Chapter 14 Financial Mng Flashcards
What does Capital budgeting refer to?
All aspects around long term investment
What does Capital Structure refer to?
All aspects of ways in which long term financing is obtained
Includes debt and equity
What is Working Capital Management?
Relates to current assets such as inventory, current liabilities .
What 2 possible actions can a firm take to improve their Gross Profit Margin?
1) Increase sales. Relax credit standards for credit sales.
2) reduce costs by finding cheaper supplier.
Also reconsider having less slow turnover items
What possible 2 actions can a company take to increase their Net Profit Margin?
1) increase sales. Relax credit standards to increase credit sales.
2) reduce operating expenses
Name 2 possible actions a company can take to increase their Return on assets?
1) increase sales / relax cr standards for more cr sales
2) review assets and outsource if need be / improve productivity
How is income calculated?
Income = Units sold x Price per unit
Income can also come from other sources like interest received.
What is Fixed Costs?
It is that portion of the total cost that remain unchanged no matter what else change.
Eg rent
What is the purpose of the Statement of Financial Performance?
Determine profit / loss
and how it has been distributed.
The longterm objective is to increase the value of the business. Name 2 ways in which this can be accomplished.
Investing in assets that will add value
Keeping cost of capital as low as possible
What is the risk-return principle?
The greater the risk the greater the return
What is meant with the break-even analysis?
It is the point where no profit or loss is realised.
The point where total costs equal total income.
N = F
———-
(SP - V)
What is the financial function in financial management concerned with?
The flow of funds
What is Financial Management responsible for?
The efficient management of all facets of the financial function
Capital can be described as?
The accrued power of disposal over the products + services used by a business to generate a monetary return or profit.
What does the liquidity of a business mean?
Refers to a business’ ability to satisfy its short-term obligations as they become due.
Ie. Ability to pay trade creditors by due dates.
Financial management is based on 3 principals. Name them.
1) Risk-return principle
2) Cost-benefit principle
3) Time value of money principle
A change in which 3 components will result in a change in the profit made by a business?
- Unit selling price of its product
- volume of production + sales
- costs (fixed and variable)
The term SP - V is referred to as?
The marginal income
or
Variable profit
What is the purpose of the Breakeven analysis?
- contribute in prep of budgets
- setting targets
- forms basis of strategic decisions
The greater a business’ fixed costs are …
the greater its exposure will be to negative effects of a decline in sales.
What is the key concept to remember with regard to the time value of money?
The value of money changes because of interest rates.
The future value of an initial investment is determined by?
Means of compounding
What would the formula be to calculate the future value of an original investment?
n
FVn = PV (1 + i)
PV - original investment / present value
FVn - the future value of investment after n periods.
i is the interest rate per period expresses as a decimal number
n is the number of discrete periods over which investment extends
What is meant with the “discounting process” in terms of present value?
It is the reverse of the compounding process.
What is the factor known as?
1
------------
n
(1 + i )The present value factor
or
discounting factor for a future single amount
What are the 3 most important implications of tome value of money?
1) Inflow must be accelerated (debtors to pay sooner)
2) Outflow should be delayed (pay cr as late as possible)
3) Manage inventory as optimally as possible - it represents capital that does not earn a return before it is sold.
What are the 4 aids to the Financial Management’s disposal to help with its financial analysis?
Statement of Financial Performance
Statement of Financial Position
Cash Flow Statement
Financial Ratios
What are the 2 approaches to drawing up a funds-flow statement?
1) according to changes in net working capital
2) according to changes in cash position, including current bank account
Which are the 4 interested parties that use financial ratios of the business?
MANAGEMENT
control, planning, decision-making
SUPPLIERS OF BORROWED CAPITAL
ability of buss to repay debts
INVESTMENT ANALYSTS
to evaluate buss as investment opp
LABOUR UNIONS
with view on salary negotiations
An integrated budgeting system for a manufacturing business consists of 2 main types of budgets. What are they?
Operating budgets
Financial budgets
Operating budgets include 3 responsibility centres. Name them.
COST BUDGETS - (measure efficiency)
manufacturing-cost budgets
discretionary-cost budgets
INCOME BUDGETS - (measure marketing + sales effectiveness)
PROFIT PLAN / PROFIT BUDGET (measure income and expenses for managers’ units)
Which budget is the most critical part of a profit budget?
Income budget
What are financial budgets used for?
Used by Financial Management for execution of planning, task control, financing and balance sheet budgets.
What are the 3 major purposes of the Financial Budgets?
1) verify viability of operational planning
2) reveal financial action
3) indicate how operating plans will affect furure.
What do the financial budgets consist of?
Capital expenditure
Cash budgets
Financing budgets
Balance sheet budgets
The financial budgets are prepared from information contained in the ….
Operating budgets
The capital expenditure budget indicates…
the expected budgeted future capital investment in physical facilities.
The cash budgets indicate :
Sources of expected cash inflows
Expected cash outflows
Expected availability of cash in comparison with expected need for it
Why is the financing budget developed?
To assure the business
of availability of funds to
- meet budgeted shortfall of receipts relative to payments
in the short term
and to schedule medium term and long term borrowing
The financing budget is developed in conjunction with the?
Cash budget
Which budget brings together all the other budgets to project how the business’ finances will look?
The budgeted statement of financial position
An analysis of the budgeted statement of financial position may suggest …..
Problems (such as poor solvency due to over-borrowing)
Or
Opportunities (such as excessive liquidity - opp to expand)
The problem of the managerial challenge (where mng only consider their own departments due to a lack of insight) brought on by traditional budeting can be overcome by..
Zero based budgeting
or
the Balanced scorecard approach
What is zero based budgeting?
It enables a business to look at its
activities and priorities
afresh on an annual basis.
Current assets include:
Cash,
An integrated budgeting system for a manufacturing business consists of 2 main types of budgets. What are they?
Operating budgets
Financial budgets
Operating budgets include 3 responsibility centres. Name them.
COST BUDGETS - (measure efficiency)
manufacturing-cost budgets
discretionary-cost budgets
INCOME BUDGETS - (measure marketing + sales effectiveness)
PROFIT PLAN / PROFIT BUDGET (measure income and expenses for managers’ units)
Which budget is the most critical part of a profit budget?
Income budget
What are financial budgets used for?
Used by Financial Management for execution of planning, task control, financing and balance sheet budgets.
What are the 3 major purposes of the Financial Budgets?
1) verify viability of operational planning
2) reveal financial action
3) indicate how operating plans will affect furure.
What do the financial budgets consist of?
Capital expenditure
Cash budgets
Financing budgets
Balance sheet budgets
The financial budgets are prepared from information contained in the ….
Operating budgets
The capital expenditure budget indicates…
the expected budgeted future capital investment in physical facilities.
The cash budgets indicate :
Sources of expected cash inflows
Expected cash outflows
Expected availability of cash in comparison with expected need for it
Why is the financing budget developed?
To assure the business
of availability of funds to
- meet budgeted shortfall of receipts relative to payments
in the short term
and to schedule medium term and long term borrowing
The financing budget is developed in conjunction with the?
Cash budget
Which budget brings together all the other budgets to project how the business’ finances will look?
The budgeted statement of financial position
An analysis of the budgeted statement of financial position may suggest …..
Problems (such as poor solvency due to over-borrowing)
Or
Opportunities (such as excessive liquidity - opp to expand)
The problem of the managerial challenge (where mng only consider their own departments due to a lack of insight) brought on by traditional budeting can be overcome by..
Zero based budgeting
or
the Balanced scorecard approach
What is zero based budgeting?
It enables a business to look at its
activities and priorities
afresh on an annual basis.
Current assets include:
Cash, marketable securities, debtors and inventory.
What does the time value of money principle mean?
A person could increase the value of any amount of money by earning interest.
If however the amount is invested in inventory, equipment, vehicles ect then it cannot earn interest
What is the cost of holding cash?
Loss of interest
Loss of purchasing power
Why is there a loss of purchasing power when cash is held?
During a period of inflation an erosion of the value of the money occurs. This is even worse if no interest is earned.
What is the cost of little or no cash? Name 4.
- loss of goodwill (harm supplier relationships when paying late)
- loss of opportunities
- inability to claim interest
- cost of borrowing (have to borrow if short on cash)
Give an example of a marketable security.
Short term treasury bills issued by government
Name 3 reasons why businesses need cash.
- transaction motive
- precautionary motive (unexpected events)
- speculative motive (unexpected bargains / specials)
What are the 3 most important facets of debtor management?
Credit Policy
Credit Terms
Collection Policy
When managing debtors realistic Credit standards revolve around which 4 things?
1) Character - willingness to pay
2) capacity - ability to pay
3) capital - financial resources
4) conditions - economic conditions
What are the 4 costs / disadvantages of allowing credit?
- loss of interest
- costs in determining creditworthyness
- cost of admin and record keeping
- bad debts
What is the cost of holding stock?
Loss of interest
Storage costs
Insurance
Obsolescence
What are the costs / disadvantages of no or little stock?
Loss of customer goodwill
Production interruptions
Loss of flexibility
Re-order costs
What is the NPV?
Net present value
It is the difference between the present value of all the annual net cash flows
and
the present value of all cash outflows directly related to a project
What is the formula for NPV?
NPV = present value of net cash inflows - initial investment
What are the decisional criteria for the NPV?
Accept - projects with NPV>0
Reject - projects with NPV<0
No contribution - projects NPV=0 (normally rejected)
What is the 1 limitation of the NPV?
It does not take RISK into consideration
Name 4 most common short-term financing forms.
Trade credit
Accruals
Bank overdrafts
Factoring
What advantages do Ordinary shares hold for business?
- no risk to business: dividends not compulsory
- serves as security (attracting capital)
Name the 3 approaches to short-term financing.
1) Matching approach (hedging)
2) Aggressive approach
3) Conservative approach
What is the Matching approach in short-term financing about?
Also known as hedging
Matching the period with the expected life of the asset
What is the Aggressive approach about in short-term financing?
Using more finance than is needed
What is the conservative approach about with regards to short-term financing?
Current asset requirements are funded with more long-term funds
Name the 2 liquidity ratios.
current ratio
acid test ratio
What is the purpose of Liquidity ratios?
To provide an indication of the ability of a business to meet its short-term obligations
What does the current ratio reflect?
The relationship between the value of current assets and the extent of the current liabilities
Current assets
Current ratio = _______________
Current liabilities
What is the acid-test ratio about?
Inventory be converted into cash immediately in short-term. The acid-test should be used in combination with current-ratio test.
How do you calculate the acid-test ratio?
Current assets- inventory
Acid test ratio = ————————–
current liabilities
What does the current ration calculation indicate?
The smaller the ratio - greater possibility won’t be able to meet debt obligations fully.
Traditionally a ratio of 2:1 is recommended
Answer eg 2,2:1 - R2,20 of current assets are available for every R1 of its current liabilities
What does the answer in the acid-test ratio indicate? Eg. R1,4 : 1
For every R1 of current liabilities the business has R1,40 of current assets, excluding inventory.
Minimum of 1:1 is recommended
If the acid-test ratio is too high eg. 5:1 what could this mean?
Either
- the firm is carrying too much inventory
- selling too much on credit
- collecting debt too slowly
- has too much cash on hand
What is the purpose of Solvency ratios?
To indicate the ability of a business to repay its debts from the sale of
gives the business indication to extent to which it will have access to additional loan capital
also extent of risk in current financing
What is the debt ratio about?
Debt 100
Debt ratio= —— X —–
Assets 1
Answer in %.
Means % of assets that were financed by debt
Max debt ratio should be 50%
What is the gearing ratio about?
Owners equity
Gearing ratio = —————
Debt
Eg. 1,7 : 1 means for each R1 the business has R1,70 in owners equity
Minimum ratio of 1:1
How is the gross profit margin calculated?
Gross profit. 100
———— X —-
Sales 1
Indicates how profitable sales have been.
What is Net profitability and how is it calculated?
Net income. 100
———— X —–
Sales 1
Indication of overall profitability
What is the Return on Capital ratio about?
Net profit after tax. 100
—————— X. —-
Capital employed. 1
There are 2 types of ordinary shares. What are they?
Par value shares. (all have same value)
Non-par value shares
