Question

1. What is financial forecasting and why is it important?

2. why is working capital so important to a firm's continued profitability? There are three types of capital policies:

3. Explain how a firm uses commercial paper as a short-term financing source and explain the disadvantage of using this form of financing>

Disadvantages:

a.

b.

Answer 1

1. Financial forecasting & its importance:

A financial forecast is defined as a financial plan or budget for a business. It is derived by estimating two things: it is nothing but the income that the business is expected to receive & expenses that it is expected to pay. However it is not an easy task to make such estimation but some decent guesses can be made to make up a financial forecast.

It is important for the following reasons:

• It helps the business to plan ahead. For example in case of an airline industry, the major expense is fuel if fuel costs are expected to rise two years from now steps can be taken to offset the cost increase that is predicted.
• It is useful to make important decision on requirement of loans or any other financial assistance from outsiders. For example if someone wants to start a new business banks require these kinds of forecasting to provide the required financial assistance..

2. Working capital has become the daily necessity for any business as they require regular amount of cash to make continued payments, cover unexpected costs & to purchase materials that are used in the production of goods. It is considered to be a metric for efficiency, liquidity & overall health of the organization. It acts as a reflection of various activities of company like collection of revenue, debt management, inventory management, payment to suppliers. This is because it includes inventory, accounts payable & receivable, cash, portions of dent that are due within a year & other short term accounts. Proper working capital management focuses on maintaining balance between current assets & current liabilities which helps the business to not only cover their financial obligations but also boost their earnings.

There are three types of working capital policies that a firm may adopt moderate working capital policy, conservative working capital policy & aggressive working capital policy which describes the relationship between sales level & level of current assets.

3. CP is defined as an unsecured form of promissory note that pays a fixed rate of interest. It is issued by large banks or financial institutions in order to cover short term receivables & meet short term obligations like funding for a new project.

Limitations:

• It is an odd method of financing because if the firm is not able to redeem its paper because of financial difficulties then the extending the duration of CP is not possible.
• Only organizations that are financially secured & rated highly can use CP as a source of financing.