FINANCE

Question 1

[role] Strategic role

Answer 1

The strategic role of financial management is to provide the financial resources to allow the implementation of the business’s strategic plan. It ensures that a new business continues to operate, grow and is able to achieve its financial objectives.

Question 2

[Role] Objectives of financial management

Answer 2

Profitability- the ability of a business to maximise profit. This is achieved by carefully monitoring the business’s revenue and pricing policies, costs and expenses.

Growth- the ability of the business to increase its size in the longer term. Growth ensures that a business is sustainable into the future.

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.

Liquidity- the ability of a business to pay short-term liabilities using current assets. Therefore the current assets need to be greater than the current liabilities.

Solvency- the extent to which a business can meet its financial commitments in the longer term

Question 3

[Role] Interdependence with other KBF

Answer 3

Operations- finance is required for inputs, machinery, land, etc. to create value whilst receiving a return on investments.

Marketing- finances are required for advertising to occur which generate sales

HR- finance is important aspect to help human resources achieve its resources. The information finance gathers on earnings, productivity and customer satisfaction provides insights into the staffing and development needs of a business and without this HR cannot do their job effectively.

Question 4

[Influences] External sources of finance

-debt- short-term borrowing

Answer 4

Debt: short term borrowing

Factoring- selling of a company’s accounts receivable (money that is owed to a business) at a discount to a finance company for immediate cash.

Overdraft- an arrangement between the business and its bank that allows the business to borrow money from the bank at short notice through its cheque or current account.

Commercial bills- are a type of bill of exchange (loan) issued by institutions other than banks.

Question 5

[Influences] debt- long-term borrowing

Answer 5

Debentures- fixed interest securities issues by a company that will pay a fixed interest rate on the money loaned to the company for a set time period. They are issued by a company for a fixed rate of interest and for a fixed time.

Unsecured notes- are loans made by finance companies and are not secured by any assets, and therefore presents the most risk to the investors in the note (the lender). For this reason it attracts a higher rate of interest than a secured note.

Leasing- short-term operational procedures

Mortgage- loans with a fixed schedule of payments that is repaid over a number of years with interest

Question 6

[Influences] Equity: ordinary shares

Answer 6

New issues- a security that has been issued and sold for the first time on a public market.

Rights issue- the privilege granted to shareholders to buy new shares in the same company

Placements- allotment of shares, debentures, etc, made directly from the company to investors

Share purchase plans- an offer to existing shareholders in a listed company the opportunity to purchase more shares in that company without brokerage fees. The share can also be offered at a discount to the current market price.

Question 7

[Influences] Private equity

Answer 7

Private equity refers to securities that are held in companies that are not listed and not publicly traded in the Australian Securities Exchange (ASX). The aim of the private company (like the publically listed companies who sell ordinary shares) is to raise capital to finance future expansion/investment of the business.

Question 8

[Influences] Financial institutions

Answer 8

BANKS- Accept deposits from the general public and provide funds for loans and, in turn, make investments

INVESTMENT BANKS- Provide specialised advice and services for businesses financial needs. They deal with businesses and governments in raising large amounts of capital by underwriting share issues.

FINANCE COMPANIES- Make loans to consumers and businesses. They raise capital through share issues and funds through debenture issue.

SUPERANNUATION FUNDS- Collect portion of wage to set aside until retirement

LIFE INSURANCE COMPANIES- Customers pay premium to cover risks

UNIT TRUSTS- Take funds from a large amount of small investors

ASX- Exchange shares

Question 9

[Influences] Government

Answer 9

ASIC- Australian Securities and Investments Commission

ASIC aims to reduce fraud and unfair practises in financial markets and financial products.

COMPANY TAXATION

Companies and corporations in Australia pay company tax on profits. Company tax is paid before profits are distributed.

Question 10

[Influences] Global market

Answer 10

ECONOMIC OUTLOOK

The projected changes to the level of economic growth throughout the world. It may increase the demand for products/services and the interest rates on funds borrowed internationally.

AVAILABILITY OF FUNDS

Refers to the ease with which a business can access funds on the international financial markets. The availability of funds depends on the risk, demand and supply and the domestic economic conditions.

INTEREST RATES

Interest rate are the cost of borrowing money. The higher level of risk involved in lending to a business, the higher the interest rates.

Question 11

[Processes] Plan/imp. Financial needs

Answer 11

Financial needs are essential to determine where a business is headed and how it will get there. Important financial information needs to be collected before future plans can be made. A new business will have to determine its start-up costs, e.g. cost of equipment and employees. Once a business has begun operations financial information from balance sheets, incomes statements and cash flow statements need to be analysed to determine if profits can be given to shareholders.

Question 12

[Processes] Plan/imp. Budgets

Answer 12

Budgets provide information in quantitative terms about requirements to achieve a particular purpose. Budgets are often prepared to predict a range of activities relating to short-term and long-term plans and activities.

Question 13

[Processes] Plan/imp. Record Systems

Answer 13

Record systems are the mechanisms employed by a business to ensure that data is recorded and the information provided by record systems is accurate, reliable, efficient and accessible.

Question 14

[Processes] Plan/imp. Financial Risks

Answer 14

These are the risks to a business of being unable to cover its financial obligations, such as the debts that a business incurs through borrowings, both short-term and longer term.

Question 15

[Processes] Plan/imp. Financial controls

Answer 15

Financial controls are the policies and procedures that ensure that the plans of a business will be achieved in the most efficient way. This enables the manager to determine if the objectives set were achievable or need to be reassessed.

Question 16

[Processes] Plan/imp. Debt financing

Answer 16

Relates to the short-term and long-term borrowing from external sources by a business. External (debt finance) is a liability as it is owed to sources external to the business.

Advantages:
• Readily available
• Interest payments can be tax deductible
• Increased funds lead to increased earnings and profits
• Loans provide a business with the opportunity to grow
• Profits are not shared with the lender of the loan

Disadvantages:
• Costs to a business-establishment costs and ongoing fees and charges
• Security is required by the business
• Regular payments have to be made
• Increased risk if debt comes from financial institutions because the interest that the bank charges
• Interest rates can vary over the loan period-making it more expensive
• If it is a secured loan, defaulting on the loan may lead to loss of an asset

Question 17

[Processes] Plan/imp. Equity financing

Answer 17

Related to the internal sources of finance in the business. It is the money lent to the business in exchange for ownership, including start-up capital.

Advantages:
• Remains in the business for an indefinite time
• Does not need to be repaid on a set date
• Safer than debt
• Cheaper that other sources of finance as there is no interest
• There is flexibility in timing of dividend payments
• The debt to equity (gearing/leverage) ratio decreases, lowering the risk to the business

Disadvantages:
• Requires sufficient profits to be made so that the business can continue to operate
• Lower profits and lower returns for the owner
• Equity is hard to obtain and can take time to organise and, therefore, may limit growth
• Not tax deductible
• Central ownership is reduced, causing a loss of control in decision-making
• High demand for dividend payments to shareholders may reduce the level of retained profits

Question 18

[Processes] Plan/imp. matching the terms and source of finance to business purpose

Answer 18

When a business identifies and plans to meet its financial objective, it is necessary to match the terms of finance with its purpose. This requires a business to consider:
• The terms, flexibility and availability of finance
• The cost of each source of funding- equity and debt
• The structure of the business- small business and public company

Question 19

[Processes] Limitations of financial reports

Answer 19

DR. VANETICE

DEBT REPAYMENTS
Financial reports can be limited because they do not have the capacity to disclose specific information about debt repayments e.g. how long the business has had or has been recovering the debt.

VALUING ASSETS
The process of estimating the market value of assets or liabilities. Some assets change value over time due to inflation and the market. Therefore it would have been worth less in the past ad would not reflect the true value.

NORMALISED EARNINGS
Earnings on the balance sheet are adjusted to remove unusual or “one-off” events to show the true earnings of the company.

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 financial fluctuations.

CAPITALISING EXPENSES
Process of adding a capital expense to the balance sheet that is regarded as an asset (in that it will add to the value of the company) rather than as an expense.

Question 20

[Processes] Ethical issues related to financial reports

Answer 20

Businesses have legal and ethical responsibility to provide accurate financial records.

Ethical issues include:

• AUDITS- independent check of accuracy of financial records and accounting procedures.
• RECORD KEEPING
• GST OBLIGATIONS
• REPORTING PRACTISES
• Should not attempt to make a business look more profitable
• Business credit card for personal expenses

Question 21

[Strategies] Cash flow management

Answer 21

CASH FLOW STATEMENTS
Indicate the movement of cash. Used to show the trends of short-term and long-term cash inflows and outflows.

DISTRIBUTION OF PAYMENTS
By spreading expenses over the whole year there is more equal cash outflow each month rather than one huge outflow one month.

DISCOUNTS FOR EARLY PAYMENT
A business may offer discounts to encourage people to pay their payments early to improve cash flow.

FACTORING
The selling of accounts receivable for a discounted price to a finance company.

Question 22

[Strategies] Working capital management- CONTROL OF CURRENT ASSETS

Answer 22

Working capital- the funds available for short-term financial commitments of a business.

CONTROL OF CURRENT ASSETS
Cash - It is the most liquid current asset in the business. it is important as it allows the business to be able to pay its debts, loans and accounts in the long-term. Businesses can increase their cash amount by sale and leaseback. However, too much cash can be unproductive.
Accounts receivable - the total money that customers owes to a business. The collection of accounts receivable is important in managing working capital. Managing accounts receivable involves: checking credit rating of prospective customers, sending customers statements monthly and at the same time each month so debentures know when to expect accounts, following up on accounts that are not paid by the due date and putting policies into place for collecting bad debts.
Inventories - the total amount of goods or materials in a store or factory (stock). Inventory controls involves a balance between too much and too little stock. Strategies involved in the management of inventory include: regular and ongoing stocktaking, control systems, use of sales to convert stock into cash.

Question 23

[Strategies] Working capital managements- CONTROL OF CURRENT LIABILITIES

Answer 23

CONTROL OF CURRENT LIABILITIES

    Accounts payable - sums of money owed by the business to its suppliers. Some strategies include payment on time, taking advantage of early payment discounts and maintain a good credit rating for continuing access to lines of credit provided by suppliers.
    Loans - sums of money that are borrowed from financial institutions for the purpose of funding such things as property and equipment. Control of loans involves comparing the cost of the loan to other sources of finance to find the most appropriate and cost effective source.
    Overdraft - a relatively cheap and convenient form of short-term borrowing. Businesses may control overdrafts by ensuring that all cash received is promptly deposited in the business's account to reduce the amount owing.

Question 24

[Strategies] Working capital managements- STRATEGIES

Answer 24

STRATEGIES

Leasing- the hiring of an asset from another person or company. By leasing assets the business maintains more working capital to invest in other assets and opportunities for expansion of the business.

Sale and lease-back - involves selling of assets such as buildings and equipment and leasing them back from the purchaser. This increases a business’s liquidity as the cash that is obtained from the sale is used as working capital.

Question 25

[Strategies] Profitability management- COST CONTROLS

Answer 25

COST CONTROLS

Fixed and variable costs

• fixed cost do not change when the level of activity changes e.g. rent, insurance. To minimise fixed costs it is essential to negotiate satisfactory arrangements initially or to take advantage of discounts for early payments.
• variable costs change proportionally with the level of operating activity in a business e.g. advertising, employee wages, overtime payments. Strategies to reduce variable costs include: negotiating discounts with all suppliers, reducing the number of suppliers and/or switching to a cheaper supplier.

Cost centres
- the expenses associated with each key business function. Businesses attempt to control costs by allocating a proportion of total costs to particular parts of the business. These cost centres are then responsible and held accountable for the costs that they incur.

Expense minimisation
- the reduction of costs and expenses in order to maximise the profits and gain a competitive advantage. Strategies include outsourcing, sales and lease-back, replacing labour with technology and improving the budget and accountability. This is done to reduce expenses consuming valuable resources within the business.

Question 26

[Strategies] Profitability management- REVENUE CONTROLS

Answer 26

REVENUE CONTROLS

Marketing objectives:

• sales objectives- the link between the marketing plan and the financial plan. Sales targets are to maximise sales, increase the turnover of stock and maximise revenues.
• sales mix - the range of products and services sold by the business. Businesses should control this by maintaining a clear focus on the important customer base when decided whether to diversify or extend product ranges or ceasing production. Need to review each product’s profit-margin contribution.
• Pricing policy - is necessary as the setting of prices is a complicated task and staff need to be aware of the business strategy for pricing. The main aim of pricing policy is to balance sales with profits. Pricing decisions should be closely monitored and controlled. Overpricing could fail to attract customers, while under-pricing may bring higher sales but may result in cash shortfall and low profits. Need to review price penetration, price skimming, price points and discounts.

Question 27

[Strategies] Global financial management - EXCHANGE RATES

Answer 27

The foreign exchange rate is the ratio of one currency to another; it tells us how much a unit of one currency is worth in terms of another. Exchange rates fluctuate over time due to variations in demand and supply. Such fluctuations in the exchange rate create further risk for global businesses. Currency fluctuations will impact on the revenue profitability and production costs.

A currency appreciation raises the value of the Australian dollar in terms of foreign currencies. This means that each unit of foreign currency buys fewer Australian dollars. However, one Australian dollar buys more foreign currency. Therefore, an appreciation makes our exports more expensive on international markets but prices for imports will fall. The result of the appreciation reduces the international competitiveness of Australian exporting businesses.
A currency depreciation lowers the price of Australian dollars in terms of foreign currencies. Therefore, each unit of foreign currency buys more Australian dollars. The result is that our exports become cheaper and the price of imports will rise. An depreciation, therefore, improves the international competitiveness of Australian exporting businesses.

Question 28

[Strategies] Global financial management - INTEREST RATES

Answer 28

INTEREST RATES

Interest rates can have an impact on the willingness and ability of businesses to invest in business activities, and of customers to purchase goods and services. Low interest rates reduce borrowing costs and encourage expansion. High interest rates increase borrowing costs and discourage expansion. It is therefore important to find the lowest interest rate, as exchange rate fluctuations can make repayments more costly.

Question 29

[Strategies] Global financial management - METHODS OF INTERNATIONAL PAYMENT

Answer 29

METHODS OF INTERNATIONAL PAYMENT

Payment in advance: the exporter/seller receives payment by the buyer before the products are sent. There is a risk of the goods not being sent.

Letter of credit: commitment where the buyer/importer’s bank promises to pay the exporter a specified amount when the documents proving shipment of goods are presented.

Clean payment: the goods are shipped before payment is received. This is used when businesses and their exporters have a good relationship and history.

Bill of exchange: a document written by the exporter demanding payment from the importer at a specified time. This method of payment allows the exporter to maintain control over the goods until payment is either made or guaranteed.

Question 30

[Strategies] Global financial management - HEDGING

Answer 30

HEDGING

Hedging is the process of minimising the risk of currency fluctuations. Hedging helps reduce the level of uncertainty involved with international financial transaction.

Question 31

[Strategies] Global financial management - DERIVATIVES

Answer 31

DERIVATIVES

Derivatives are financial instruments that support a business’s hedging activities. It is a financial contract that is based on the future market value of an asset such as a commodity, shares or currency. The main purpose is to reduce risk for one party. They include:

1. Forward exchange contracts= the bank will guarantee the exporter a certain exchange rate on a certain rate.
2. Currency option contracts= gives the buyer the right to buy or sell foreign currency at some time in the future.
3. Swap contracts= an agreement to exchange currency in the spot market to reverse the transaction in the future.