2. Finance Flashcards

Question 1

Q

What is the strategic role of financial management?

Answer

A

Financial management is the planning and monitoring of a business’s financial resources to enable the business to achieve its financial objectives. Financial management is crucial if a business is to achieve its financial goals

Question 2

Q

What are the objectives of financial management?

Answer

A

Profitability

Profitability is the ability of a business to maximise its profits. Profits satisfy owners or shareholders in the short term but are also important for the longer-term sustainability of a firm.

Growth

Growth is the ability of the business to increase its size in the longer term. Growth of a business depends on its ability to develop and use its asset to increase sales, profits and market share.

Efficiency

Efficiency is the ability of a business to minimise its costs and manage its assets so that maximum profit is achieved with the lowest possible level of assets.

Liquidity

Liquidity is the extent to which a business can meet its financial commitments in the short-term (less than 12 months).

Solvency

Solvency is the extent to which the business can meet its financial commitments in the longer term (more than 12 months). A good indicator to measure solvency is to use gearing.

Question 3

Q

What are short term and long term financial objectives?

Answer

A

Short term

Short-term financial objectives are the tactical (1 - 2 years) and operational (day-to-day) plans of a business. These would be reviewed regularly to see if targets are being met and if resources are being used efficiently.

Long term

Long-term financial objectives are the strategic plans of a business. They are determined for a set period of time, generally more than five years.

Question 4

Q

What is the interdependence of finance with other key business functions?

Answer

A

Interdependence with operations

Finance requires operations to produce good quality, cost-effective products that fulfil the needs/wants of consumers, facilitating the maximisation of profits. However, operations require finance to develop budgets + cost controls and allocate funds to successfully produce goods/services.

Interdependence with marketing

Finance requires marketing to generates sales, increasing the business’ value and assisting with the financial goal of managing cash flow; while marketing requires finance to determine its budget and fund the advertisement of products with.

Interdependence with human resources

Human Resources ensures employees that fulfil the finance functions of a firm, have attained the correct skills and training. Finance ensures human resources achieve their objectives as it provides performance measurement data providing insight into what must be improved.

Question 5

Q

What are the internal sources of finance and name whether they are part of internal or external equity?

Answer

A

Refers to funds generated from inside the business.

Retained Profit (Internal Equity)

Retained profits are those generated from business activity, but rather than be divided among shareholders, it is reinvested back into the firm.

Private Equity (External Equity)

Private equity is just capital or shares of ownership that are not publicly traded or listed (unlike stocks, for example).

Ordinary Shares (External Equity)

An ordinary share occurs when an individual invests in a firm to become a part-owner and receive dividends.

Question 6

Q

What are the various types of ordinary shares?

Answer

A

The various types of ordinary shares include:

New issue shares

A security that has been issued or sold for the first time.

Rights issue shares

The privilege granted to shareholders to buy new shares in the same company.

Placement shares

Shares, debentures, and so on made directly from the company to investors.

Question 7

Q

What are external sources of finance for short-term borrowing?

Answer

A

Overdraft (External Debt)

The bank allows a business or individual to overdraw their account up to an agreed limit for a specific time. An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero.

Commercial Bills (External Debt)

Commercial Bills are a type of bill or loan issued by institutions other than banks. The firm that takes out this loan receives this money immediately but has to repay it to the institution in its full amount, including interest all on one set day.

Factoring (External Debt)

Factoring is selling of accounts receivable (invoices owed to the business) for a discounted price to a finance or factoring company.

Question 8

Q

What are external sources of finance for long-term borrowing?

Answer

A

Mortgage (External Debt)

A mortgage is a loan secured by the property of the borrower (the business). A mortgage is repaid through regular payments over an agreed period of time. It incurs interest.

Debenture (External Debt)

Debentures are issued by a company for a fixed rate of interest and over a fixed period of time. On maturity, the company pays the debenture by buying it back in addition to a lump sum of interest.

Unsecured notes (External Debt)

An unsecured note is a loan for a set period of time but is not backed by any collateral or assets, and therefore presents the most risk to the investor. Companies take this risk as it carries a higher rate of interest than secured notes.

Leasing (External Debt)

A lessor purchases/owns equipment, and the lessee (the business) pays to use it. Allows a business to use equipment without a huge capital outlay.

Question 9

Q

What are the various types of financial institutions?

Answer

A

Banks

Banks obtain their money from the savings of individuals. When someone needs funds from the bank, they will loan the money invested by individuals to give to this person/business with interest.

Investment banks

Investment banks trade in money, securities and financial futures. They can provide working capital and advise businesses on mergers and takeovers.

Finance companies

They provide loans to firms and individuals to pursue business ventures. Some specialise in factoring. They raise capital through debentures. Not only this but they have the security of priority over the firm’s assets in the event of liquidation.

Life insurance companies

Provide loans to the corporate sector (Businesses) through receipts of insurance premiums. People pay insurance, then the money gets pulled together by the insurance company, using these premiums to provide loans to businesses.

Superannuation funds

Superannuation funds are the money put aside by your employer for your retirement. They also provide loans and invest in other businesses in the hope to make money to give back to the owners of super-funds. These owners have the opportunity to choose where their money gets invested.

Unit trusts

Also known as mutual funds. They take funds from a large number of small investors and invest them in shares, currency etc (run by a mutual fund manager who gives them advice on the best place to invest their money).

Australian Securities Exchanges (ASX)

ASX offers products and services including shares, warrants, securities etc.

Question 10

Q

What are the two markets within the ASX?

Answer

A

Primary Market

New issue of debt instruments by the borrower of funds (offering shares for the very first time - known as floating the business).

Secondary Market

They operate through the purchase and sale of existing securities.

Question 11

Q

What is the influence of government forum ASIC?

Answer

A

Australian Securities and Investments Commission (ASIC)

ASIC enforces and administers the Corporations Act 2001 and protects consumers in all areas involving finances. The aim of ASIC is to assist in reducing fraud and unfair practices in financial markets and financial products. ASIC ensures that companies adhere to the law, collects information about companies and makes it available to the public.

Question 12

Q

What is the influence of company taxation?

Answer

A

Company taxation

This tax is levied at a flat rate of 30 per cent of net profit. The Aus Gov has undertaken this process of reform of the federal tax system in order to improve Australia’s international competitiveness and make Australia an attractive place to invest, thereby driving long-term economic growth.

Question 13

Q

What are the global market influences?

Answer

A

Economic outlook
The availability of funds
Interest rates

Question 14

Q

What is the influence of the future economic outlook?

Answer

A

Economic Outlook

Positive economic outlook - Increasing demand for goods and services means firms need to meet demand by increasing production. This will decrease unemployment
Negative economic outlook - Decreasing demand for goods and services means firms produce less, increasing unemployment.

Question 15

Q

What is the influence of the availability of funds?

Answer

A

The availability of funds refers to the ease with which a business can access funds (for borrowing) on the international financial markets. The international financial markets are made up of a range of institutions, companies and governments prepared to lend money.

Question 16

Q

What is the influence of interest rates?

Answer

A

High interest rates

Businesses are less likely to borrow funds to invest in capital with a high-interest rate as it increases the cost of debt.

Low interest rates

Businesses are more likely to borrow funds to invest in capital with a low interest rate as the cost of debt is lower.

Question 17

Q

Outline the importance of financial planning and implementing.

Answer

A

Financial planning is essential if a business is to achieve its goals. Financial planning determines how a business’s goals will be achieved. The figure below shows the process of financial planning and implementing.

Question 18

Q

What is the process of financial planning and implementing?

Answer

A

Determining financial needs - To determine where a business is headed and how it will get there, it is important to know what its needs are. Important financial info needs to be collected before future plans can be made e.g balance sheets.
Developing Budgets - They provide financial information for a business’s specific goals and are used in strategic, tactical and operational planning.
Maintaining record systems - Record systems are employed by businesses to ensure data recorded is accurate and reliable. Management bases its decisions on the info when needed and must have guarantees that the info is accurate and reliable.
Identifying financial risks - It is the risk to a business of being unable to cover its financial obligations. To minimise financial risk, businesses must consider the amount of profit that will be generated ensuring it is sufficient enough to cover the cost of debt and create revenue
Establishing financial controls - Financial controls ensure that plans determined will lead to the achievement of the business’s goals in the most efficient way. Control is particularly important in assets such as accounts receivable, inventory and cash.

Question 19

Q

The financial needs of a business are determined by what?

Answer

A

The financial needs of a business will be determined by:

the size of the business
the current phase of the business cycle
future plans for growth and development
capacity to source finance — debt and/or equity
management skills for assessing financial needs and planning.

Question 20

Q

What is debt financing?

Answer

A

Relates to the short-term and long-term borrowing from external sources by a business. Debt can be attractive to businesses because funds are usually readily available and interest payments are tax-deductible.

Question 21

Q

What are the advantages of debt financing?

Answer

A

Funds are readily available and can be acquired on short notice.
Interest payments are tax-deductible
Flexible payment periods and types of debt are available.
It will not dilute the current ownership in the business.

Question 22

Q

What are the disadvantages of debt financing?

Answer

A

There is an increased risk if debt comes from financial institutions because interest charges may increase.
Regular repayments have to be made.
Lenders have first claim on any money if the business ends in bankruptcy.
Debt can be expensive, e.g. interest must be paid.

Question 23

Q

What is equity financing?

Answer

A

Relates to the internal sources of finance in the business. In the case of equity finance, shareholders’ funds represent the highest proportion of total funds to finance business operations. Equity finance is the most important source of funds for companies because it remains in the business for an indefinite time as funds do not have to be repaid at a set date.

Question 24

Q

What are the advantages of equity financing?

Answer

A

Cheaper than other sources of finance as there are no interest payments
The owners who have contributed the equity, hold control over how that finance is used
Less risk for the business and the owner

Question 25

Q

What are the disadvantages of equity financing?

Answer

A

Lower profits and lower returns for the owner
Long, expensive process to obtain funds this way
Ownership is diluted, i.e. the current owners will have less control

Question 26

Q

What is the importance of matching the terms and source of finance to business purpose?

Answer

A

Finding the correct source of finance to fund activities related to business decisions and financial objectives is imperative. The terms of finance must be suitable for the purpose for which the funds are required. The use of short-term finance to fund long-term assets, for example, causes financial problems because the amount borrowed must be repaid before the long-term assets have had time to generate increased cash flow.

Question 27

Q

What are the main areas of a business that are monitored?

Answer

A

Cash flow statement
Income statement
Balance sheet

Question 28

Q

What is the cash flow statement?

Answer

A

The cash flow statement gives important info regarding a firms ability to pay its debts on time. It indicates the movement of cash receipts and cash payments resulting from transactions over a period of time. It can also identify trends and can be a useful predictor of change.

A cash flow statement shows whether a firm can:

Generate favourable cash flow (inflows exceed outflows)
Pay its financial commitments as they fall due
Have sufficient funds for future expansion or change.

Question 29

Q

What is opening cash balance on the Cash flow statement?

Answer

A

It is the amount of cash at the beginning of the period e.g first day of the month.

Question 30

Q

What is closing cash balance on the Cash flow statement?

Answer

A

It is the amount of cash at the end of the period e.g last day of the month.

Question 31

Q

How do you calculate the closing cash balance on a cash flow statement?

Answer

A

Closing cash balance = opening cash balance + net cash flow

Question 32

Q

How do you calculate net cash flow on a cash flow statement?

Answer

A

Net cash flow = total cash inflows + total cash outflows

Question 33

Q

What is the income/revenue statement?

Answer

A

The revenue statement is a summary of the income earned and the expenses incurred over a period of trading. It helps users of information see exactly how much money has come into the business as revenue, how much has gone out as expenditure. The revenue statement shows:

Operating income earned from the main function of the business.
Operating expenses incurred in the main operation of the business.

Question 34

Q

What is the formula used to calculate gross profit on the income/revenue statement?

Answer

A

Gross profit = revenue - COGS

Question 35

Q

What is the formula used to calculate net profit on the income/revenue statement?

Answer

A

Net profit = gross profit - operating expenses

Question 36

Q

What is the formula used to calculate COGS on the income/revenue statement?

Answer

A

COGS = opening stock + purchases - closing stock

Question 37

Q

What is COGS on the income/revenue statement?

Answer

A

Cost of goods sold on an income statement represents the expenses a company has paid to manufacture, source and ship a product or service to the end customer.

Question 38

Q

What is opening stock on the income/revenue statement?

Answer

A

Opening stock can be described as the initial quantity of any product held by a business during the start of any financial year or accounting period and is equal to the closing stock of the previous accounting period.

Question 39

Q

What is closing stock on the income/revenue statement?

Answer

A

Closing stock is the amount of inventory that a business still has on hand at the end of a reporting period. This includes raw materials, work in process, and finished goods in inventory.

Question 40

Q

What is the operating profit before tax on the income/revenue statement?

Answer

A

Profit before tax (PBT) is a measure that looks at a companies profits before they have to pay corporate income tax.

Question 41

Q

What is the operating profit after tax on the income/revenue statement?

Answer

A

Profit after tax is a measure of earnings before interest and taxes, adjusted for the impact of taxes.

Question 42

Q

What are extraordinary items on the income/revenue statement?

Answer

A

Extraordinary items are gains or losses in a company’s financial statements that are infrequent or unusual.

Question 43

Q

What is the balance sheet?

Answer

A

The balance sheet shows the financial stability of the business. Analysis of the balance sheet can indicate whether:

The business has enough assets to cover its debts
The interest and money borrowed can be paid
The assets of the business are being used to maximise profits
The owners of the business are making a good return on their investment.

Question 44

Q

What is the formula used to calculate assets on a balance sheet?

Answer

A

Assets = liabilities + owners equity

Question 45

Q

What is the formula used to calculate owners equity on a balance sheet?

Answer

A

Owners equity = assets - liabilities

Question 46

Q

What is the formula used to calculate liabilities on a balance sheet?

Answer

A

Liabilities = assets - owners equity

Question 47

Q

What are current assets on a balance sheet?

Answer

A

Current assets are those that may be converted into cash within a period of 12 months. They include cash, accounts receivable, inventories, securities, pre-paid liabilities and other liquid assets.

Question 48

Q

What are non current assets on a balance sheet?

Answer

A

Non current assets are those that require a period longer than 12 months to be converted into cash. They include, investments in other companies, intellectual property (e.g patents), property and equipment.

Question 49

Q

What are current liabilities on a balance sheet?

Answer

A

Current liabilities consist of short term financial obligations that are due typically within one year. They include wages, interest, accounts payable and other accrued expenses.

Question 50

Q

What are non current liabilities on a balance sheet?

Answer

A

Non current liabilities are those obligations not due for settlement within 12 months. They include, long term lease obligations, long term loans, deferred revenue and bonds payable.

Question 51

Q

What are accounts receivables on a balance sheet?

Answer

A

Accounts receivable is the amount owed to a seller by a customer. As such, it is an asset, since it is convertible into cash on a future date. It is listed under current assets as it is usually convertible into cash within less than one year.

Question 52

Q

What are accounts payables on a balance sheet?

Answer

A

Accounts payable is generated when a company purchases goods and services from its suppliers on credit. Accounts payable is expected to be paid off within a year and therefore is a current liability.

Question 53

Q

What is owners equity on a balance sheet?

Answer

A

Owner’s equity (also referred to as net assets) is the owner’s claim to company assets after all go the liabilities have been paid off.

Question 54

Q

What is drawing by owner on a balance sheet?

Answer

A

This refers to the withdrawals of a business’s assets by the owner for their personal use.

Question 55

Q

What is retained profit on a balance sheet?

Answer

A

Retained profits (also referred to as retained earnings) is the amount of net income left over for the business to keep once it has paid expenses + dividends.

Question 56

Q

What are overdrafts on a balance sheet?

Answer

A

With an overdraft, the bank allows a business or individual to overdraw their account up to an agreed limit for a specified time, to help overcome temporary cash shortfall.

Question 57

Q

What is the liquidity ratio?

Answer

A

This ratio is used to assess the ability of a business to turn assets into cash in order to meet its short-term financial obligations. The ratio used to measure liquidity may be referred to as the current ratio, working capital ratio or liquidity ratio. Liquidity is generally measured through a balance sheet.

Ratio

Current ratio = current assets current liabilities

Question 58

Q

Finish the sentence…

It is generally accepted that a ratio of 2:1 indicates a sound financial position for a firm. That is, the firm should have ? the amount of ? to cover its ?

Answer

A

It is generally accepted that a ratio of 2:1 indicates a sound financial position for a firm. That is, the firm should have double the amount of current assets to cover its current liabilities.

Question 59

Q

A liquidity ratio of 0.35 : 1 means what for the business?

Answer

A

This means that for every $1 of short term liabilities, the firm has 35 cents of short term assets to pay that debt. The firm can only pay 35 cents per $1.

Question 60

Q

What are some strategies for improvement if the liquidity ratio is too low?

Answer

A

Factoring debtors
Sale and lease back of non-current assets
Sale of inventory

Question 61

Q

What are some strategies for improvement if the liquidity ratio is too high?

Answer

A

Adopt just in time (JIT) inventory
Invest in non-current assets

Question 62

Q

What is the gearing ratio?

Answer

A

Gearing ratios determine a business’s solvency, that is their ability to meet long term debts. It measures the relationship between debt and equity and therefore shows a firms financial stability. The ratio used to measure solvency may be referred to as the debt to equity ratio, working capital ratio or liquidity ratio. Gearing is generally measured through a balance sheet. Debt : Equity - should be kept at <1 : 1.

Ratio

Debt to equity ratio = total liabilities total equity

Question 63

Q

Finish the sentence…

It is generally accepted that a ratio should show ?** or equal to levels of **?** to debt. A ratio of 1:1 indicates a conservative average of gearing. An interpretation of 25:75 is characterised as **?** geared; while a firm showing 75:25 is **? geared.

Answer

A

It is generally accepted that a ratio should show higher or equal to levels of equity to debt. A ratio of 1:1 indicates a conservative average of gearing. An interpretation of 25:75 is characterised as lowly geared; while a firm showing 75:25 is highly geared.

Question 64

Q

What does a debt to equity ratio of 1.64 : 1 mean for the business?

Answer

A

As 1.64 is greater than 1, assets are being funded by more debt than equity. This means the firm is highly geared.

Answer 65

A

Increase debt financing
Control the balance between debt and equity

Answer 66

A

Lower debt e.g by sale and leaseback, factoring
Increase equity funding
Using the cash raised to reduce liabilities

Answer 67

A

This objective is the most important. It consists of three ratios, the gross profit ratio, net profit ratio and return on owners equity. Profitability assesses whether the business is utilising its resources to achieve maximum profit.

Answer 68

A

The gross profit ratio indicates the proportion of sales revenue that is consumed by COGS. It assesses whether the business is maintaining an adequate margin between sales and purchases. Gross profit is generally measured through a revenue statement.

Ratio

Gross profit ratio = gross profit x100 sales

GP = Sales - COGS

Answer 69

A

GPR is usually expressed as a percentage. Clearly higher figures are better than lower. However, GPR figures are only useful when compared to similar businesses, industry averages or past performance. A falling figure or lower than industry average GPR may indicate a problem with pricing or costs of purchases.

Answer 70

A

This means, for every $1 of sales revenues, 32.25c became gross profit.

Answer 71

A

Raise prices (as long as sales are not compromised)
Obtain stock at lower prices by finding cheaper supply or negotiating (keeping an eye of quality so sales are not compromised)

Answer 72

A

The net profit ratio takes into account expenses and therefore measures the percentage of each dollar of sales that is left after all expenses are paid. It assesses whether the business is maintaining an adequate margin between sales and purchases. Net profit is generally measured through a revenue statement.

Ratio

Net profit ratio = net profit x100 sales

NP = GP - expenses

Answer 73

A

NPR is usually expressed as a percentage. Clearly higher figures are better than lower. However, NPR figures are only useful when compared to similar businesses, industry averages or past performance. A falling figure or lower than industry average NPR is generally a concern.

Answer 74

A

This means that for ever $1 of sales revenue, 5.4c became net profit.

Answer 75

A

Raise prices (as long as sales are not compromised)
Obtain stock at lower prices by finding cheaper supply or negotiating (keeping an eye of quality so sales are not compromised)

Answer 76

A

ROE indicates the returns the owner/shareholders receive on the money they have invested. It assesses whether the business is using its equity funds correctly. ROE is generally measured through a revenue statement and/or balance sheet.

Ratio

Return on owners’ equity = net profit x100 owners’ equity

NP = GP - expenses

Answer 77

A

ROE is usually expressed as a percentage. Clearly higher figures are better than lower. The return for owners has to be compared to what they could receive from alternative investments. Low rates and declining rates of ROE would indicate that the owners’ assets are not generating adequate returns.

Answer 78

A

This means that for every $1 of owners’ equity there was 6.5c net profit generated.

Answer 79

A

Any strategy that will improve net profit e.g lower COGS, increase sales revenue, reduce expenses, increase prices, improve efficiency.
Remove or exit areas of poor return and concentrate on areas with higher growth potential

Answer 80

A

This objective consists of two ratios, the expense ratio and the accounts receivable turnover ratio. Profitability assesses whether the business is utilising its resources to achieve maximum profit.

Answer 81

A

The expense ratio assesses whether the business is managing its operating expenses efficiently. The ratio expresses the amount of every sales dollar that is absorbed by operating expenses. This indicates the day-to-day efficiency of management. The expense ratio is generally measured through a revenue statement.

Ratio

Equity ratio = expenses x10 sales

Answer 82

A

The expense ratio is generally expensed as a percentage. The lower the expense ratio, the more efficient the business. A high ratio may indicate poor control over operating expenses however to understand what is a high or normal expense ratio, figures must be compared to industry averages & budgeted ratios.

Answer 83

A

In this case, for every $1 of sales revenue, 26.99c was absorbed by operating expenses.

Answer 84

A

The main strategies to improve the expenses ratio centre around reducing expenses required to generate the level of sales by:

Carefully monitoring cost centres
Being aware that indiscriminate cost-cutting can damage the competitive situation by damaging quality and reputation (with extreme consequences).

Answer 85

A

This ART ratio assesses whether the business is collecting its accounts receivable efficiently. The accounts receivables turnover ratio measures the effectiveness of a business’ credit policy and collection procedures i.e how efficiently it collects the debts owed to it. ART is generally measured through a revenue statement and/or balance sheet.

Ratio

Accounts receivable turnover ratio = credit sales accounts receivable

= no. of times accounts receivable turned over in one year

No. of days on av. that acc rec were outstanding = 365 ART

Answer 86

A

Quicker turnover means more efficient collection procedures. Generally, businesses allow 30-60 days which reflects an ART ratio of 4-6 times a year. Longer periods than this indicate poor credit control, poor credit policy, liquidity problems and potential cash flow issues.

Answer 87

A

In this case, it takes about 16.24 days on average to collect the accounts receivable. This is just over 2 weeks weeks - this is quite a quick turnover of accounts.

Answer 88

A

Managers can avoid accounts receivable problems by:

Carefully monitoring their accounts and who they give credit to
Be vigilant with credit collection procedures
Provide discounts for early payments and penalty (interest charges) for late payments
Using factoring if the cash flow problem becomes serious

Answer 89

A

Ratios calculated are used to make comparisons over different time periods, against standards & with similar businesses.

By comparing previous & current year results, financial managers can identify trends in profits, costs & overall financial stability.
Managers can determine whether the business is meeting its goals of increasing profitability, efficiency, liquidity and solvency.
They can benchmark (see if business performance is above the industry average).

Answer 90

A

Normalised earnings
Capitalising expenses
Valuing assets
Timing issues
Debt repayments
Notes to the financial statements

Answer 91

A

Normalised earnings are adjusted to remove the effects of seasonality, revenue and expenses that are unusual or one-time influences. Normalised earnings help business owners understand a company’s true earnings from its normal operations.

Answer 92

A

This refers to an accounting method where a business records an expense as an asset on the balance sheet rather than as an expense on the income statement. This does not accurately represent the true financial condition of the business as it understates the expenses and overstates the profits as well as the assets of the business.

Answer 93

A

Asset valuation is the process of determining the current value of a company’s assets, such as stocks, buildings, equipment, etc. Asset-based valuation allows a business to calculate their net worth.

Answer 94

A

Under the matching principle, when an accountant records revenue, they should also record at the same time any expenses that were directly related to that revenue. When this principle is followed, the revenue earned will match the costs that were incurred to earn that revenue.

Answer 95

A

Financial reports can be limited because they do not have the capacity to disclose specific information about debt repayments. The recording of debt repayments on financial reports can be used to distort the ‘reality’ of the business’s financial position.

Answer 96

A

Notes to the financial statements report the details and additional information that are left out of the main reporting documents. These notes contain important information such as the accounting methodologies used for recording transactions that can affect the overall return expected from an investment in a company.

Answer 97

A

Audited accounts
Record keeping
Reporting practices

Answer 98

A

The audit is an independent check of the accuracy of financial records and accounting procedures, and it has an important role in this process. Audits are an important part of the control function and are generally used to examine the financial affairs of a business. There are three types, internal audits, management audits and external audits.

Answer 99

A

All accounting processes depend on how accurately and honestly data is recorded in financial reports. Source documents must be created for every transaction, even those in which cash has changed hands. There is a temptation to take cash payments, and not record the transaction, lessening tax.

Answer 100

A

Not only are accurate financial reports necessary for taxation purposes, but stakeholders are entitled to access a business’s financial information. To pretend that profit is lower than it should be is to attempt to defraud the ATO and is illegal.

Answer 101

A

Cash flow is the movement of cash in and out of a business over a period of time. If more money goes out than comes in, or if money must be paid out before cash payments have been received, there is a cash flow problem.

Answer 102

A

Cash flow statements indicate the movement of cash receipts and cash payments resulting from transactions over a period of time. They can also identify trends and can be a useful predictor of change.

Answer 103

A

Management must implement strategies to ensure that cash is available to make payments when they are due, these include:

Discounts for early payment

This strategy is most effective when targeted at those debtors who owe the largest amounts over the financial year period. This is not only beneficial for the debtors who are able to save money but it also positively affects the business’s cash flow status.

Factoring

Factoring is the selling of accounts receivable for a discounted price to a finance or specialist factoring company. The business saves on the costs involved in following up on unpaid accounts and debt collection.

Distribution of payments

Distributing payments throughout the year means there is a more equal cash outflow each month rather than large outflows in particular months. This ensures large expenses are not incurred all at once, preventing cash shortfalls.

Answer 104

A

Working capital management involves determining the best mix of current assets and current liabilities needed to achieve the objectives of the business. A business must have sufficient liquidity so that cash is available or current assets can be converted to cash to pay debts.

Answer 105

A

Control of current assets requires management to select the optimal amount of each current asset held, as well as raising the finance required to fund those assets.

Cash

Cash ensures that the business can pay its debts, repay loans and pay accounts in the short term and that the business survives in the long term.

Receivables

A business must monitor its accounts receivable and ensure that its timing allows the business to maintain adequate cash resources.

Inventories

Inventories make up a significant amount of current assets, and their levels must be carefully monitored. Too much inventory or slow-moving inventory will lead to cash shortages. Insufficient inventory of quick-selling items may also lead to loss of customers, and hence lost sales.

Answer 106

A

This involves being able to convert current assets into cash to ensure that the business’s creditors (accounts payable, bank loans or overdrafts) are paid.

Payables

A business must monitor its payables and ensure that its timing allows the business to maintain adequate cash resources. The holding back of accounts payable until their final due date can be a cheap means to improve a firm’s liquidity position.

Loans

Management of loans is important, as costs for establishment, interest rates and ongoing charges must be investigated and monitored to minimise costs.

Overdrafts

Overdrafts are a convenient and relatively cheap form of short-term borrowing for business. They enable a business to overcome temporary cash shortages.

Answer 107

A

Businesses use a number of strategies to manage working capital, which is required to fund the day-to-day operations of a business. Strategies for working capital management include:

Leasing

Leasing involves the payment of money for the use of equipment that is owned by another party. Advantages include: It allows the business to make use of good quality assets, which might have been unaffordable.

Sale and leaseback

Sale and lease-back refers to the process of selling an owned asset to a lessor and then leasing the asset back through fixed payments for a specified period of time.

Answer 108

A

Profitability management involves the control of both the business’s costs and its revenue. Accurate and up-to-date financial data and reports are essential tools for effective profitability management.

Answer 109

A

Fixed and variable

Fixed costs do not change when the level of activity changes. Examples of fixed costs are salaries. Variable costs are those that vary in direct relationship to the levels of operating activity or production in a business. Such costs include labour costs and materials.

Cost centres

A cost centre is a department within a business that is responsible for a particular set of activities that benefits the organisation. By treating the cost centre as a separate unit, the business can measure how much they are spending on that function each year.

Expense minimisation

Profits can be weakened if the expenses of a business are high, as they consume valuable resources within a business. Guidelines and policies should be established to encourage staff to minimise expenses where possible.

Answer 110

A

In determining an acceptable level of revenue with a view to maximising profits, a business must have clear ideas and policies, particularly about its marketing objectives including the sales objectives, sales mix or pricing policy.

Marketing objectives

Sales objectives - Sales objectives must be pitched at a level of sales that will cover costs, both fixed and variable, and result in a profit.
Sales mix - Changes to the sales mix can affect revenue. Businesses should control this by maintaining a clear focus on the important customer base on which most of the revenue depends before diversifying products.
Pricing policy - Pricing policy affects revenue and, therefore, affects working capital. Pricing decisions should be closely monitored and controlled. E.g overpricing could fail to attract buyers.

Answer 111

A

Exchange rates
Interest rates
Methods of international payment
Hedging
Financial instrument hedging

Answer 112

A

Exchange rates fluctuate over time due to variations in demand and supply. In terms of an appreciation, the value of AUD increases relative to foreign dollars; while a depreciation will decrease the value of AUD when dominated in foreign currency terms.

Answer 113

A

A business that plans to either relocate offshore or expand domestic production will generally need to raise finances to undertake these activities. A global business has the option of borrowing money from financial institutions in Australia, or they can borrow money from financial markets overseas.

Answer 114

A

Payment in advance

The payment in advance method allows the exporter to receive payment and then arrange for the goods to be sent.

Letter of credit

A letter of credit is a document that a buyer can request from their bank that guarantees the payment of goods will be transferred to the seller.

Clean payment

Under this method, the exporter ships the goods directly to the importer before payment is received.

Bill of exchange

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

Answer 115

A

When two parties agree to exchange currency and finalise the deal immediately the transaction is called a spot exchange. However, it’s possible for a business to minimise the risk of currency fluctuation through hedging.

Answer 116

A

Derivatives

Derivatives are simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations. The three main derivatives available for exporters:

Forward exchange contract - A forward contract will lock in an exchange rate today at which the currency transaction will occur at the future date.
Options contract - Gives the buyer (option holder) the right, but not the obligation, to buy or sell foreign currency at some time in the future.
Swap contract - A currency swap is an agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future.

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