Finance Function.pdf

Discusses the Finance function as one of the main functional areas in an organization

1. THE FINANCE FUNCTION

2. The Finance Function
•An important management responsibility that deals with the
”procurement and administration of funds with the view of
achieving the objectives of business” (Medina, 1988)
Determination of
fund requirements
Procurement of
funds
Effective and
efficient use of funds
Short-term
Long-term

3. Determination of Fund
Requirements
Any organization, including the engineering firm, will need
funds for the following specific requirements:
1.To finance daily operations
2.To finance the firm’s credit services
3.To finance the purchase of inventory
4.To finance the purchase of major assets

4. FINANCING DAILY OPERATIONS
The day-to-day operations of the engineering firm will require
funds to take care of expenses as they come. Money must be
made available for the payment of the following:
1.Wages and salaries
2.Rent
3.Taxes
4.Power and light
5.Marketing expenses (e.g. advertising, entertainment,
travel expenses, telephone and telegraph, stationery and
printing, postage, etc.)
6.Administrative expenses (e.g. auditing, legal, services,
etc.)

5. The 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:
1.Cash sales
2.Collection of Accounts Receivables
3.Loans and Credits
4.Sale of assets
5.Ownership contribution
6.Advances from customers

6. LONG-TERM ASSETS
Production equipment
Land
Buildings
LONG-TERM FINANCING
Long-term debt
Common stock
Retained earnings
SHORT-TERM FUND
SOURCES
Commercial banks
Commercial paper houses
Finance companies
Factors
Insurance companies
ACCOUNTS RECEIVABLE
Marketable securities
Taxes
Salaries
Wages
Rent
Insurance
Supplies
Materials
CUSTOMERS
SALES
CASH
INVENTORY
The Firm’s Finances and Cash Flow

7. SHORT-TERM SOURCES OF FUNDS
-loans and credits with repayment schedules of less than a year
Suppliers:
1.Tradecreditors
2.Commercialbanks
3.Commercialpaperhouses
4.Financecompanies
5.Factors
6.Insurancecompanies
Advantages Disadvantages
Easiertoobtain Maturesmorequickly
Often less costly Attimes maybe more costly than
long-term debts
Offers flexibilityto the borrower

8. 1.Tradecreditors–suppliersextendingcredittoabuyerforusein
manufacturing,processing,orresellinggoodsforprofit
Instrumentsused:
•Open-bookcredit–unsecuredandpermitsthecustomertopayforgoods
deliveredtohiminaspecifiednumberofdays
•Tradeacceptance-atimedraftdrawnbyaselleruponapurchase
payabletoaselleraspayee,andacceptedbythepurchaserasevidence
thatthegoodsshippedaresatisfactoryandthatthepriceisdueand
payable
•Promissorynotes–anunconditionalpromiseinwritingmadebyone
persontoanother
2.Commercialbanks–institutionswhichindividualsorfirmstap
assourceofshort-termfinancing;grantstwotypesofshort-
termloans:withandwithoutcollateral
3.Commercialpaperhouses–helpbusinessfirmsinborrowing
fundsfromthemoneymarket

9. 4.Financecompanies–financialinstitutionsthatfinance
inventoryandequipmentofalmostalltypesandsizesof
businessfirms
5.Factors–institutionsthatbuytheaccountsreceivablesoffirms,
assumingcompleteaccountingandcollectionresponsibilities
6.Insurancecompanies

10. LONG-TERM SOURCES OF FUNDS
1.Long-term debts
a.Term loans –a commercial or industrial loan from a commercial
bank, commonly used for plant and equipment, working capital,
or debt repayment
Advantages:
•Quickly generated compared to other long-term sources
•Flexible, i.e., can be easily tailored to the needs of the borrower
•Low cost of issuance compared to other long-term sources
b.Bonds-a certificate of indebtedness issues by a corporation to
a lender. It is a marketable security that the firm sells to raise
funds. Ownership of bonds can be transferred to another
person.

11. Types of Bonds Feature
Debentures No collateral requirements
Mortgagebond Secured by real estate
Collateral trust bond Secured by stocks and bonds ownedby the
issuing corporation
Guaranteedbond Payment of interest or principal is
guaranteed by one or moreindividuals or
corporations
Subordinated debenturesWith an inferior claim over other debts
Convertible bonds Convertible into shares of common stock
Bondswith warrants Warrants are options which permit the holder
to buy stock of the issuing company at a
stated price
Income bonds Pays interest only when earned

12. 2.Common stocks
-represent ownership of corporations
-can be cheaper and more stable sources of long-term funds if
properly utilized
-do not have maturity and repayment dates
3.Retained earnings
-Corporate earnings not paid out as dividends
-Can be used by the firm indefinitely

13. The Best Source of Financing
To determine the best source, Schalland Haley recommends
that the following factors must be considered:
1.Flexibility
2.Risk
3.Income
4.Control
5.Timing
6.Other factors (e.g. collateral values, flotation costs, speed,
and exposure)

14. The Firm’s Financial Health
In general, the objectives of engineering firms are as follows:
1.To make profits for the owners;
2.To satisfy creditors with the repayment of loans plus
interest;
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, etc.

15. Indicators of Financial Health
The financial health of an engineering firm may be
determined with the use of three basic financial statements:
1.Balance Sheet (also called Statement of Financial Position)
2.Income Statement (also called Statement of Operations)
3.Statement of Changes in Financial Position

16. Risk Management and
Insurance
Risk –refers to the uncertainty concerning loss or injury
Examples:
•Fire
•Theft
•Floods
•Accidents
•Nonpayment of bills by customers (bad debts)
•Disability and death
•Damage claim from other parties

17. TYPES OF RISK
Pure risk
-one in which there is only a chance of loss
-are insurable
e.g. exposure to loss of the company’s motor car due to theft
•Speculative risk
-one in which there is a chance of either loss or gain
-not insurable
e.g. investment in common stocks

18. Risk Management
-an organized strategy for protecting and conserving assets
and people
-purpose is to choose intelligently from among all the
available methods of dealing with risk in order to secure the
economic survival of the firm
-designed to deal with pure risks

19. METHODS OF DEALING WITH RISK
1.Avoid risks.
e.g. non ownership of a property to avoid risk of losing it
2.Retain risks.
Risk retention–method of handling risk wherein the
management assumes the risk
Planned risk retention (self-insurance): a conscious and deliberate
assumption of a recognized risk
Unplanned risk retention:when management does not recognize that a risk
exists and unwisely believes that no loss could occur
3.Reduce hazards.
e.g. prohibiting unauthorized persons to enter the cashier’s
office to reduce the hazard of theft.

20. 4.Reduce losses.
e.g.physically separating buildings to minimize losses in cases of fire;
using fireproof materials on interior building construction;
storing inventory in several locations to minimize losses in cases of
fire and theft;
maintaining duplicate records to reduce accounts receivable losses;
transporting goods in separate vehicles instead of concentrating
high values in single shipments;
limiting legal liability by forming several separate corporations
5.Shift risks.
e.g. hedging
subcontracting
incorporation
insurance