Business HSC - Finance

Role of financial management

The planning and monitoring of a business's financial resources to enable the business to achieve its financial objectives.

Strategic Role of financial management

To ensure that a business achieves its goals and objectives. This can only be accomplished if the business's finances are managed effectively. The strategic role of financial management includes:
• setting financial objectives and ensuring the business is able to achieve these goals
• sourcing finance
• preparing budgets and forecasting future finances
• preparing financial statements
• maintaining sufficient cash flow
• distributing funds to other parts of the business

Financial plans

A comprehensive document outlining a business’s current financial position, short and long term monetary goals, and the strategies to achieve them

Business owners need a financial plan for two main reasons:

1. Need it to get finance from others (banks and investors)

2. Help owners check if their business is viable, which means it will survive, which means it will survive and not waste time or money

Objectives of financial management

1. Profitability

2. Growth

3. Efficiency

4. Liquidity

5. Solvency

Profitability

The turn a business earns from its operations. It is the difference between revenue (money coming in) and expenditure (money going out)

1. Profit levels must be high enough to attract new capital (money/investment), especially for public companies

2. If it is too low, owners and creditors (banks) may worry and try to get their money back. This can cause share prices to drop and make it harder for the business to repay debts

Liquidity

A business’s ability to pay its short term debts when they need to be paid. The business must have enough cash flow, or be able to quickly turn current assets like stock into cash, to meet its financial obligations.

Insolvency

The business cannot pay back its debts. Creditors (people the business owes money to) may start legal action, such as liquidation, to get their money back

Efficiency

A business’s ability to minimise costs and manage assets to get their maximum profit with the least resources. By improving efficiency through monitoring its inventories, cash and accounts receivable, it gives the business a competitive edge to lower the prices, helping it win more customers, increase its market share, and make more profit.

Growth

When a business increases its size and structure for the long term. By using its assets to increase sales, profit, and market share, it allows the business to stay strong.

3 ways to grow:

1. Expanding

2. Merging and acquisition

3. Diversification

Solvency

A business’s ability to pay its long-term financial debts. It is important for shakeholders, owners, creditors as it shows how risky their investment is. With good solvency, the business can pay back laons and stay strong in the future

Short-term goals

Tactical and operational plans of a business. Financial management may concentrate on short-term objectives related to maximising profits or market share or liquidity

Long-term goals

Broad goals, which are set for a period of timer (over 5 years), requiring a series of short term goals to assist its achievement. It could be increasing profit or market share.

Influences on financial management

1. External sources of finance

2. Financial institutions

3. Influenes of government

4. Global market influence]

5. Internal sources of finance

Internal sources

Funds generated from inside the business, for example profits that are retained (kept) to support later growth/expansion.

Retained profits

Profits that a business keeps instead of paying them out to the owners or shareholders in order reinevest the business. It is the cheapest financial source, ensuring financial stability and enabling the business to maintain control.

External finance

The funds provided by sources outside the business, including banks, other financial institutions, government, suppliers or financial intermediaries.

Debt finance

A business borrows money from outside sources instead of using money from the oweners, which help the business grow and earn profit yet increase financial risks

Overdrafts

When a bank allows a business/individual to overdraw their account up to an agreed limit and for a specified time to help overcome a temporary cash shortage. Since interest is charged daily, no fixed payment schedule, it gives the business time to manage cash flow and helps prevent disruptions to business operations.

Commercial bills

Short-term loans from financial institutions, usually for amounts over $100,000 and terms of 30 to 180 days. The borrower gets the money righ away and repays with interest at the end of the term

Factoring

Where a business sells its accounts receivable to a factoring company at a discount to get cash quickly (often up to 90% of the value of receivables within 48 hours). It helps improve cash flow, liquidity, and gearing (the balance between debt and equity)

Mortgage

A long-term loan used to buy property, where the property itself is used as security (the loan period is between 25 to 30 years)

Debentures

A contract for a loan from members of the public to a publicly listed company (Ltd). The company writes a prospectus approved by ASIC, allowing it to issue debentures for cash, which will be repaid later with interest.

Unsecured notes

A loan from investors for a set period of time, which is not secured against the business’s assets (more risky) yet attract a higher rate of interest.

Leasing

The payment of money for the use of equipement (cars, plant, machinery, computers,…) that is owned by another party. This helps the business use the equipment without the large capital outlay, but the interest charges may be higher than for other forms of borrowing

Equity

An external source of funds refers to the finance raised by a company through inviting new owners. This includes:

1. Ordinary shares (new issue, rights issue, placements, share purchase plan)

2. Private equity