Finance Flashcards
What are the objectives of financial management?
profitability, growth, efficiency, liquidity, solvency
What are the internal sources of finance?
retained profits
What are the influences on financial management?
Internal sources of finance
External sources of finance
Financial institutions
Influence of government
Global market influences
What are the types of external sources of finance?
Debt
Equity
What are the types of short term borrowing (debt)?
overdraft, commercial bills, factoring
What are the types of long term borrowing (debt)?
mortgage, debentures, unsecured notes, leasing
What are the types of equity?
Ordinary shares
Private equity
What are the types of ordinary shares?
new issues, rights issues, placements, share purchase plans
What are the types of financial institutions?
banks, investment banks, finance companies, superannuation funds,
life insurance companies, unit trusts and the Australian Securities Exchange
What are the types of influence of government?
Australian Securities and Investments Commission,
company taxation
What are the types of global market influences?
economic outlook, availability of funds, interest rates
What are the processes of financial management?
Planning and implementing
Monitoring and controlling
Financial ratios
Limitations of financial reports
Ethical issues related to financial reports
What are the steps in planning and implementing?
financial needs, budgets, record systems, financial risks,
financial controls
What are the components of monitoring and controlling?
cash flow statement, income statement, balance sheet
What ratio measures liquidity?
The current ratio
What ratio measures gearing?
debt to equity ratio
What ratios measure profitability?
gross profit ratio
net profit ratio
return on equity ratio
What ratios measure efficiency?
Expense ratio
Accounts receivable turnover ratio
What are the limitations of financial reports?
normalised earnings, capitalising expenses, valuing
assets, timing issues, debt repayments, notes to the financial statements
What are the cash flow management strategies?
distribution of payments, discounts for early payment, factoring
What are the working capital management strategies?
control of current assets
control of current liabilities
leasing, sale and lease back
Profitability managment
cost controls – fixed and variable, cost centres, expense minimisation
revenue controls – marketing objectives
What are the methods of international payment?
payment in advance, letter of credit, clean
payment, bill of exchange
define financial management
The planning and monitoring of a business’ financial resources to enable the business to achieve its financial objectives.
__% of small businesses fail due to _____ (ASIC).
44% of small businesses fail due to poor financial management (ASIC).
What does the strategic role of financial management include?
- Setting financial objectives and ensuring the business is able to achieve these goals.
- Sourcing finance
- Preparing budgets and forecasting future finances.
- Preparing financial statements.
- Maintaining sufficient cash flow.
- Distributing funds to other parts of the business.
Define the objective: profitability
the ability of a business to maximise its profits.
Define the objective: Growth
the ability of a business to increase its size in the longer term.
Define the objective: efficiency.
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.
Define the objective: liquidity
The extent to which a business can meet its financial commitments in the short term (less than 12 months).
Define the objective: Solvency
The extent to which a business can meet its financial commitments in the longer term (more than 12 months).
What are the types of short term financial objectives?
Tactical
Operational
What are (short term) tactical objectives?
1-2 yrs to complete
What are (short term) operational objectives?
day-to-day tasks
What are long term financial objectives?
The strategic plans of a business.
- Form the basis on which short-term goals are established.
How does the finance function rely on operations?
To produce the products.
How does the finance function rely on Marketing?
To promote the products
How does the finance function rely on human resources?
To manage the staff
Define internal sources of finance.
Funds generated from inside the business.
Define external sources of finance.
Funds provided by sources outside the business, including banks, other financial institutions, government, suppliers or financial intermediaries.
Define debt finance
Relates to the short-term and long-term borrowing from external sources by a business.
Describe an overdraft
A bank allows a business to overdraw on their account up to a certain limit to overcome a temporary cash shortfall.
Describe commercial bills.
Loans issued by financial institutions, usually over $100,000 between 30-180 days. The borrower receives the money immediately and promises to pay it back at a later date with interest.
Describe factoring
Selling accounts receivable at a discount to a firm that specialises in collecting accounts receivable.
What is a mortgage?
A loan secured by the property of the borrower (business).
What is a debenture?
A promise issued by a company to repay a loan for a fixed rate of interest and for a fixed period of time.
What is an unsecured note?
A loan from investors for a set period of time that is not secured against a business’ assets.
What is leasing?
The payment of money for the use of equipment that is owned by another party.
Define equity finance.
As an external source of funds, refers to the finance raised by a company through inviting new owners.
Define a dividend.
A distribution of a company’s profits (yearly or half-yearly) to shareholders, calculated as a number of cents per share.
What is private equity?
The money invested in a private company (not listed on ASX).
What is the aim of private equity?
Aim to raise capital to finance future expansion/investment.
What is the role of financial institutions?
Collect funds and invest them in financial assets.
Define superannuation.
A scheme set yo by the federal government, which requires all employers to make a financial contribution to a fund that will provide benefits to an employee when they retire.
Define the Australian Securities Exchange.
The primary stock exchange group in Australia.
What is the aim of the Australian Securities and Investments Commission?
Assist in reducing fraud and unfair practices in financial markets and products.
What is the process of reform?
Tax reform is the process of changing the way taxes are collected or managed by the government.
Define economic outlook.
The projected changes to the level of economic growth throughout the world.
Define availability of funds.
refers to the ease with which a business can access funds (for borrowing) on the international financial markets.
Define interest rates
The cost of borrowing money.
What are the financial needs of a business determined by?
- size of the business
- phase of business life cycle
- future plans for growth and development
- capacity to source finance
- management skills for assessing financial needs and planning
What is a budget?
A financial document used to estimate future revenue and expenses over a period of time.
What can a budget show?
- Cash requirements for planned outlays.
- Cost of capital expenditure against earning capacity.
- Estimated use and cost of inputs and inventory.
- Number of and cost of labour hours required for production.
What are the types of budgets?
Operating budgets
Project budgets
Financial budgets
What are operating budgets?
Relate to main activities of a business.
What are project budgets?
Relate to capital expenditure and research and development.
What are financial budgets?
Relate to the financial date of the business.
Define record systems.
The mechanisms employed by a business to ensure that the data are recorded and the information provided is accurate, reliable, efficient and accessible.
What are the advantages of record systems?
- informs performance and where improvements need to be made.
- Investors and financial institutions are more likely to invest or make loans to a business that can demonstrate its financial position.
- Allow for future planning and control procedures to ensure goals are achieved.
- Prevent fraud and theft by employees.
Define financial risks.
The possibility of financial loss to businesses.
What are the types of financial risk to a business?
Credit risk
Market risk
Liquidity risk
Operational risk
What is credit risk?
The danger associated with borrowing money.
What is market risk?
This risk of changing conditions in the specific marketplace in which a company competes for business.
What is liquidity risk?
A business’ cash flow and whether the business has sufficient funds to meet their financial obligations.
What is operational risk?
The various dangers faced during the day-to-day management of a business.
What are some examples of operational risk?
Legal problems
Fraud risk
Human resource issues
Business model risk
What are some examples of liquidity risk?
- A situation where they don’t have enough cash to pay their expenses.
- Borrowing too much (high gearing).
What are some examples of market risk?
- increasing no. consumers shopping online.
- Increasing competition.
What are some examples of credit risk?
- Risks faced by extending credit to customers who may be unable to pay.
- interest rate risk.
Define financial controls.
The procedures, policies and means by which a business monitors and controls the allocation and usage of its resources.
What are the advantages of debt financing?
- Funds are usually readily available and can be acquired at short notice.
- Increased funds should lead to increased earnings and profits.
- Interest payments are tax deductible (reducing cost of debt financing).
- Flexible payment periods and types of debt available.
- It will not dilute ownership in the business.
What are the disadvantages of debt financing?
- Increased risk if debt comes from financial institutions because interest, bank charges and government charges may increase.
- Security is required by business (assets).
- regular repayments have to be made
- Lenders have first claim on any money if the business ends in bankruptcy.
- Debt can be expensive (interest must be paid).
What are. the advantages of equity finance?
- Does not have to be repaid unless the owner leaves.
- Cheaper than any other sources of finance as there are no interest payments.
- The owners who have contributed the equity retain control over how that finance is used.
- Low gearing
- Less risk for business and the owner.
- Remains within the business for an indefinite time, because funds do not have to be repaid at a set date as with debt financing.
What are the disadvantages of equity financing?
- Lower profits and lower returns for the owner.
- The expectation that the owner will have about the return on investment.
- Long, expensive process to obtain funds this way.
- Ownership is diluted
- Requires sufficient profits to be made so that the business can continue to operate.
- Provides confidence to creditors and lenders, who are more willing to lend to a business if there are equity funds.
- They act as a safety net for unexpected downturns of changes in the business’ activities.
What are the implications of using short term finance to fund long term assets?
Causes financial problems because the amount borrowed must be repaid before the long-term assets have had time to generate increased cash flow.
What are the implications of using long term finance to fund short term situations or assets?
Means the business is still paying the mortgage long after the situation is resolved or the stock has been sold and profits will be reduced.
What is a cash flow statement?
A financial statement that indicates the movement of cash receipts and cash payments resulting from transactions over a period of time.
What can a cash flow statement show about a firm?
Whether a firm can:
- Generate a favourable cash flow
- pay its financial commitments as they fall due.
- have sufficient funds for future expansion or change.
- obtain finance from external sources when needed.
- pay drawings to owners or dividends to shareholders.
What is an income statement?
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 and how much has been derived as profit.
What does an income statement show?
- operating income earned from the main function of the business.
- Operating expenses.
Define expenses.
The costs incurred in the process of acquiring or manufacturing a good or service to sell and the costs associated with managing all aspects of the sales of that good or service.
Define cost of goods sold.
the value of stock that a business has sold to its customers.
COGS =
Opening stock +
Purchases -
Closing stock
Gross Profit =
Sales (revenue) - COGS
Net Profit =
gross profit - expenses
What is a balance sheet?
A summary of a business’ assets and liabilities at a particular point in time. Represents the net worth of the business.
Define assets
items of value owned by a business.
Define liabilities
items of debt owed to outside parties.
Define current assets.
assets that a business can expect to use up, or turn over, within 12 months.
Give an example of a current asset.
Stock
Define non current assets
those assets that have an expected life of longer than 12 months.
Give an example of a non current asset.
Land
Define current liabilities
those debts which are expected to be repaid in less than 12 months.
Define non current liabilities.
long-term items of debt
Give an example of current liabilities.
overdraft
Give examples of non current liabilities.
mortgage
debenture
Define owner’s equity.
the funds contributed by the owner(s); represents the net worth of the business.
What does the balance sheet indicate?
- Whether the business has enough assets to cover its debts
- whether the interest and money borrowed can be paid.
- whether the assets of the business are being used to maximise profits.
- whether the owners of the business are making a good return on their investment.
What is the fundamental accounting equation?
Assets =
Liabilities + Owner’s equity
What is the current ratio?
current assets/current liabilities
What is the debt to equity ratio?
total equity
What is the gross profit ratio?
Sales
What is the net profit ratio?
Sales
What is the return on equity ratio?
Net profit/
Total equity
What is the expense ratio?
total expenses/
Sales
What is the accounts receivable turnover ratio?
Accounts receivables
Do you want a high or low current ratio?
High
Do you want a high or low debt to equity ratio?
Low
Do you want a high or low gross profit ratio?
High
Do you want a high or low net profit ratio?
High
Do you want a high or low return on equity ratio?
High
Do you want a high or low expense ratio?
Low
Do you want a high or low accounts receivable turnover ratio?
- High number of times collected per year.
- Low number of days to collect.
Define normalised earnings
Earnings that have been adjusted to take into account changes in the economic cycle to remove one-off or unusual items that will affect profitability.
Define capitalising expenses.
When a business records an expense as an asset rather than an expense on the income statement.
Define valuing assets.
The process of estimating the value of assets when recording them on a balance sheet.
What is the matching principle?
Expenses incurred by a business must be recorded on the income statement for the accounting period in which the revenue to which those expenses relate is earned.
What are notes to the financial statements?
Report the details and additional information that are left out of the main reporting documents.
What is an audit?
An independent check of the accuracy of financial records and accounting procedures.
What are some ethical reporting practices?
Audited accounts
Record keeping
Reporting practices
What are the types of audits?
Internal audits
Management audits
External audits
Define cash flow
the movement of cash in and out of a business over a period of time.
What is meant by distribution of payments as a cash flow management strategy?
Distributing payments throughout the month, year or other time period so that large expenses do not occur a the same time and cash shortfalls do not occur.
What is meant by discounts for early payment as a cash flow management strategy?
When a business offers customers a percentage reduction on the total invoice value when its settled before the payment deadline.
What are the advantages of discounts for early payment as a cash flow management strategy?
- Reduces risk of late payment and associated costs.
- Can increase customer loyalty and improve customer relationships.
- Improves working capital and extra liquidity.
- Reduces risk of non-payment and bad debt.
What are the disadvantages of discounts for early payment as a cash flow management strategy?
- Decrease profit margins
- Impact ability to forecast cash flow
- No guarantee that customers will continue to pay back early.
What are the advantages of factoring as a cash flow management strategy?
- immediate cash injection
- No debt or interest
- quick and easy to arrange
- customer more likely to pay on time
- frees up time, avoid hassle of collecting debts
What are the disadvantages of factoring as a cash flow management strategy?
- reduces profit margin on each invoice they sell.
- Can be more expensive than other short-term financing.
- Damage relationship with customers.
- indicate cash flow issues to customers.
Define working capital management
determining the best mix of current assets and current liabilities needed to achieve the objectives of the business.
Define leasing.
The payment of money for the use of equipment that is owned by another party.
Define sale and lease back
The process of selling an owned asset to a lessor and then leasing the asset back through fixed payments for a specific period of time.
Define profitability management.
Involves the control of both the business’ costs and its revenue.
Define fixed costs.
Costs that are not dependent on the level of operating activity in a business (paid regardless of what happens in the business).
Define variable costs.
Costs that vary in direct relationship to the levels of operating activity or production in a business.
What are some examples of variable costs?
labour
energy
What are cost centres?
Particular areas, departments or sections of a business to which costs can be directly attributed.
In revenue controls, what factors should be considered when pricing?
competitors prices
costs of production
short and long term goals
image/prestige
government policies
Define foreign exchange market.
A market that determines the price of one currency relative to another.
Define foreign exchange rate.
The ratio of one currency to another; it tells how much a unit of one currency is worth in terms of another.
When $A appreciates, exports…
Exports become more expensive
When $A appreciates, exports become more expensive, businesses…
businesses lose their international competitiveness
When $A appreciates, imports…
Imports become cheaper
When $A appreciates, imports become cheaper, inputs…
inputs in the transformation process become cheaper if purchased from overseas.
When $A depreciates, exports…
Exports become cheaper
When $A depreciates, exports become cheaper, businesses…
businesses increase their international competitiveness.
When $A depreciates, imports…
Imports become more expensive
When $A depreciates, imports become more expensive, inputs…
inputs in the transformation process become more expensive if purchased from overseas.
What method of international payment has the least risk for the exporter?
Payment in advance
What method of international payment has the most risk for the exporter?
Clean payment
What are the methods of international payment in order of risk for the exporter (least to most risk).
Payment in advance
Letter of credit
Bill of exchange
Clean payment
Define payment in advance.
A payment method that allows the exporter to receive payment and then arrange for the goods to be sent.
What is a letter of credit?
A document that a buyer can request from their bank that guarantees the payment of goods will be transferred to the seller. It is issued by the importer’s bank to the exporter promising to pay them a specified amount once certain conditions have been met.
Define bill of exchange.
A document drawn up by the exporter demanding payment from the importer at a specified time.
Define clean payment.
Occurs when the exporter ships the goods directly to the importer before payment is received.
Define spot exchange rate.
the value of one currency in another currency on a particular day.
Define hedging.
The process of minimising the risk of currency fluctuations to help reduce the level of uncertainty involved with international financial transactions.
What are the types of hedging?
Natural hedging
Financial instrument hedging
What is financial instrument hedging?
Use of derivatives to minimise risk or spread of exchange rate fluctuations.
What is natural hedging?
When a business adopts strategies to eliminate or minimise the risk of foreign exchange exposure. It provides itself with a natural hedge.
What are derivatives?
Simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations.
What are the types of derivatives?
Forward exchange contracts
Option contracts
Swap contracts
What is a forward exchange contract?
A contract to exchange one currency for another currency at an agreed exchange rate on a future date, usually after a period of 30, 90 or 180 days.
What is an option contract?
Gives the buyer the right, but not the obligation to buy or sell foreign currency at some time in the future.
What is a swap contract?
An agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future.
What is the main advantage of swap contracts?
Allow the business to alter its exposure to exchange fluctuations without disregarding the original transaction.
Where are short term loans found on the balance sheet?
current liabilities
Advantages of an overdraft
- Helps overcome temporary cash shortfalls
- Helps businesses with liquidity problems (acts like a safety net)
- Interest rates usually lower than other types of borrowing
- No regular repayment schedule (pay back when they can)
Disadvantages of an overdraft
- Repayable on demand
- Requires some form of security
- bank charges need to be monitored and businesses need to have policies.
Advantages of commercial bills
- flexible in terms of the interest that needs to be paid and the repayment period.
Disadvantages of commercial bills.
Secured against business’ assets
Advantages of factoring
- Business receives funds within 48hrs of supplying invoices to the factoring company.
- improves cash flow
- improves gearing
- Business does not have to worry about chasing up accounts receivable.
What is factoring with recourse?
Bad debts will still be the responsibility of the business.
What is factoring without recourse?
Business transfers responsibility for non-collection to the factoring company.
What are the advantages of leasing as a source of finance?
- Assists with cash flow
- Costs may be lower than other methods of financing
- If some assets are leased, business may be in a better position to borrow funds
- Form of long-term financing without reducing control of ownership.
- Payments are fixed for a period
- Lease repayments are tax deductible
- Payments usually include maintenance, insurance, finance costs.
What are the disadvantages of leasing as a source of finance?
- Interest charges may be higher than any other forms
- Penalty on lease termination
What is a new issue?
A security that has been issued and sold for the first time on a public market.
What is a rights issue?
An invitation for existing shareholders to purchase additional shares in the same company at a discount to the market share price on a set future date.
- Have right but not obligation to purchase.
What is a placement?
Involves creating new shares return for capital and issuing them to selected investors at a discount to the market price of the company’s shares.
What is the main difference between a rights issue and a placement.
In a rights issue, ownership is not diluted.
What is the aim of a placement?
To persuade large investors to invest in company.
What is a share purchase plan?
An offer to existing shareholders in a listed company to purchase newly issued shares in that company without brokerage fees.
What are finance companies?
Non-bank financial intermediaries that specialise in smaller commercial finance.
What are life insurance companies?
Non-financial intermediaries who provide cover and a lump sum payment in the event of death.
What is the primary market of the ASX?
Deals with the new issue of debt instruments by the borrower of funds.
What is the secondary market of the ASX?
Deals with the purchase and sale of existing securities.
How is the primary market advantageous for businesses?
Enables a company to raise new capital through the receipt of proceeds from the sale of securities.
How much tax does a company pay on profits?
Flat rate of 27.5%
What are the advantages of tax reform?
- Increases Aus’ competitiveness
- Makes Aus a more attractive place to invest.
= long term economic growth, more jobs and higher wages.
What are the issues that arise with valuing assets on the balance sheet?
- When an asset is recorded, its value is written as its historical cost.
- Some assets are very difficult to value.
What does the matching principle mean?
When an accountant records revenue, they should also include at the same time any expenses that were directly related to that revenue.
What are examples of what the notes to the financial statements can inform?
accounting methodologies
how the figures were calculated and the procedures to develop them
What do auditors do?
Establish whether the financial statements are fairly presented and in accordance with generally accepted accounting principles.
What are internal audits?
Conducted internally by employees to check accounting procedures and accuracy.
What are management audits?
Conducted to review firm’s strategic plan and determine if changes should be made.
What are external audits?
When a company becomes a large proprietorship they must have their annual financial report audited.
In working capital management, what current assets does a business need to control?
Cash, receivables, inventories
In working capital management, what current liabilities does a business need to control?
Payables
Loans
overdrafts
What are the advantages of sale and lease back?
- Helps improve a business’ liquidity since it enables the business to receive a large cash injection from the sale of the asset, which can then be used as working capital if the business is experiencing a cash shortfall.
- Business continues to benefit from use of asset.
What are the advantages of cost centres?
- Allows management to measure, budget and control costs for each specific function.
- Helps management utilise resources more efficiently.
- Track expenses.
What is lean production?
When a business aims to eliminate waste at every stage of the production process.
What is one way a business can minimise expenses?
lean production
What is the purpose of a cost volume profit analysis?
Can determine the level of revenue sufficient for a business to cover its fixed and variable costs to break even, and predict the effect on profit of changes in the level of activity, prices or costs.
What is the impact of overpricing?
Could fail to attract buyers.
What is the impact of underpricing?
Could result in cash shortages and low profits.
What causes exchange rate fluctuations?
variations in demand and supply.
What movement of the Australian dollar causes a decrease in market share, sales ad export income?
An appreciation of the $A.
What movement of the Australian dollar causes an increase in market share, sales ad export income?
A depreciation of the $A.
What is the risk of borrowing finance overseas?
Exchange rate movements
How can exchange rate movements impact a business borrowing overseas?
- Any adverse currency fluctuations could see the advantage of cheaper overseas interest rates quickly eliminated.
- In long term, the ‘cheap’ interest rates may end up costing more.
When is payment in advance usually used?
Often used if the other party is a subsidiary or when the credit worthiness of the buyer is uncertain.
What are the types of bill of exchange?
Document against payment
Document against acceptance.
What is a document against payment?
Importer can only collect goods after paying for them.
What is a document against acceptance?
Importer may collect goods before paying for them.
When is a clean payment usually used?
Usually only used when exporter is confident that importer will pay by agreed time.
What are the steps in a bill of exchange?
- Seller and buyer enter into a sales contract
- The goods are shipped
- exporter presents shipping documents through the banking system. Usually, buyers cannot take delivery of the goods until they have the shipping documents.
- bill against payment or bill against acceptance
- Upon payment of acceptance, documents are released to the buyer to enable them to obtain the goods.
What are some examples of natural hedging?
- Establishing offshore subsidiaries
- Market strategies to reduce price sensitivity of exported products
- Import and export contracts in $A.
- Arranging for import payments and export receipts denominated in the same foreign currency.
What is the advantage of an options contract?
Buyer is protected from unfavourable exchange fluctuations, but can gain from favourable.
What is the advantage of a forward exchange contract?
Bank guarantees exporter fixed rate of exchange for the money generated from the sale of the exported good.
What is an advantage of a bill of exchange for the exporter?
Allows the exporter to maintain control over their goods until payment is made or guaranteed.
What does the growth of a business depend on?
Ability to develop and use its asset structure to increase sales, profits and market share.
What is gearing?
The extent to which a business relies on debt compared to equity.
How do other functions depend on the finance function?
- Finance function has to supply the necessary funds to each aspect of the business in order to effectively carry out their activities.
How does operations depend on finance?
Allocation of adequate funds to purchase inputs and carry out transformation.
How does marketing depend on finance?
Allocation of adequate funds to undertake the various forms of promotion.
How does human resources depend on finance?
Allocation of adequate funds to pay for staff.
What are retained profits?
Funds put back into the business to fund future activities of the business.
What is short term borrowing used for?
Used o finance temporary shortages in cash flow or finance for working capital.
When is short term borrowing repaid?
within 12 months
When is long term borrowing repaid?
longer than 12 months.
What is long term borrowing usually used for?
To purchase major assets
eg. buildings.
Where are long term loans recorded on the balance sheet?
non-current liabilities.
What are some common policies and procedures that promote control?
- Clear authorisation and responsibility for tasks in the business
- Separation of duties
- Qualification restrictions
- Control of cash
- Protection of assets
- Control of credit procedures
Interpret a current ratio of 2:1
A ratio of 2:1 means that there us $2 in current assets for every $1 in current liabilities. The business is in a sound financial position.
Interpret a current ratio of 1:1
There is only $1 in current assets to meet every $1 in current liabilities and thus the business would struggle to meet its short term financial commitments.
Interpret a debt to equity ratio of 1:1 (100%)
For every $1 of owner’s equity put into the business, the business borrows $1 (debt).
Interpret a debt to equity ratio of 2:1 (200%)
For every $1 of owner’s equity put into the business, the business borrows $2 (debt). The business is increasing risk, there is a higher gearing ratio and the business is becoming less solvent. It will face increasing financial difficulties meeting its long term financial commitments.
How can a high gearing ratio be an advantage?
A higher ratio means the business is borrowing more and thus has more funds to finance activities in the business. As a result, its capacity to expand and increase profits is increased.
High debt to equity ratio=
highly geared, less solvent, higher risk
Low debt to equity ratio
lowly geared, more solvent, lower risk
Interpret a gross profit ratio of 0.1:1 (10%)
Every dollar of sales generates 10c in gross profit.
Interpret a net profit ratio of 0.1:1 (10%)
Every dollar of sales generates 10c in net profit.
Interpret a return on equity ratio of 0.1:1 (10%)
For every dollar invested, they receive 10c in return.
Interpret an expense ratio of 0.3:1 (30%)
This means that for ever dollar of sales, 30c is absorbed by expenses.
What is a float?
When a company has just listed on ASX and they offer shares through an IPO (Initial Public offering).
What does the purchase of ordinary shares mean?
Means they have become part-owners of a publicly listed company
- Voting rights + dividends
Why do companies usually issue a rights issue?
To raise additional funds or pay down debt.
How does leasing assist with cash flow?
Cash outflows spread over several years.
What are the types of leasing?
Operating lease
financial lease
What is an operating lease?
Assets leased for short period of time and can be cancelled.
What is a financial lease?
Repayments are fixed for the economic life of the asset, cheaper than operating lease.
What is a mortgage used for?
To finance property purchases eg. new premises, factory, office.
How are mortgages repaid?
Repaid with interest, with regular repayments, over an agreed period of time.
How does a debenture work?
Investors lend money to the company and in return they issue a debenture and then repay the loan at a date in the future.
What is the main feature of unsecured notes?
Not secured against business’ assets.
Which form of debt is the most risk to investors?
Unsecured notes
Why is placements a disadvantage for existing shareholders?
Ownership is diluted
What are some of the wide range of financial products/services that banks offer?
Offering credit cards, cheques, overdrafts, insurance, investment and savings accounts
Lending money through personal & business loans
Mortgages
Internet banking, ATMs (Automatic teller machines)
Financial advice
Business banking, trading in financial markets, stockbroking, insurance, funds management
How do banks make profit?
They accept money as savings at a lower interest rate then lend that money at a higher interest rate.
What do banks do?
Receive savings as deposits from individuals, businesses and the government and in turn, make investments and loans to borrowers.
What do investment banks do?
Provide services in both borrowing and lending for the business sector.
What are some examples of what investment banks do?
Trade in money, securities, financial futures
Arrange long-term finance for company expansion
Provide working capital
Advise on mergers and takeovers
Arrange project finance
Provide portfolio investment management services
How do finance companies raise money?
Raise money through debentures.
How much is superannuation?
Employees have to pay super contributions of 11% of an employee’s ordinary time earnings (on top of salary/wages).
What do superannuation funds do with the money?
Invest the money from superannuation contributions in many things
eg. company shares, property, managed funds.
How do life insurance companies make a profit?
People pay regular premiums.
How do life insurance companies work?
Insurer guarantees to pay the designated beneficiary a sum of money upon death or circumstances specified in contract.
What do life insurance companies do in the corporate sector?
provide both equity and loans to the corporate sector.
What do unit trusts do?
Take funds from a large number of small investors and invest them in specific types of financial assets.
Define Australian securities and investments commission
An independent statutory commission accountable to the commonwealth parliament.
What does Australian securities and investments commission do?
Enforces and administers Corporations Act 2001.
Protects consumers in investments, life & general insurance, superannuation, banking (in Aus).
Collects info about companies for public → financial info.
If business breaches law, they investigate & fix matters.
→ able to enforce consequences: imprisonment, monetary penalties.
What does a positive economic outlook mean?
Increasing world economic growth
How does a positive economic outlook influence a business?
Increasing demand for products + services
Decrease in interest rates on funds borrowed internationally from the financial market.
Why does a positive economic outlook mean lower interest rates?
There is less risk with repayments
How does a poor economic outlook impact a business?
Decrease in production/output
reduced profits
increased interest rates
What are the advantages of a business plan in identifying financial needs?
Guarantee institutions that their financial commitment will be successful
Sets out how much finance is required, proposed sources of finance, range of financial statements.
Show that the business can generate an acceptable return for the investment.
What are the advantages of budgets?
- Enable constant monitoring of objectives and provide a basis for:
Administrative control
Direction of sales effort
Production planning
Control of stocks
Price setting
Financial requirements
Control of expenses & production cost.
Why would some businesses capitalise expenses?
Makes profitability look better
Improves assets
In working capital management, why should a business control the current asset; cash?
Cash ensures that a business can pay its debts, repay loans and pay accounts in the short term, and that a business survives in the long term.
What can excess inventories lead to?
lead to an increased level of unused assets, leading in turn to increased costs and liquidity problem.
How can a business increase cash?
selling non-essential non-current assets eg. company car.
How can a business control cash?
Planning for the timing of cash receipts, cash payments and asset purchases to avoid cash shortages or excess cash.
What is a reasonable period of payment of accounts?
30 to 90 days
What is the disadvantage of a tight credit policy?
- less attractive
- customers choose to buy from other firms.
In working capital management, how can a business control the current asset; receivables?
- offering bonuses or rewards for early repayment
- late payment fees
- Check credit rating of prospective customers
- follow up on unpaid accounts past due date
- factoring
In working capital management, how can a business control the current asset; inventories?
Barcoding and computerised stock records
Just in time
In working capital management, how can a business control the current liability; payables?
- Ensure that their timing allows the business to maintain adequate cash resources.
- The holding of accounts payable until their final due date can be a cheap means to improve a firm’s liquidity position.
- Take advantage of discounts offered by some creditors
- Pay by due date to avoid extra charges for late payment
- Review suppliers and the credit facilities they provide: cheaper alternatives.
In working capital management, how can a business control the current liability; loans?
- Costs for establishment, interest rates and ongoing charges must be investigated and monitored to minimise costs
- Minimise use of short term loans (higher interest)
- Investigating alternative sources of funds and different financial institutions.
What are the advantages of leasing as a working capital management strategy?
-Cash outflows spread over several years
- Allows business to make use of good quality assets
- Payments considered operating expenses, tax deductible
- Flexibility to upgrade assets
- Reduces risk of technology obsolescence since leased asset can be upgraded
- Reduces risk of unpredictable costs
- Help with cash flow forecasting and budgeting
By law, how long must a business keep records of financial transactions?
For at least 5 years.
How are debt repayments a limitation of financial reports?
Limitation because financial reports don’t have capacity to disclose info about debt repayments:
- How long business has had or has been recovering debt
- Capacity of debtor to repay amount owed
- Whether debt repayments have been held over until another accounting period
- When the debts are due
How are notes to the financial statements a limitation of financial reports?
Stakeholders may not read these as they are not in the main documents.
In profitability management, how can fixed and variable costs be controlled?
- Changes in the volume of activity need to be managed in terms of the associated changes in costs.
- Comparisons of costs with budgets, standards and previous periods ensure that costs are minimised and profits maximised.
