Business: Finance

Role of finance

Specific planning and management of a business's financial resources in order to assist the business achieve its financial objectives

Finance

Concerned with acquiring and managing the funds that are needed so that goods and services can be produced, can come from inside the business or from outside the business

Role of financial reports

Monitors and evaluates these statements to achieve objectives

Financial objectives

All lead to profit / wealth maximisation

PLEGS - profitability, liquidity, efficiency, growth, solvency

Profitability

Revenue - fixed and variable costs, important because impacts whether a company can secure financing from a bank, attract new investors to fund its operations and grow in business, finance its own activities and provide return for owners

3 outcomes = break even, profit, loss

Gross profit

= sales revenue - cost of goods sold

Net profit

Gross profit - expenses

Expenses

Expenditure that a business incurs to engage in activities not directly associated with the production of goods or services

Growth

Ability of a business to incense size, physical and /or financial increase, achieved by other objectives such as profitability and accumulating assets

Efficiency (financial)

Ability of a business to minimise its costs and manage its assets to maximise profits, how effectively it con allocate money to expenses, how quickly the business receives money owed to it, important as it indicates how efficiently the business can generate sales revenue from it expenses

Operational efficiency

More output for same amount of inputs, same output from less inputs

Liquidity

Measures a business's ability to meet short term obligations, being able to keep enough cash or cash equivalents on hand to pay short team debts when they fall due, important to maintain positive relationship with suppliers, ensuring paid on time, meet loan repayment obligations to avoid additional interest charges or late fees

Solvency

Measures a business ability to meet long term obligations / broad measure of risk, insolvent it unable to meet financial obligations = high gearing: debt > equity, solvent it able to meet financial obligations = low gearing: debt < equity

Sources of finance

Means of obtaining / sourcing finance: access to funds and / or cost of funds will affect growth and other financial objectives, a business requires finance / funding in order to operate and take advantage of business opportunities

Internal finance

Funds generated from inside the business: internal equity = retained profits/ earnings, owners equity

Retained profits / earnings

All profits not distributed but some are kept in the business as a cheap and accessible source of finance for future activities, not paid as dividends

Owner's equity

Capital contributed by the owners

External finance

Finance provided from external sources through creditors or lenders

Debt finance

External funds borrowed from a bank, an investor, or another business, requires repayment of loan plus interest payments

Advantages of debt finance

Won't dilute current ownership in the business, interest payments are tax deductible, funds ave usually readily available and can be acquired on little notice, flexible payment periods and types of debt are available

Disadvantages of debt finance

Security is required by the business», regular payments have to be made, debt can be expensive due to interest, lender have first claim on money if bankrupt, increased risk if debt come from financial institutions because interest, bank charges, and government charges may increase

Short term borrowing = current liabilities ( < 12 months)

Overdraft, commercial bills, factoring

Overdraft

A bank allows a business or individual to overdraw their account up to an agreed limit and for a specified time, allows for a business to draw on more funds than are available in the account, purchase of stock, payment of expenses, interest + admin fees and charges

Commercial bills

Banns issued short term loans for larger amounts ( usually over $ 100,000) usually for bulk purchases

Factoring

Enables a business to raise funds immediately by selling accounts receivable at a discount to a factoring business, a debt collector

Long term borrowing = non current liabilities (> 12 months )

Mortgage, debentures, unsecured notes, leasing

Mortgage

Legal agreement by which a bank or other creditor lends money at interest in exchange for taking title of the debtor's property, purcnese of property, interest and admin fees and charges

Debentures

Debt securities issued by a company for a fixed rate of interest for a fixed period, secured against company assets, long tem assets

Unsecured notes

Loan from investors for a set period. Like debentures but offer higher rate of return, not secured against company assets, less security to lenders than debenture

Leasing

Involves payment of money for the use of equipment that is owned by another party

Equity finance

Internal or external sources of finance contributed by the owners or raised by selling shares in the business, float ordinals shares, private equity

Advantages of equity finance

Does not hat to be repaid unless owner leaves business, no legal requirements, cheaper as no interest payments, less risk, ownes who has contributed retain control over how finance is used

Disadvantages of equity finance

Lower profits and lower returns for the owner, expectation of return on investment, long, expensive process, ownership is diluted, current owners have less control

Float ordinary shares ( public companies )

Commonly traded shares on ASX, obtain voting rights and portions of profit, share value determinant by companies performance

Private equity ( private companies)

Money invested into private companies by invitation of new owners, to raise funds for the business , typically to fund expansion / investment

Types of shares for public companies

Ordinary shares, new issues, rights issue, placements, share purchase plan

Rights issue

Privilege granted to shareholders to buy new shares in the same company

Share placement

Allotment of shares made directly from the company to the investors at a discounted rate

Share purchase plan

An offer to existing shareholders to purchase more shares in the company without brokerage fees and also avoids having to issue a prospectus

Financial statement

Shows you where a company's money came from, where it went, and where it is now, balance sheet, income statement, cash flow statement

Cash flow statement

Monitors cash inflows and cash outflows in a business

Opening cash balance, cash inflows, cash outflows, net cash flow ( inflows - outflows), closing cash balance

Income statement

Financial statement that measures business profitability

Sales revenue, - cogs ( opening stock + purchases - closing stock) = gross profit, - expenses = net profit

Balance sheet

Business assets and how those assets have been funded debt and/ or equity

Left side: current assets ( accounts receivable, cash, stock), non-current assets,

Right side: current liabilities ( accounts payable ), non current liabilities, owner equity.

A = L +OE