Finance Bx

Strategic Role Of Financial Management

The strategic role of financial management refers to the planning, organising, and controlling of financial resources to ensure the business achieves its long-term objectives, sustains profitability, and survives in a competitive market

Profitability (ST)

Refers to the money a business makes from its operation after all expenses have been accounted for, involves maximising sales and minimising cost.

Growth (LT)

Refers to the ability of a business to increase its size through merging, acquisitions, (external strategy), or increase their sales, market shares, direct expansion overseas (internal strategy).

Efficiency (ST)

The ability of a business to maximise the return from its assets with minimal costs (to do more with less), less wastage of resources

Liquidity (ST)

Ensuring a business has enough cash to fund its day-to-day activities and to pay off short term debt through selling assets to cash; easily accessible money

Solvency (LT)

The extent to which a business can meet its financial commitments in the long term (more than 12 months), it indicates the level of risk they have of failure.

Short-Term Objectives

The tactical (one to two years) and operational (day-to-day) plans of a business.

• They are reviewed regularly to see if targets are being met and if resources are being used to achieve the objectives.

Long Term Objectives

The strategic plans of a business. They are determined for a set period (3-5 years).

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ID Operations

• Finance is required for inputs, machinery, land etc. to create value whilst receiving a return on investments.

• Operations manages stock & outsourcing whilst finance monitors the cost of it.

ID Marketing

• Generates sales which assist with the short-term financial goal of managing cash flow.

• Finance establishes budgets and forecasts marketing must follow.

ID HR

• Finance provides funds for wages/salaries & HR strategies such as training/development.

Retained Profits (Internal)

Refers to funds generated from inside the business, profits can be retained, or owners can contribute funds.

Overdraft (ST)

A short-notice loan from a bank (usually a feature where you can ‘withdraw’ more money than you have).

• Only pay interest when the account is in deficit.

• Available at short notice, flexible however high interest, can demand repayments anytime. 

Commercial Bills (ST)

A short-term loan from a bank or other financial institutions for usually larger amounts($100,000 or more)

• Flexible, only pay interest at end however secured to assets.

Factoring (ST)

Selling your accounts receivable for a discounted price. Sold to third parties/debt collectors.

• Do so to get cash short-term/immediately.

• Immediate cash injection however reduces profit margin.

Mortgage (LT)

Large loans from a bank secured against a business's land/buildings.

• Repaid with interest over an agreed period of time.

• Access to large money w/ low interest rates however if no repayments, banks take assets.

Debentures (LT)

Large loans are secured from investors (instead of banks), with regular interest payments for a fixed period of time.

• debenture backed by collateral.

Unsecured Notes (LT)

A loan from investors for a set period of time, but they are not secured against the business’s assets. 

• Easy for businesses to acquire and fast however high interest rates + no security.

Leasing (LT)

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

• Provides long-term financing without reducing ownership, cheaper short term however the business doesn’t own the asset.

Equity

Business raising/getting money by giving up some sort of ownership of the business.

New issues

A security that has been issued and sold for the first time on a public market.

Right Issues

An invitation to existing shareholders to purchase additional new shares in the same company.

Placements

creating new shares and issuing them to selected investors at a discount to the market price of the company’s shares

Share Price Plans

an offer to existing shareholders in a listed company to purchase newly issued shares in that company without fees.

Private Equity

The money invested in a company not listed on the Australian Securities Exchange (ASX).

• Businesses invites new private owners to the business so level of control will be higher.

Financial Institution

• Banks: Stores money and provides loans. Major operators in financial markets are the most important source of funds for businesses. Offers credit cards, cheques, overdrafts.

• Investment bank: Borrowing and lending services to the business sector. Borrowing and lending services to the business sector. Provides loans and the ability to customize loans to meet specific needs however may not have best conditions for business.

• Finance companies: Non-bank institutions that specialise in smaller commercial finance. Have fast access to finance however may have high interest rates.

• Superannuation: Federal government requiring employers to make a financial contribution to a retirement fund. 

• Life-Insurance Companies: Non-bank financial institutions that provide cover and a lump sum payment. 

• Unit trust: Funds from a large number of small investors pooled together and invested.

• Australian Securities Exchange: The market in which buying and selling of shares takes place, businesses can raise capital by issuing shares on the primary market, pre-owned shares can be traded on the secondary market. 

Influences of Government

ASIC: Reduce fraud, unfair practices in financial markets and financial products.

• Protects consumers by ensuring trading is fair, transparent. Regulating companies, collecting information and making it available to the public. Monitors companies under Corporations Act 2001, possible punishment for breaching rules → fines, prisons,fees.

Company Taxation: Both private and public Australian businesses are required to pay company tax on their profits earned in the financial year. 

• Taxation helps international competitiveness, drives long term economic growth, attractive place to invest → help businesses compete globally, have a stable taxing structure, support expansion.

Economic Outlook

Refers specifically to the projected changes to the level of economic growth throughout the world.

• Positive outlook increases demand for products+services. Decreases interest rates on funds.

Availability of Funds

Refers to the ease with which a business can access funds (for borrowing) on the international financial markets.

• Conditions based on risk, demand and supply, and domestic economic conditions. 

Interest Rates

The cost of borrowing money.

• The higher the level of risk involved in lending to a business, the higher the interest rates. 

Planning and Implementing

• Financial needs: Important financial information needs to be collected before future plans can be made, needs of a business are determined by the size of business, current phase of business cycle, capacity to source finance and management skills.

• Budgets: Are forecasts of expenditures and revenues. As they are forecasts, they guide decision-making and also provide a basis on which to assess the actual financial performance. 
  
  

• Record systems: the mechanisms employed by a business to ensure financial data is recorded and the information is accurate and accessible, needs to be reliable when complying with tax laws.
  
  

• Financial risk: Threats to a business if being unable to cover its financial obligations. The larger the borrowings the higher the risk, credit risk (borrowing money), market risk (changing conditions in marketplace), liquidity risk (cash flow) and operational risk (dangers during day-to-day management).
  
  

• Financial control:  a business monitors and controls the allocation and usage of its resources in the most efficient way, e.g., reconcile accounts daily, measure actual performance, control of cash and credit checks on new customers.

Debt Financing (A&D)

Debt financing: Money owed to external sources in the form of debt repayments.

• Funds are usually available and can be acquired short notice, interest are tax deductible, not dilute business. However, regular repayments, security/collateral required, high interest.

Equity Financing (A&D)

Equity financing: Internal source of finance in business.

• Access to funds from private/public investors, no interest, low gearing. However, selling ownership (diluting), conflict of interest in business decision making, reduces profitability due to shareholders.

Matching terms and source of finance to business purpose

• The use of short-term financial needs to be used for the purchase of short-term assets such as using an overdraft to buy more inventory/stock. 

• The use of long-term finance needs to be used for the purchase of long-term assets such as using a lease for plant and equipment with a 10-year lifespa

Cash Flow Statement, Income Statement, Balance Sheet

• Cash flow statement: A financial statement that indicates the movement of cash receipts and cash payments. Can measure inflows and outflows of cash.
  
  

• Income statement: A summary of the income earned and the expenses incurred over a period of trading. Shows net profit, gross profit, cogs. The statement allows the business to monitor the data, identify issues and then take corrective actions.
  
  

• Balance sheet: A summary of a business’s assets and liabilities at a particular point in time. Shows assets, liabilities, owners equity.  Shows the financial stability, liquidity, solvency and profitability. A= L+OE

Financial Ratios

• Liquidity: Current ratio (current assets / current liabilities), measures the capacity of the business to pay its short-term debts as they fall due, 2:1 indicates a sound financial position.

• Gearing (solvency): Debt to equity (total liabilities / total equity), the extent to which the firm is relying on debt or outside sources to finance the business, a ratio greater than 1 means the business has less equity than debt, 0-1 more equity than debt. 
  
  

• Gross profit (gross profit / sales), difference between sales revenue and the direct cost of goods sold. To show the average gross profit generated by each dollar of sales.

• Net profit (net profit / sales)  the amount of sales revenue that results in net profit. To show the proportion of sales revenue returned as a net profit.

• Return on equity (net profit / total equity), how effective the funds contributed by the owners have been in generating profit and hence a return on their investment. 

• Accounts receivable turnover rate: (credit sales / accounts receivable) (365 / answer to calculate days), the effectiveness of a business’s credit policy and how efficiently it collects debts. 

• Expense: (total expenses / sales), shows the expenses incurred to make the sales.

Comparative Ratio Analysis

• Over different time periods: The business assesses its current ratios against the ratios it achieved in prior periods. This helps to determine relevant trends in data such as in profit, costs and financial stability,  and determine if business is meeting goals of PLEGS.
  
  

• Against standards: Necessary to establish how the business is performing against what has been determined to be best practice (standard/benchmark) e.g 2:1 rule for liquidity.
  
  

• Similar businesses: other businesses in the same industry, establish whether performance is above average, if below, business plans will need to be reviewed and new strategies worked out.

Limitations of Financial Reports (NCVTDF)

• Normalised earnings: Process of removing one time or unusual influences from the balance sheet to show true earnings of a company. E.g lawyer fees, sale of assets. Can cause misleading if companies manipulate influences to appear more stable.
  
  

• Capitalising expenses: Recording an expense as an asset on the balance sheet rather than as an expense on the income statement, understates the expenses and overstates the profits, e.g research and development 
  
  

• Valuing assets: Process of estimating the market value of assets using discounted cash flow or guideline method company. Valuing intangibles (goodwill, intellectual property), and asset may not reflect true market value (overstatement, understatement)

  
  

• Timing issues: Expenses must match revenue when it is earned, if not can lead to understated income or expenses, leading to lower taxes and a misleading view of profit. 
  
  

• Debt repayments: Financial reports can’t provide specific information about these debts: The balance sheet says how much the business’s debts are, but not when it is owed. 
  
  

• Financial statements: Additional notes at the end of a financial statement, very long and technical jargon, difficult to understand.

Ethical Issues

• Audited accounts: An audit is an independent check of the accuracy of financial records and financial procedures. Audits are an important part of the control function and are used to examine the affairs of a business. Internal, management, external. Ensures financial records are in line with accepted accounting standards
  
  

• Record keeping: Accounting processes depend on the accuracy and honesty of the data recorded. Source documents must be created for every transaction made.
  
  

• Reporting practices: Faking and lowering profits than they actually are in order to pay less company tax is an attempt to defraud the ATO which is both illegal and unethical.

Cash Flow Management

• Distribution of payment: Process of scheduling, allocating and making payments over a period of time rather than in a single lump sum. Using a cash flow forecast allows to identify potential periods of shortfalls and surpluses. 
  
  

• Discount for early payments: Offering debtors, a discount for early payments. . This reduces the risk of late payment or non-payment, improves working capital and provides extra liquidity. Reduces gross and net profit. 
  
  

• Factoring: Selling accounts receivable for a discounted price to finance or specialist factoring companies. Immediate cash injection, however, limits profit margins.

Control of Current Assests

Control of current assets: Last less than 12 months. Ensuring there is enough cash and liquid to pay expenses. 

• Cash: ensures the business can pay its debts, repay loans and pay accounts in the short term, planning for the timing of cash receipts, cash repayments and asset purchases avoids the situation of cash shortages or excess cash.
  
  

• Receivables: Must monitor its receivables to ensure timing allows the business to maintain adequate cash resources. Businesses should adopt a strong policy of collecting debts such as reminding customers, offering incentives for early repayment and assessing a customer’s credit history before giving credit.

• Inventories: Levels of inventories must be monitored so excess or insufficient levels of stock do not occur, leading to unnecessary expenses. Just in time inventory and a computerised inventory management system allows for monitoring and protection

Control of Current Liabilites

Control of Current Liabilities: Short-term debts, less than 12 months. Converting current assets into cash.

• Payables: sums of money owed by the business to other businesses from whom it has purchased goods and services, recorded as accounts payable, holding back on accounts payable until due date improves liquidity, and takes advantage of discounts offered by creditors.

• Loans: borrowed funds in the short-term, management of loans is important as interest rates and ongoing charges must be investigated and monitored, control of loans involves investigating alternative source of finance

• Overdrafts: Convenient and cheap, overcoming temporary cash shortages. Business can control its overdraft by ensuring that all cash received is promptly deposited into the business’s overdraft account to reduce the amount owing. 

• Leasing: Preserving cash reserves, boosting liquidity, and avoiding large upfront capital expenditures for equipment or assets. Payments are usually tax deductible, payments are stable, maintenance costs are paid for by the lessor.

• Sale and leaseback: Refers to the process of selling an owned asset to a lessor and then leasing the asset back through fixed payments for a specific period of time. Immediate cash injection improves liquidity in the case of cash shortfalls. The value of non-current assets decreases over time while expenses increase.

Cost Controls

• Fixed and variable: fixed costs do not change with the level of operating for a business e.g lease payments,interest on loans, variable costs increase with output, e.g. electricity costs and raw material cost. Financial managers can try to shift expenses from fixed to variable in the pursuit of lower costs. 

• Cost centres: Areas within the business where costs can be identified. Allows management to measure, budget and control costs for each specific function and utilise resources more efficiently establishing a cost centre where a manager or team is responsible for the costs reduces wastage.

• Minimising expenses: Cost minimisation requires the business to identify areas where costs are high (e.g. staffing costs, borrowing costs, promotions costs or leasing costs), and then pursue means by which to reduce these to the lowest level possible. 

Revenue Control

• Sales objective: continuously improve the processes that result in sales, if business meets its customer’s demands more effectively than competitors, sales will improve, improved quality or faster delivery.
  
  

• Sales mix: the breakdown of sales revenue by products, meeting customer needs and taking advantage of their target market.
  
  

• Pricing policy: Affects working capital. Overpricing could not attract buyers. Underpricing may bring higher sales but result in cash shortfalls and lower profits. 

Methods of International Payment (PLCB)

Payment in advance: Seller doesn't ‘ship’ the goods until the payment is received, good for sellers, bad for buyers. An example is individual customers. Risk is with the importer. 

Letter of credit: Actual letter issued by the buyer’s bank. It guarantees the transfer of the money if the producer meets specifications. 

Clean payment: Buyer doesn't pay until the goods are received. No risk for buyers, very risky for sellers. The seller does it for trustworthy buyers.

Bill of exchange: A document drawn up by the exporter demanding payment from the importer at a specified time. 

• Document against payment: Importers can collect the goods only after paying for them.

• Document against acceptance: Importers may collect the goods before paying for them.

Hedging

Hedging: Refers to the process of minimising the risk of currency fluctuations to help reduce the level of uncertainty involved with international financial transactions.

Natural hedging: a number of strategies to eliminate risk of foreign exchange exposure.

• Establishing offshore subsidiaries (a company overseas in that country).

• Insisting on both import and export contracts denominated in Australian dollars. This effectively transfers the risk to the buyer (importer). 

• Implementing marketing strategies that try to reduce the price sensitivity of exported products.

Derivatives

Derivatives: simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations.

• Forward exchange contracts: A contract to exchange one currency for another currency at an agreed exchange rate on a future date.
  
  

• Options Contracts: Gives the buyer (option holder) the right, but not the obligation, to buy or sell foreign currency at some point in time in the future.
  
  

• Swap Contracts: An agreement to exchange currency on the spot market with an agreement to reverse the transaction in the future