
86
Q

what are the advantages of choosing debt over equity

A
  • 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

AFM 132 (12 decks)

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