HSC Business Finance Financial Process

Financial planning

Financial planning determines how a business's goals will be achieved.​

Involves: Determining financial needs, Developing budgets, Maintaining record systems, Indentifying financial risks, Establishing financial controls.

Financial needs

Financial information needs to be collected to form a basis for planning (balance sheets, income statements, cash flows, bank statements etc).

How financial needs are determined

->The size of the business​

->The current phase of the business cycle​

->Capacity to source finance( debt or equity)​

->Management skills for assessing financial needs​

->​Future plans for growth and development​

Budgets

These provide information in quantitative terms. They enable constant monitoring of objectives. They allow the business to track:

->Sales effort​

->Administrative control​

->Production planning​

->Price setting ​

Three types of budgets

Operating budgets, Project budgets, Financial budgets.

Operating Budget

Relates to the main activities of the business (sales production, raw materials, expenses, COGS).​

Project budget

Relates to capital expenditure (purchasing of assets).​

Financial budget

The predictions around the operating and project budgets. Financial budgeting includes income statements, balance sheets and cash flows.

Record systems

The mechanisms employed by a business to ensure that data is recorded in an accurate, reliable, efficient and accessible format.

It is critical because managers base their decisions of the information produced.​

Financial risks

The risk of a business not being able to cover its financial obligations (debts and borrowing). ​

Considerations to avade risk:

->Level of profit to justify risk​

->Liquidity of business's assets​

Types of financial problems in the Financial Controls

->Theft

->Fraud​

->Damage or loss of assets​

->Errors in record keeping systems ​

Common practices to promote control relating to Financial Controls

->Clear authorisation and responsibility for tasks in the business​

->Separation of duties​

->Rotation of duties​

->Control of cash​

->Protection of assets​

->Control of credit procedures​

Debt and Equity Finance

External or debt finance is a liability to the business.

Equity finance relates to internal sources of finance. ​

When deciding which type of finance to use, the business will take into account the purpose of the finance.

Debt Finance

Usually readily available and interest payments are tax deductible.​

Equity Finance

The most important source of funds because it remains in the business for an indefinite period.​

Matching the Terms and Sources of Finance to Business Purpose

The terms of finance must be suitable for the purpose for which the funds are required.

The short term finance is used to fund long term assets, causes financial problems because the amount borrowed must be repaid before the long term assets have had time to generate increased cash flow.

Monitoring and Controlling

The main financial controls used are:​

->Cash flow statements​

->Income statements​

->Balance sheets​

Cash flow statements

Indicates the movement of cash receipts and cash payments resulting from transactions over a period of time.

The statement shows:​

->Whether a business can generate a positive cash flow (inflows exceed outflows).

->Can pay financial commitments as they fall due​.

->Have funds for future expansion​.

->Obtain finance from external sources.

Preparing a cash flow requires the business to be divided into three categories

1. Operating Activities: Inflows (Income from sales​, Dividends, Interest received​) & Outflows (Suppliers​, Employees​, Other operating expenses).

2. Investing activities: Relates to the purchase and sale of non-current assets and investments.

3. Financing Activities: Relates to the borrowing activities of the business.​ Inflows involve (Equity, Debt) & Outflows (Repayments of debt​, Drawings of the owner, payment of dividends).

Balance Sheet

Represents a business's assets and liabilities and net worth (equity).​

->Assets: Current assets can be turned into cash within 12 months. Non current assets are not expected to be turned into cash within 12 months.

->Liabilities: Are claims by others against the business. Current liabilities must be paid within 12 months. Non current liabilities are longer term debts​.

->Owners' Equity: The funds contributed by the owners and represents the net worth of the business​. Owners' equity comprises two elements: capital and retained profits.

Assets = Liabilities + Owners' Equity

APRA

Australian Prudential Regulatory Authority

ASIC

Australian Securities and Investments Commission

ASX

Has the responsibility to ensure corporations comply with the requirements of the law, disclosure and transparency of company details to shareholders and the public.​

Calculating Financial Ratios and Strategies to Improve Performance

->There are three types of analysis:​

•Vertical analysis: compares figures within one financial year (expressing gross profit as a % of sales).​

•Horizontal analysis: compares figures from different financial years​.

•Trend analysis: compares figures for periods of three to five years.

->Analysis is aimed at:​

•Liquidity​

•Gearing​

•Profitability​

•Efficiency

Liquidity

The extent to which a business can meet its financial commitments (debts) in the short term (less than 12 months). This measures the business's ability to pay their current liabilities with their current assets.

Current Ratio = Current Assets/Current Liabilities​

Solvency (Gearing)

Gearing measures the relationship between debt (external finance) and equity (internal finance). The higher gearing (greater debt to equity) the greater the risk for the business but the greater the potential for profit. ​

Business needs to consider:​

•Return on investment​

•Cost of debt​

•Size and stability of business's earning capacity​

•Liquidity​

•Purposes of short term debt​

Debt to equity Ratio (Gearing): Total Liabilities/Total Equity​

•The higher the ratio the less solvent is the firm (higher the risk).

Profitability

The earning performance of the business. Parties interested in profitability:​

•Owners and shareholders​

•Creditors​

•Lenders​

Profit ratios include: gross profit ratio, net profit ratio, and return on equity ratio.

Gross Profit Ratio

Represents the amount of sales that is available to meet expenses resulting in net profit.​ Gross profit must be at a level that allows the payment of expenses and the recording of a profit.

Gross profit ratio = Gross Profit/Sales​

Net Profit Ratio

Represents the profit or return to the owners.​ The expenses after gross profit must be low enough to generate a net profit.​

Net profit ratio = Net Profit/Sales

Return on Equity Ratio

This measures the return on the owner's investment in the business.

Return on Equity Ratio = Net Profit/ Total Equity (Owners' Equity)

Efficiency Ratios

The ability of the business to use its resources effectively in ensuring financial stability and profitability. ​

Includes: expense raito, accounts receivable turnover ratio.

Expense Ratio

Compares total expenses with sales. The ratio indicates the amount of sales that are allocated to individual expenses (day to day efficiency of the business)​.

Expense Ratio = Total Expenses/ Sales

Accounts Receivable Turnover Ratio

Measures the effectiveness of a business's credit policy and how effectively it collects its debts. ​It measures how many times the accounts receivable balance is converted into cash or how quickly debtors pay their accounts.

Accounts Receivable Turnover ratio = Sales/Accounts Receivable

Assess Business Performance Using Comparative Ratio Analysis

Involves comparing a company's analysis against other figures (benchmarks, industry averages, previous performance).​

Identifying the Limitations of Financial Reporting​

Nominalised earnings, Capitalised expenses, Valuing assets, Timing issues and Debt Repayments.

Normalised earnings

Earnings adjusted to take into account cyclical changes in the economy or one time influences​.

Capitalised expenses

Costs incurred when financing a non-current asset (purchasing a factory would involve legal fees and stamp duty).

These expenses are capitalised (add to the cost of the asset). They are therefore depreciated over time and are not deducted from revenue.​

Valuing assets

When an asset is listed on the balance sheet its value is its historical cost. The main value of using this cost is that it can be verified but the original cost maybe different to current market value (inflation, depreciation or appreciation).​

With assets that reduce in value over time (depreciate) accountants must follow general rules regarding what rate to use.

Intangible assets are difficult to value. Not all intangibles are recorded on the balance sheet although they are used to earn income.

Timing issues

Accountants can vary the timing of revenue flows and debt repayments to make the business appear more profitable. Many transactions occur in a business and they need to be recorded at the actual time they occur.

Debt repayments

When analysing a financial report, the gearing ratio is often used to determine whether the business can meet their long term financial commitments.

Debt repayments can affect this through:

•How has the business been trying to recover the debt​.

•The capacity of the debtor to repay the amount​

•What provisions does the business have in place for doubtful debts​

•Have debt repayments been held over until another accounting period

Ethical Issues Related to Financial Reports​

Businesses have an ethical and legal obligations to ensure financial records are accurate.

Audited Accounts

An independent check of the accuracy of financial records and accounting procedures.​

Types of Audits:

•Internal audits: conducted internally by employees to check accounting procedures​.

•Management audits: this is the review of the company's strategic plan​.

•External audits: these are a requirement of the Corporations Act 2001 (Cwlth)​.

Record Keeping

All accounting processes depend on how accurately and honestly data is recorded in financial reports. ​

Report Practices

Shareholders in a private company are legally entitled to receive financial reports annually. ​