Topic 1 - Business Studies (Finance)

Financial management

Planning and monitoring financial resources to meet financial objectives

Strategic role of financial management

Funds long-term goals in the strategic plan, e.g. expansion, new technology

Key activities of financial management

Set objectives, source finance, budget, prepare statements, manage cash flow

Five financial objectives

Profitability, growth, efficiency, liquidity, solvency (People Get Excited Like Summer)

Profitability

Earning profit consistently after expenses

Growth

Increasing business size - sales, assets, market share

Efficiency

Keeping costs low relative to revenue

Liquidity

Paying short-term debts as they fall due (CA > CL)

Solvency

Paying all debts as they fall due (TA > TL); long-term stability

Short-term vs long-term objectives

Short: tactical/operational (1-2 yrs). Long: strategic (5+ yrs)

Conflict between objectives

Growth cuts short-term profit; holding excess cash cuts profitability

Interdependence

Key functions (operations, marketing, HR, finance) rely on each other

Finance & operations

Finance funds equipment; operations controls production costs

Finance & marketing

Finance sets the budget; marketing generates sales revenue

Finance & HR

Finance funds wages/training; HR manages labour costs

Internal finance

Funds from within the business - retained profits, owners' equity

Retained profits

Profits kept in the business, not paid as dividends

Retained profits - pros/cons

Cheap, no interest, keeps control / limited amount, lower dividends

External finance

Funds from outside the business - debt or equity

Debt finance

Borrowed funds repaid with interest; no loss of ownership

Equity finance

Funds from new owners; no repayments but dilutes control

Matching principle

Short-term finance for short-term needs; long-term finance for long-term assets

Gearing

Proportion of debt to equity; more debt = higher risk

Overdraft

Overdraw account to an agreed limit; flexible, high interest

Commercial bill

Short-term loan (30-180 days, $100k+) repaid in full at maturity

Factoring

Selling accounts receivable at a discount for immediate cash

Mortgage

Long-term loan secured by property

Debentures

Secured company bond; fixed interest, fixed term

Unsecured notes

Unsecured loan from investors; higher interest due to higher risk

Leasing

Paying to use an asset you don't own; no big upfront cost

New issue (IPO)

Shares offered to the public for the first time via a prospectus

Rights issue

New shares offered to existing shareholders, usually below market price

Placement

Shares sold privately to a few investors; quick, no prospectus

Share purchase plan (SPP)

Existing shareholders buy new shares; no prospectus, capped at $30,000

Private equity

Investment in companies not listed on the ASX

Financial institutions

Take funds from savers and lend/invest them in businesses and individuals

Banks

Largest source of business funds; take deposits and lend them out

Investment banks

Lend to businesses, arrange finance, advise on mergers and share issues

Finance companies

Non-bank lenders; quick finance at higher interest (leasing, factoring)

Life insurance companies

Invest policyholders' premiums in businesses as equity and loans

Superannuation funds

Invest compulsory retirement contributions in shares and company debt

Unit trusts (managed funds)

Pool small investors' funds to invest in specific assets

ASX

Australia's main stock exchange; companies raise equity by issuing shares

ASIC

Enforces the Corporations Act; regulates companies and investigates misconduct

Company tax rate

30% standard; 25% for base rate entities (turnover under $50m)

Effect of lower company tax

More retained profits for reinvestment

APRA

Regulates banks, insurers and super funds

RBA

Sets the cash rate, which influences interest rates

Global economic outlook

Affects demand, availability of funds and interest rates

Credit crunch

Lenders unwilling to lend during a downturn

Overseas borrowing - benefit

Can be cheaper if overseas interest rates are lower

Exchange rate risk

If AUD falls, overseas loans cost more to repay

Hedging

Reducing financial risk, e.g. with derivatives (swaps, futures)

Financial planning process

Needs → budgets → record systems → financial risks → financial controls

Budget

Quantitative forecast used for planning and control

Three types of budgets

Operating, project, financial

Record systems (AREA)

Accurate, reliable, efficient, accessible

Financial risks

Poor liquidity, insolvency, high borrowing

Financial controls

Policies protecting assets, e.g. separating duties, staff rotation, audits

Debt - pros

Available, tax-deductible interest, no loss of ownership

Debt - cons

Repayments, interest, security required, rates can rise

Equity - pros

No repayments, lower gearing and risk

Equity - cons

Dilutes ownership, slow and costly, dividends not tax deductible

Matching terms to purpose

Short-term assets → short-term finance; long-term assets → long-term finance

Other factors when choosing finance

Cost, flexibility, availability, control

Cash flow statement

Shows cash inflows and outflows over a period

Three cash flow activities

Operating, investing, financing

Closing cash formula

Opening cash + inflows − outflows

Income statement

Revenue and expenses over a period, showing profit or loss

Gross profit

Sales − cost of goods sold (COGS)

COGS formula

Opening stock + purchases − closing stock

Net profit

Gross profit − expenses

Balance sheet

Assets, liabilities and equity at a point in time

Accounting equation

Assets = Liabilities + Owners' equity

Current ratio

Current assets ÷ current liabilities; good 1:1 to 4:1 (liquidity)

Debt to equity ratio

Total liabilities ÷ total equity; good 0.5-1.5:1 (gearing/solvency)

Gross profit ratio

Gross profit ÷ sales; higher is better

Net profit ratio

Net profit ÷ sales; 5-15% acceptable, 15%+ very good

Return on equity

Net profit ÷ total equity; 15%+ is high

Expense ratio

Total expenses ÷ sales; lower is better (efficiency)

Accounts receivable turnover

Sales ÷ accounts receivable; 365 ÷ answer = days to collect debts

Comparative ratio analysis

Compare over time, against standards, with similar businesses

Vertical / horizontal / trend analysis

One year / two years / 3-5 years

Creative accounting

Deliberately altering reports to mislead; unethical, often illegal

Normalised earnings

Earnings adjusted to remove one-off items

Capitalising expenses

Recording a cost as an asset spread over years; inflates current profit

Valuing assets

Historical cost understates value; revaluations can be inflated

Timing issues

Shifting when income/expenses are recorded to mislead or cut tax

Debt repayments (limitation)

Reports don't show the full picture of debt obligations

Notes to the financial statements

Extra explanations; can bury important information

Audit

Independent check of financial records; required for public companies

Triple bottom line

Reporting on people, planet and profit

Consequences of unethical reporting

ASIC fines, directors banned/jailed, loss of trust