MANAGING THE FINANCE FUNCTION

Engineering firms need funds to finance their operations. To be assured of continuous supply of funds, there is a need to manage properly the finance function. When funds are made available in right amounts at the right time, the engineering organization may be expected to function properly. When funds are not enough to finance planned activities, the risk of failure to achieve objectives becomes apparent.

The engineer manager must understand that the finance function is very important management concern. This is true because without adequate funds it will be difficult.

WHAT THE FINANCE 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 objectives of business.

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

DETERMINATION OF FUND

REQUIREMENTS

PPROCUREMENT OF FUNDS

EFFECTIVE AND EFFICIENT USE

OF FUNDS

1.Short –term2.long-term

1.Short-term 2. Long term

1.Short- term 2. long term

THE 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 major assets.

FINANCING DAILY OPERATIONS The day-to-day operations of the engineering firm will require funds to take care of

expresses 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 like those for advertising, entertainment, travel expenses,

telephone and telegraph, stationery and printing, postage. 6. administrative expenses like those for auditing, legal, services.

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-day credit extensions to costumers. Constructions firms will have to finance the construction government projects that will be paid many months later.

When a new chemical manufacturing firm finds difficulty in convincing distributors to carry their products, a credit extension may solve the problem. A new problem however will be created.

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.

The purchase of adequate inventory, however will require sufficient funding and this must be secured.

Sometimes, inventories unnecessarily tie up large amount of funds.

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 investments in capital assets like land, 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. 2. Collection of Accounts Recievables. 3. Loans and Credits. 4. Sales Assets. 5. Ownership contribution. 6.Advances from customers.

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 short-term lending Is also short term credits are made easily available to qualified borrowers.

2. short-term financing is often less costly. Since short term financing is favoured by creditors.

3. short-term financing offers flexibility to the borrower.

DISADVANTAGE OF SHORT-TERM CREDITS

1. short term credits mature more frequently. This may please the engineering firm in a tight position more often than necessary. when the frequency of the firms cash inflows are more than twelve months apart, the firm could be in serous trouble meeting its short-term obligations.

Short-term debts may, at times, be more costly than long- 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 2.commercial banks 3.commercial paper houses 4. finance companies 5. factors and 6.ibnsurance companies

Trade creditors refer to suppliers extending credit to a buyer for use in manufacturing, processing or reselling goods to profit. The instruments used in trade credit consist of the following; (1) open-book credit, (2) trade acceptance, and (3) promissory notes.

The open book credit is unsecured and permits the customer to pay for goods delivered to him in specified number of days.

The trade acceptance is a time draft drawn by a seller upon a purchase payable to the seller as payee, and accepted by the purchaser as evidence that the goods shipped are satisfactory and that the price is due and payable.

A promissory note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a certain sum of money to , or to the order of, a specified person or to bearer.

Commercial banks are institutions which individuals or firms may tap as source of short-term financing. Commercial banks grant two types of short term financing. Commercial banks grant two types of short-term loans (1) those which require collateral, and (2) those which do not require collateral. Examples of commercial banks granting short-term loans are City trust, Premier Bank, and Land Bank.

Commercial paper houses are those that help business firms in borrowing funds from the money market. Under this scheme, the business firm in need of funds issues a commercial paper which is a short term promissory note,

Business finance companies are financial institutions that finance inventory and equipment of almost all types and sizes of business firms. Examples of finance companies in the Philippines are Philacor Credit Corporation and Consolidated Orix Leasing and Finance Corporation.

Factors are institutions that buy the accounts recievables of firms, assuming complete accounting and collection responsibilities. Engineering firms which maintain sizable amounts of accounts recievable may avail of the services of factors when they are in dire need of cash..

Insurance companies are also possible sources of short-term funds. Industry reports indicate that insurance companies in the Philippines regularly make investments in short-term commercial papers and promisory notes.

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 long-term debts are sub-classified into term loans and bonds.

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 sources of funds are as follows;

1. Funds can be generated more quickly than other long-term sources. 2. they are flexible example, they can be easily tailored to the needs of the

borrower. 3. the cost of issuance is long 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. Since the ownership of bonds can be transferred to another person, investors are attracted to buy them.

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

common stocks. Since common stocks represents ownership of corporations, many investors are placing their money in them.

Retained Earnings retained earnings refer to “corporate earnings not paid out as dividends. This

simply means that whatever earnings that are due to the stock holders of a corporation are reinvested. Because these retained earnings can be used by the firm indefinitely, they become an important source of long-term financing.

Type of bond Feature 1.Debentures no collateral requirement 2.Mortgage bond secured by real estate 3.Collateral trust bond secured by stocks and bonds and bonds owned by the issuing corporation 4.guaranteed bond payment of interest or principal is guaranteed by one or more individuals or corporation 5.subordinated debentures with an inferior claim over other debts 6.convertible bonds convertible into shares of common stock 7. bonds with warrants warrants are option which permit the holder to buy stock of the issuing company at a stated

price 8. income bonds pay interest only when earned

THE BEST SOURCE OF FINANCING

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

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

1.Flexibility 2. risk 3.income 4.control 5. timing 6. other factors like collateral values, floatation cost, speed, and exposure

FLEXIBILITY

Some find sources impose certain restrictions on the activities of the borrowers. An example of a restriction is the prohibition on the issuance of additional debt instruments by the borrower.

As some fund sources are less restrictive, the flexibility factor must be considered. In general, however short-term fund sources offer more flexibility than long term-sources.

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.

Generally short-term “subject the borrowing firm to more risk than does financing with long term debt. “this happens because of two reasons;

1. short-term debts may not be renewed with the same term as the previous one, if they can be renewed at all.

2. since repayments are done more often, the risk of defaulting is greater.

INCOME

The various sources of funds, when availed of will have their own individual effects in the net income of the engineering firm. When the firm borrows, it must generate income to cover the cost of borrowing and still be left with sufficient returns for the owners.

It is possible that the the owners were enjoying higher rates of return on their investments before borrowing was made. The reverse may happen, however at other times. Nevertheless, the effects on income must be considered in determining the source of funding to be used.

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 if the current owners do not want this to happen, they must consider other means of financing.

TIMING

The financial 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 equity.

OTHER FACTORS

There are other factors considered in determining the best source of funds. There are as follows;

1. collateral values: are there assets available as collateral? 2. Floatation cost: how much will it cost to issue bonds or stocks? 3. speed : how fast can the funds required be raised? 4. 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 interest; 3. to maintain the viability of the firm so that costumers will be assured of a

continuous supply of products or services, employees will be assured of employment , suppliers will be assured of market.

The foregoing objectives have better chances of achievement if the engineering firm is financially healthy and has the capacity to be so on A LONG-TERM BASIS,

INDICATORS OF FINANCIAL HEALTH

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

1. Balance sheet- also called statement of financial position; 2.income statement –also called of operations; 3. statement of changes in financial position.

RISK MANAGEMENT AND INSURANCE

The engineer manager, especially those at the top level, is entrusted with the function of marking profits for the company. This will happen if losses brought by improper management of risks 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 daily basis the destruction of life and property. Companies that could not cope with issues are forced to shutdown, according to reports.

fortunately, the engineer manager is not entirely helpless. He can use sound risk management practices to avoid the threat of bankruptcy due to losses.

RISK DEFINED

Risk refers to the uncertainty concerning loss or injury. The engineering firm is faced with a long list of exposure to risk, some of which are as follows;

1. fire 2. theft 3. floods 4. accidents 5.non-payment of bills by costumers (bad debts) 6. disability and death 7. damage claim from other parties.

TYPE OF RISK

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

Speculative risk is one in which there is a chance of either loss or gain. This type of risk is not insurable. An example of a speculative risk in investment in common stocks

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.

Risk is designed to deal with pure risks, while the application of sound management practices are directed towards speculative risk that are inherent and cannot be avoided.

METHODS OF DEALING WITH RISK

There are various methods of dealing with risk, they are as follows;

1. the risk may be avoided 2. the risk may be retained 3. the hazard may be reduced 4. the losses may be reduced 5. the risk may be shifted

A person who wants to avoid the risk of losing a property like a house can do 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 the case other methods of handling risk must be considered. Risk retention is a method of handling risk wherein the management assumes the risk. A planned risk retention, also called self-insurance, is a conscious and deliberate assumption of a recognized risk. In this case management decides to pay losses out of currently available funds.

Hazards may be reduced by simply instituting appropriate measures in a variety of business activities. An example is prohibiting unauthorized persons to enter the cashier’s office. This will reduce the hazard of theft. Another example is prohibiting company drivers from taking alcohol or drugs while on duty.

When losses occur in spite of preventive measures, the severity of loss may be limited by way of reducing the concentration of exposures. Examples of efforts on loss reduction are as follows;

1. physically separating buildings to minimize losses in case of fire, 2. using fireproof materials on interior building construction; 3. storing inventory in several locations to minimize losses in cases of fire and theft; 4. maintaining duplicate records to reduce accounts recievable losses; 5. transporting goods in separate vehicles instead of concentrating high values in

single shipments; 6. prohibiting key employees from travelling together; and 7. limiting legal liability by forming several separate corporations.

When a constructor is confronted with a contract bigger than his company’s capabilities, he may invite sub-constructors in so that some of the risk may be shifted to them.

In corporation, a stockholder is able to make profits out of his investments but without individual responsibility for whatever errors in decisions are made by the management. The liability of the stockholder is limited to his capital constribution.

To shift risk to another party, a company buys insurance. When a loss occurs, the company is reimbursed by the insurer for the loss incurred subject to the term of the insurance policy.