Managing

Financial
Resources
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 17
Chapter

Understanding
Accounting and
Financial Information

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 Financial Statement
• A Financial Statement is a summary of all the financial
transactions that have occurred over a particular period.
• Financial statements indicate a firm’s financial health
and stability, and are key factors in management
decision making.
• The key financial statements of a business are:
1. The Balance Sheet – Reports the firm’s financial condition on
a specific date. Details what the company owns and owes on
a specific date.
2. The Income Statement – Summarizes revenues, cost of
goods sold, and expenses (including taxes), for a specific
period and highlights the total profit or loss, the firm
experienced during that period.
3. The Statement of Cash Flows – Provides a summary of
money coming into and going out of the firm. It tracks
company’s cash receipts and cash payments.
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 Income Statement
• An income statement is a financial statement that
measures a company's financial performance over a
specific accounting period.
• It shows the profit after deducting all the costs,
expenses and taxes.
• It also summarizes all of the resources that have
come into the firm (revenue) and all the resources
that have left the firm (expenses), and the resulting
net income or net loss.

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How to Compile Income Statement:

Revenue
- Cost of Goods Sold (COGS)
= Gross Profit (gross margin)
- Operating Expenses
= Net Income (before taxes)
- Taxes
= Net income/ loss

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 Revenue

• It is an income, which is generated from sale of

goods or services, or any other use of capital or
assets, associated with the main operations of an
organization before any costs or expenses are
deducted.
• Also known as the monetary value of what a firm
received for goods sold, services rendered, and
other payments (e.g. rent received).

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Cost of Goods Sold (COGS)
• A measure of the cost of merchandise sold or cost
of raw materials and supplies used for producing
items for trade.
• Also known as Cost of Goods manufactured.
• Cost of goods sold includes the purchase price, any
freight charges paid to transport goods and any
costs associated with storing the goods.

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Gross Profit (Gross Margin)
• It refers to how much a firm earned by buying (or
making) and selling merchandise/ products.
• When we subtract the costs of good sold from net
sales, we get gross profit or gross margin.
• In a service firm, COGS might be absent, therefore,
Gross profit is equal to net sales.

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 Operating Expenses
• Costs involved in operating a business
• It includes rent, utilities, supplies, insurance and
salaries.
• Other Operating Expenses like Depreciation are
much more complex.
• Depreciation is the systematic write-off of the cost
of a tangible asset over its estimated useful life.
- The monetary value of an asset decreases over
time due to use, wear and tear or obsolescence.

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 Net Profit or Loss
• After deducting all expenses, the firm’s net income before
taxes can be determined.
• It is also known as net earnings or net profit.
• After allocating taxes, we get the net income (or net loss)
the firm incurred from revenue minus sales returns, costs,
expenses, and taxes over a period of time.

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 Income Statement Exercise

Sam’s Tech Ltd. had sales of $100,000 in 2020. The

cost of goods sold was $65,000, operating expenses
(excluding depreciation) were $10,000, interest
expenses were $5,000 and depreciation expense was
$10,000. The firm’s tax rate is 35 percent.

a. Calculate the Earning before tax (EBT)?

b. Calculate the Net income/ profit?

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 Income Statement
Sam’s Tech Ltd. had sales of $100,000 in 2022. The cost of goods sold was
$65,000, operating expenses (excluding depreciation) were $10,000, interest
expenses were $5,000 and depreciation expense was $10,000. The firm’s tax
rate is 35 percent.
a. Calculate the Earnings Before Tax (EBT)?
b. Calculate the Net Income /Profit?

Sales 100,000.00
COGS (65,000.00)
Gross Profit 35,000.00
Operating Expenses (10,000.00)
Depreciation (10,000.00)
EBIT 15,000.00
Interest (5,000.00)
EBT 10,000.00
Income Tax 10,000*35% (3,500.00)
Net Income / Loss 6,500.00
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The Goals and Functions of
Financial Management

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 Finance & Managers
• Finance: The function in a business that acquires funds
for the firm and manages those funds within the firm.
– Financial activities include preparing budgets, doing
cash flow analysis, and planning for the expenditure of
funds on such assets as plant, equipment, and
machinery.
• Financial Management: The job of managing a firm’s
resources so it can meet its goals and objectives.
• Financial Managers: Managers who examine financial
data prepared by accountants and recommend strategies
for improving the financial performance of the firm.
– Financial managers must understand accounting (and
in fact many of them have backgrounds in accounting)
but they are not accountants within the company. They
are decision-makers and managers in the truest sense
of the word.
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 What is Financial Management?

• Financial management or business

finance is concerned with managing
an entity’s money.
• Functions:
– Allocate funds to current and fixed assets
– Obtain the best mix of financing alternatives.
– Develop an appropriate dividend policy
within the context of the firm’s objectives.

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 The Goals of Financial Management

“Earn the highest possible profit for

the firm”

▪ Also known as Wealth Maximization Goal.

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 The Goals of Financial Management
↑ Profitability → ↑ Risk
↓ Profitability → ↓ Risk
▪ Higher profits /returns are always associate with higher
level of risk e.g. investing in stocks vs. savings accounts
▪ Stocks may be more profitable but are riskier
▪ Savings accounts are less profitable and less risky.

Financial manager must choose appropriate

combination of potential profit (return) and level of
risk (safety).

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Functions and Activities of Financial Management
▪ Functions involve:
▪ raising funds for the firm at minimal cost and acceptable
risk.
▪ investing those funds in company assets so as to earn an
attractive return given acceptable risks.
▪ Activities include:
▪ Working Capital Management
▪ Short-term (S/T) financial decisions (<1 year)
Example: managing cash and other current assets
▪ Capital Budgeting
▪ Long-term (L/T) financial decisions (>1 year)
Example: purchasing a new machine in the future -
Financing decisions (capital structure)
▪ How to raise money: loans? leases? shares? bonds?
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 18
CHAPTER

FINANCIAL
MANAGEMENT

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 Financial Planning
● Financial Planning: Financial planning involves analyzing
short term and long term money flows to and from the firm.
● The overall objective of financial planning is to optimize the
firm’s profitability and make the best use of its money.
● Financial planning is a key responsibility of the financial
manager in a business.
● Financial planning involves three steps:
1. Forecasting both short-term and long-term financial
needs
2. Developing budgets to meet those needs, and
3. Establishing financial control to see how well the
company is doing what it is set out to do.

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 Financial Planning
Financial
Plan
Short-term Long-term
Forecasting Forecasting
Operating
Budget
Capital Cash
Budget Budget

Financial Feedback
Feedback
Controls
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 Financial Planning
● Forecasting financial needs
● Forecasting is an important part of any firm’s
financial plan.
● Short-term forecast: Forecast that predicts
revenues, costs, and expenses for a period of one
year or less.
● Long-term forecast: Forecast that predicts
revenues, costs, and expenses for a period longer
than one year and sometimes as far as 5 or 10
years into the future.
● Cash flow forecast: Forecast that predicts the cash
inflow and outflows in future periods, usually months
or quarters.
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 Financial Planning
● Working with the Budget Process
● Budget: A financial plan that sets forth
management’s expectations, and on the basis of
those expectations, allocates the use of specific
resources throughout the firm.
● A budget becomes the primary guide for the firms
financial operations and financial needs.
● As a financial plan, the budget depends heavily on
the accuracy of the firm’s balance sheet, income
statement, statement of cash flows, and short-term
and long-term financial forecasts, which all need to
be as accurate as possible.
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 Financial Planning
● Working with the Budget Process
● To effectively prepare budgets, financial
managers must take their forecasting
responsibilities seriously.

There are usually several types of budgets

established in a firm’s financial plan:
1. A capital budget
2. A cash budget
3. An operating (master) budget

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 Financial Planning
• Capital budget: a budget that highlights a firm’s spending
plans for major asset purchases that often require large sums
of money. Purchase of assets as property, buildings and
equipment etc.
• Cash budget: A budget that estimates a firm’s projected cash
inflows and outflows that the firm can use to plan for any cash
shortages or surpluses during a given period. Important
guidelines that assist managers in anticipating borrowing, debt
repayment, operating expenses etc.
• Operating (Master) budget: The budget that ties together all
of a firm’s other budgets; it is the projection of dollar/money
allocations to various costs and expenses needed to run or
operate the business, given projected revenues. How much
the firm will spend on supplies, travel, rent, advertising,
salaries and so on.

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 Financial Planning
● Financial planning plays an important role in the operations
of the firm. This planning often determines what long-term
investments are made, when specific funds will be needed,
and how the funds will be generated. Once a company has
forecast its short-term and long-term financial needs and
established budgets to show how funds will be allocated,
the final step in financial planning is to establish financial
controls.
● Establishing financial control
● Financial control: A process in which a firm periodically compares its
actual revenues, costs, and expenses with its projected ones.
● Most companies hold at least monthly financial reviews as a way to
ensure financial control.
● Financial controls also help reveal which accounts, which
departments and which people are varying from the financial plans.

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 Financial Planning
Process

Forecast Cash Flow Budget Cash Needs

Short-term & Long-term Operating, Cash, &
Uses Capital

Compare Results Control Differences

Modify Forecasts & Actual vs. Projected
Budgets Flows

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Need for Operating Funds
• In business, the need for operating funds never
seems to cease. That is why sound financial
management is essential to all businesses.
• Different firms need funds available for different
reasons. However, in virtually all organizations
there are certain operational needs for which
funds must be available. Key areas include:
– Manage Daily Operations
– Controlling credit operations
– Acquire needed Inventory
– Capital Expenditures

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 Need for Operating Funds
• Manage Daily Operations
– The challenge of sound financial management is to see that funds
are available to meet the daily cash needs without compromising
investment potentials.
– Efficient cash management is particularly important to small firms in
conducting their daily operations because their access to capital is
generally much more limited than that of larger businesses.
• Controlling credit operations
– Financial managers know that making credit available helps keep
current customers happy and attract new customers.
– Selling in credit results in business’s assets tied up in it’s credit
accounts – that means firms need to use some of its available
funds to pay for the goods or services already sold to customers
who bought on credit. Managers in such firm must develop efficient
collection procedure.
– One way to decrease the time, and therefore expenses, involved in
collecting accounts receivable is to accept bank credit cards.

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 Need for Operating Funds
• Acquire needed Inventory
– To satisfy customers, businesses must maintain inventories that
often involve in sizable expenditure of funds.
– Although it’s true that firms expect to recapture their investment in
inventory through sales to customers, a carefully constructed
inventory policy assists in managing the firms available funds and
maximizing profitability.
– It is important for a business of any size to understand that a poorly
managed inventory system can seriously impact cash flow and drain
its finances dry.
• Capital Expenditures
– Capital Expenditure: Major investment in either tangible long-term
assets such as land, buildings, and equipments or intangible assets
such as patents, trademarks and copyrights.
– In many organizations, purchase of major assets – such as land for
future expansion, manufacturing plants to increase production
capabilities, research to develop new-product ideas – is essential.

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 Need for Operating Funds
• Capital Expenditures (cont’d)
– Business expansions can cost large sums of money with no
guarantee that the expansion will be commercially successful.
– Therefore, it is critical that companies evaluate all the possible
options before committing what may be a large portion of their
available resources. For this reasons financial managers and
analysts evaluate the appropriateness of such purchases or
expenditures.
• The need for operating funds raises several questions
– How does the firm obtain funds to finance operations and other
business necessities?
– Will specific funds be needed by the firm in the long term or short
term?
– How much will it cost to obtain these needed funds?
– will these funds come from internal or external sources?

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 Alternative Sources of
Funds
• Short-term financing: Borrowed capital that
will be repaid within one year.

• Long-term financing: Borrowed capital that

will be repaid over a specific period longer than
one year.

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 Why Firms Need Funds
Short-Term Funds Long-Term Funds
• Meeting monthly • New product
expenses development
• Unanticipated • Replacing capital
emergencies expenditure
• Cash-flow problems • Mergers or acquisitions
• Expanding current • Expansion into new
inventory markets
• Temporary promotional • Building new facilities
programs

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 Sources of Funds
Short-Term Long-Term
• Trade Credit • Debt
• Promissory Notes – Term-Loan
• Family/Friends – Bonds
• Banks, etc. • Secured
– Secured Loan • Unsecured
– Unsecured Loan • Equity
• Line of credit
– Stock
• Factoring
– Retained
• Credit Cards
Earnings
– Venture Capital
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 Sources of Funds
Short-Term
• Trade Credit: The practice of buying goods and services now
and paying for them later.
– Businesses often get terms 2/10 net 30 when receiving trade credit.
• Promissory Notes: A written contract with a promise to pay
supplier a specific sum of money at a definite time.
– Suppliers hesitate to give trade credits to organizations with
poor credit history, no credit history or history of slow
payment. In such situations suppliers may insist on a
promissory note.
– Promissory notes can be sold by the supplier to a bank at a
discount.

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 Sources of Funds
Short-Term
• Family/Friends: Many small firms obtain short-term funds by
borrowing from family and friends. If asking for help from family
or friends, it’s important both parties:
1. Agree to specific loan terms
2. Put the agreement in writing
3. Arrange for repayment the same way they would for a bank loan

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 Sources of Funds
Short-Term
• Banks, etc.: Banks and other financial institutions offer different
types of loans to customers.
–Secured Loan: A loan backed by something valuable,
such as property. E.g. Automobile loan.
• The item of value is called collateral.
• If the borrower fails to pay the loan, the lender may take
possession of the collateral.
• Collateral takes some of the risk out of lending money.
–Unsecured Loan: A loan that is not backed by any
specific assets.
• Normally a lender will give unsecured loans only to highly
regarded customers, i.e. long-standing customers or
customers considered financially stable.
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 Sources of Funds
Short-Term
• Line of credit: A given amount of unsecured short-term funds
a bank will lend to a business, provided that funds are readily
available.
– If a business develops a good relationship with a bank, the bank
may open a line of credit for the firm.
– A line of credit is not guaranteed to a business.
– The primary purpose is to speed the borrowing process.
• Revolving credit agreement: A line of credit that is
guaranteed by the bank.
– As businesses mature and become more financially secure, the
amount of credit increases and firms also apply for a revolving
credit agreement.
– Banks usually charge a free for guaranteeing such an
agreement.
• Both lines of credit and revolving credit agreements are
particularly good sources of funds for unexpected cash needs.
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 Sources of Funds
Short-Term
• Commercial Finance Companies: Organizations that make short-term
loans to borrowers who offer tangible assets as collateral.
• Factoring: The process of selling accounts receivable for cash.
– A relatively expensive source of short term funds.
– Even though factoring can be an expensive way of raising cash, it is
popular among small businesses.
– Factoring is not a loan; it is the sale of an asset (accounts receivable).
– Discount rates charged by factors are usually higher than loan rates
charged by banks or commercial finance companies.
• Commercial paper: Unsecured promissory notes of $100,000 and up
that mature (come due) in 270 days or less.
– Sometimes a large corporation needs funds for just a few months and
wants to get lower rates of interest than those charged by banks.
– Commercial paper states a fixed amount of money the business agrees to
repay to the lender (investor) on a specific date. The interest rate for
commercial paper is stated in the agreement.

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 Long Term Debt Financing
• Long-term financing loans generally come due within 3 -7
years but may extend to 15 or 20 years.

• Term-Loan Agreement -- A promissory note that requires the

borrower to repay the loan with interest in specified monthly or
annual installments.

• A major advantage of debt financing is the interest the firm

pays is tax deductible.

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 Sources of Funds
Long-Term
• Long-term funding comes from two major types of financing, debt financing
and equity financing.
• Debt Financing
– Term-Loan: Debt financing by borrowing money from lending
institutions.
• A term loan agreement is a promissory note that requires the
borrower to repay the loan in specified installments (e.g. monthly or
yearly).
• Most long-term loans require collateral, which may be in the form of
real estate, machinery, equipment, stock or other items of value.
– Bonds: Debt financing by issuing bonds
• If an organization is unable to obtain its long-term financing needs by
getting a loan from a lending institution, it may try to issue bonds.
• To put it simply, a bond is like a company IOU with a promise to
repay the amount borrowed on a certain date.
• A bond is a long-term debt obligation of a corporation or government.
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 Who Can Issue Bonds?
1. Federal, state, and local
governments
2. Federal government agencies
3. Corporations
4. Foreign governments and
corporations

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 Sources of Funds
Long-Term
• Bonds (cont’d)
– Secured bond: A bond issued with some form of
collateral.
• If the bond’s indenture (terms and agreements) are
violated, the bondholder can issue a claim on the
collateral.
– Unsecured: A bond backed only by the reputation of
the issuer, also called a debenture bond.

• Bonds are a key means of long term financing for many

organizations. They can also be valuable investment for
private individuals or institutions.

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 Sources of Funds
Long-Term
• Equity Financing: Equity financing involves selling ownership of
the firm in forms of stock, or using earnings that have been retained
by the company to reinvest or by selling ownership in the firm to
venture capitalists.
– Stock: Selling ownership shares (called stocks).
• The purchasers of stock becomes owners in the
organization.
• The number of shares of stock that will be available for
purchase is generally decided by the organization’s board of
directors.
• The first time a company offers to sell its stock to the general
public is called an initial public offering (IPO).
• Companies can issue stock for public purchase only if they
meet requirements set by the Securities and Exchange
Commission (SEC) as well as various government/ state
agencies. 44
 Sources of Funds
Long-Term
– Retained Earnings: Often a major source of long-term funds.
• Are usually most favored source of meeting long-term
capital needs since a company that uses them saves
interest payments, dividends, and any fees for issuing
bonds or stock.

– Venture Capital: Money that is invested in new or emerging

companies that are perceived as having great profit potential.
• An entrepreneur or finance manager must remember that
venture capitalists invest in a company in return for part
ownership of the business.

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