2. processes of financial management

Question 1

Compare debt and equity financing as a financial management process?

Answer 1

• Equity is generally safer than debt
• Equity requires sufficent profits business can continue operating

Question 2

what are advantages of debt finance

Answer 2

• Interest payments are tax deductible business expenses
• Regular payments - makes future cash flows certain - better planning
• Funds are usually readily available and can be acquired at short notice

Question 3

what are disadvantages of debt finance

Answer 3

• Can be expensive
• Repayments begin immeadiatley and must be met regardless of cash flow
• Collateral needed to secure loan

Question 4

what are advantages of equity finance

Answer 4

• No repayments - more cash flow
• Cash flow generated - can be used for further investment and expansion
• Does not incur interest charges
• Low gearing - use resources of owner not external
• Less risk for the business and owner

Question 5

what are disadvantages of equity finance

Answer 5

• Exchanging ownership of business - diluted
• Lower profits and lower returns for owner
• Does not provide tax deduction

Question 6

Why is the process of monitoring and controlling important in financial management?

Answer 6

Inconsistent methods of review and systems of control will have an immediate impact on the viability of the business.

Requires management to monitor the internal and external factors impacting finance in business.

Question 7

What are the financial controls used for monitoring?

Answer 7

Cash flow statements, income statements, and balance sheets.

These provide information on how effectively finance is being used in a business and whether the business has sufficient funds to meet unforeseen circumstances.

Question 8

What is a cash flow statement?

Answer 8

Provides link between the income statement and balance sheet.

Gives important information regarding a firm’s ability to pay its debt on time.

Question 9

What does a cash flow statement indicate?

Answer 9

Movement of cash receipts and cash payments resulting from transactions over a period of time.

Identify trends, useful predictor of change, if business can pay financial commitments, and have enough funds for expansion.

Question 10

Who are the users of cash flow statements?

Answer 10

Creditors and lenders of finance, owners and shareholders, potential shareholders.

They use it to assess the ability of the business to manage cash and check if the business had positive cash flow over the last years.

Question 11

What are the three categories of business activities in a cash flow statement?

Answer 11

1. Operating activities - cash inflows and outflows relating to the main activity of the business.
2. Investing activities - cash inflows and outflows relating to the purchase and sale of non-current assets and investments.
3. Financing activities - cash inflows and outflows relating to the borrowing activities of the business.

Question 12

what is the cash flow statement equation?

Answer 12

Net Cash Flow = Total Cash Inflows - Total Cash Outflows.

Question 13

What is an income statement?

Answer 13

A summary of the income earned and the expenses incurred over a period of trading.

Question 14

What do income statements show?

Answer 14

They show operating income from the main function of the business, operating expenses, and allow for comparisons and analysis of trends before making important financial decisions.

Question 15

What are the steps to completing an income statement?

Answer 15

1. Record income earned
2. Record COGS
3. Calculate gross profit
4. Calculate net profit

Question 16

What are the income statement equations?

Answer 16

COGS = opening stock + purchases - closing stock
Gross profit = operating income/sales - COGS
Net Profit = gross profit - expenses

Question 17

What is a balance sheet?

Answer 17

represents a business’s assets and liabilities at a particular point in time and represents the net
- worth (equity) of the business.
Shows financial stability

Question 18

What are assets?

Answer 18

• items of value owned by the business
• C - use up, or turn over, within 12 months
• NC - expected life of longer than 12 months

Question 19

What are liabilities?

Answer 19

• items of debt owed to outside parties
• C - expected to be repaid in less than 12 months
• NC - long-term items of debt

Question 20

What is owners equity?

Answer 20

funds contributed by the owner(s) and represents the net worth of the business.
Comprised of capital and retained profits

Question 21

What does a balance sheet indicate?

Answer 21

• Financial stability
• Enough assets to cover debt
• If money borrowed can be paid
• If assets are being used to maximise profits
• If owners are making good ROI

Question 22

what is the balance sheet equation?

Answer 22

Assets = Liabilities + Owners Equity

Question 23

What is financial analysis?

Answer 23

Involves looking into and making meaning of the financial information gathered from the business. Must compare to past performance, industry average and competition.

Question 24

What are the three main ways to analyse data over time?

Answer 24

1. Vertical analysis - comparing figures in one financial year
2. Horizontal analysis - comparing figures from different financial years
3. Trend analysis - comparing figures for period of 3-5 years.

Question 25

What are financial ratios?

Answer 25

Used to analyse the financial state and condition of the business. To make an educated and accurate representation of the financial position of the business to make meaningful decisions.

Question 26

What are the four different types of financial measures used to analyse the state/condition of the business?

Answer 26

- Liquidity - Gearing/solvency - Profitability - Efficiency Must be used alongside others to make an accurate description of business financial position.

Question 27

What is the working capital/current ratio?

Answer 27

Current assets/current liabilties

Question 28

What does the liquidity/current ratio/working capital ratio do?

Answer 28

Measure the business' ability to meet its financial commitments in the short term. ## Footnote Comparing current assets to current liabilities - how well it can be converted. Should not be used by itself.

Question 29

What is working capital?

Answer 29

How much funds a business has to continue operating even after current liabilities are paid off. ## Footnote Working capital = current assets - current liabilities.

Question 30

What is the ideal current ratio?

Answer 30

2:1 ## Footnote Too high - tied up money that has not been collected and is being wasted/inefficient. Too low - not enough current assets to meet current liabilities.

Question 31

What does the debt to equity ratio measure/show?

Answer 31

- Gearing/solvency of a business - Shows how much the business is depending on debt/external sources of finance to fund the business

Question 32

What does a highly geared business mean?

Answer 32

Heavily reliant on debt finance ## Footnote High debt to equity ratio; Greater risk but greater potential for profit, returns for investors and growth.

Question 33

What does a debt to equity ratio above 1 mean?

Answer 33

Less equity than debt ## Footnote Business is less solvent; Not enough equity to cover long term debt; But could have more growth opportunities.

Question 34

What does a debt to equity ratio below 1 mean?

Answer 34

Business has more equity than debt.

Question 35

What are the three ways of measuring profit?

Answer 35

- Gross profit ratio - Net profit ratio - Return on equity ratio - ROI

Question 36

for each profitability ratio, what is ideal?

Answer 36

Higher the ratio the better

Question 37

what is the gross profit ratio

Answer 37

Question 38

what is the net profit ratio?

Answer 38

Provides the most accurate level fo profitability of a business (after all expenses are gone) Sales should be maximised and expenses should be minimised for a high level of net profit.

Question 39

what is the return on equity ratio?

Answer 39

How much money getting back from investment Indicate how profitable and effective the business is Need informaiton from balance sheet and revenue statement

Question 40

How can efficiency be measured?

Answer 40

- Expense ratio - use of expenses - Accounts receivable turnover ratio - how quickly can they collect accounts recievable The quicker you can collect money, the quicker you can utilise money to enable the business to grow. Otherwise they wont have that money to achieve their financial objectives or meet objectives.

Question 41

what does the expense ratio tell you and what is ideal

Answer 41

Lower ratio better High ratio indicates poor management and high expenses. The difference between the net profit ratio and gross profit ratio

Question 42

what is the expense ratio

Answer 42

Question 43

what does the accounts recievable ratio tell you

Answer 43

Higher the ratio the better - shows it takes less days to collect

Question 44

what is an ideal accounts recievable turnover ratio

Answer 44

Less than 30 days or more 12 times a year

Question 45

what is the accounts recievable turnover ratio

Answer 45

365/x to find days on average

Question 46

list the limitations of financial reports

Answer 46

1. normalised earnings 2. capitalising expenses 3. valuing assets 4. timing issues 5. debt repayments 6. notes on financial statement

Question 47

how can normalised earnings be a limitation of financial reports

Answer 47

The process of removing one off or unusual influences from the balance sheet to show the true earnings of a company.

Question 48

how can capitalising expenses be a limitation of financial reports

Answer 48

The process of adding a capitalised expense to the balance sheet that is regarded as an asset (in that it will add to the value of the company and is therefore recorded on the balance sheet) rather than an expense (in this situation, it would be recorded on the income statement).

Question 49

how can valuing assets be a limitation of financial reports

Answer 49

The process of estimating the market value of assets or liabilities. The valuation can be used in variety of contexts for a business, including investment analysis, mergers and acquisitions and financial reporting.

Question 50

how can timing issues be a limitation of financial reports

Answer 50

The business’ financial position may not be a true representation if the business has experienced seasonal fluctuations.

Question 51

how can debt repayments be a limitation of financial reports

Answer 51

Financial reports can be limited because they do not have the capacity to disclose specific information about debt repayments.

Question 52

how can notes on financial statements be a limitation of financial reports

Answer 52

Notes report the details and additional information that are left out of the main reporting financial documents.

Question 53

what are some ethical issues related to financial reporting

Answer 53

1. audited accounts 2. record keeping 3. reporting practices

Question 54

what is an audit and its purpose?

Answer 54

Audit – an independent check of the accuracy of financial records and accounting procedures. Purpose: obtain an independent opinion on the financial statements of a business

Question 55

what is are the types of audits?

Answer 55

1. Internal audits – conducted internally by employees 2. Management audits – conducted to review the firms strategic plan to determine if changes should be made 3. External audits – requirement of Corporations Act 2001, firms financial reports are investigated independently

Question 56

who are the users of audits?

Answer 56

1. Financial institutions 2. Owners 3. Shareholders 4. Potential investors

Question 57

what is record keeping and why can it be an ethical issue?

Answer 57

Firm should keep records of all business transactions (cash inflows and outflows) to comply with taxation laws. If transactions are not recorded it will not show up as business revenue, reducing business profit for the year, possibly resulting in lower tax burden. Evading taxation responsibilities – receive fines more than what they save, harm reputation of business.

Question 58

how can reporting practices be unethical?

Answer 58

can report lower profits than they actually have to reduce their tax obligations

Question 59

why is pretending profit is lower than it is bad?

Answer 59

- Defrauding the ATO - Illegal - Unethical - Make it more difficult to persuade existing shareholders of bank to lend money - Counter productive when potential buyer subjects reports to close scrutiny.