Finance Flashcards
SYLLABUS: What part of the syllabus does strategic role of financial management go under?
Role of financial management
What is the strategic role of financial management?
To plan, monitor and control the allocation of a businesses’ finances in order to link the goals of the business with the resources it has.
What are the objectives of financial management?
Growth, Liquidity, Efficiency, Profitability and Solvency (GLEPS)
What are the internal sources of finance?
Retained profits, Sale of assets and Working Capital
Influences on Financial Management
- Internal sources of finance - retained profits
What are the two types of external sources of finance?
Debt and equity
What are the short-term sources of debt finance?
Overdraft, commercial bills and factoring
What are the long-term sources of debt finance?
Mortgage, debentures, unsecured notes and leasing
What are the two main sources of equity finance?
Ordinary shares and private equity
What are the types of ordinary shares?
New issues, right issues, placements and share purchase plans
What are the financial institutions?
Australian Securities Exchange, Banks, Investment Banks, Superannuation Funds, Life Insurance Companies, Unit Trusts
(ABI’S FLU)
Which government institutions have an influence on financial management?
- Australian Securities and Investments Commission (ASIC)
- Company taxation
What are the global market influences?
- Global economic outlook
- Availability of funds
- Interest rates
What are the steps in the planning cycle?
- Address the present financial position
- Determine financial needs
- Develop budgets
- Maintain record systems
- Identify financial risks
- Establish financial controls
(ADDMIE)
Which part of the syllabus does the planning cycle cover?
Processes of financial management
- Planning and implementing - financial needs, budgets, record systems, financial risks, financial controls
What are the 3 advantages of debt financing?
- Interest repayments on a loan is tax deductible
- Increased earnings and profits should be result of increased funds
- The bank or lending institution has no say in the way the business is run and does not have any ownership compared to equity finance
What are 3 disadvantages of debt financing?
- Regular repayments need to be made
- Assets can be held as collateral to the lender
- Increased risk as interest rates, bank charges, government charges and the principal have to be repaid
What are 3 advantages of equity financing?
- Less risk as nothing was borrowed
- Cheaper as there are no repayments
- Low gearing (internal resources are used rather than external)
What are 3 disadvantages of equity financing?
- Lower profits and returns for the owner
- Investors may need to be consulted before making big decisions
- The business becomes limited as it can only make money by selling shares. This is expensive and time consuming.
What is the accounting equation for the balance sheet?
Assets = Liabilities + Owner’s Equity
What does the balance sheet show managers?
- The financial stability of the business
- What the business owns and owes
How do you calculate the cost of goods sold?
Cost of Goods Sold = Opening stock + Purchases - Closing Stock
How do you calculate the net profit?
Net profit = Gross Profit - Expenses
What does the Income Statement tell managers?
How much money is being spent compared to how much is coming in and what is leftover as profit.
What does the Cashflow statement show managers?
- The ability of business to pay its’ debts on time
- Cash coming in and cash coming out of the business
- How finance is being used effectively in the business
How do you calculate the current ratio?
Current Assets divided by Current Liabilities
How do you calculate the Gearing ratio?
Total liabilities divided by Total equity
How do you calculate the Gross Profit ratio?
Gross profit divided by Sales times by 100 then expressed as a percentage
How do you calculate the Net profit ratio?
Net profit divided by sales times by 100 then expressed as a percentage
How do you calculate the accounts receivable turnover ratio?
Sales divided by Accounts Receivable, this is expressed as times per year. To express it in days, divide 365 by the figure.
How do you calculate the expense ratio?
Expenses divided by sales times by 100 and then expressed as a percentage.
How do you calculate return on owner’s equity ratio?
Net profit divided by Total equity times by 100 and then expressed as a percentage
What are the limitations of financial reports?
- Normalised earnings
- Notes to financial statement
- Capitalising expenses
- Debt repayments
- Timing issues
- Valuing assets
(2NCDTV)
What is the biggest ethical issue in preparing budgets?
Over-estimating revenues and underestimating costs.
What are the specific areas of ethical concern?
- Asset valuations
- Size of inventory
- Accounts receivable
What are the financial management legal regulations for companies?
- Act in good faith
- Exercise power appropriately
- Exercise reasonable discretion
- Avoid conflicts of interest
What is an audit?
An independent examination of financial records and the procedures used to create them
What are the 3 types of audits?
- Internal audits: conducted by employees
- Management audits: conducted to review the strategic plan
- External audits: conducted by independent specialist firms
What is cash flow?
The movement of cash in and out of the business over a period of time
What are the strategies for managing cash?
- Distribution of Payments
- Discounts for Early Payments
- Factoring
(DDF)
What is Working Capital?
Working Capital indicates the amount of available cash to meet short term debts
Why is controlling current assets important?
To ensure liquidity of a business
What aspects of current assets is controlled to ensure that working capital is managed?
- Cash
- Accounts Receivables
- Inventory
What aspects of current liabilities need to be controlled to ensure management of working capital?
- Accounts payable
- Loans
- Overdrafts
What are the strategies for managing working capital?
- Leasing
- Sale-and-Lease Back
What is profitability management?
Profitability management involves the control of businesses’ costs and revenue
What are 3 things that is being compared in the Comparative Ratio Analysis?
- How the business is performing over time (e.g. Comparing one year’s performance to the previous year/s)
- How the business compares to other businesses within the industry
- Against standard benchmarks
How do you improve profitability?
Sales MUST increase and expenses MUST decrease AT THE SAME TIME
What are fixed costs?
Costs that have to be paid regardless of what is happening
E.g. Salaries, insurance, rent, etc.
What are variable costs?
Costs that change proportionately with the level of operating activity
E.g. The Christmas period would result into an increase in materials and labour
What are the cost controls in profitability management?
- Fixed costs and variable costs
- Cost centres
- Expense minimisation
What are the two types of controls in profitability management?
Cost controls and revenue controls
- These are interdependent strategies ensuring that the businesses’ profitability is maximised
What are the two types of costs associated with cost centres?
Direct costs and indirect costs
What are direct costs?
Direct costs are sourced to a particular area
I.e. The HSIE department would have to pay for a Commerce app by themselves as they are only department in the school that would benefit from it.
What are indirect costs?
Indirect costs are sourced to many projects
I.e. Each of head of department of school would have to contribute towards the payment of a study app as it benefits all of them.
What is a cost centre?
A method of identifying and recording where, and the amount of costs that have been allocated to a particular area.
- Example: Each item that has been purchased are allocated to a certain number - stationery 100, raw materials 201, etc
- This allows the business to see how much money is spent in each area.
How do minimise expenses?
- Expense Minimisation
Focus on reducing costs everywhere
(FORCE)
- By reducing costs and keeping revenues high, profits increase!
Note: BE SPECIFIC!
What goes under the profitability management - revenue controls syllabus dot point?
Marketing objectives
What are the marketing objectives of revenue controls?
- Sales objectives
- Changing to sales mix
- Pricing policy
What does sales objectives involve?
Setting a high sales target for staff so that expenses can be met and a profit can be earned.
- costs-volume-profit analysis
What does sales mix involve?
- Changing sales mix
- Diversifying and expanding product range
For the purpose of meeting customer’s needs and wants
- This is a revenue control
What is pricing policy?
- Altering prices so that more profit is made and costs are covered.
This is a revenue control
What is Global Financial Management concerned with?
- Planning
- Organising
- Monitoring
- Controlling
of a businesses’ money and resources
What syllabus dot points go under Global Financial Management?
- exchange rates
- interest rates
- methods of international payment: payment in advance, letter of credit, clean payment, bill of exchange
- hedging
- derivatives
What are the methods of international payment?
- payment in advance
- letter of credit
- clean payment
- bill of exchange
What is payment in advance?
When the importer pays the exporter for its’ goods before they receive them.
What is the letter of credit?
- A guarantee from the importer’s bank to pay the exporter when the exporter fulfils the terms of the agreement.
What is clean payment (open account)?
- When the exporter’s goods are first shipped to the importer before the importer sends payment
- The importer receives an invoice stating:
.amount owed
.credit terms - Requires complete trust between importer and exporter
What is bill of exchange?
- A document drawn up by the exporter demanding payment from the importer at a specified time
What are the two types of bills of exchange?
- Document (Bill) against payment: importer can collect the goods only AFTER paying for them
- Document (Bill) against acceptance: importer may collect the goods BEFORE paying for them
What is hedging?
A global financial management strategy utilised by the business to minimise risk from currency/interest rate fluctuations.
E.g. Qantas & Fuel
What is a derivative?
- A form of hedging utilised to protect the business against fluctuation in price, demand and supply.
- Simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations
- It’s a product sold by banks
What is a spot exchange rate?
The value of one currency on a particular day.
What is spot exchange?
When two parties agree to exchange currency and finalise a deal immediately
What are the two types of hedging?
- Natural hedging: Doing things like arranging for import payments and export receipts to be in the same foreign currency
- Financial instrument hedging: these are financial products called derivatives
What are the 3 main derivatives available for exporters?
- Forward exchange contract
- Options contract
- Swap contract
What is a forward exchange contract?
A contract to exchange one currency for another at an agreed exchange rate on a future date, usually after a period of 30, 90 or 180 days
What is an 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
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 financial influence is the most difficult to manage?
Currency fluctuations
What is an exchange rate?
An established value of the country’s currency
This is achieved through the foreign exchange dealers’ buying and selling of each other’s currency.
The ratio of one currency to another- it tells how much one unit of currency is worth to another
What is the acronym for the global financial strategies?
C - Currency Fluctuations (Exchange Rates) H - Hedging I - Interest Rates M - Methods of International Payment D - Derivatives (CHIMD)
What is the effect of currency appreciation?
- This means that each unit of foreign currency buys LESS Aussie $
- Makes Australian exports more expensive (bad) on international markets but prices for imports will fall (good)
What is the effect of currency depreciation?
- This means that each unit of foreign currency buys MORE Aussie $
- Exports become cheaper (good) & price of imports rise (bad), making Australia more competitive globally
What is venture capital?
An organisation that provides finance for high risk business when banks or other organisations reject the business idea.
I.e. Richard Branson of Virgin
How does the Venture Capital method make money?
- Charging interest
- Gaining shares of the business
What is a key term that Miss Dalla likes?
Cash injection
- Used for working capital
What is the industry average of the current ratio?
2:1
What is the industry average for the Gearing ratio?
0.5 - 0.7: 1
What is the industry average for net profit?
Standard Industry Average = 10%
High = 11% - 18%
Low = Less than 10%
What is the industry average on return on owner’s equity?
18% = high
10 - 17% = average
Less than 10% = low
The higher, the better return.
What is the industry average for gross profit?
The higher, the better
- No real industry average however 40% - 50% is considered to be good
What does trade credit involve?
- Paying the debt you owe as late as possible from last specified date
What is an unsecured note?
A loan for a set period of time but is not backed by any collateral or assets
- Presents the most risk to the investors in the note (the lender).
- Higher rate of interest
What is a new issue?
Shares that are issued and sold for the first time
(AKA primary shares)
What is efficiency?
The ability of the business to use its’ limited resources effectively to maximise outcome of its’ goals and to remain financially stable & profitable
What are the short-term financial objectives of a business?
- tactical (1-2 years)
- operational (day-to-day)
- must be reviewed regularly to see if targets are being met and resources being used effectively
- most important short-term financial goal is to remain liquid
What are the long-term financial objectives of a business?
- strategic plans of the business (greater than five years)
- tend to be broad (e.g. increase profits, increase market share) however a number of short-term goals need to be achieved first
- need to be reviewed annually
- long term goals include efficiency, solvency, profitability, growth
What does the term “turnover” refer to?
How quickly money is gained
What is the most important thing to do when deciding which strategies to recommend?
Go back to the statement
What are the strategies to improving liquidity ratio?
- Tighten credit policy
- Encourage cash payments
- Factor debts
- Negotiate payment plans with suppliers
- Leasing
- Sale-and-lease-back
What are the strategies to improving solvency ratio?
- Increase owners equity
- Reinvest profits
- Negotiate payment plans with suppliers
- Source cheaper loans
What are strategies to improve the gross profit ratio and why?
- Source cheaper suppliers: this will reduce COGS
- Increase sale price of items: to earn more
- Have a sale: to get rid of excess stock hence reducing closing stock
What are strategies to improving the net profit ratio and why?
- Reduce expenses: BE specific
- Increase sale price of items: to earn more revenue
- Have a sale: to get rid of excess stock
What are strategies to improving return on owner’s equity ratio?
- Whatever used for Net Profit works well here!
- Reinvest profits: as you borrow less by doing this!
What does retained profits involve?
Profits that have been earnt but not distributed
- Business can utilise the funds for emergency situations
What is a commercial bill?
- A type of bill of exchange issued by institutions other than banks
- This is given for larger amounts, usually over $100 000
- For a period of between 90 and 180 days
What are the types of leasing?
Operating leases- short periods (usually shorter than the life of the asset). Can be cancelled without penalty
Financial leases- for the life of the asset (usually 3-5 years). Penalties for cancellation
What is a debenture?
Issued by a company for a fixed rate of interest and for a fixed period of time
- Not secured to property
What is a mortgage?
A loan secured by the property of the borrower (business).
- Used to finance property purchases (e.g. factory, office, etc)
- Repaid via regular repayments up to 15-30 years
What does leasing involve?
The payment of money for the use of equipment that is owned by another party
What is private equity?
- money invested in a private company not listed on the ASX
- aim is to raise capital to finance future expansion/ investment of the business
What is new issue?
Shares that are issued and sold for the first time
(AKA primary shares)
What is a rights issue?
A privilege given to shareholders to buy more shares within same company
What is a placement?
- An allotment of shares, debentures, and so on made directly from the company to investors
What are share purchase plans?
An offer to existing shareholders in a listed company the opportunity to purchase more shares in that company without brokerage fees
What are the characteristics of company taxation?
- Companies in Australia must pay tax on
profits at a flat rate of 30% - Company tax is paid before profits are distributed to shareholders (dividends)
What are the characteristics of the Australian Securities and Investment Commission?
- Enforces and administers Corporations Act & protects consumers in areas of investments, life & general insurance, superannuation
- Aim is to assist in reducing fraud and unfair practices in financial markets
What is the Global Economic Outlook?
- Projected changes to the level of economic growth throughout the world
Provide characteristics of the positive outlook (boom)
- Increase in demand for products/ services
- Increase in profits as sales increase
- Increase in investment leading to an increase in interest rates
Provide characteristics of a negative outlook (recession)
- Decrease in demand for products/ services
- Reduction in sales as profits drop
- Decrease in investment due to a decrease in interest rates
What is the availability of funds?
- The ease with which a business can access funds for borrowing on the international finance markets
- Various conditions and rates apply
- GFC in 2008/2009 impacted greatly on the availability of finance on a world wide scale
What are interest rates?
- Cost of borrowing money
- The higher the level of risk, the higher the interest rate
- Australia’s interest rates are generally higher than the US or Japan, so businesses tend to borrow $$ from overseas when wanting to expand globally
How has globalisation affected financial management?
Has created more interdependence between economies and their financial sectors which relies on trade to expand & increase profits
What are the factors to consider when matching the terms and sources of finance to business purpose?
- terms of finance
- the structure of the business
- flexibility of the source of funds
- the availability of the finance
- the level of control over the finance
What are the 3 types of budgets?
- Operating budgets: Related to the main activities of the business I.e. Sales, production, COGS
- Project budgets: Related to capital expenditure and R&D
- Financial budgets: Related to the financial data of the business and include the income statement, balance sheet and cash flow
What are the 3 types of activities in the Cashflow statement?
- Operating activities: main activity I.e. Provision of goods and services
- Investing activities: Purchase and sale of non - current assets and investments. Used to generate income of the business I.e. Selling equipment
- Financing activities: Borrowing activities i.e. Inflow - capital contribution from owner, outflow - repayment of debts
What is the industry average in both days and times per year for accounts receivable turnover ratio?
30 days and 12 times per year
What are normalised earnings?
- Adjusting for one off influences or taking off something from the balance sheet to show the true earnings of a company
- Removal of one time of unusual influences from the balance sheet
I.e. Sale of land
What are Nots to Financial Statements?
Any additional information that will assist investors in understanding the business’ reports:
- accounting methods
- additional information
- record transactions
What are capitalising expenses?
Adding a capital expense to the balance sheet that’s regarded as an asset rather than expense
I.e. Research and Development
What are debt repayments in limitations to financial reports?
- Any money that is owed to or by the business
- Financial statements don’t disclose any information about debt repayments
I.e. How long the business has been trying to recover the debt and it’s’ process
List the methods of payment that is of least risk to the most risk for the exporter
- Payment in advance
- Letter of credit
- Bill of exchange
. Document against payment
. Document against acceptance - Clean payment
What are strategies to improve expense ratio?
- Reduce expenses (be specific)
- Source cheaper suppliers
- Increase sales (by either having a sale or increase sale place)
What are strategies to improving accounts receivable turnover ratio?
- Tighten credit policy
- Increase sales (by either having a sale or increase sale price)
- Factoring
What are the 3 types of expenses?
- Selling expenses: I.e. Maintaining a company car
- Admin expenses: I.e. Wages for sales executives
- Financial expenses: I.e. Interest
What does timing issues involve?
When the business delays the recording of a purchase in their balance sheet
- This will gives a misleading interpretation of the business’ position
What does valuing assets involve?
- The process of estimating the market value of assets or liabilities
I.e. Recording an asset for more or less its’ market value
Why is working capital management important?
To ensure the appropriate balance occurs between current assets and current liabilities.
What current assets need to be controlled in working capital management?
- Accounts receivable
- Stock/Inventory
- Cash at bank
What current liabilities need to be controlled in working capital management?
- Accounts payable
- Loans
- Overdraft
What are the statements that need be controlled in financial management?
- Cash flow statement
- Income statement
- Balance sheet
