hsc finance
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HSC business studies notesTRANSCRIPT
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Business Studies- Finance
Role of financial management
Strategic role of financial management
Strategic financial management is the process of setting long-term objectives throughout the
business and deciding what will be needed to achieve these objectives
Developing a strategic plan a part of a firms financial management will ensure the business
grows
Business goals such as increasing profits are translated into business objectives that provide
detail about the firms mission, purpose and function
Business objectives: Break the business operations into achievable and manageable outcomes
that can be measured and evaluated
Financial management: Refers to the planning, organising and monitoring/controlling of the
financial or monetary resources to achieve the goals, objectives and plans of the business
Managing business finances are crucial to ensure the success of a business, with the following
possibly occurring if finances are not correctly managed:
Overstocking materials
Insufficient cash to pay suppliers
Inadequate capital for expansion
The main role of financial management can be broken down into three types of decisions:
Finance decisions where will the business source its money from?
Investment decisions how will the business use its finance to generate income?
Dividend decisions how will the business distribute any profits?
Objectives of financial management - Profitability, growth, efficiency, liquidity, solvency
In order to achieve its long term goals, firms must first set out and achieve a number of short
term goals including:
Goal Description
Profitability The ability of a business to maximise its profits In order to increase profitability, firms must monitor and aim to increase
revenues whilst reducing costs at the same time
Growth The ability of the business to increase its size in the longer term A significant financial objective as it ensures the firm is sustainable in the future, The growth of a firm depends on the firms ability to use its asset structure to
increase sales, profits and market share
Efficiency The ability of a business to utilises its resources effectively in ensuring financial stability and profitability
Occurs when a firm can minimise costs and manage assets in order to maximise profits
By increasing productivity through staff or technological machinery, a firm can
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increase its efficiency and thus minimise costs
Liquidity The ability of a business to pay its debts as they fall due In order to, a firm must have sufficient positive cash flow or convert assets to
liquid funds to pay debts
Solvency The extent to which the business can meet its financial commitments in the longer term, usually greater than 12 months
Important to owners, shareholders and creditors as it is an indication of the risk associated to their investment in the particular firm
- Short term and long term objectives
Short Term Long term
Are the operational (day-to-day) and tactical (1-2 years) plans
Reviewed regularly to see if targets are achieved, and could include sales targets for each month or output increases
are the strategic (5 years +) plans of a business
can involve aims to expand into emerging markets such as Asia, become a market leader and increase market share
in order to be achieved, the shorter term operational and tactical goals must be achieved first
performance is reviewed annually to see if the targets for each year are met, such as growing 5% each year in order to gain 20% market share in 4 years
Interdependence with other key business functions (KBF) The key business functions include operations, marketing, finance and human resources
In order to achieve certain goals such as market share, all functions must work together in
order to achieve this
If, for example, a business was to set a strategic goal of increasing its market share by 5%, this
would affect:
Operations, as production methods would need to be altered to become more
efficient/productive and thus minimise costs
Marketing, as extensive advertising to increase market awareness would be required
Human resources, as additional labour would be required to produce higher outputs
Finance, as additional funds may be needed in order to alter operations production
methods, pay for additional marketing and additional labour costs
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Influences on financial management
Internal sources of finance-retained profits A business can finance its operations from external sources, internal sources, or, more
commonly, a combination of both
The Internal Finance: The funds provided by the owners of business or from the outcomes of
business activities (retained profits)
Internal finance comes from the following sources:
Owners Equity: The funds contributed by owners or partners to establish and build the
business
Retained Profits: Involve retained earnings which arent redistributed to dividends and other
means. In Australia about 50% of profits are retained for future reinvesting, and provides firms
with a cheap and accessible form of finance
External Sources of Finance External Finance: The funds provided by sources outside the business including banks,
other finance institutions, government, suppliers or financial intermediaries
- Debt: Short term borrowing (overdraft, commercial bills, factoring), long-term borrowing
(mortgage, debentures, unsecured notes
Short term Borrowing
Used to finance temporary shortages in cash flow or finance for working capital
Repaid within 1-2 years
Type of Debt Description
Bank overdraft Common type of short term borrowing Consists of businesses able to overdraw its account to
an agreed limit Overdrafts assist firms with short term liquidity
problems, due to a slum in sales etc Interest rates are lower than on other forms of
borrowing, other costs and fees are minimal
Commercial Bills A type of loan for large amounts of money (over 100k) issued by institutions other than banks, basically an IOU for the period of between 90-180 days
Borrower receives the money immediately and then promises to pay the principal + Interest by the time the period has ended
Factoring The selling of accounts receivable for a discounted price to a finance or factoring company
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A firm can receive up to 90% of the amount of receivables within 48 hrs of submitting its invoices to the factoring company
Obvious downside is that not all of accounts receivable go to the business, as the factoring company charges a fee/commission cost of finance
A factoring company can offer: Without recourse: The business transfers responsibility for
non-collection to the factoring company With recourse: The business will still have the responsibility
of its bad debts Comes with greater risks and higher costs than other
sources of finance Previously viewed negatively but attitudes towards
factoring have improved over the last decade
Long-term Borrowing
Funds borrowed for periods longer than two years, and is able to be both secured or
unsecured with interest rates also having the options of variable or fixed
Used in real estate, offices and factories and capital equipment
Type of Debt Description
Mortgage
A loan secured by the property of the borrower (business) A loan secured by the property of the borrower (the business), which
cannot be sold or used as security for another loan until the current loan has been repaid in full
Debentures (bond)
Issued by a company for a fixed rate of interest and for a fixed time The amounts of profits made by the firm have no impact upon the interest
as it is fixed Not secured to specific property
Unsecured notes
A loan for a set period of time but is not backed by any collateral or assets Most risk to lenders, thus attracting high rates of interest compared to a
secured note Firms sell these to generate money for initiatives such as acquisitions
Leasing
Involves the payment of money for the use of equipment that is owned by another party
The lease is an agreed period of time, and both the costs and benefits of the equipment is transfers from the leaser to the lessee
Long term lease cant usually be cancelled Two types of leasing:
Operating leases short-term, usually less than the life of the asset
Financial leases lessor buys asset on behalf of lessee and as
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such the lease usually lasts for the life of the asset
- Equity-ordinary shares (new issues, rights issues, placements, share purchase plans), private
equity
Refers to finance raised by a company by issuing shares
Ordinary shares
Most commonly traded shares in Australia, with purchasers becoming part owners of a
publicly listed company
The return on these shares is capital growth and dividends
Dividends: A distribution of a firms profits (either yearly or half yearly) to shareholders and is
calculated as a number of cents per share (Dividend yield)
Types of ordinary shares include:
New Issue: A security that has just been issued and sold for the first time (primary
market)
Rights Issue: The privilege granted to shareholders to buy new shares in a company
which they already hold shares in
Placements: Allotment of shares, debentures etc made directly from the firm to
investors
Share purchase plan: An offer to existing shareholders in a listed company to
purchase more shares in that company without brokerage fees. These shares can also
be offered at a discount compared to the current market price
Financial Institutions- Banks, Investment banks, finance companies,
superannuation funds, life insurance companies, unit trusts and the
Australian Securities Exchange
Financial Institutions
Description
Banks Major operations in the financial markets and most important source of finance for businesses
Receive deposits from individuals, business and governments, make investments and loans to borrowers
Since the GFC in 2008, banks have been more cautious in lending policies making it harder for businesses the obtain finance
E.g ANZ, CBA, Westpac,
Investment Banks One of the fastest growing sectors in Australia They provide services in both borrowing and lending primary to the
business sector They:
Advise on mergers and acquisitions Arrange project finance Trade money, securities and finance futures Operate unit trusts, cash management trusts, property trusts and
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equity trusts E.g JP Morgan, Goldman Sachs, CITI, UBS, RBS,
Finance Companies Non-bank intermediaries that specialise in smaller commercial finance Regulated by the Australia Prudential Regulation Authority (APRA) They act as intermediaries in financial markets by providing loans to
both individuals and businesses Some companies also specialise in factoring or cash flow financing Capital leant out is raised through debentures (fixed term with fixed
interest) These loans are secured, thus the asset can be sold off if the business
paying the loan fails e.g Aussie and Yellow Brick Road
Superannuation Funds
Rapid growth in the last 20 years due to compulsory superannuation contribution legislation
Provide funds to the corporate sector through the investment of funds received from contributions
They invest in long term securities such as company shares, government and company debt due to long term nature of superannuation
e.g ING Direct
Life insurance companies
Provide corporate loans through receipts of insurance premiums Provide large amounts of both equity and loan capital to firms Can sometimes be very risky for those who depend upon insurance
payouts (eg QLD floods) E.g Allianz, AIA
Unit Trusts Known as mutural funds, and take funds from a large number of small investors and then invest in certain types of financial assets
Include on the short term money market (cash management trusts), shares, mortgages, property and public securities
Some trusts are connected to management firms that manage a diversified investment portfolio for investors
E.g AXA
ASX Australian securities exchange is the primary stock exchange in Australia
Functions as a market operator which offers products and services including shares, futures, real estate investment trusts, exchange traded options etc
Both the primary and secondary market, and oversees all share transactions with public companies
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Influence of Government- ASIC, company taxation Government can influence business behaviour and financial management decision making
through economic policy making such as Fiscal and Monetary policy, and also microeconomic
reform
Australian Securities and Investments Commission (ASIC)
Ensures that companies adhere to laws concerning investments and collects & publishes
information about companies
Aims to assist in reducing fraud and unfair practices in financial markets and financial products
such as insider trading
Since 1998 has been responsible for enforcing the Corporations Act
Company Taxation
Tax is paid on profits, and is currently a flat rate of 30% unlike personal tax which is
progressive
Is paid BEFORE profits are distributed to shareholders as dividends
Has been systematically reduced over the last decade to increase global competitiveness and
attract foreign investment
This rate was reduced from 36 to 34% for 2000-01 and then 30% until 2013
Global Market Influences
Almost uncontrollable by businesses, however management strategies can be implemented in
order to minimise the effects on a business
Globalisation has created a larger interdependence between economies and their business
sectors which relies on trade for expansion and increased profits
The three main global market influences upon firms include:
Economic outlook (bull market-boom, bear market-bust/economic slowdown)
Availability of funds (the difficulty to obtain funds)
Interest rates (cost of finance)
Global economic outlook
Refers specifically to the projected changes in the level of economic growth throughout the
world
Positive prospects = easier availability to finance, higher consumer confidence thus increased
consumption and demand for G&S = Higher levels of economic growth, business profits etc
Negative prospects = more difficult to gain finance, lower consumer confidence thus reduced
demand for G&S = lower levels of economic growth, business profits etc
Availability of Funds
Refers to the ease with what a business can access funds on the international finance markets
These international financial markets are made up of governments, companies, institutions etc
which are prepared to lend money
Lending is determined on various conditions including:
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Risk
Demand and supply
Domestic economic conditions
GFC is good example of how the availability (or rather unavailability) of funds on a global level
can have a negative impact on businesses in Australia
Interest Rates
The cost of borrowing money
Higher levels of risk = higher interest rates
Interest rates in Australia have historically been higher than most other nations, increasing the
incentive for Australian businesses to borrow from overseas sources
Changes in exchange rates can either amplify or negate the advantages of overseas borrowing,
depending on the direction of the change)
Processes of Financial Management
Planning and Implementing- Financial needs, budgets, record systems,
financial risk, financial controls Planning processes involve the setting of goals and objectives, determining the strategies
to achieve those goals and objectives, indentifying and evaluating alternative courses of
action and choosing the best alternative for the business
Financial Needs
In order to determine where a business is heading, it is important to know what its needs
are
Financial information must be connected before future plans are made, and include
balance sheets, income statements, cash flow statements, sales forecasts etc
The financial needs of a firm are determined by:
Size of the firm
Phase in the business cycle
Future plans for growth and development
Capacity to source finance- debt and/or equity
Financial information is needed to show that the business can generate an acceptable return
for the investment being sought and should, therefore include an analysis of financial
performance such as a cash flow statement and balance sheet
Budgets
Provide information in quantitative terms (facts and figures) about requirements to achieve a
particular purpose
They provide the facts and figures for planning and decision making and enable constant
monitoring of progress and problem areas
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They reflect the strategic planning decisions about how resources are to be used and provide
financial information for a businesss specific goals and are accordingly used in strategic,
tactical and operational planning
Enable constant monitoring of objectives and provide a basis for admin control, production
planning, price setting and control of expenses
Used in both the planning and controlling aspects of a firm
Planning: Can be used to review past figures and trends to plan for realistic goals for
the future etc
Control: Planned performance can be compared to actual performance with
corrective action taking place if required
Operating Budgets: Relate to the main activities of a business and may include budgets
relating to sales, production and raw materials
Project Budgets: Relate to capital expenditure and R&D
Financial Budgets: Relate to financial data of a business and include budgeted income
statements, balance sheets and cash flow statements
Record Systems
Record systems are the mechanisms employed by a business to ensure that data is recorded
and the info provided by record systems is accurate, reliable, efficient and accessible
The double entry recording system is used to minimise errors, as entries can be seen to
balance, and checks to find errors can be carried out quickly and easily
This is done as management base decisions on previous records when needed, therefore all
records must be reliable and accurate
Financial Risks
The risk to a business of being unable to cover its financial obligations such as debts incurred
through short & long term borrowing
Businesses must consider whether the profit generated as a result of borrowing is enough to
cover the repayments
Generally, the higher the risk, the higher the return both the business and the financial
institution lending the funds will expect. (e.g higher risk for banks = higher interest rates)
Financial Controls
The policies and procedures that ensure that the plans of a business will be achieved in the
most efficient manner
The most common causes of financial problems are:
Theft
Fraud
Damage/loss of assets
Errors in record systems
Common policies/procedures that promote control within a business include:
Clear responsibility for tasks
Separation of duties
Rotation of duties
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Debt and Equity Financing- advantages and disadvantages of each Business can choose to gain finance from both external and internal sources, and usually
adopt an approach to utilise both sources
Debt Finance
Debt finance refers to the short and long term borrowing from external sources by a business
Include mortgages, loans, overdrafts etc from banks and other financial institutions
Equity Finance
Equity finance refers to the internal sources of finance in the business, such as owners equity
and retained profits
Include retained profits, owners equity and primary shares
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Comparing debt and equity finance
Matching the terms and source of finance to business purpose The terms of finance must be also suitable for the structure of the business and the purpose
for which the funds are required
The costs of each source of funding must be determined and balanced against the expected
rate of return
Structure of a business can also influence financial decisions, eg unincorporated businesses
will have difficulties obtaining equity finance
Other costs associated with a source of finance, eg setup costs and interest payments must
also be considered
Flexibility of finance should also be considered eg overdraft v debentures
Availability of finance cannot be taken for granted and must also be considered
Level of control maintained must also be considered, especially when choosing between debt
and equity finance
Monitoring and Controlling- Cash flow statement, Income statement,
Balance Sheet
Financial Statements
Monitoring and controlling is essential for maintaining business viability and affects all aspects
of financial management
The main financial controls used for monitoring are:
Income statements
Balance sheets
Cash flow statements
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Cash flow Statement
A financial statement that indicates the movement of cash receipts and cash payments
resulting from transactions over a given period of time
Provides the link between the income statement and balance sheet, and gives important
information regarding the firms ability to pay its debts on time
Creditors, lenders, owners and shareholders all use a CFS to assess the ability of a
business to manage its cash and identify cash flow management trends over time
A better predictor of a firms status rather than profitability, and shows whether a firm
can:
Generate positive cash flow
Have sufficient funds for future Investment
Pay servicing costs (rent, interest, dividends, accounts payable)
The activities of the firm are separated into 3 distinctive categories on the cash flow statement
including:
Operating Activities: The cash inflows/outflows relating to the main activity of the
firm (provision of G&S, income from sales, dividends and interest received whilst
outflows consist of payments to suppliers and employees
Investing Activities: Cash inflows/outflows relating to the purchase and sale of non-
current assets and investments, such as selling a company car or purchasing new
capital machinery
Financing Activities: The cash inflows/outflows relating to equity or debt. Inflows
involve the $ received from issuing shares or borrowing from financial institutions,
whilst outflows consists of servicing costs such as interest
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Income Statement
Shows the operating results for a given period of time. It shows the revenue earned and
expenses incurred over the accounting period with the resulting profit or loss
Operating income: Earned from the main function of the business such as sales of
inventories, services and other operations such as interest and rent
Operating expenses: Including purchase of inventories, payments for services and
other operations including advertising, rent, telephone and insurance
Managers can compare and analyse trends using a collection of previous income statements
before making important financial decisions, and can identify the reasons for
increases/decreases in profits etc
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Balance Sheet
Represents a businesss assets and liabilities at a particular point in time, expressed in money
terms, and represents the NET worth of the business and the stability of the firm
Assets: The items of value owned by the business, current can be turned into cash
within 12 months whilst noncurrent assets are not expected to be turned into cash
within 12 months
Liabilities: Claims by people other than owners against the assets (items of debt) and
represent what is owed by the business. Current liabilities must be paid within 12
months, whilst noncurrent liabilities are expected to be paid in a period longer than 12
months, such as a mortgage
Owners Equity: Represents the owners financial interest in the business or net worth
of the business, also referred to as capital
Shows the financial stability of a business, and analysis of the sheet can indicate weather:
The firm has enough assets to cover its debts
The interest and principal borrowed can be repaid
The assets are being used to maximise profits
The accounting equation (Assets = Liabilities + Owners Equity) forms the basis
of the accounting process and shows the relationship between assets, liabilities
and owners equity
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Financial Ratios Analysis involves working the financial information into significant and acceptable forms that
make it more meaningful, and highlighting relationships between different aspects of a
business
Interpretation involves making judgements and decisions using data gathered from analysis
Gearing is the proportion of debt finance compared to the proportion of equity used
determines solvency
3 types of analysis including vertical, horizontal and trend analysis
Vertical: Compares figures within one financial year, e.g expressing gross profit as a %
of sales
Horizontal: Compares figures from different financial years, such as 2011 to 2012
Trend: Compares figures from periods of 3-5 years
The type of analysis utilised will depend on the reasons that the information is required for,
such as comparing figures, percentages or ratios for different firms within the same industry
Financial Ratio Ratio Example Purpose
Liquidity
450 000/150 000 = 3:1 - The firm has $3 of
assets for every $1 of current liabilities, indicating that the firm is in a sound financial position, that is, it is liquid and will be able to pay for its debts in the short term
Identifies a limited indication of the ability of the firm to meet its liabilities
- Analyses short-term stability
- Generally accepted that 2:1 is sound
- HIGHER is better
Gearing Debt to Equity Ratio
50 000/ 150 000 = 33.3% - The firm has
$0.33 in external debt (liabilities) for every $1 of internet debt (owners equity). A ratio of 1:1 indicates a sound financial position this firm is in a safe position
it shows the extent to which the firm is relying on debt or outside sources to finance the business
- LOWER is better - Under 100% is
accepted
Profitability Gross Profit Ratio
Net Profit Ratio
Gross Profit Ratio 20 000/100 000 x100 = 20% Net Profit Ratio 15 000/100 000 x100 = 15%
Gross Profit Ratio Represents the amount of sales that is available to meet expenses resulting in net profit. It Shows changes from one accounting period to another, and indicates the effectiveness of
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Return on Equity Ratio
Return on Equity Ratio 15 000/150 000 x100 =10%
planning policies concerning pricing, sales etc
- Usually compared to previous years
- Indicates effectiveness of policies regarding pricing, discounts, sales and supply chain.
- HIGHER is better Net Profit Ratio Represents the profit or return to the owners, and shows the amount of sales revenue that result in net profit.
- Represents final % of sales received by owners
- HIGHER is better - Can identify COGS
or expenses as problem when compared to gross profit ratio
Return on Equity Ratio Shows how effective the funds contributed by the owners have been in generating profit, and hence a return on their investment.
- Shows how effective equity has been in generating profit
- HIGHER is better
Efficiency Expense Ratio
Accounts Receivable turnover Ratio
Expense Ratio 5000/100 000 x100 = 5% Accounts Receivable turnover Ratio 100 000/10 00 = 10%
Expense Ratio Compares total expenses with sales and indicates the amount of sales that are allocated to individual expenses such as selling,
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admin etc, therefore indicating the day to day efficiency of the firm
- Can be used on individual expense categories or expenses as a whole
- LOWER is better Accounts Receivable turnover Ratio Measures the effectiveness of a firms credit policy and how efficiency it collects it debts. It measures how many times the account balance is converted into cash or how quickly debtors pay their accounts. By dividing it by 365, firms can determine the average length of time it takes to convert the balance into cash
Comparison of Financial Ratios
Financial ratios are meaningless until compared to one or more of the following:
Previous years
Industry averages/competitors
Business goals
Limitations of financial reports- normalised earnings, capitalising
expenses, valuing assets, timing issues, debt repayments, notes to the
financial statements
There are six key limitations of financial reports:
o Normalised earnings the process of removing one-time or unusual income
(including high/low sales due to level of economic activity) for the balance
sheet to show the true earnings of a company
o Capitalised expenses the process of incorporating costs incurred in financing
a non-current asset into the assets value in the balance sheet
o Valuing assets either original/historical cost or depreciated/appreciated cost
o Timing issues seasonal influences may distort a financial statement since they
only represent a given period of time
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o Debt repayments financial statements do not show the business ability to
collect its debts
o Notes to financial statements contain information such as accounting
methods used and how they affect the results of the financial statements
Ethical issues related to financial reports
Ethical considerations are closely related to legal aspects of financial management
Legislation exists to guard against unethical business activity, but there is often a time
lag between the recognition of a problem and its legal implementation
The ASX officiates requirements for public companies
Audited Accounts
An audit is an independent check of the accuracy of financial records and accounting
procedures
There are three main types of audits:
o Internal audits conducted by employees
o Management audits conducted to review strategic plans
o External audits required by federal law, performed by specialised
accountants outside the business
In 2005 Australian businesses were required to adopt international financial reporting
standards (IFRS)
Record Keeping
Records must be kept for ALL transactions, including cash transactions, else the
business can be found guilty of tax fraud
Accurate record keeping is necessary for taxation purposes as well as for other
stakeholders
GST Obligations
All businesses must complete a BAS every 3 months, which reflects the sum of
transactions with customers
Failure to declare all GST or claiming input credits to which they are not entitled is
both unethical and illegal
Reporting Procedures
Businesses must provide the government (ATO) and shareholders (if any) with
accurate financial reports, as well as making them available to any other stakeholders
Inaccurate and/or dishonest reporting is both unethical and illegal
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Financial management strategies
Area of Management
Identify strategies and outline features How effective is this strategy
Cash flow management
Distribution of payments - Involves distributing debits through
the month, year or other period to ensure cash shortages dont occur
Discounts for early payments - Involves offering discounts for early
payments by creditors Factoring
- The selling of accounts relievable for a discounted price to a finance or specialist factoring company
Distribution of payments - Is effective in identifying
periods or potential shortages and surpluses, so the firm can overcome these problems before the actual event occurs
Discounts for early payments - Is effective when
targeting creditors who owe large amounts, although these discounts do reduce the overall level of revenue and the profitability of the firm
Factoring - Growing in popularity as
a way to improve working capital
Working capital management
Control of CA Cash
- Planning for the timing of cash shortages to ensure overdrafts or other forms of debt finance do not need to be taken out to cover short term liabilities
Receivables - Monitoring the firms accounts
receivables and ensuring their timing allows the business to maintain adequate cash resources
Inventories - Must ensure an efficient inventory
management to reduce holding costs
Control of CA Cash
- Effective in guarding against sudden shortages or distributions of cash
Receivables - Effective in improving
shot term liquidity although tight credit control policies can sway potential consumers away
Inventories - Effective in generating
cash to pay for purchases and pay suppliers on time
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Control of CL Accounts payables
- Monitoring payables and paying these debts close to the due date to improve the liquidity of the firm, as some suppliers allow a period of interest fee trade credit before requiring payment for goods purchased
Loans - Managing short term loans or
utilising other types of short term finance can reduce interest rates
overdrafts - A relatively cheap form of debt
finance, however they need to be carefully monitored as bank charges may vary depending on the type
Leasing - The hiring of an asset from another
individual or company who has purchased the asset and retains ownership of it. Allows 100% finance
Sale and Lease-back - The selling of an owned asset to a
lessor and leasing the asset back through fixed payments for a specified number of years
Control of CL Accounts payables
- Frees up funds to cover other short term liabilities
Loans - This is effective in
reducing costs of a business, as short term loans are generally an expensive form of debt finance
Overdrafts - Allows cash supplies to
be controlled and provides the firm with short term finance to cover liabilities and debts
Leasing - Frees up cash that can
be used elsewhere in the business so the level of working capital is improved, whilst also allowing a firm to increase its number of assets, consequently leading to an increase in revenue and profits
Sale and Lease-back - Is highly effective in
increasing the firms liquidity because the cash that is obtained from the sale is the used as working capital
Profitability Management
Cost Controls Fixed + variable
- Monitoring the levels of both fixed and variable costs are important, with changes in the volume of activity needing to be managed with the rising variable costs
Cost centres - A cost centre is part of an
organization that does not produce direct profit and adds to the cost of running a company. Examples of cost centres include research and
Cost Controls Fixed + variable
- Comparing costs with budgets, standards ad previous periods can ensure that future costs are minimised and profits maximised
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development departments, marketing departments, help desks
- Firms must identify the source and amounts of its costs in order to effectively reduce these costs. Cost centres pose both direct and indirect costs, with direct costs being allocated solely to a particular department, activity etc whereas indirect costs are those shared by all aspects of the business, such as electricity
Expense minimisation - Involves the business implementing
guidelines and policies to promote employees working more efficiently and minimising waste
Revenue Controls Marketing objectives
- Altering pricing policies can influence the profitability and consequently the working capital of a firm. The business must decide the price of their product based on the costs associated with producing the good, competition pricing, short and long term goals (e.g market share etc) and the image and positioning of the product, such as a high end product which is priced highly
Expense minimisation
- This can effectively reduce costs and increase the firms profitability as these policies can make the firm more efficient and minimise expenses as much as possible
Revenue Controls Marketing objectives
- These pricing strategies can effectively improve or worsen the current position of the firms working capital stance, as overpricing could reduce sales levels and consequently reduce working capital, whilst underpricing can increase sales but reduce the profitability of the firm, also impacting negatively upon the working capital of the business
Global Financial Management
Exchange Rates - Cyclical factors which a firm has no
control over, so the firm must adapt - Can significantly impact upon the
international competitiveness of the firm
- An appreciation would result in higher prices for individuals overseas, consequently reducing international competitiveness and demand for the firms goods
- A depreciation will increase
Exchange Rates - this will accordingly
increase sales and working capital of the firm as their international competitiveness has improved
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international competiveness as the goods will be cheaper on the world market, accordingly increasing demand and sales
- If a firm is facing a situation of an appreciation, they must find ways to minimise costs so they can reduce prices in order to regain international competitiveness which was diminished by the appreciation
Interest Rates
- Firms can utilise overseas debt finance as it generally has lower interest rates compared to domestically in order to reduce costs, however these savings can easily be shifted into increased costs if the $AUD depreciates greatly
Methods of International payment Payment in advance
- Involves the exporter to receive payment and then arrange for goods to be sent,
Letter of credit - A commitment made by the
importers bank which promises to pay the exporter the amount when documents proving the shipment of the goods are presented
Clean payment - Where the payment is sent to, but
not received by the exporter before the goods are transported
Bill of exchange - Document drawn up by the exporter
demanding payment from the importer at a specified time. Widely used by exporters to main control over the goods until payment is made or guaranteed, two methods include:
- Document against payment: The importer can collect the goods only after paying for them
- Document against acceptance: The importer may collect the goods before paying for them
Hedging - The process of minimising the risk of
currency volatility. Involves a spot
Interest Rates
- highly risky, the risk reward ratio is low as there is always uncertainty that the $AUD could depreciation, which would effectively increase costs instead of save money which was intended with foreign borrowing
Methods of International payment Payment in advance
- very low risk for exporters as the payment has already been made, however very few importers to this as it is highly risky for them
Letter of credit - low risk and popular
amongst many exporters as when the bank is involved the transaction cannot be withdrawn, ensures working capital and is effective at doing so
Clean payment - minimal risk to the
exporter and ensures working capital as the goods will be paid for, however it is not favoured by importers
Bill of exchange - high risks as importers
may not pay at for an document against acceptance, which will significantly impact upon the working capital of the firm.
Hedging - is effective in
minimising the risks of
-
exchange rate which fixes the exchange rate for the transfer of financial flows at the rate on the day or agreement. E.g deciding a rate of $AUD 1.05, with imports being paid for this 3 weeks later despite the rate at that point of time depreciating to $AUD 1.02
- Natural Hedging: Can include arranging for import payments and export receipts denominated in the same foreign currency, thus any losses from a movement will be offset by gains from the other. Along with this, insisting on both import and export contracts denominated in $AUD to effectively transfer the risk to the importer only
- Financial instrument hedging: Through derivatives to minimise or spread risk of exchange rate volatility
Derivatives - Financial instruments which when
used can lessen the exporting risk associated with exchange rate volatility, however if used incorrectly can pose significant negative implications
- Forward exchange contract: A contract which allows an agreed exchange rate after a period of 30,90 or 180 days guaranteed by the bank
- Options contract: gives the buyer the right, but not the obligation to buy or sell a foreign currency at some time in the future. This protects holders from unfavourable fluctuations yet maintain the ability for gains if the rate upswings whilst holding
- Swap contract: An agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future.
exchange rates which are a cyclical factor which cannot be controlled by the firm
Derivatives - Can be effective in
minimising risk of exporting goods for a firm, however if done incorrectly costly implications can arise.