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 objective of business”.

The Determination of Fund 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

Financing Daily Operations

1. Wages and salaries
2. Rent
3. Taxes
4. Power and Light
5. Marketing Expenses
6. Administrative Expenses

Financing the Firm’s Credit Services

It is oftentimes unavoidable for the firms to extend credit to customers.
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.

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.

Financing the Purchase of Major Assets

Companies, at times, need to purchase major assets.

THE SOURCES OF FUNDS

1. Cash sales
2. Collection of Accounts Receivables
3. Loans and Credits
4. Sales Assets
5. Ownership contribution
6. Advances from customers

SHORT-TERM SOURCES OF FUNDS

Short-term Sources of Funds –are those with repayment schedules of less than one year.

ADVANTAGES OF SHORT-TERM CREDITS

1.They are easier to obtain.
2.Short-term financing is often costly.
3.Short-term financing offers flexibility to the borrower.

DISADVANTAGES OF SHORT-TERM CREDITS

1. Short-term credits mature more frequently.
2. Short-term debts may, at times, be more costly than the long-term debts.

SUPPLIES OF SHORT-TERM FUNDS

1. TRADE CREDITORS -refers to suppliers extending credit to a buyer for use in
manufacturing, processing, or reselling goods for profit.
The Instruments Used In Trade Credit Consist Of The Following.
A.OPEN-BOOK CREDIT-is unsecured and permits the customer to pay for goods delivered to
him in a specified number of days. For financially weak engineering firms, the open-book credit
is a very useful source of financing.
B. 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 price is due and payable.
Sellers allowed the buyer to pay within a certain number of days
C. PROMISSORY NOTES-is an unconditional promise in writing made by one person to
another, signed by the marker, 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.
2. COMMERCIAL BANKS-are institutions which individuals or firms may tap as source of
short-term financing.
Commercial banks grant two types of short-term loans
a. Those which require collateral,
b. Those which do not require collateral
3. COMMERCIAL PAPER HOUSES-are those that help firms in borrowing funds from the
money market.it is sold to investors through commercial paper house.
4. BUSINESS FINANCE COMPANIES-are financial institutional that finance inventory and
equipment of almost all types of business firms.
5. FACTORS-are institutions that buy the accounts receivables of firms, assuming complete
accounting and collection responsibilities.
6. INSURANCE COMPANIES-are also possible source of short-term funds. Industry reports
indicates that insurance companies in the Philippines are regularly make investments in short-
term commercial papers and promissory notes.

LONG –TERM SOURCES OF FUNDS

Long-term sources of fumds are classified as follows:
1.LONG-TERM DEBTS –are sub-classified into term loans and bonds
a.TERM LOANS-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
ADVANTAGES
1.Funds can be generated more quickly than other long-term sources.
2.They are flexible, they can be easily tailored to the needs of the borrower.
3.The cost of issuance is low compared to other lomg-term sources.
BONDS-is a certificate of indebtedness issued by a corporation to a lender.

TYPES OF BONDS
1.DEBENTURES-no collateral needed
2.MORTGAGE BOND-secured by real estate
3.COLLATERAL TRUST BOND-secured by stocks and bonds owned by the issuing
corporation.
4.GUARANTEED BOND-payment of interest or principal is guaranteed by one or more
individuals or corporations
5.SUBORDINATED DEBENTURES- with an interior claim over other debts
6.CONVERTIBLE BONDS-convertible into shares of common stock
7.BONDS WITH WARRANTS-warrants are options which permit the holder to buy stock of the
issuing company at a stated price
8.INCOME BONDS-pays interest only when earned
2.COMMON STOCKS-the third source of long-term funds consist of the issuance of common
stocks.
3.RETAINED EARNINGS-refers to corporate earnings not paid out as individuals.

THE BEST SOURCE OF FINANCING

- The engineer manager or whoeveis in charge must determine which source is the best for
the firm

Factors that should be considered in determining the best source of financing

1. Flexibility - the ability to settle debt in shorter period of time to be able to shift to
another
type of financing.
- borrower should choose fund source with less restriction and
prohibition.
2. Risk - the chance that the company will be affected negatively with the chosen
finance
Source
SHORT – TERM debt is more at risk because :
 It is not renewable with the same terms, if renewable at all
 Risk of defaulting is greater because of often payment

3. Income - when the firm borrows, it must generate enough income to cover the cost
of borrowing and left with sufficient returns for the owner.
4. Control - when new owners are taken in because of the need for additional capital,
the current group of owners may loose control of the firm
- consider other means of financing
5. Timing - Financial market has its ups and downs, choose the best time for
borrowing and selling equity.

Other factors to be considered

A. Collateral Value - other than money, TANGIBLE ASSETS AND INTANGIBLE

ASSETS
 B. Flotation Cost - Cost of issuing bonds or stocks
- Total cost incurred by a company by offering its securities to
public. They arise from expenses such as registration, legal, and underwriting fees.
C. Speed - How fast can the funds be raised
D. Exposure - to what extent will the firm be exposed to other parties.

INDICATORS OF FINANCIAL HEALTH

Three basic financial statements:
1. Balance sheet
2. Income statement
3. Statement of changes in financial position

RISK MANAGEMENT AND INSURANCE

What is Risk?
Refers to the uncertainty concerning loss or injury.
Risks that engineering firms face:
1. Fire
2. Theft
3. Floods
4. Accidents
5. Non-payment of bills by customers
6. Disability and death
7. Damage claim from other parties

Types of Risk
1. 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.
2. Speculative risk – is one in which there is a chance of either loss or gain. This type of risk is
not insurable.
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:
1. The risk may be avoided
2. The risk may be retained
3. The hazard may be reduced
4. The losses may be reduced
Examples of efforts on loss reduction:
A. Physically separating buildings to minimize losses in case of fire;
B. Using fireproof materials on interior building construction;
C. Storing inventory in several locations to minimize losses in case of fire and theft;
D. Maintaining duplicate records to reduce accounts receivable losses;
E. Transporting goods in separate vehicles instead of concentrating high values in single
shipments;
F. Prohibiting key employees from travelling together;
G. Limiting legal liability by forming several separate corporations.
5. The risk may be shifted
Examples of risk shifting:
A. Hedging – refers to making commitments on both sides of a transaction so the risks offset
each other
B. Subcontracting – When a contractor is contract bigger than his company’s capabilities, he
may invite sub-contractors in so that some of the risks may be shifted to them.
C. Corporation – In a 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.
D. Insurance – When a loss occurs, the company is reimbursed by the insurer for the loss
incurred subject to the term of the insurance policy.