CHAPTER 12

MANAGING THE FINANCEFUNCTION

WHAT THE FIANCE FUNCTION IS

The finance function is an important management responsibility that deals with the “procurement and administration of funds with the view of achieving the objective of business” . If the engineer manager is running the firm as a whole , he must be concerned with the determination of the amount of funds required, when they are needed, how to procedure them, and how to effectively and efficiently use them.

In the performance of his duties, the engineer manager , at whatever management level he is, must do his share in the achievement of the financial objectives of the company.

the finance function is one of the three basic management functions. The other two are production and marketing.

1. Short-term 2. Long-term

1. Short-term 2. Long-term

1. Short-term 2. Long-term

Determination of fund requirement

Procurement of funds

Effective and

efficient use of funds

THE DETERMINATION OF FUND REQUIREMENT

Any organization, including the engineering firm, will need funds for the following specific requirement:

1. to finance daily operations2. to finance the firm’s credit services3. to finance the purchase of inventory4. to finance the purchase of major assets

FINANCING DAILY OPERATION

The day to day operation 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 salaries2. rent3. taxes4. power and light5. marketing expenses like those for advertising, entertainment , travel expenses, telephone and telegraph , stationary and printing , postage , etc.6. administrative expenses like those for auditing ,legal , services, etc.

FINANCING THE FIRM’S CREDIT SERVICES

It is oftentimes unavoidable for firms to extend credit to customers. If the engineering firm manufactures products, sales terms vary from cash to 90 days credit extensions to customers. Construction firms will have to finance the construction of government projects that

FINANCING THE PURCHASE OF INVENTORY

The maintenance of adequate inventory is crucial to many firms. Raw materials, supplies , and parts are needed to be kept in storage so they will be available when needed. Many firms cannot cope with delays in the availability of the required material inputs in the production process, so these must be kept ready whenever required.

FINANCING THE PURCHASE OF MAJOR ASSET

Companies at times , need to purchase major assets. When top management decides on expansion, there will be a need to make investment in capital assets like hand, plant, and equipment

It is obvious that the financing of the purchase of major assets must come from long-term sources.

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 . Cash is derived when the firm sells its produces or services2. Collection of Accounts Receivable. Some engineering firms extend credit to customers . When these are settled , cash is made available 3. Loans and credits. When other sources of financing are not enough, the firm will have to resort to borrowing4. Sale of assets. Cash is sometimes obtained form the sale of the company’s assets5. Ownership contribution. When cash is not enough, the firm may tap its owners to provide more money6. Advances from customers. Sometimes, customers are required to pay cash advances on orders made. This helps the firm in financing its production activities

SHORT-TERM SOURCES OF FUNDS

Loans and credits may be classified as short-term, medium-term, or long-term. Short-term sources of funds are those with repayment schedules of less than one year. Collaterals are sometimes required by short-term creditors.

Advantages of short-term credits. When the engineering firm avails of short-term credits, the following advantages may be derived:

1. They are easier to obtain. Creditors maintain the view that the risk involved in shot-term lending is also short-term. Thus, short-term credits are made easily available to qualified borrowers2. Short-term financing is often less costly. Since short-term financing is favored by creditors, they make it available at less cost.

3. short-term financing offers flexibility to the borrower. After the borrower has settled his short-term debt, he may consider other means of financing , if he still requires it. Long-term financing , in contrast, eliminates this option. He is stuck with the long-term funds even if he no longer requires it.

Disadvantages of short-term credits. Short-term financing has also some disadvantage. They are as follows:

1. short-term credits mature more frequently. This may place the engineering firm in a tight position more often than necessary. When the frequently of the firm’s cash inflows are more than twelve months apart, the firm could be in serious trouble meeting its short-term

2. short-term debts may, at times, be more costly than long-term debts. When short term expenditures, the

frequent renewals, adjustment of terms, and shopping for new sources may prove to be more costly

Supplies of short-term funds. Short-term financing is provided by the following:

1. trade creditors- refer to suppliers extending credit to a buyer for use in manufacturing , processing or reselling goods for profit2. commercial banks- are institutions which individuals or firms may tap as source of short-term financing3. commercial paper houses- are those that help business firms in borrowing funds from the money market4. finance companies- are financial institutions that

finance inventory and equipment of almost all types and sizes of business firms5. factors- are institutions that buy the accounts receivable of firms, assuming complete accounting and collection responsibilities 6. insurance companies- are also possible sources of short-term funds

LONG-TERM SOURCES OF FUNDS

There are instances when the engineering firm will have to tap the long-term sources of funds. An example is when expenditures for capital assets become necessary. After the amount required is determined, a decision has to be made on the type of sources to be used.

Long-term sources of funds are classified as follows:1. long-term debts2. common stocks, and3. retained earnings.

Term loans . A term loan is a “ commercial or industrial loan from a commercial bank, commonly used for plant and equipment , working capital , or debt repayment. Term loans have maturities of 2 to 30 years

The advantages of term loans as a long-term source of funds are as follows:

1. Funds can be generated more quickly than other long-term sources.2. They are flexible , i.e. , they can be easily tailored to the needs of the borrower.3. The cost of issuance is low compared to other long-term sources.

Bonds . A bond is a certificate of indebtedness issued by a corporation to a lender. It is a marketable security that the firm sells to raise funds.

Common stocks. The third source of long-term funds consists of the issuance of common stock

Retained earnings . Retained earnings refer to “ corporate earnings not paid out as dividends. This simply means that whatever earning that are due to the stock holders of a corporation are reinvested.

THE BEST SOURCES OF FINANCING

As there are various fund sources, the engineer manager, or whoever is in charger, must determine which source is the best available for the firm.

To determine the best source, schall and Haley recommends that the following factors must be considered.

1. flexibility- some fund sources impose certain restrictions on the activities of the barrowers 2. risk- when applied to the determination of fund sources, risk refers to the chance that the company will be

affected adversely when a particular source of financing is chosen.3. income- the various sources of funds, when availed of, will have their own individual effects in the net income of the engineering firm4. control- when new owners are taken in because of the need for additional capital, the current group of owners may lose control of the firm

5. timing- financing market has its ups and downs. This means that there are times when certain means of financing provide better benefits than at other times. The engineer manager must , therefore, choose the best time for borrowing or selling equity6. other factors like collateral values , flotation cost, speed , and exposure. - collateral values: are there assets available as

collateral? - Flotation cost: how much will it cost to issue bonds or stocks? - speed: how fast can the funds required be raised? - Exposure: to what extent will the firm be exposed to other parties

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 interest3. to maintain the viability of the firm so that customers will be assured of a continuous supply of products or, employees will be assured of employment , suppliers will be assured of a market, etc.

INDICATORS OF FIANCIAL HEALTH

The financial health of an engineering firm may be determined with the use of three basic financial statement. These are as follows

1. Balance sheet- also called statement of financial position

2. income statement- also called statement of operations;

3. statement of changes in financial position.

To be able to determine the financial health of a firm, the appropriate financial analysis must be undertaken.

RISK MANAGEMENT AND INSURANCE

the engineer manager , especially those at the top level, is entrusted with the function of making profits for the company . This will happen if losses brought by improper management of risk are avoided.

Risk is a very important concept that the engineer manager must be familiar with. Risks confront people everyday. Companies are exposed to them. Newspapers report on a daily basis the destruction of life and property. Companies that could not cope with losses are forced to shot down, according to reports.

RISK DEFINED

Risk refers to the uncertainly concerning loss or injury . He engineering firm is faced with a long list of exposure to risks, some of which are as follows:

1. fire2. theft3. floods4. accidents5. nonpayment of bills by customers ( bed debts)6. disability and death7. damage claim from other parties

Types of risk

risk may be classified as either pure or speculative. Pure risk is one in which “ there is only a chance of loss” . This means that there is no way of making gains with pure risks. An example of pure risk is the exposure to loss of the company’s motor car due to theft. Pure risks are insurable and may be covered by insurance

What is Risk Management

risk management is “ an organized strategy for protecting and conserving assets and people “ the purpose of risk management is “ to choose intelligently from among all the available methods of dealing with risk in order to secure the economic survival of the firm

Methods of dealing with risk

there are various methods of dealing with risks. they are as follows.1. the risk may be avoided2. the risk may be retained3. the hazard may be reduced4. the losses ma be reduced5. the risk may be shifted

A person who want to avoid the risk of losing a property like a house can do so by simply avoiding the ownership of one. There are instances ,however, when ownership cannot be avoided like those for equipment , appliances, and materials used in the production process. In this case, other methods of handling risk must be considered.