REVIEW QUESTIONS - Chapter 1 Overview of Financial Management REVI...

Copyright © 2014 by Nelson Education Ltd.Chapter 1 Overview of Financial Management

REVIEW QUESTIONS

• Explain the key difference between what financial management focused on in the past

versus today.

In the past, financial management focused primarily on external activities (e.g., raising money, acquisitions, legal matters), that is, one segment of the statement of financial position. Today, although the management of raising money from investors is still important, financial management has focused increasingly on the other segment of the statement of financial position, finding ways to manage more efficiently and effectively all assets of a business, that is, non-current assets and current assets.

• What factors of the external environment have an impact on a company’s financial

statements?

All external factors have an impact on a company’s financial statements. They include economic activities, political activities, world economies, technological changes, industry activities, and efficiencies related to manufacturing activities.

• Define financial management.

Financial management means ensuring that a company uses its resources in the most efficient and effective way to maximize profitability, which ultimately increases the value of the business.

• Why is it important for managers to ask questions such as “How are we doing?” and

“How will our business be protected?”

These questions focus on the five major functions of financial management: (1) the company's overall financial performance; (2) the company's liquidity, or ability to pay its on-going operating expenses and determine the need to borrow short-term funds; (3) how the company's money should be spent; (4) where long-term funding will come from; and (5) how the business will be protected while maximizing investors' share value.

• Differentiate between the role of the treasurer and the role of the controller.

The controller manages how funds are spent and invested by establishing accounting and financial reporting policies and procedures, maintaining the accounting, auditing, and management control mechanisms, and analyzing financial results. The treasurer is (Finance for Non-Financial Managers, 7th Canadian Edition Pierre Bergeron) (Solution Manual, For Complete File, Download link at the end of this File) 1 / 4

1-2 Chapter 1 Overview of Financial Management © 2014 by Nelson Education Ltd.responsible for raising funds and managing the liability and equity side of the statement of financial position.

• Why should operating managers be responsible for the finance function?

Managers are accountable for their decisions as they impact, directly or indirectly, the financial performance of their business unit or organization as a whole. They understand their operating environment, know exactly where they want to go, and have an appreciation about what needs to be done in order to reach their objectives.

• What are the four financial objectives? What do they mean?

(1) Efficiency refers to the relationship between assets employed in a business and profit. (2) Liquidity is a company's ability to meet its short-term financial obligations, such as paying suppliers, creditors, and employees. (3) Prosperity is growth in all segments of a business, including revenue, profit, dividend payments, non-current assets, equity, and working capital. (4) Stability refers to the financial structure of a business, that is, an appropriate balance between the funds provided by lenders and those provided by shareholders.

• Comment on the importance of the “return on revenue” financial objective.

The return on revenue financial objective impacts on the four financial objectives.Efficiency is improved since there is a direct connection between revenue and profit (costs as a percentage of revenue go down); liquidity is improved since more cash is available for spending on working capital such as trade receivables and inventories; prosperity is enhanced since more cash is also available for spending on all assets (current and non-current); and stability is also improved since more profit is added to the equity side of the statement of financial position.

• Differentiate between internal financing and external financing.

Internal financing is obtained from retained earnings, that is, profit for the year plus depreciation/amortization, as well as from reductions in working capital accounts.External financing is obtained from long-term lenders and shareholders.

• What are investing decisions and financing decisions?

Investing decisions are related to the acquisition of non-current assets. These decisions deal with the accounts appearing on the assets side of the statement of financial position such as non-current assets (e.g., property, plant, and equipment) and intangible assets. Financing decisions deal with the accounts listed on the liability and equity side of the statement of financial position, that is, funds borrowed from long- term lenders and shareholders.

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Chapter 1 Overview of Financial Management 1-3 © 2014 by Nelson Education Ltd.

• What are non-current assets?

Non-current assets are permanent assets such as equipment, machinery, and buildings.

• What are working capital accounts?

Working capital accounts are shown on the statement of financial position under the headings current assets and current liabilities. These current assets (e.g., inventories and trade receivables) can be converted into cash within a twelve-month period while current liabilities (e.g., trade and other payables, short-term borrowings) must be paid within a twelve-month period. All these accounts are part of the cash conversion cycle and one of the basic objectives of management is to accelerate this cycle.

• What accounts in the statement of income and the statement of financial position are

included in (a) investing decisions, (b) financing decisions, and (c) operating decisions?

Investing decisions deal with non-current assets and other assets listed in the statement of financial position. Financing decisions involve non-current liabilities or long-term borrowings and a section of the equity account listed in the statement of financial position. Operating decisions deal with accounts listed in the statement of income and accounts related to current assets and current liabilities in the statement of financial position.

• What is the weighted average cost of capital?

The weighted average cost of capital is the cost associated with financing non- current assets, and usually refers to the more permanent forms of financing such as mortgages, bonds, and preferred and common shares.

• What is an operating decision? Give some examples.

An operating decision is a decision that affects the accounts included on the statement of income, such as revenue, cost of sales, distribution costs, and administrative expenses, and accounts in the statement of financial position such as inventories and trade receivables. Examples would include decisions related to looking for more efficient manufacturing methods, hiring additional employees, changing the level of advertising, and reducing the level of inventories and/or trade receivables.

• What is gross profit?

Gross profit is the difference between revenue and cost of sales.

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• Why is it important for operating managers to understand the fundamentals of

financial management?

There are three key individuals responsible for finance in business: the treasurer, the controller, and operating managers. Operating managers are responsible for making important decisions related to the acquisition of assets (e.g., inventories, trade receivables, and non-current assets), and activities affecting the bottom line: cost of sales, distribution expenses, and administrative expenses. The more operating managers understand the finance function, the better are the chances that they will improve their decision-making skills and consequently, make more enlightened decisions.

• What is transparency?

Transparency can be defined as how a business’s processes and related information resources, assets, and outcomes can be made more visible and open to inspection by stakeholders.

• Differentiate between legislation and corporate governance.

Government (the ultimate gatekeeper of public confidence in public markets) legislation has to do with the enactment and implementation of laws for all public company boards, management, and public accounting firms. These laws deal with (1) building a stronger framework for effective governance, (2) establishing high standards and healthy board dynamics, (3) setting up guidance for effective corporate communications, and (4) pin-pointing how red flags should be highlighted to signal the need for prompt investigation and action. Corporate governance gives directives to board members (who bear the ultimate authority and accountability for an organization’s affairs) on how they should govern their organization. The key responsibility of effective directors and top-level managers is to develop a model of governance that aligns and instills shared values throughout their organization and to evaluate the model periodically for its effectiveness.

• Will the finance function be more important in the future than it was in the past?

Discuss.

Answers should suggest that the finance function is already more important than in the past and will continue to increase in importance as companies compete globally, technological changes occur more and more quickly, and global competition requires responding to the requirements of different governments and a variety of stakeholders.

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