ACC 400 - University of Phoenix



ACC/400 Week Four

Financial Management

• INTRODUCTION

A student walks into a car dealership, looks at the window sticker and falls over with apparent sticker shock. She is then awoken some time later to the smell of ink and paper. She is slumped over at the sales desk with a pen in her hand having just signed the last sales document. In her slumber, she has elected to lease her new vehicle rather than buy it. Why?

The same student has to come up with a down payment. In her confusion, she elects to take a second mortgage out on her home for the down payment rather than use cash from her savings account. Why?

Financial management, whether it be personal or organizational is much the same. Do we buy or lease? What type of financing is in the best interest of the organization; equity (using corporate cash) or debt (borrowing funds from others)? What is your responsibility as the CFO, controller, or staff accountant to ensure that the “correct” financing vehicle is utilized to maximize earnings to the organization? Finally, as the CFO, controller, or staff accountant, is it possible that the optimal financing vehicle for the organization may contradict or interfere with the internal controls of the organization?

This Week in Relation to the Course

Week Four is broken up into two separate concepts within the framework of overall financial management:

1. Lease versus buy.

2. Components of the capital structure (debt or equity financing).

Should we lease or should we buy? The answer to that question should be mainly a financial question or issue, however the intended use of the asset should be considered. Two main types of leases exist, operating and capital. An operating lease smells and tastes simply like “renting” (i.e. it is not capitalized and typically referred to as off balance sheet financing). Operating leases are typically utilized by organizations that are looking for fixed payments, no residual risk, and a limited useful life of the asset. Capital leases smell and taste much like that of a normal purchase. Once the four basic tests are passed, the financing appears on balance sheet and has all the characteristics of a normal purchase transaction.

The capital structure concepts reviewed in this course are supplements to other finance and accounting courses. Discussion revolves around the affect on taxes, financial ratios, and potential issues with lending arrangements in respect to the balance sheet, all from an accounting perspective. One can not underestimate the accounting tax affect on the financials that a financial transaction can have.

How Readings Solidify Concepts

Haven’t you ever wondered what the debt-to-equity ratio really means? Haven’t you spent night after night wondering what the four tests were to establish classification as either an operating or capital lease?

Corporate finance and financial management are hot areas for new college graduates to gain valuable experience into the operations of an organization. In one way or another, the treasury function (cash management) of an organization is involved with every aspect of its operations. Whether during the sales forecast process or the manufacturing process, cash and its management is always of vital importance. You can expect to walk away from Week Four with a fundamental understanding of the cash generation and payment functions utilized within organizations.

Practical Application and Questions for Thought

You should expect to gain valuable experience in this Week that you can apply at work or at home. Consider this, the next time you make a big ticket purchase (auto, furniture, electronics, etc.) ponder the implications of how you fund the transaction. If you pay cash, you have given up the opportunity cost you would have received from those dollars. If you finance, you are paying a cost for the opportunity to utilize someone else’s money. The affects to you as an individual, or to the entity you have entered into the transaction with, are important. They say a lot about the economic conditions in which you both operate and your expectations for the future.

Many organizations have various groups that manage cash needs. How does the accountant ensure that the appropriate internal controls are placed on the activities?

Why would an organization choose to finance its operations via one method or the other (i.e. debt vs. equity)?

One of the four tests for capital vs. operating lease transactions is the economic life test. How does the accounting department identify what your organization’s expected time use is in relation to its economic life for a specific asset?

Summary to Encourage Learning

Financial management is not an easy subject for students, or instructors for that matter, to discuss and theorize upon. The concepts are difficult and the various mechanisms in practice today to finance purchases, move items off the balance sheet, or create special purpose entities are quite remarkable. What one may view as an alternative to financing may become obsolete or old news before the transaction has been closed.

There are more ways to manage risk, mitigate interest rate shifts, and hedge on future activity than imaginable. The one constant, however, is this; organizations need cash to operate. To get cash, organizations must generate it via two basic channels, the capital markets or a lender. Which one is the best or most economical is dependent on the organization and its current or projected financial picture.

References

Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2007). Financial accounting: Tools for business decision making (4th ed.). Hoboken, New Jersey: John Wiley & Sons.

Schroeder, R.G., Clark, M.W., & Cathey, J.M. (2005). Financial Accounting Theory and Analysis (8th Ed.). Hoboken, New Jersey: John Wiley & Sons.

Williams, J.R., Haka, S.F., & Bettner, M.S. (2005). Financial and Managerial Accounting (13th ed.). New York, NY: McGraw-Hill Companies.

Fleet, W., Summers, J., & Smith, B. (2006). Communication Skills Handbook for Accounting (2nd ed.). Milton, Qld 4064: John Wiley & Sons.

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