finance Flashcards
role of financial management
provide the link between what a business wants to achieve in the future and the resources needed to achieve the goals.
strategic role of financial management
to plan, manage, control and safeguard finances to help the business achieve its strategic and financial goals, including increasing profits, ensuring liquidity and solvency, funcing investment and managing debtors and managing financial risk including foreign exchange, theft and trade related exposures
profit formula
profit = revenue - expenses
The levels of profitability are important because
- profitability levels must be high enough to attract new capital
- if the level is too low, owners and creditors become concerned and attempt to recover their money
- potential employees will look at this when deciding to take a job
- if the level of profit is too low, or the business makes long term losses, either the shareholders will close the business or the business will become insolvent
growth SPMG
- growth in sales (increase in revenue - more sales of goods and services)
- growth in profit (increase in revenue less expenses)
- growth in market share (increase proportion of market sales)
- growth in geographic scope ( increase in number of stores operated by the business of number of states or countries in business sells its products)
efficiency
If accounts receivable collection is more than 30 days, then the business needs to be more efficient with the collection of payments
relationship between inputs and output - efficiency
If more output can be obtained from the same input, then efficiency occurs
liquidity
a business’s ability to pay its short-term obligations as they fall due
factors influencing liquidity
- types of industry eg supplying electricity needs less money available
- amount of cash tied up in customer debts and inventory
- how easy inventory can be turned into cash
- efficiency with which customer debts are collected
solvency
the ability of the business to meet its financial obligations in the long term
short term vs long term financial obligations
short term = -one year
long term = one year+
Liquidity is set short term goal, while solvency is a long term goal.
internal sources of finance
retained earnings (profits)
Owners Equity
retained earnings
where the business has made profits in prior years which have not been distributed to shareholders as dividends, some of the profit has been retained in the business.
owners equity
owners equity at the start of the business will consist of cash from savings, sale of assets and borrowings, which the owner/s are responsible for paying. As the business grows the owner/s may decide to draw less in wages (retained profits )and therefore increasing their equity in the business
external sources of finance
money that has been acquired from people or institutions other than the owners of the business. It is money that has been borrowed and it is called debt finance.
why would someone use debt finance?
interest paid on debt is usually lower than the returns a business could generate from its operations
the interest paid on the debt is tax deductible
debt - short term borrowing OD CB F
overdraft
commercial bill
factoring
overdraft
standby loan facility that the business arranges in advance with the bank. The bank will agree with the business a limit for the overdraft and that the business can overdraw their account (borrow money) up the agree limit.
commercial bill
promise made by the business to pay the bank a fixed amount on a fixed date with an agreed interest rate
factoring
source: finance companies
Factoring is the sale by the business of accounts receivable to a factoring business.
used to address a cash flow need.
debt - long term borrowing M D UN L
mortgage
debentures
unsecured notes
leasing
mortgage
source: banks
a long term loan to the business which is secured by a mortgage over property owned by the business.
A mortgage toal is a secured loan where there is less risk for the lender
debentures
a document creating a long term to the business by a lender who is lending money to the business as an investment.
fixed term, fixed interest rate, secured against assets to attract investors
unsecured notes
source: investors
they are a loan to the business from investors, different in that they are insecure. As there is more risk to the lender, there is higher interest rates
leasing
source: finance companies
under a lease the business being the lessee, pays for the right to use an asset but does not own it. The lessor is the owner. Leasing is essentially renting assets that the business needs rather than purchasing them.
equity - ordinary shares NI RI P SPP
new issue
rights issue
placements
share purchase plan
new issue
a security has been issued and sold for the first time on a public market
rights issue
privilege granted to shareholders to buy new shares in the same company
placements
allotment of shares, debentures, made directly from the company to investors
share purchase plan
an offer to existing shareholders in a listed company the opportunity to purchase more shares in that company without brokerage fees
equity - private equity
the money invested in a private company not listed on the ASX. The aim of the private company is to raise capital to finance expansion/investment of the business.
Eg owners of private companies selling equity in the business to the sharks on shark tank
banks
Banks in australia are a source of both short-term (overdraft and commercial bills) as well as long term finance (mortgages)
retail banking
includes deposit taking, cheque account and credit card services and is usually conducted in a bank’s branch network. The target market is the household consumer
wholesale banking
large transaction services such as arranging domestic and overseas borrowings for business, especially large companies
investment banks
these deal with businesses and governments in raising large amount of capital investment banks generally want some equity in the business borrowing the funds, so that they can influence the direction of the business’s activities.
finance companies
Finance companies act as intermediaries in financial markets.
They provide loans to businesses and individuals through consumer hire-purchase loans, personal loans and secured loans to businesses.
life insurance companies
life insurance companies provide loans to the corporate sector through receipts of insurance premiums, which provide funds for investment
superannuation funds
major holders of shares and government securities ad are also active in property financing.
unit trusts
A unit trust is a form of collective investment constituted under a trust deed. A unit trust pools investors’ money into a single fund, which is managed by a fund manager.
ASX
The ASX does not provide finances to businesses
The ASX is a market for the subsequent resale, between investors, of shares issued by the company. The ASX is not the sources of finance, the investors who purchase the new shares are the source of finance
company taxation
Company taxation laws have an influence on the finance manager as they will consider the different tax treatment of debt versus equity funding when selecting the appropriate source of funding and may prefer debt funding as it has a better impact on after tax profits
financial needs
forecasts will identify needs for finance within the business to purchase stock, pay off liabilities etc
budgeting O + F
details in money terms about what the business wants to achieve.
- Operations budgets - provide estimates of revenue generated and the expensive made to generate this revenue
- Financial budgets - uses information from operating budget and estimated revenue and expenses from operations
record systems
increase reliability and efficiency the record keeping systems which finance put in place are then used throughout the business as transaction occur between the business and it’s suppliers and it’s customers.
financial risks
A financial risk refers to a matter impact the ability of the business to meet financial obligations. The larger the amount of borrowing the other business has, the higher the level of financial risk.
financial controls
financial controls are a set of policies and procedures that finance put in place within the business to reduce the transfer and resources of the business will be used inappropriately or stolen.
matching the terms and sources of funds to business purpose
match as closely as possible details the terms and sources of Finance used with the life expectancy of the businesses assets
cash flow statement
- Cash flow forecast - which is a monthly prediction into the future of cash movements in and out of a business
- Cash flow statement - which is an annual statement for past movement of cash in and out of a business
cash flow forecast aim
The aim of the forecast is to identify the cash problems and future.
income statement
an income statement is a summary of all income generated and expenses incurred over specific time.
this calculates 2 types of profits:
gross profit - revenue (sales) and cost of goods sold
net profit - good profit less than all other expenses
asset - current and non-current
Is what the business owns they are under the direct control of the business asset can be classified into groups based on their liquidity
current assets converted into cash within a year e.g. Cash Stock inventory
non current assets - financial items used for longer than one accounting period. It would take longer than a year to convert them into cash. e.g. Buildings machinery equipment
liabilities current and non-current
debts owed by the business
- current liabilities paid within 12 months e.g. overdraft, wages, accounts payable
- non current liabilities be paid over a long period e.g. Loan, mortgage
owners equity
what the owner adds to the business so that the assets balance with the liabilities
accounting equation
assets = liabilities + owner’s equity
owner’s equity = assets - liabilities
liquidity ratio
The higher the number the higher the liquidity
A current ratio greater than 1:1 is desirable, 2:1 would indicate very safe liquidity
gearing
financial risk
expressed as: debt:equity
meaning: greater than 0.5:1 = high financial risk (gearing)
between 0.25:1 and 0.5:1 normal gearing
less than 0.25:1 lowly geared
gross profit ratio
needs to be compared to prior periods for this business and to similar businesses in order to determine whether the level of gross profit margin produced is sound
higher the number indicates better profitability
net profit ratio
needs to be compared to prior periods for this business and similar businesses in order to determine whether the level of net profit margin produced is sound
higher the number indicates better profitability
return on equity ratio
needs to be compared to prior periods for this business and to similar businesses in order to determine whether the level of return on equity produced is sound
higher the number indicates better return on equity
expense ratio
measure of the proportions that selling costs represent compared to sales
compare to other businesses an past ratios to assess performance
accounts receivable turnover ratio
how good the business is at collecting payments or invoices sent to customers
lower the number indicates better expense management
comparative ratio analysis
compare the performance of the same business over time
to compare the performance of the business with similar businesses
to compare its performance against common standards
normalising earnings
adjust the earnings by removing the usual transactions and this is called “normalising the earnings”
more consistent but inaccurate representation of that financial year’s transactions
capitalising expenses
expenses in the income statement would be taken out and classified as assets in the balance sheet
added to cost of assets , not deducted from revenue in the period they occurred and are deducted through depreciation to delay the full recognition of that expense
valuing assets
When an asset is listed on the balance sheet, its value is written at its historical cost
This is done this way to make sure every business values their assets in the same manner.
However the original cost of an asset on a balance sheet is different from its market value.
inaccurate representation of total asset value
timing issues
financial reports cover activities over a period of time, usually a year. Therefore the business’s financial position may not be a true representation if the business has experienced seasonal fluctuations
debt repayments
a limitation of financial report is that they do not have the capacity to disclose specific information about debt repayments such as:
- how long the business has been recovering from debt
- capacity of the business to repay its debt
- adequacy of provision and methods the business to repay debts
- are the debt repayments held over from previous reports
notes to the financial statement
These notes provide additional information and details about items included in the balance sheet and income statement such as methods of recording transaction, director loan debts etc.
can become a limitation of recorded inaccurately
Audited actions
business accounts can be monitored through auditing. And audit is an independent check of financial records of the accuracy of financial records and accounting procedures. There are several types of audits these include
Record keeping
summary of every transaction the business does involving money
companies must keep record of each transaction
Reporting practises
- stakeholders entitled to access reports
- small private companies - shareholders are entitled - banks as a shareholders will ask
- ATO must receive information
two types of financial management strategies
avoid trouble:
prevent the business getting into financial trouble, what the business should do when managed properly to avoid and manage financial risks
respond to trouble:
respond to a financial problem which has been identified ie cash flow, working capital and profitability problems
cash flow management strategy objective
how to avoid cash flow problem and what to do if there is a cash flow problem
cash flow management strategy 1: cash flow statements
regularly preparing and acting on cash flow forecasts of future cash flows
By using the cash flow forecast the finance function is able to identify potential cash flow problems and the proactively manage those problems
cash flow management strategy 2: distribution of payments
paying amount at different time through the months and year to ensure that cash outflows associated with payments do not worsen or crate a cash flow problem
cash flow management strategy 3: discounts for early payments
offering discounts for yearly payment of invoices by customers will result in an increase in cash and may address the cash flow problems the business has.
cash flow management strategy 3: discounts for early payments
offering discounts for yearly payment of invoices by customers will result in an increase in cash and may address the cash flow problems the business has.
cash flow management strategy strategy 4: factoring
sale by the business of accounts receivable, at a discount to a finance company (factoring business)
selling debtors (accounts receivable) to a finance company at a discount in order to convert accounts receivable to cash that can be used by the business
what does working capital management address
how to avoid a working capital problem what to do if you have a working capital problem ie CA s less than CL
working capital management strategy 1: control of current assets
take actions to ensure that the values of cash, inventory and accounts receivable on the balance sheet represent an accurate measure of available funds. If not controlled, business could have working capital
working capital definition
the difference between a business’ current assets and current liabilities. It is used as a measure of the ability of the business to pay its financial obligations in the short term
what does control of current assets control
cash
inventory
accounts receivable
working capital management strategy 2: control of current liabilities
take actions to ensure that the values of accounts payable and overdrafts on the balance sheet are minimised
what does control of current liabilities control
accounts payable
loans
overdrafts
working capital management strategy 3: leasing
to acquire new equipment to use in the business, rather than use cash (reducing working capital), lease from a finance company
working capital management strategy 4: sale and lease back
selling a non-current asset used in the operation of the of the business and leasing it back from the owner. Convert the non current asset into a current asset (cash) increasing working capital
