Finance Flashcards
Strategic role
long-term financial management
Business objectives
break the business operations into achievable and
manageable outcomes that can be measured and evaluated
Financial management
planning and monitoring of a business’s financial resources to enable the business to achieve its financial goals
Financial resources
business resources with a monetary or money value
Objectives of financial management
profitability, growth, efficiency, liquidity, solvency
short-term and long-term
Profitability
refers to the profit a business receives in return for its productive effort and investment
increase sale revenue or decrease expenses
Growth
the ability of the business to increase its size in the longer term
direct expansion
merging
acquisition
Efficiency
the ability of a business to use its resources effectively in ensuring financial stability and profitability
Liquidity
the extent to which a business can meet its short-term financial commitments
too much = miss opportunities
increase sale revenue or decrease expenses
Solvency
the extent to which a business can meet its long -term financial commitments
Short-term financial objectives
tactical (1-2 years) and operational (day to day)
They are reviewed regularly to see if targets are being met and if resources are being used to the best advantage to achieve financial objectives.
Long-term financial objectives
strategic (3+ years)
They tend to be broad goals and each will require a set of short-term goals to assist in achievement
The business should review their progress annually to determine if changes need to be implemented
HR + Finance
funds- wages, training
aim- efficiency
ex. qantas fund 275m on training
Operations + Finance
funds- inputs
aim- efficiency, decrease costs, liquidity
ex. qantas fund 2b on new planes (2013-2014)
Marketing + Finance
funds- promo, research
aim- growth, increase market share
ex. qantas budget plans (jetstar) and marketing
Internal finance
funds provided by the owners of the business (ex.
owners equity) or from the outcomes of the business activities (retained profits)
Owner’s equity
funds contributed by owners or partners to establish and build the business
Retained profits
all profits that are not redistributed, but are kept in the business as cheap and accessible sources of finance for future activities
External sources of finance
debt :
short term borrowing (cof- commercial bills, overdraft, factoring)
long term borrowing (muld- mortgage, unsecured notes, leasing, debentures)
equity:
ordinary shares (prns- placements, rights issues, new issues, share purchase plan)
private equity
External finance
funds provided by sources outside the business
Debt
funds obtained from a source outside the business
long term + short term
Overdraft
an account with a bank allowing a business to overdraw on their account up to an agreed figure
–> costs are minimal/ interest rates are low –> assists in short term liquidity problems
Commercial bills
bills of exchange issued by an institution and in large amounts (more than 50k) over a period of 90-180 days
–> borrower receives the sum immediately + promises to repay with interest at a future date, secured against business assets –> cash to help meet financial obligations
funds repaid within a year
Factoring
selling accounts receivable for a discounted price to a finance or factoring company
–> raise funds immediately –> meet financial obligations –> not received full amount of accounts receivable
Without recourse - business transfers responsibility for bad debts to factoring company
With recourse -bad debts are still business’ responsibility
Mortgage
a loan secured by the property of the borrower or business ex. property
asset mortgaged can’t be sold or used as security for more borrowings until mortgage is repaid
–> fund real estate, land, building purchases
Debentures
issued by a company (large business) for a fixed rate of interest and for a fixed amount of time (usually 3-20 years)
fixed interest rate - not impacted by business profits
security offered over the company’s assets
Unsecured notes
a loan from investors for a set period of time
not secured against business assets
high interest rate due to increased risk to investor
Leasing
involves the payment of money for the use of equipment owned by another party
operating leases - assets leased for time + interest and eventually own asset
financial lease - assets leased for time + interest, never owns asset
advantages:
payments are tax deductions
without reducing control of ownership
keep up to date with technology
disadvantages:
interest charges may be higher than other forms of borrowing
Advantages and disadvantages of debt
advantages: payments are tax deductions without reducing control of ownership easily available different types increase possible profit
disadvantages: more financial obligations may cost more over time can require security too much can scare off investors increased risk
Advantages and disadvantages of equity
advantages:
cheaper than debt (dividends not legally required)
doesn’t add to debt
fewer risks
disadvantages:
long process
ownership is diluted
not as many options
Dividends
distribution of a company’s profits to shareholders
Sale and leaseback
a financial transaction where one sells an asset and
leases it back long term, continuing to use the asset but no longer owning it
New issues
a security that has been issued and sold for the first time on a public market
offered during an initial public offering (IPO)
requires prospectus
rime consuming
Rights issue
privilege granted to shareholders to buy new shares in the same company
Rights issue
privilege granted to shareholders to buy new shares in the same company
no obligation to buy
Placement
additional shares offered at a discount to certain investors
faster
pay extra fees to make up shortfalls
Share purchase plan
offer to existing shareholders to purchase more shares without brokerage fees
does not require a prospectus
faster
Private equity
money invested in a private company (not listed on the ASX)
aim is to raise capital to finance future expansion/investment
shares offered privately to potential investors
Financial institutions
Banks Unit trusts Finance companies Superannuation funds Investment banks Life insurance companies
Banks
main provider of finance to business and consumers
can only provide loans that have an acceptable level of risk
ex. commonwealth, westpac
offers: deposit accounts (transaction, cheque, savings, fixed term), overdrafts, credit cards, short + long term loans, leases, services (advice)
Investment banks
specialise in investment banking for medium to large cooperations
ex. macquarie bank, ABN AMRO
offers: commercial bills, loans (secured/ unsecured) , investment funds (managed funds, hedged funds), financial market trading (debt securities, fx)
Finance companies
loans to business and consumers
usually higher interest rates w less strict criteria
raise funds by issuing debentures to public
ex. GB finance, Esanda
offers: loans, credit cards, leasing, factoring
Superannuation funds
financial contributions that individuals and their employers make to fund for retirement
ex. AGEST, CBUS
offers: equity capital, debt securities
Insurance companies
cover various risks that people and businesses face, such as life insurance (compensation in event of death/ injury)
ex. GIO, NRMA
offers: premiums, equity capital
Unit trusts
managed by a trustee (usually a company), raise funds from investors and invest those funds in various investments
can earn higher return from pooled funds than if acted independently (avoids tax)
ex. investment funds of australia….unit trust
offers: mortgage funds, cash management trusts, share market funds (equity growth funds), property trusts types: property trusts mortgage trusts equity trusts fixed interest trusts
Australian Securities Exchange (ASX)
primary stock exchange group in Australia provides a forum for businesses and individuals to buy and sell shares
Primary market- enables a company to raise new capital through the issue of shares
Secondary market- pre owned securities such as shares are traded between investors
Integrated Trading System (ITS) providing a system for transfer of ownership
CHESS- keeps record of share ownership
Influence of government
ASIC
Company taxation
Australian Securities and Investment Commission (ASIC)
regulates financial companies, financial markets, financial services organisations and professionals
aim: protect consumers by reducing fraud + unfair practices in financial markets
By:
ensures companies follow the law - can investigate + determine appropriate remedies (e.g. prison)
collects info about companies + makes it available to the public
Company taxation
all companies must pay tax
27% of net profit
Aus. government aims to reform the federal tax system to make Australia a more attractive place to invest
Global market influence
Availability of funds
Interest rates
Economic outlook
Economic outlook
refers specifically to the projected changes to the level of economic growth throughout the world
Positive:
increased demand for products and services → increased production trade + output
decrease interest rates for funds borrowed internationally from financial markets (due to decreased risk of repayments)
Negative:
decreased product demand + increased interest rates
Availability of funds
the ease in which a business can access funds for borrowing on international financial markets
Based on:
Risk
Demand + supply
Domestic economic conditions
GFC → increased interest rates due to high risk levels in lending (due to decreased availability of funds)
Interest rates
cost of borrowing money
more risk = more interest
Aus has higher interest rates than most countries
→ businesses borrowing from overseas sources due to lower interest rates
***increased risks of currency fluctuations = low interest rates might cost more
Process of financial management
planning + implementing monitoring + controlling financial ratios limitations of financial reports ethical issues related to financial reports
Planning and implementing
record systems budgets financial controls financial needs financial risks
Financial needs
must know needs in order to determine business direction
financial information must be collected
financial position determined by balance sheets, income + cash flow statements
financial needs of a business are determined by:
Business size
Current phase of BLC
Future plans of growth + development
Budget
provide information in quantitative terms (facts and figures) regarding the requirements to achieve a particular purpose
show:
cash required for planned outlays for a particular period the cost of capital expenditure and associated expenses against earning capacity
estimated use and cost of raw materials or inventory number and cost of labor hours required for production
Types of budgets
Operating
Project
Financial
Project budgets
relate to capital expenditure, + research + development
include information about the purpose of asset purpose, lifespan of an asset + revenue the asset would generate
Operating budgets
relate to the main activities of a business
can include budgets relating to sales, production, expenses + COGS
Financial budgets
financial data of a business
Record systems
mechanisms employed by a business to ensure that data are recorded and the information provided by record systems is accurate, reliable, efficient and accessible
management bases decisions on this information when needed
minimise errors- double entry system ensures errors are found quickly
Financial risks
the risks to a business of being unable to cover its financial obligations
bad debts can reduce profitability
highly geared –>inability to meet financial obligations → bankruptcy
liquid in order to meet short-term commitment
exchange rate risks (hedging can help)
Financial controls
policies + procedures ensuring that business plans will be achieved efficiently common causes of financial problems: theft fraud loss of assets errors in record systems
**budgets are form of financial control
Factors that must be considered when preparing a budget
review of past figures + trends
proposed expansion
proposals to alter price + quality of products
external environment considerations
Terms and purpose
must be suitable to the structure and purpose of the funds
Ex short-term finance should be used to match short-term purposes such as managing a temporary cash shortfall
Sources
a business will need to consider the costs, benefits and risks associated with debt and equity finance and choose that which is most appropriate
Matching principle
current liabilities fund current assets/ non current liabilities fund non current assets
Monitoring and controlling
cash flow statement
income statement
balance sheet
Financial ratios
liquidity: high current ratios (2:1)
gearing: low
debt to equity ratio (1:2 small, 100% for large companies)
profitability: high
gross profit ratio
net profit ratio
return on equity (over 20%)
efficiency:
expense ratio low
accounts receivable turnover ratio high (14-30)
comparative ratio analysis:
over different time periods
against common standards
with similar businesses
Limitations of financial reports
normalised earnings capitalising expenses valuing assets timing issues debt repayment notes to financial statements
Normalised earnings
unusual or one off events that affect profit or financial stability are removed, as they are not consider a normal aspect of the business revenue
Capitalising expenses
accounting method where expenses are recorded as an asset on the balance sheet instead of an expense on the income statement
understates expenses + overstates profits and assets
ex. R&D
Valuing assets
the process of estimating the value of assets when recording them on a balance sheet, because value can depreciate/appreciate or hard to value
Type of finance for stock/ inventory
overdraft/ commericial bill
Type of finance for manufacturing equipment
debentures (5 year)
Type of finance for factory building
mortgages
Type of finance for company cars
leasing
Type of finance for company cars
leasing
Timing issues
do not include income/ expenses hat occur outside time period
matching principle → accurate representation of financial position
Debt repayments
the money owed to the business or owed by the business
recording of debt repayments can distort the ‘reality’ of the business’s status
Notes to the financial statement
additional information provided (on how reports were prepared which affects figures)
Ethical issues
businesses have an ethical + legal responsibility to provide accurate financial records
business laws regulate management conduct + the requirement to disclose accurate information
important for shareholders - investment decisions based on this information
Audit
an independent check of the accuracy of financial records + accounting procedures
internal Audit: Conducted to review the business’s strategic plan + determine if changes need to be made
external audits: Requirement of the Corporations Act 2001 (Cwlth)
Financial reports are investigated by an independent audit accountant to guarantee authenticity
Auditor publishes a statement indicating the accuracy of the financial records + reports
Fictitious revenue
revenues that do not exist included
Hidden liabilities and expenses
not included in balance sheet or income statments
fradulent asset valuations
variation of historical value
reckless valuing of intangibles ex goodwill
Financial strategies
cash flow management
working capital management
profitability management
global finance management
Cash flow
movement of cash into and out of a business over a period of time
Problems if too much is going out or not enough is going in
Inflows - sales, accounts receivable
Outflows - payments to suppliers, loan interest, operating expenses + loan repayments
Cash flow statements
used to plan for periods where business expect a shortage of cash - avoid liquidity issues
ex. apple outsourced debt finance in 2015 –> decrease in outflows by 53%
Cash flow strategies
distribution of payments
discounts for early payment
factoring
Distribution of payments
distribute payments throughout the month, year or other period - ensures large expenses don’t occur at the same time + prevents cash shortages
pay when due unless incentives are provided for paying early
equal cash outflow each month
Discounts for early payment
Effective when targeted at creditors with large amounts owing to the business
Positively impacts business’ cash flow
Factoring
selling accounts receivable to factoring firms at a discounted price
instant cash injection into business - immediate cash inflow
business saves on costs involved in following up on debt collection
Working capital strategies
sale
leasing
sale and lease back
Balance sheet
shows financial stabillitiy
short term compare current assets to current libailities using liquidity ratio
long term determine gearing
Revenue/income/ profit and loss statement
profitabiltity - gross profit ratio, net profit ratio
efficiency- expense ratio, accounts turnover ratio
Common current assets (3)
cash
inventories
accounts receivable
Common current liabilities (3)
accounts payable
loans
overdrafts
Leasing
is the hiring of an asset from another person or company who has purchased the asset and retains ownership of it
frees up cash that can be used elsewhere in the business = the level of working capital is improved
an expense = tax deductible
operating leases - assets leased for time + interest and eventually own asset
financial lease - assets leased for time + interest, never owns asset
Sale and lease back
is the selling of an owned asset to a lessor and leasing the asset back through fixed payments for a specified number of years
increases liquidity - cash is obtained from the sale → cash being used as working capital
Profitability strategies
cost controls:
fixed and variable
cost centres
expense minimisation
revenue controls:
marketing objectives
Fixed costs
not dependent on the level of operating activity
ex. salaries, depreciation, insurance, lease
Variable costs
change proportionately according to the level of business activity
ex. materials and labor used in the production of a particular item
Cost centres
particular areas/departments/sections of a business to which costs can be directly attributed
Direct costs: are those that can be allocated to a particular product
ex. depreciation of equipment used solely in the production of one good
Indirect costs: shared by more than one product ex. the depreciation of equipment used to make several products would have indirect costs allocated on some equitable basis
Expense minimization
eliminate waste and unnecessary spending
Marketing objectives
aim to increase sales → increased revenue
sale objectives must aim for a level of sales which covers fixed + variable costs → profit
cost-volume-profit analysis sales mix (product) pricing policy (price)
Cost-volume-profit analysis
determine revenue levels needed to cover costs + to break even
Sales mix (product)
clear focus on the important customer base on which most of the revenue depends on by diversifying or extending product ranges, or ceasing production on particular lines
research should be carried out to identify the potential effects of sales mix changes before decisions are made
Pricing policy (price)
overpricing may fail to attract buyers
under-pricing may → higher sales but cash shortages + low profits
factors influencing pricing:
costs of producing the good/ service
prices charged by competitors - consumers are price conscious today
short + long-term goals
image + quality expectation of customers
government policies
ex. apple decreased selling price in 2015 which resulted in increased profit (cheaper suppliers)
Global financial management
hedging methods of int. payment derivatives interest rates exchange rates
Exchange rate
value of a country’s currency in terms of another
effects:
fluctuations → risk for global businesses
appreciation → international market exports more expensive but imports cheaper
depreciation → foreign currency units buying more AUD$ → cheaper exports + more expensive imports = more competitive
ex. apple in appreciation of = lower sales revenue and demand (2016)
Interest Rates
global businesses can borrow funds from interest financial markets to increase competitiveness
high risk - exchange rate movements - long-term: ‘cheap’ rates may cost more
effects:
high interest = increase borrowing costs and discourage expansion
low interest = reduce borrowing costs and encourage expansion
Methods of international payment
payment in advance
clean payment- open account
letters of credit
bills of exchange
Clean payment- open account
export goods first
more secure for importer = more risks for exporter
payment in advance
import pay first
more risks for importer = more secure for exporter
Bills of exchange
A document drawn up by the exporter demanding payment from the importer at a specified time
less secure for exporter but can comunicate directly to banks to reduce risk
Document (bill) against payment:
importer collects goods after payment
Document (bill) against acceptance:
importer may collect goods before payment
Letters of credit
a document the buyer can request from their bank that guarantees payment of goods will be transferred to the seller
more risk for importer if terms are not met = more secure for exporter as bank takes on risk
commitment can’t be withdrawn by bank
Hedging
the process of minimising the risk of currency fluctuations
natural hedging strategies:
establishing offshore subsidiaries
arranging for import payments + export receipts in the same foreign currency
implementing marketing strategies that attempt to reduce price sensitivity in exported products
insisting that both import + export contracts are denominated in Australian dollars
Derivatives
financial instruments used to lessen the exporting risks associated with currency fluctuations
forward exchange contract
options contract
currency swap
Spot exchange rate
the value of one currency in another currency on certain day
Forward exchange contract
contract to exchange one currency for another at an agreed exchange rate on a future date
Options contract
option to buy and sell foreign currency at some time in the future
Currency swap
agreement to exchange currency in the sport market with an agreement to reverse the transaction in the future
Gross profit formula
sales - cogs
Net profit formula
gross profit - expenses
Assets
liabilities + equity
