HSC BUSINESS STUDIES FINANCEROLE OF FINANCIAL MANAGEMENT

STRATEGIC ROLE OF FINANCIAL MANAGEMENTFinancial management is defined as the planning and monitoring of a businesss financial resources in order to enable the business to achieve its financial objectives. (Crucial if a business is to achieve its financial goals; predominantly maximising profits)Financial resources - Those resources in a business that have money value ie. Cash, liquid securities, assetsThe strategic role of financial management refers specifically to the strategies that are adopted by the business with regards to managing financial resources to achieve its short and long-term goals.The strategies that a business uses to achieve its goals are incorporated into a strategic plan (encompasses a long term view of the business). This entails the strategies for monitoring the financial resources of a business, such as: monitoring an businesss cash flows paying its debts

If managed incorrectly a number of problems may exist including: Insufficient cash to pay suppliers Insufficient capital to expand Too many non-productive assets Delays in payment Possible business failure

OBJECTIVES OF FINANCIAL MANAGEMENT Maximise the businesss Profitability, growth, efficiency, liquidity, solvency Short term and long termThe objectives of financial management are to maximise: Profitability, growth, efficiency, liquidity, solvencyThe responsibility of financial management is to make decisions about the best way to achieve those objectivesPROFITABILITY Refers to the ability of a business to maximise its profits, which is significant in satisfying owners and/or investors in the short term in accordance with the longer term sustainability of a firm To ensure profit is maximised, a business must carefully monitor its revenue and pricing policies, costs/expenses, inventory and asset levels

GROWTH Refers to a sustained increase in the size of a business Ensures the sustainability of the business into the future (Important financial objective of management) Growth can be achieved by: Increasing sales and profits Increasing the value of the assets [Any item of economic value owned by an entity] in a business Increasing the physical size of the business by expanding or moving to a larger office or factoryEFFICIENCY The ability of a business to minimise its costs and manage its assets so that maximum profit is achieved with the lowest possible level of assets (inputs) A business that aims for efficiency must monitor the levels of inventories and cash (control measures) LIQUIDITY Refers to a business ability to transfer the value of their assets quickly into cash (Eg. Selling inventory in), in order to meet its financial obligations (liabilities) generally in the short term Yearly management of cash flow is essential to even out fluctuations in the levels of cash inflows and outflows. (Ensures that has supplies of cash when needed to satisfy the demands of firms which they owe)SOLVENCY Refers to the extent to which a business can meet both its short and long term financial commitments as they fall due.Solvency indicates: Financial stability Risks to a businesss investment (Will be able to pay or not for money borrowed used to invest in capital i.e. Machinery, capital)SHORT TERM AND LONG TERM The financial objectives can be translated into both short term and long termSHORT-TERM FINANCIAL OBJECTIVES Are the tactical (1 to 2 years) and operational (day to day) objectives of a business. They are mainly concerned with managing cash flow and ensuring that the balance between current assets and current liabilities is positive for the business, so that the business is able to pay off its debt obligations when they fall due, hence remaining solvent.LONG-TERM FINANCIAL OBJECTIVESLong term financial objectives exist over a predetermined period of time (Usually 5 years or more). These generally are more broad (e.g. to increase profit margins & maximise growth). They are generally monitored annually to determine if changes need to be implemented.

INTERDEPENDENCE WITH OTHER KEY BUSINESS FUNCTIONSInterdependence refers to the mutual dependence that each of the functions have on each other in terms of relying on each other to perform effectively and at full capacity.FINANCE & OPERATIONS Financial managers need to allocate adequate funds to the operations function in order for the creation of value to the inputs, thereby generating sales In terms of operations, a business may seek changes to the supply chain in order to reduce the level of expenses incurred by the businessFINANCE & MARKETING Allocation of adequate funds to the marketing function in order to advertise, thereby generating sales which is used as a means of enhancing shareholder value (Increase the price of shares)FINANCE & HUMAN RESOURCES HR requires funds to remunerate staff as well as funding effective human resource strategies like training and development HR is essential in hiring employees fit for roles within the finance departmentOVERALL The financial manager must allocate funds to each department to operate successfully. The manager will also need to develop budgets and cost controls for each department. INFLUENCES ON FINANCIAL MANAGEMENT

INTERNAL SOURCES OF FINANCE RETAINED PROFITSINTRO: INTERNAL AND EXTERNALA business cannot establish itself without funds to enable it to pursue its activities. In the establishment of a business, owners and/or shareholders usually contribute funds. When a business is considering growth and development in later years, it may seek to source funds internally or externally, which is assessed through financial decision making (Relevant information analysed to determine appropriate course of action). INTERNAL SOURCES OF FINANCE Obtained from within the business; either from the businesss owners (equity) or from the activity of the business (retained profits). Owners Equity refers to the funds contributed by the owners to establish and build the business. They tend to be the owners personal savings Retained Profits (Most common source of internal finance) in which all profits are not distributed, but are kept in the business as an accessible source of finance for future activities. This net profit therefore acts as a source of reinvestment back into the business.

EXTERNAL SOURCES OF FINANCE DEBT short-term borrowing (overdraft, commercial bills, factoring), long-term borrowing (mortgage, debentures, unsecured notes, leasing) EQUITY ordinary shares (new issues, rights issues, placements, share purchase plans), private equityExternal finance refers to the funds provided by sources outside the business including banks, other financial institutions, government, suppliers or financial intermediaries. External sources of finance are broadly categorised as either debt or equity each will influence the financial management decision of a business.Debt refers to any money that has been borrowed. Regular repayments on the borrowing must be made so firms have to generate sufficient earnings to make the payments.Types of external debt include short-term (Would be repayable within 12 months) and long-term (Over 12 months).Debt: Short term borrowing This type of borrowing is used to finance temporary shortages in cash flow or finance for working capital.Examples of short term debt financing: OVERDRAFT Arrangement between a business and a bank that allows the business to overdraw their account up to an agreed limit and for a specified time, to assist in overcoming a temporary cash shortfall/ short-term liquidity problems. Costs for overdrafts are minimal and interest rate levels are lower than on other forms of borrowing. COMMERCIAL BILLS Refers to a document that orders the payment of a certain amount of money loaned at some fixed future date (bill of exchange). The document is issued by institutions other than banks (i.e. businesses with surplus funds), and are given for larger amounts, usually $100,000 for a period of between 90 and 180 days. A business uses this method to finance temporary periods of lower cash inflows or higher cash outflows. These funds are repaid within a year. FACTORING Important source of short-term finance that enables a business to raise funds immediately (Improving cash flow and gearing) by selling accounts receivable at a discount to a finance company. The company will pay the seller the value of the accounts minus a discount. (Imposes a greater risk of bad debts being the responsibility of the business)

The factory company takes over management and collection of unpaid accounts under terms. A factoring company may offer its services with or without recourse: 1. With recourse factoring: The business will pay the factor the amount owing (remaining responsible), should the factor fail to recoup all the debts. (Business will still be responsible for the value of all bad debts) (More common)

2. Without recourse factoring: Business transfers responsibility for recouping the debt to the factoring company. If there are debts that cannot be collected, then the factor incurs the loss.

Examples of Long term debt financing: (funds borrowed for periods longer than two years & can be secured or unsecured) MORTGAGE A loan which is repaid over a set number of years with interest. They are used to finance property purchases & are secured by the borrower. The property used to secure the loan cant be used as a security for further investment or sold until the mortgage is repaid. DEBENTURES - Debentures are issued by a company for a fixed rate of interest and for a fixed time. Debentures are usually not secured to specific property. Companies that borrow offer security to the lender usually over the companys assets. On maturity, the company repays the amount of the debenture by buying back the debenture. UNSECURED NOTES Loan that is not secured by a businesss assets. This poses the greatest risk & hence offers higher interest rates. (Higher return on loan) LEASING - Leasing is a long-term form of borrowing equipment & non-current assets owned by another party (Requires payment of money for use in the form of rent). This reduces the cost of acquiring these assets as full value of the asset in one transaction does not have to be made instantly. Two types of leases exist:A financial lease is for a set time and payments cover interest and cover the life span of the product. An operational lease refers to assets leased for short periods, usually shorter than the life of the asset. Operating leases can be cancelled, often without penalty.

Equity Refers to the value of (cash) raised by a company by issuing shares to the public on the Australian Securities Exchange. (Alternative to debt funding)Equity as a source of external finance includes: (Examples of equity finance) Ordinary shares (new issue, rights issue, placements, share purchase plan) Private equityORDINARY SHARES Most common traded shares to the public (through the securities exchange) & when sold transfer part ownership of the business to the shareholder. (Receives payments in the form of dividends)The following are variations of ordinary shares:

New Issue - A security that has been issued and sold for the first time on a public market (Also referred to as Primary Shares). A prospectus (document that describes the financial security) is issued through a stockbroker. Rights Issue The privilege granted to shareholders to buy new shares in the same company Placements - Offering additional shares to specific institutions and specific investors. The company does this without a formal prospectus. These funds may be used to expand activities or to acquire businesses. Share purchase plans - an offer to sell shares to existing shareholders for a discounted price.PRIVATE EQUITY Refers to the money invested in a (private) company not listed on the Australian securities exchange (ASX). The aim of the private company (like the publicly listed companies who sell ordinary shares) is to raise capital to finance future expansion/investment of the business.

FINANCIAL INSTITUTIONS BANKS, INVESTMENT BANKS, FINANCE COMPANIES, SUPERANNUATION FUNDS, LIFE INSURANCE COMPANIES, UNIT TRUSTS AND THE AUSTRALIAN SECURITIES EXCHANGE Financial institutions Institution that provides financial services for its clients or members (Channel between savers and borrowers of funds)BANKS Major operators in financial markets & are the main providers of finance/funds for businesses Supervised by the Reserve Bank of Australia Banks receive savings as deposits from individuals, businesses and governments, and, in turn, make investments and loans to borrowers. Interest is charged on the cost of borrowingThey provide a no. of corporate services including: Online banking Insurance & superannuation Legal and tax advice Risk management Economic outlooksEXAMPLES: NAB, Commonwealth Bank, Westpac, ANZINVESTMENT BANKSInvestment banks differ from Authorised Deposit taking institutions (Big four Banks) in that they are primarily focused on providing borrowing and lending services to the business sector. They specialise in arranging financial transactions for companies & projectsInvestment banks are further involved in: Trading money, securities & futures Providing advice on mergers and acquisitions Arranging overseas finance Operating trustsEXAMPLES: Macquarie BankFINANCE AND LIFE INSURANCE COMPANIESFinance and life insurance companies are non-bank financial intermediaries that provide secured and non-secured loans but do not take deposits from the general public. These companies are regulated by (APRA).

Finance Companies They provide loans to businesses and individuals through consumer hire-purchase loans, personal loans and secured loans to businesses. (Higher interest rates) They are also the major providers of lease finance to businesses. Some finance companies specialise in factoring or cash flow financing. Finance companies raise capital through share issues (debentures)

EXAMPLES: Australian Guarantee Corporation, Custom Credit CorporationLife insurance companies provide insurance (Guarantee of compensation for specified loss, illness or death in return for payment) against death & disability through selling policies & receiving regular premiums (Financial cost of obtaining an insurance cover) that guarantee a minimum payout upon death. EXAMPLES: MLC, AMP, Allianz SUPERANNUATION FUNDSThese organisations provide funds to the corporate sector through investment of funds received from superannuation contributions of members. Superannuation funds are able to invest in long-term securities as company shares, government and company debt because of the long-term nature of their funds, and thereby lend retirement savings.UNIT TRUSTS (aka mutual funds) Take funds from a large number of small investors and invest them in specific types of financial assets Unit trusts investments include the short-term money market (cash management trusts), shares, mortgages and property, and public securities.AUSTRALIAN SECURITIES EXCHANGE(ASX) Formed in 2006 with the merger of the Australian Stock Exchange & the Sydney futures Exchange Is a market that brings together buyers and sellers to exchange shares.

The ASX acts as both a primary & secondary market

A primary market deals with the issue of new shares & securities, whilst a secondary market deals with the sale and purchase of existing securities and shares.

The ASX assists companies to raise initial capital finance through issue of shares, and provides a market for existing (company shares, futures, contracts for difference, trusts, other forms of securities) to be traded.

INFLUENCE OF GOVERNMENT AUSTRALIAN SECURITIES AND INVESTMENT COMMISSION (ASIC), COMPANY TAXATION

The government influences a businesss financial management decision making through economic policies and current and changing legislation. Two important government influences on financial management are: THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION ASIC is an independent statutory commission accountable to the Commonwealth parliament. It enforces and administers the Corporations Act 2001 (Cth) & protects consumers in the areas of investments, insurance, superannuation, & banking (except lending) in AU . The aim of ASIC is to assist in reducing fraud and unfair practices in financial markets and products. ASIC ensures that companies adhere to the law, collects information about companies and makes it available to the public. COMPANY TAXATIONCompanies and corporations in Australia pay company tax on profits (Imposed by the Australian Government), which is presently 30% of net profit. Company tax is paid before profits are distributed to shareholders as dividends. The government plans to lower taxes to foreign investment, and create new jobs.

GLOBAL MARKET INFLUENCES ECONOMIC OUTLOOK, AVAILABILITY OF FUNDS, INTEREST RATESGlobal market influences increasingly affect business financial decisions, and this is specifically evident in the availability of funds for loans and the interest rates charged for these loans, in accordance with the global economic outlook.

GLOBAL ECONOMIC OUTLOOKThe global economic outlook refers specifically to the projected changes to the level of economic growth throughout the world. If the outlook is positive (high economic growth) then this will impact on the financial decisions of a business. This may include: Increasing demand for products and services. Hence, businesses will need to increase production to meet demand and will require funds to purchase equipment, employ or train staff, or expand the size of the business Decrease the interest rates on funds borrowed internationally from the financial money market. This results mainly from a decrease in the level of risk associated with repayments. As business sales increase, so too does profits.However a poor economic outlook will impact on financial decisions of a business in the opposite to those mentioned above.

AVAILABILITY OF FUNDSRefers to the ease with which a business can access funds (for borrowing) on the international financial markets (Made up of institutions, companies and governments that are prepared to lend money to those who require capital). The availability of funds depends on the risk, demand and supply and the domestic economic conditions.

INTEREST RATES (AFFECTS both Savings/deposits & loans)Are the cost of borrowing money. The higher the level of risk involved in lending to a business, the higher the interest rates.

PROCESSES OF FINANCIAL MANAGEMENT

PLANNING AND IMPLEMENTING FINANCIAL NEEDS, BUDGETS , RECORD SYSTEMS, FINANCIAL RISKS, FINANCIAL CONTROLS DEBT AND EQUITY FINANCING ADVANTAGES AND DISADVANTAGES OF EACH MATCHING THE TERMS AND SOURCE OF FINANCE TO BUSINESS PURPOSEFinancial management is responsible for the financial planning of the business. Financial planning determines how a businesss goals will be achieved.The elements in the planning cycle are: DETERMINING FINANCIAL NEEDSFinancial needs are essential to determine where a business is headed and how it will get there; it is important to know what its needs are.The financial needs of a business are determined by a situational analysis of the current financial position of the business with regards to the size of the business, the current phase of the business cycle, capacity to source finance (debt and/or equity) as well as any future plans for growth and development.These plans are developed into balance sheets, income statements, cash flow statements, budgets & a range of other documents that provide financial information on a business capacity to generate an acceptable return for the investment being sought. DEVELOPING BUDGETS (to identify sources of revenue and expenses)A budget is a plan predicting the revenue and expenses of a business for a future time period. It provides quantitative information (i.e. cash required for planned outlays) about requirements to achieve a particular purpose. They allow for constant monitoring & progress checks of production.Budgets can be classified as operating, project or financial budgets. Operating budgets relate to the main activities of a business and may include budgets relating to sales, production, raw materials, direct labour, expenses and cost of goods sold. It may be used to produce an income statement & plan inventory levels, labour requirements or raw materials.Project budgets relate to capital expenditure (purpose of asset purchase, life span, & revenue that would be generated from the purchase) and research and developmentFinancial budgets relate to the financial data of a business & include the budgeted income statement, balance sheet and cash flows. The income statement and balance sheet reflect the results of operating activities and the cash flow statement shows the liquidity of a business. They provide a forecast of flows of inflows of cash which is significant in organising finance for slower than expected growth. (MAINTAINING) RECORD SYSTEMSRefers to the mechanisms employed by a business to ensure that data are recorded (i.e. Sales, expenses, assets & liabilities) and the information provided by records systems is accurate, reliable, efficient and accessible. Minimising errors in the recording process and producing accurate and reliable financial statements are important aspects of maintaining (effective) record systems, whereby a business improves efficiency and is able to identify issues of concern and opportunity. IDENTIFYING FINANCIAL RISKSFinancial risk is the risk to a business of being unable to cover its financial obligations, such as the debts that a business incurs through borrowings, both short term and longer term.The main financial risk arises from not having enough cash flow to meet its commitments such as the debts that a business incurs through borrowings, both short term and longer term.If the business is financed from borrowings there is higher risk. The higher the risk, the greater the expectation of profits or dividends. In minimising financial risks a business can take advantage of business opportunities. Strategies to reduce risk include credit controls, hedging, derivatives, insurance & diversification. ESTABLISHING FINANCIAL CONTROLS The most common causes of financial problems and losses are: theft, fraud, damage or loss of assets and errors in record systems.Financial controls are the policies and procedures that ensure that the plans of a business will be achieved in the most efficient way.Financial controls include budgets, cash flow statements, income (revenue) statements & balance sheets.Policies to promote control are rotation of duties, control of cash where cash is banked daily, protection of assets and control of credit procedures. DEBT AND EQUITY FINANCING ADVANTAGES AND DISADVANTAGES OF EACH The finance for a business comes from both internal and external sources, and most businesses use a combination of both. External or debt finance is a liability to a business as it is money owed to external sources. Equity finance relates to the internal sources of finance in a business & takes the form of money obtained from investors in exchange for an ownership share of the business.ADVANTAGES AND DISADVANTAGES OF DEBT FINANCEAdvantages of DebtDisadvantages of Debt

Interest payments are tax deductible therefore reducing the cost of debt financing Funds are usually readily available Increased funds should lead to increased earnings and profits

Increased risk if debt comes from financial institutions because interest, bank charges, government charges and the principal have to be repaid Repayments begin immediately and must be met regardless of business cash flow Collateral (assets that can be taken if loan cannot be repaid) is often needed to secure a loan Lenders have first claim on any money if the business ends in bankruptcy

ADVANTAGES AND DISADVANTAGES OF FINANCE EQUITYAdvantages of EquityDisadvantages of Equity

Does not have to be repaid unless the owner leaves the business; Investors hope to reclaim their investment out of future profits Low gearing (Ratio between debt and equity finance/ Lower the ratio, lower percentage of borrowed funds) Does not incur interest charges, so cheaper than other sources of finance Less risk

Investors become part-owners of the business gaining a say in business decisions, hence managers face a loss of control Lower profits and return from the owner since a proportion of the profits go to the additional new owners The expectation that the owner will have about the return on investment (ROI)

MATCHING THE TERMS AND SOURCE OF FINANCE TO BUSINESS PURPOSE ***

The matching principal is vital as it allows businesses to determine the most appropriate source of finance to fund activities while ensuring financial objectives are met. Some influencing factors (in selecting the most appropriate source of finance) include: The terms of finance

Must be suitable for the structure of the business and the purpose for which the funds are required. E.g. Short-term finance options should be suitable to match the short-term purposes of the business, such as managing a temporary cash flow shortfall.

The structure of the business

Small businesses have fewer opportunities for equity capital than larger businesses. Equity for unincorporated businesses has to be raised from private sources or by taking on another partner. Public companies can raise equity by issuing shares to the public. Therefore, there are greater opportunities in raising equity capital.

Costs

Must be measured for each of the available sources of funds, as costs fluctuate depending on market and economic conditions

Flexibility

Business often require sources of funds to be variable so that, if firms have excess funds, borrowings can be paid off more quickly, increased or renewed as conditions change. Bank overdrafts provide greater flexibility for business than debentures and factoring

The availability of finance

Too heavy a dependence on a small number of investors can increase risk if investors start to pull out or their commitments cannot be met. A business credit rating may influence the various sources of finance it has access to.

The level of control

In that case of equity finance, introducing more partners or a change in business structure can lead to a change in the level of control over the business.

MONITORING AND CONTROLLING CASH FLOW STATEMENT, INCOME STATEMENT, BALANCE SHEETThe process of monitoring and controlling is essential in all aspects of business functions, especially in the processes of financial management, in order to maintain business viability.The main financial controls used for monitoring include cash flow statements, income statements and balance sheets.CASH FLOW STATEMENTS

Is a financial statement that indicates the movement of cash receipts (cash inflow) and cash payments (cash outflow) resulting from transactions over a period of time. It gives important information regarding a firms ability to pay its debts (financial obligations) on time, Further to this it shows whether a business has sufficient funds for future expansion or changeIn preparing a cash flow statement, the activities of a business are generally divided into three categories Operating activities: Cash outflow and inflow relating to the provision of goods and services (E.g. Cash inflows: Sales plus dividends and interest received) (E.g. Cash outflows: Payments to suppliers, employees & insurance, rent) Investing activities: Cash inflows and outflows relating to purchase and sale of non-current assets and investments (E.g. Selling old motor vehicle, & Purchasing new plant and equipment) Financing activities: Cash inflows and outflows relating to the borrowing activities of the business. Borrowing inflows can relate to equity (issue of shares or capital contribution from owner) or debt (loans from financial institutions). Cash outflows relate to the repayments of debt and cash drawings of the owner or payments of dividends to shareholders.

INCOME STATEMENTS (aka Profit and Loss Statements) The income statement shows the operating efficiency that is income generated & expenses incurred It indicates the businesss profitability and efficiency & shows the operating income earned (ie. Sales of inventories, service etc.) from the main function of the business as well as operating expenses such as purchase of inventories, payment for services etc.The difference between the income and expenses is the profit or if expenses exceed income the loss.Gross Profit = Sales- COGS Cost of Goods Sold = Opening Stock + Purchases Closing stockNet Profit = Gross Profit ExpensesBy examining figures from previous income statements managers can compare and analyse trends prior to making important financial decisions (to maintain strategic direction), (Regarding increases/decreases in expenses/profits)

BALANCE SHEETSA balance sheet represents a businesss assets and liabilities at a particular point in time, expressed in money terms, and shows the: financial stability of the business (Has enough assets to cover its liabilities) Assets are being used efficiently The owners are making a good returnThe accounting equation, which forms the basis of the accounting process, shows the relationship between assets, liabilities and owners equity.Assets = Liabilities + Owners Equity

Assets = Current assets + Non-Current assets

Assets represent what is owned by the business and are items of valueLiabilities represent what is owed by the business and are items of debtCurrent Assets/Liabilities are those that can be used or need to be paid in the short term E.g. Cash, bills, short term loansNon-current assets/liabilities refer to those that cant be used or dont have to be paid in the short term. Eg. Properties, MortgagesOwners equity is the funds contributed by the owner(s) for it to acquire resources and begin operating

FINANCIAL RATIOS LIQUIDITY CURRENT RATIO (CURRENT ASSETS CURRENT LIABILITIES) GEARING DEBT TO EQUITY RATIO (TOTAL LIABILITIES TOTAL EQUITY) PROFITABILITY GROSS PROFIT RATIO (GROSS PROFIT Sales); NET PROFIT RATIO (NET PROFIT SALES); RETURN ON EQUITY RATIO (NET PROFIT TOTAL EQUITY) EFFICIENCY - EXPENSE RATIO (TOTAL EXPENSES SALES), ACCOUNTS RECEIVABLE TURNOVER RATIO (SALES ACCOUNTS RECEIVABLES) COMPARATIVE RATIO ANALYSIS OVER DIFFERENT TIME PERIODS, AGAINST STANDARDS, WITH SIMILAR BUSINESSESThe financial statements of a business must be analysed to gain a thorough understanding of the activities of a business. The analysis involves comparing similar figures contained in the financial statements and balance sheets. The main types of analysis include: vertical (within one year), horizontal (between different years) and trend (over a period of 35 years). The analysis of financial statements is usually aimed at the areas of financial stability (liquidity and gearing), profitability and efficiency.FINANCIAL RATIOS measure relationships between different elements of financial statements and may be expressed in different ways e.g. as a percentage, a fraction, a times figure or a rateLiquidityLiquidity is the extent to which the business can meet its financial commitments in the short term. This means, a business must have enough resources to pay its debt and cover unexpected expense.Current assets (assets that a business can expect to convert into cash within 12 months i.e. cash and accounts receivable) and current liabilities (are liabilities that a business must repay within the short term i.e. overdraft and accounts payable) determine the liquidity or short-term financial stability of a business; hence a current ratio can be used to show liquidity.Current Ratio= Current Assets

Current Liabilities

Expressed: Percentage or ratio (usually ratio)Current assets and liabilities are turned into cash within 12 months. For example, assets such as inventories and accounts receivable would be paid in a month or two, as would liabilities, such as the firms own accounts payable. It is generally accepted that a ratio of 2:1 indicates a sound financial position for a firm. That is, the firm should have double the amount of assets to cover its liabilities.(Ratio of less than 1:1 indicates there are insufficient assets to pay current commitments or liabilities)However an acceptable ratio will also depend on a number of factors, such as the type of firm, how other firms in the industry are operating and factors in the external environment. Gearing Refers to the ratio between debt (external finance) and equity (internal finance) that is used to finance the activities of a business.Debt to equity (gearing) = Total Liabilities

Total equity (owners equity)

Expressed: Percentage or ratio (usually ratio)The debt to equity ratio shows the extent to which the firm is relying on debt or outside sources to finance the business. Important control aspect for management because the relationship between debt and equity must be carefully balanced The degree of gearing will depend on the type of business. For instance: Mining companies are generally heavily geared as the cost to finance operations is high but the return on investment is high The higher the debt to equity ratio (Highly geared firm that uses more debt than equity), the less solvent the firm and the more risk with regard to longer term financial stability in terms of being unable to meet its longer term obligations Investors, thus, would be less attracted to the firm An acceptable gearing ratio is 1.5:1 or 66% equity but this will depend on factors such as the type of industry & earning capacity Strategies to improve: Reducing Debt Increasing use of equity financing where possible.ProfitabilityProfitability is the earning performance of the business and indicates its capacity to use resources to maximise profit. The income statement is used to measure the profitability of the business. Figures from this statement are used to calculate the gross profit and net profit ratios.GROSS PROFIT RATIOGross profit represents the amount of sales that is available to meet expenses resulting in net profit. A fall in the rate of gross profit may mean a fall in the rate of net profit. The amount of that decrease depends on factors such as price reductions, theft, and errors in determining prices.Gross Profit Ratio= Gross Profit (%) This ratio is always expressed as a percentage

Revenue (from sales)Higher the percentage the betterStrategies to improve:-Reducing COGS factors-JIT Management-Advertising/Promotion/Marketing/SalesNET PROFIT RATIORepresents the profit or return to the ownersNet Profit Ratio = Net Profit(%) Ratio is always expressed as a percentage Revenue (from sales)The net profit ratio shows the amount of sales revenue that result in net profit. A firm would be aiming at a high net profit ratio. A low net profit ratio indicates that expenses should be examined to see whether reductions can be made.RETURN ON EQUITY RATIOThe return on equity ratio shows how effective the funds contributed by the owners have been in generating profit, and hence a return on their investment.Return on Equity ratio = Net Profit Ratio can be expressed as either a decimal/percentage

Total equity (Owners equity)The higher the ratio or percentage, the better the return for the owner. Generally acceptable minimum return should be in the order of 12-16% Less than this would be considered unacceptable because the owners could invest their money elsewhere. A return greater than 16% is considered good and a return of 20%+ is excellent.EfficiencyEfficiency is the ability of the business to use its resources effectively to ensure financial stability and profitability. It relates specifically to managements ability to achieve its goals and objectives.The two main ways to calculate efficiency include the expense ratio and the accounts receivable turnover ratio.EXPENSE RATIOThis ratio indicates the day to day efficiency of the business. The ratio indicates the amount of sales that are allocated to individual expenses such as selling, administration, COGS and financial expenses.Expense ratios need to be kept at a reasonable level, and management must monitor each type of expense in relation to sales. Higher expense ratios may be the result of poor management. The lower the ratio the better.

Expense ratio = Total expenses (%) Always expressed as a percentage SalesStrategies to improve: Reduce expenses, for example reduce overtime thus cutting wages ACCOUNTS RECEIVABLE TURNOVER RATIO Measures the effectiveness of a firms credit policy and how efficiently it collects its debt

Accounts receivable turnover ratio = Sales

Accounts Receivable

Note: Always expressed as times or daysNote: The sales may appear as credit salesNote: To express in days: (How often debts are being repaid)365 accounts receivable turnover ratioDebt collection figures indicate relative efficiency in the collection of debts (The activity of making individuals and businesses pay debts). High turnover ratios indicate the business has efficient debt collection.Strategies to improve:- Offering discounts for early payment of debt- Chasing up slow paying debtors- Changing payment term/credit term- Withdrawing credit facilities- Encouraging cash sales, possibly through discounts for cash sales.If a business account turnover is (E.g. 84 days) but creditors only allow 30 days to be paid, cash-flow problems may occurComparative Ratio Analysis can be used for comparisons, such as: Over different time periods Comparing ratios for a business over various periods to identify trends and assist with interpretation of ratio results. Against common standards Ratios are compared with industry averages to assist managers interpretation and decision making on the businesss performance. With similar businesses Comparing ratios from businesses in the same industry and of same size to give an insight into business performance.

LIMITATIONS OF FINANCIAL REPORTS NORMALISED EARNINGS, CAPITALISING EXPENSES, VALUING ASSETS, TIMING ISSUES, DEBT REPAYMENTS, NOTES TO THE FINANCIAL STATEMENTSThere are limitations to financial reports. They can be misinterpreted and can be misleading, both of which will impact on the decision making of management and potentially put the business at risk.Limitations of financial reports include the following: Normalised earnings: This is the process of removing one time or unusual influences from the balance sheet to show the true earnings of a company. An example of this would be the removal of a land sale, which would achieve a large capital gain (profit from the sale of property or of an investment). Capitalised expenses are where one-off operating expenses are regarded as an asset (capitalized), which can then be depreciated over time and recorded in the balance sheet of the business. This causes the operating expenses to decrease thus increasing operating profit for the business, and the assets of the business will increase and this will cause a change to the liabilities of the business. Valuing assets is the process of estimating the market value of assets or liabilities. Some assets change value over time due to inflation and the market. Therefore it would have been worth less in the past and would not reflect the true value. This means assets have to be revalued to account for the appreciation or depreciation. Some assets like patents or goodwill also cannot be recorded as it is hard to place a value on these intangible items. Timing issues: Finance reports cover activities over a period of time, usually one year. Therefore, the businesss financial position may not be a true representation if the business has experienced seasonal fluctuations. Debt repayments can present a point of concern. Reports do not have the capacity to disclose specific information about debt repayments such as: * How long the business has had or has been recovering the debt * The capacity of the business or its debtor to repay the amount/s owed (What if a debtor is close to bankruptcy and will not be able to repay a debt?) Therefore, financial statements in isolation are limited in their usefulness when analysing performance. Notes to financial statements are the details and additional information that are left out of the main reporting documents and put separately at the end, such as the balance sheet and income statement. Information can include the explanation of individual items in the reports, the valuing system used for assets and how the value for an intangible asset was arrived at.

ETHICAL ISSUES RELATED TO FINANCIAL REPORTSBusinesses have an ethical and legal responsibility to provide accurate financial records.The main ethical issues related to financial reports are as follows: Inappropriate cut-off periods and misuse of funds. An audit is an independent examination of financial information and can be internal or external. All public companies have their accounts externally audited to make sure information is a true record of finances. Large businesses will also frequently use internal auditors. Fictitious revenues Revenues that do not exist and have been included to make the business look better than it really is. Hidden liabilities and expenses Expenses not included in balance sheets or income statements to hide the true outgoing from owners, shareholders or other stakeholders. Improper disclosures or omissions Can obscure the real position of a business or imply something exists when it does not. Fraudulent asset valuations Variation of historical value or reckless valuing of intangible assets such as goodwill. To pretend profits are lower than reality would defraud the ATO. Deemed Illegal, Unethical & in trying to raise capital, investment would be harder to find.

Accurate financial reports depend on the quality of record keeping & are necessary for taxation purposes as well as for other stakeholders.Auditing involves an independent check of the accuracy of financial records.Three types of audits exist: INTERNAL AUDITS: Conducted internally by employees to check the accuracy of financial records MANAGEMENT AUDITS: Conducted to review the firms strategic plan. Audits may cover HR, finance & the production process EXTERNAL AUDITS: These are required under the Corporations Act 2001 (Cth). The firms financial reports are audited by professional, independent audit specialists to guarantee authenticity FINANCIAL MANAGEMENT STRATEGIES

CASH FLOW MANAGEMENT CASH FLOW STATEMENTS DISTRIBUTION OF PAYMENTS,DISCOUNTS FOR EARLY PAYMENT, FACTORINGCash flow refers to the movement of cash in and out of a business over a period of time. Management is required to make sure payments are made and received without creating a cash flow problem. Cash inflows come from sales, accounts receivable and commissions. Cash outflows include wages, payments to suppliers, insurance and loan repayments.A cash flow statement provides important information regarding a firms ability to pay its debts on time. A cash flow statement can assist in identifying periods of potential shortfalls and surpluses (Distribution of payments)MANAGEMENT STRATEGIESManagement must implement strategies to ensure that cash is available to make payments when they are due.Management strategies for cash flow include: DISTRIBUTION OF PAYMENTSBy Distributing payments throughout the month, year or other period a business is able to prevent cash shortfalls from occurring. (Desirable for businesses that receive regular cash inflows) DISCOUNTS FOR EARLY PAYMENTBusinesses can offer discounts for cash and early payments which encourages quick payment from debtors, improving cash flow for the business. It can be a cheaper option than overdraft. Overdrafts and lines of credit can assist businesses in periods where cash outflow is greater than cash inflow. This is an expensive short term solution.FACTORINGFactoring is the selling of a companys accounts receivable to a finance company for immediate cash. It improves working capital by giving a business immediate access to cash from its credit sales.

WORKING CAPITAL (liquidity) MANAGEMENT Control of current assets - cash, receivables, inventories Control of current liabilities payables, loans, overdrafts Strategies - leasing, sale and lease backWorking capital refers to the current assets used in the day to day operations of a business. (Eg. Cash, accounts receivables, inventories)Net working capital (liquidity) is the difference between current assets and current liabilities. Working capital is needed so that a business can buy stock and inventory and meet its current debts or financial commitments. If working capital is too less, then there will be liquidity difficulties. If there is an excess of working capital, that means assets are earning less than the cost to finance them.(Thus) Working capital management involves determining the best mix of current assets and current liabilities needed to achieve the objectives of the business.The working capital ratio is the same as the current ratioi.e. If the value of this is greater than 1:1 the firm is in a stable positionCONTROL OF CURRENT ASSETS is a part of managing working capital, and refers to the management process that determines the optimal amount of each current asset held.This includes (current assets) Cash, accounts receivables and inventoryCASHCash is critical for business success and ensures that the business can pay its debts, repay loans and pay accounts in the short term, as well as survive in the long term. Planning for the timing of cash receipts, cash payments and asset purchases avoids the situation of cash shortages or excess cash. Businesses try to keep their cash balances at a minimum and hold marketable securities as reserves of liquidity. These guard against sudden shortages or disruptions to cash flow. A bank overdraft might also be arranged to allow a business to overdraw its account to an agreed overdraft amount.RECEIVABLES (accounts receivables)Receivables refer to money owed to a business from customers to whom it has supplied goods or services. Consequently, a business must monitor its accounts receivable and ensure that their timing allows the business to maintain adequate cash resources. The quicker the debtors pay, the better the firms cash position. Strategies to control receivables include discounts on cash and early payments, following up on accounts that are not paid by the due date, sending out reminders more regularly, having clear credit policy that includes credit rating checks of prospective consumers.

INVENTORIESInventories make up a significant amount of current assets, and their levels must be carefully monitored and strategies implemented so that excess (Cash shortages) or insufficient levels of stock (loss of customers, hence loss in sales) do not occur. Strategies for the management of inventory include regular stocktaking, control systems like just-in-time and increasing sales to turn inventory into cash. CONTROL OF CURRENT LIABILITIESCurrent liabilities are financial commitments that must be paid by a business in the short term. A business must monitor and manage its current liabilities such as:PAYABLES (ACCOUNTS PAYABLE)Accounts payables refer to the money owed by the business to its suppliers. Strategies include payment on time to avoid late fees, taking advantage of early payment discounts and maintaining a good credit rating for continuing access to credit provided by suppliers.LOANSRefer to the money borrowed from financial institutions for the purpose of funding such things as the purchases of property and equipment. These loans can either be short or long term in duration. Management of loans is important, as costs for establishment, interest rates and ongoing charges must be investigated and monitored to minimise costs. Short-term loans are generally an expensive form of borrowing for a business and their use should be minimised. Further to this, the business should compare the cost of the loan to alternative sources of funds from different banks & financial institutions to find the most appropriate and cost efficient source.OVERDRAFTS a relatively cheap and convenient form of short-term borrowing. They allow a business to cover temporary cash shortages. Internet banking can be used to keep track of what is owed in the overdraftMANAGEMENT STRATEGIESStrategies for working capital management include: Leasing Sale and lease-backLEASINGLeasing is the hiring of an asset from another person or company who has purchased the asset and retains ownership of it. By leasing assets, the business has more working capital (frees up cash) to invest in other assets and opportunities for expansion of the business. It is an attractive strategy for some businesses as it is tax deductible.SALE AND LEASE-BACKSale and lease-back is the selling of an owned asset to a lessor and leasing the asset back through fixed payments for a specified number of years. Sale and lease-back increases a businesss liquidity because the cash that is obtained from the sale is then used as working capital. PROFITABILITY MANAGEMENT COST CONTROLS FIXED AND VARIABLE, COST CENTRES, EXPENSE MINIMISATION REVENUE CONTROLS MARKETING OBJECTIVESProfitability management involves the control of both the businesss costs and its revenue. Accurate and up-to-date financial data and reports are essential tools for effective profitability management.COST CONTROLSCost controls involve: Understanding and monitoring the levels of both fixed and variable costsFixed costs Costs that do not vary and must be paid regardless of the level of operating activity in the business (i.e. Salaries & insurance). To minimise fixed costs, it is essential to negotiate satisfactory arrangements initially.Variable costs Costs that vary relative to the level of operating activity in a business (i.e. Materials & labour) Monitoring the levels of both fixed and variable costs is important in a business. Accounting for and identifying the source and amount of costs through the use of cost centresCOST CENTRES - are where businesses allocate a proportion of total costs (Direct/Indirect) to particular parts of the business in order to control costs. The cost centres are then responsible for the costs that they incur, and hence management is therefore able to identify their source and amounts. In order to minimise the business will need to minimise cost centres. Expense minimisation Expense minimisation involves reducing the expenses in order to maximise the profits and gain a competitive advantage. Strategies include outsourcing, sale and lease back, replacing labour with technology, reducing inventory overheads such as using just-in-time and improving budgeting and accountability.REVENUE CONTROLSRevenue can be controlled by: Developing marketing objectives & targets Developing sales forecasts to aid budgets in predicting revenueA business can also alter their sales mix (Range of products sold by the business) to change how they market their product. Control: The business should conduct research to identify the potential effects of sales-mix changes on revenue before decisions are made (diversifying product range or ceasing production on particular lines).A business should also closely monitor and control their pricing policy to achieve the highest possible revenue. Over pricing could fail to attract buyers while underpricing may bring higher sales but may still result in cash shortfalls and low profits. GLOBAL FINANCIAL MANAGEMENT EXCHANGE RATES INTEREST RATES MATHODS OF INTERNATIONAL PAYMENT PAYMENT IN ADVANCE, LETTER OF CREDIT, CLEAN PAYMENT, BILL OF EXCHANGE HEDGING DERIVATIVESGlobal financial management refers to the strategies implemented by business to deal with the export component of business activities. Global financial management is influenced by a number of financial considerations.EXCHANGE RATESThe foreign exchange rate is the ratio of one currency to another. If A$1 = US$0.70, that means one Australian dollar is worth 70 US cents. Exchange rates/currency fluctuates over time due to variations in demand and supply, creating risks for global business.If the Australian dollar appreciates against a foreign currency, the value of the Australian dollar rises in terms of foreign currencies. The result of the appreciation, therefore, reduces the international competitiveness of Australian exporting businesses. Appreciation in the ER make interest repayments cheaper.If the Australian dollar depreciates compared to foreign currency, there is a decrease in the value of Australian dollars in terms of foreign currencies. Depreciation, therefore, improves the international competitiveness of Australian exporting businesses.Currency fluctuations, therefore, will impact on the revenue profitability and production costs.INTEREST RATESRefer to the cost of borrowing money. A business that plans to expand domestic production facilities to increase direct exporting will normally need to raise finance to undertake these activities. The advantages of overseas borrowing are that the rate of interest can be cheaper, there are fewer restrictions and finance may be acquired more quickly and easily. If overseas IR exceed domestic IR businesses will tend to supply funds overseas rather than domestically to take advantage of IR differential. METHODS OF INTERNATIONAL PAYMENTOne of the most crucial aspects of global financial management is to select an appropriate method of payment. Payment to overseas companies can be complicated as the result of cultural difference (language, taxation systems)The main methods of international payment include: Payment in Advance Whereby the exporter receives payment for the goods before they are sent. Exposes the exporter to virtually no risk, however exposes the importer to the most risk (Risk of the goods never being sent & payment already taken) Letter of Credit A commitment by the importers bank, which promises to pay the exporter a specified amount when the documents proving shipment of the goods are presented. Clean payment Occurs when the payment is sent to, but not received by, the exporter before the goods are transported. Requires complete trust between both parties Bill of Exchange A written order from a seller requesting that buyers pay the seller a specified amount of money at a specified time. The bank ensures the buyer receives its goods and that the seller is paid. Most widely used and allows the exporter to maintain control over the goods until payment is either made or guaranteed.Two types of bills exchange exist:1. Documents against payment: Using this method the importer can only receive the good after paying for them2. Document against acceptance: Using this method the importer can receive the good before paying for themHEDGINGRefers to any strategy used by the business to minimise the risk of currency fluctuations, and hence, reduce the level of uncertainty involved with international financial transactions.Hedging can occur through:1) Natural Hedging: This could include establishing offshore subsidiaries, arranging for import payments & export payments to be denominated in the same currency so that gains in one will be offset by losses in the other & implementing marketing strategies that reduce the price sensitivity of exported product2) Financial instrument hedging involves products such as derivatives to spread the risk.DERIVATIVES Simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations.The three main derivatives available for exporters include: Forward exchange contracts Is a contract in which the bank will guarantee the exporter a certain exchange rate (for the exchange of one currency for another) on a certain date. Option contracts Gives the buyer the right but not the obligation to buy or sell foreign currency when the exchange rate movement is to its advantage. It allows business to use the spot rate (exchange rate on a particular day). Swap contracts A currency swap is an agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future. The main advantage is that it allows the business to alter its exposure to exchange fluctuations without discarding the original transaction