12 Business Studies - Finance

Profitability

the earnings of a business after expenses have been paid

Efficiency

the ability of a business to minimise its costs and manage the level of assets so that the maximum profit can be achieved with the lowest level of assets

Growth

ability of a business to expand over time

Liquidity

the ability of a business to pay its short term debts as they fall due

Solvency

the long term debts of a business

Gearing

the proportion of debt to equity used to finance the activities of the business

Strategic financial management

the planning and monitoring of a business' financial resources to ensure it achieves its financial objectives

Australian Securities and Investment Commission (government influence)

enforces and administers the Corporations act, protects consumers and assists in reducing fraud and unfair practices

Company taxation (government influence)

levied at a flat rate of 30%

Global economic outlook (global market influence)

Positive outlooks increase the demand for products and services and increase interest rates (negative is opposite)

Availability of funds (global market influence)

refers to the ease with which a business can access funds for borrowing

Interest rates (global market influence)

traditionally australian interest rates are higher than other countries so businesses can benefit from borrowing overseas

External finance

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

Debt finance (external sources)

business relies on outside sources rather than the owners to finance the business

Overdraft (short term debt)

Bank allows business to overdraw their account to specified limit and for a set period of time

Commercial bills (short term debt)

Loan issued by financial institution usually for a larger amount (100 000) and for 30 to 180 days

Factoring (short term debt)

the selling of accounts receivable to a finance or factoring company for a discounted price

Mortgage (long term debt)

loan secured against the property of the business used to finance property purchases

Debenture (long term debt)

loan issued for a fixed rate of interest and for a fixed period of time (raise funds through investor instead of financial institution)

Unsecured notes (long term debt)

loan issued for a set period of time which is not secured against the assets of the business

Leasing (long term debt)

the payment of money for the use of another party's equipment

Operating lease

usually shorter than the life of the asset and can be cancelled without penalty

Financial lease

lessor buys equipment on behalf of the lessee, its usually for the life of the asset and is cheaper than operating

Equity

finance sourced by inviting other parties to be part owners of the business

Ordinary shares (equity)

ordinary share holder becomes a part owner of the business and may receive dividends

New issues

security sold on the market for the first time e.g. Australian Securities Exchange

Rights Issue

the privilege granted to existing shareholders to buy more shares in that company

Placement

portion of shares made directly from the company to investors

Shareholder purchase plan

the offer to existing shareholders to buy more shares in that company without brokerage fees

Private equity

money invested in a company not listed on the ASX= inviting other parties to become part owners through the selling of shares

Banks

receive savings as deposits from individuals, businesses and governments and in turn make investments and loans to borrowers.

Financial Needs

Helps determine where a business is headed and how to get there. Like a roadmap

Budgets

Facts and figures which estimate costs, revenues and resources. Important planning tool that determines areas of improvement in the business

Operating Budget

relates to main activities of a business including sales, production, raw materials, direct labour, expenses and COGS.

Project Budget

relate to capital expenditure and research and development

Financial Budgets

relates to financial data of a business i.e. budgeted income statement, balance sheet and cash flows

Record Systems

mechanisms to ensure that data are recorded and the information are accurate, reliable and efficient.

Financial Risk

risk the business not being able to cover financial obligations. For e.g. not paying debt when fall due

Financial controls

ensures that the plans that have been determined will lead to the achievements of a business goals in the most efficient way

Debt finance

relates to short and long term borrowing from external sources

Equity finance

relates to internal sources of finance in businesses

Debt finance advantages

readily available funds, tax deducted interest payments

Debt finance disadvantage

risk of debt

Equity finance advantage

cheap, safe and low gearing source of finance

Equity finance disadvantages

Lower profits

Cash flow statement

A financial statement that indicates the movement of cash receipts and cash payments from transactions over time

Income statements

shows the revenue earned and expenses incurred over accounting period showing profitability or loss

Balance sheet

represents a businesses assets and liabilities at a particular point in time.

Assets

items of value owned by business.

Current assets

can be turned into cash within 12 months e.g. inventories, receivables

Non-current assets

not expected to turn into cash within 12 months e.g. property, equipment, investments

Accounting equation

shows relationship between assets, liabilities and owner's equity

Current Ratio

Current Assets / Current liabilities

Gearing

the proportion of debt and the proportion of equity that is used to finance the activities of a business, which determines solvency

Debt to Equity ratio

Total liabilities / Owner's equity

Profitability

earning performance of the business that indicates its capacity to uses its resources efficiently to maximise profits

Gross profit ratio

Gross profit / Sales

Net profit ratio

Net profit / Sales

Return on Equity ratio

Shows how effective the funds contributed by the owners have been in generating profit hence, the return on their investments = Net profit / Total equity

Expense ratio

indicates the amount of sales that are allocated to individual expenses and the day to day efficiency of the business. = Total expenses / Sales

Accounts receivable turnover ratio

measures the effectiveness of a firm's credit policy and how efficiently it collects its debt = Sales / Accounts Receivable

Debt repayments

refer to either money owed to the business or by the business

Distribution of payments

strategy; involves distributing payments throughout the month to prevent cash shortfalls

Discounts for early payment

an offer to creditors for a discount in early payments

Working capital

refers to the money that is available for the day to day runnings of the business

Working capital ratio

quick measure of businesses working capital

Current liabilities

liabilities that a business must repay withing the short term

Insolvency

when business cannot pay its bills when fall due

Working capital management

involves determining the best mix of current assets and current liabilities needed to achieve business objectives

Cash budget

manages the cash use in the business. Numerical plan which forecasts a businesses estimated cash receipts and cash payments over period of 12 months

Accounts recievable

debts incurred by the customer when businesses extend a line of credit to some customers when they purchase something

Credit policy

Policies that control accounts receivable of a customer

Payables

sums of money a business owes to another business for purchasing their goods

Control of loans

involves investigating alternative sources of funds for different banks and financial institutions

Control of accounts payable

involves periodic reviews of suppliers and the credit facilities e.g. discounts, interest free credit period..

Control of overdrafts

involves monitoring budgets on a daily or weekly basis so that cash supplies are controlled

Control of account receivable

-checking credit rating of prospective customers

-sending customers statements monthly and at the same times each month

-following up on accounts that are not paid by the due date

-putting policies in place for collecting bad debts, like using a debt collecting agency

Sales and lease back

action of selling an owned asset to a lessor and leasing the asset back through fixed payments for a specified number of years.

Profitability management

involves the control of both the businesses costs and its revenue

Foreign exchange rate

the ratio of one currency to another; it tells how much a unit of one currency is worth in terms of another

Foreign exchange market

determines the prices of one currency relative to another

Payment in advance

method that allows the exporter to receieve payment and the arrange for goods to be sent

Letter of Credit

commitment by the importer's bank which promises to pay the exporter a specified amount when the documents proving shipment of goods are present

Clean payment

(easiest and quickest) occurs when the payment is sent to but not receieved by the exporter before the goods are transported *

Hedging

The process of minimising the risk of currency fluctuations

Derviatives

simple financial instruments that can be used to lessen the exporting risks associated with currency fluctiations

Forward exchange contract

contract to exchange one currency for another currency at an agreed exchange rate on a future date

Option contract

gives buyer the right to buy or sell foreign currency at later future time

Swap contract

an agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future