Finance Notes Flashcards
Define financial management
Financial Management is the planning and monitoring of a business’s financial resources to enable the business to achieve its financial objectives
Define strategic plan
Strategic Plan is a plan that encompasses the strategies that a business will use to achieve its long-term goals; 3 - 5 years
Recall the strategic role of financial management
The strategic role of financial management:
- Setting financial objectives
- Sourcing finance
- Preparing budgets and forecasting future finances
- Preparing financial statements
- Maintaining sufficient cash flow
- Distributing funds
Define financial resources
Financial Resources are those resources in a business that have a monetary or money value
Recall the objectives of financial management
The objectives of financial management:
- Profitability
- Growth
- Efficiency
- Liquidity
- Solvency
Define profitability
Profitability is the excess of revenue or income over expenses or costs
Define growth
Growth is the ability of the business to increase its size in the longer term
Recall the factors that impact profitability
Profitability is affected by:
- Revenue
- Pricing policies
- Costs and expenses
- Inventory level
- Level of assets
Recall the factors that impact growth
Growth of a business depends on its ability to increase:
- Revenue
- Profits
- Market share
Define efficiency
Efficiency is 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 liquidity
Liquidity is the extent to which a business can meet its financial commitments in the short term (less than 12 months)
Define solvency
Solvency is the extent to which the business can meet its financial commitments in the longer term (more than 12 months)
Define gearing
Gearing is the proportion of debt (external finance) and the proportion of equity (internal finance) that is used to finance the activities of a business. Gearing ratios determine the firm’s solvency
Explain the relationship between solvency and gearing
Gearing indicates the dependency of the business on external (debt) financing and hence, the ability of the business to pay off the debt
Explain why conflicts may arise between the short and long term financial objectives
Conflicts may arise as both short and long term objectives require resources, making them incompatible to a degree
Define interdependence
Interdependence is the mutual dependence that the key business functions have on one another
Outline the interdependence between finance and marketing
Finance funds the marketing activities
Marketing activities generate revenue
Outline the interdependence between finance and operations
Finance funds the operational activities
Operations makes the product, which is a profit and cost centre as it generates revenue and is costly
Outline the interdependence between finance and human resources
Finance funds the human resources
Human resources allows the business to function efficiently, generating funds
Recall the internal sources of finance
The internal sources of finance are retained profits
Define owner’s equity
Owner’s Equity is the funds contributed by owners or partners to establish and build the business, e.g. partners, private investors, selling assets, and private shares
Define retained profits
Retained Profits (earnings) is kept in the business as a cheap and accessible source of finance for future activities. Most businesses keep some of their profit in the form of retained earnings
Recall the statistic regarding retained profits
On average, Australian businesses retain 50% of profits to be invested
Recall the external sources of finance
The external sources of finance are:
- overdraft
- commercial bills
- factoring
- mortgage
- debentures
- unsecured notes
- leasing
- new issues
- right issues
- placements
- share purchase plans
- private equity
Classify overdraft
debt - short-term borrowing
Classify commercial bills
debt - short-term borrowing
Classify factoring
debt - short-term borrowing
Classify mortgage
debt - long-term borrowing
Classify debentures
debt - long-term borrowing
Classify unsecured notes
debt - long-term borrowing
Classify leasing
debt - long-term borrowing
Classify new issues
equity - ordinary shares
Classify right issues
equity - ordinary shares
Classify placement
equity - ordinary shares
Classify share purchase plan
equity - ordinary shares
Classify private equity
equity
Define overdraft
Overdraft is when a bank allows a business or individual to overdraw their account up to an agreed limit and for a specified time, to help overcome a temporary cash shortfall
No regular repayment schedule
Define commercial bills
Commercial Bills are primarily short-term loans issued by financial institutions, for larger amounts (usually over $100 000) for a period of generally between 30 and 180 days
Flexible in interest and repayment period
Define factoring
Factoring is the selling of accounts receivable for a discounted price (typically 90% of the accounts’ value) to a finance or factoring company
Define factoring without recourse
‘Without recourse’ means that the business transfers responsibility for non-collection to the factoring company
Define factoring with recourse
‘With recourse’ means that bad debts will still be the responsibility of the business
Define mortgage
Mortgage is a loan secured by the property of the borrower (business)
Repaid with interest, usually through regular repayments, over an agreed period of time
Define debenture
Debenture is a promise issued by a company to repay a loan for a fixed rate of interest and for a fixed period of time
Define unsecured note
Unsecured Note is a loan from investors for a set period of time. Unsecured notes are not secured against the business’s assets
Higher interest rate than secured notes
Define leasing
Leasing is the payment of money for the use of equipment that is owned by another party
Usually, a long-term lease cannot be cancelled
Recall the types of leasing
The types of leasing are:
- Operational
- Financial
Define operational lease
Operating leases are assets leased for short periods, usually shorter than the life of the asset. The owner carries out the maintenance on the asset. Operating leases can be cancelled, often without penalty
Define financial lease
Financial leases involve the lessor purchasing the asset on behalf of the lessee. Financial leases are usually for the life of the asset. Lease repayments are fixed for the economic life of the asset, usually between three and five years. Plant, vehicles, equipment, furniture and fittings are leased as financial leases. There are usually penalties for cancellation of financial leases. Leasing assets for long periods as financial leases is cheaper than leasing them as operating leases
Outline the benefits of leasing
- Assists a business with their cash flow
- The costs of establishing leases are low
- If some assets are leased a business may be in a better position to borrow funds
- Provides long-term financing without reducing control of ownership
- Permits 100% financing of assets
- Repayments of the lease are fixed for a period so cash flow can be monitored easily
- Lease payments are a tax deduction
- Payment usually includes maintenance, insurance and finance costs
Define equity
Equity, as an external source of funds‚ refers to the finance raised by a company through inviting new owners
Define dividend
Dividend is a distribution of a company’s profits (either yearly or half-yearly) to shareholders, calculated as a number of cents per share
Define new issue
A new issue is a security that has been issued and sold for the first time on a public market
Define rights issue
A rights issue is an invitation to existing shareholders to purchase additional new shares in the same company
Define placement
A placement involves creating new shares in return for capital and issuing them to selected investors at a discount to the market price of the company’s shares
Define share purchase plans
Share purchase plan is an offer to existing shareholders in a listed company to purchase newly issued shares in that company without brokerage fees
Define private equity
Private Equity is the money invested in a (private) company not listed on any stock market, such as the Australian Securities Exchange (ASX)
Recall the types of financial institutions
The types of financial institutions are:
- Banks
- Investment banks
- Finance companies
- Superannuation funds
- Life insurance companies
- Unit trusts
- The Australian Securities Exchange
Unit funds are also known as ___
Unit funds are also known as mutual funds
Define unit funds
Unit funds are financial institutions that pools a large sum of money from investors and invests it, typically in minerals, such as gold or silver
Define the Australian Securities Exchange (ASX)
Australian Securities Exchange (ASX) is the primary stock exchange group in Australia
Define primary market
Primary Market deals with the new issue of debt instruments by the borrower of funds
Define secondary market
Secondary Market deals with the purchase and sale of existing securities
Recall the company tax rate in Australia
In Australia, the company tax rate stands at 30% unless the company does not exceed the threshold (of $50mil AUD turnover) then it is 25%
True or False: Global market influences are largely ‘controllable’
False. Global market influences are largely ‘uncontrollable’
Recall the global market influences
The global market influences are:
- Economic outlook
- Availability of funds
- Interest rates
Recall the factors on the availability of funds
The availability of funds is affected by:
- Risk
- Demand and supply
- Domestic economic conditions
Recall the types of financial information
Types of financial information include:
- Balance sheet
- Revenue Statement (Income statement
- Cash flow statement
- Sales and price forecast
- Budget
- Bank statement
- Weekly reports from departments
- Break-even analysis
- Reports from financial ratio analysis and interpretation
Define budget
Budget is a financial document used to estimate future revenue and expenses over a period of time
Describe the role of a budget
Budgets:
- provide an accurate picture of income and expenses
- drive important business decisions in relation to finance
- reflect the strategic planning decisions
Define operating budgets
Operating Budgets relate to the main activities of a business and may include budgets relating to sales, production, raw materials, direct labour, expenses and cost of goods sold
Define project budgets
Project Budgets relate to capital expenditure, and research and development
Define financial budgets
Financial Budgets relate to financial data of a business and include the budgeted income statement, balance sheet and cash flows
Define record systems
Record Systems are the mechanisms employed by a business to ensure that data are recorded and the information provided is accurate, reliable, efficient and accessible
Recall the benefits of keeping financial records
Keeping financial records is beneficial as:
- It assists in decision-making as the business has a clear understanding of the finances
- It encourages investment as investors and financial institutions are unlikely to invest in business’ with unclear financial details
- Businesses are required by law to keep records of their financial transactions for at least five years for tax purposes
Define financial risk
Financial Risk is the possibility of an inability to cover its financial obligations, such as incurred debts
Recall the types of financial risk
Types of Financial Risk:
- Credit risk
- Market risk
- Liquidity risk
- Operational risk
Define credit risk
Credit Risk is the risk a business takes on when borrowing money and without sufficient funds to meet repayments, the business incurs penalties and interest
Define market risk
Market Risk is the risk arising from the changing conditions in the specific market in which a company competes for business, such as increased competition
Define liquidity risk
Liquidity Risk is the risk depending on the cash flow and whether the business has sufficient funds to meet their financial obligations. Therefore, it also refers to how easily a business can convert their assets into cash should they need funds
Define operational risk
Operational Risk is the risk associated with the day-to-day management of a business, such as legal problems, fraud risk, human resource issues, and business model risk. Operational risk largely arises from poor management
Define financial controls
Financial Controls are the procedures, policies and means by which a business monitors and controls the allocation and usage of its resources
Define debt finance
Debt Finance is the short-term and long-term borrowing from external sources by a business
Define equity finance
Equity Finance relates to the internal sources of finance in the business
True or False. Short-term assets and financial objectives should be achieved through the use of short-term finance and vice versa otherwise, it is not compatible
True
Define credit rating
Credit Rating is a measure of an entity’s track record in meeting financial commitments
Recall the broad categories of credit ratings
Credit ratings grade the business in 2 broad categories – investment grade and speculative grade
Define cash flow statement
Cash Flow Statement is a financial statement that indicates the movement of cash receipts and cash payments resulting from transactions over a period of time
Recall the main categories of a cash flow statement
Main categories of a cash flow statement:
- Operating activities
- Investing activities
- Financing activities
Define operating activities (cash flow statement)
Operating Activities are the cash inflows and outflows relating to the main activity of the business — that is, the provision of goods and services
Define investing activities (cash flow statement)
Investing Activities are the cash inflows and outflows relating to the purchase and sale of non-current assets and investment
Define financing activities (cash flow statement)
Financing Activities are the cash inflows and outflows relating to the borrowing activities of the business
Define income statement
Income Statement is 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
Income statements are also known as ___
Income statements are also known as revenue statements
Define cost of goods sold
Cost of Goods Sold (COGS) is the value of stock that a business has sold to its customers
Define gross profit
Gross Profit is a value derived from subtracting cost of goods sold from operating income/sales (Operating income/Sales − COGS)
Define net profit
Net Profit is the difference between the gross profit and expenses (Retained/Net profit = Gross profit − Expenses)
Net profit is also known as ___
Net profit is also known as retained profit
Define expenses
Expenses are the costs incurred in the process of acquiring or manufacturing a good or service to sell and the costs (direct and indirect) associated with managing all aspects of the sales of that good or service
Define selling expenses
Selling Expenses are costs related to the process of selling the good or service; can be directly traced to the need for sales
Define administration expenses
Administration Expenses are costs directly related to the general running of the business
Define finance expenses
Finance Expenses are costs associated with borrowing money from outside people or organisations and to minimising business risk
Define balance sheet
Balance Sheet is a summary of a business’s assets and liabilities at a particular point in time, expressed in money terms; represents the net worth of the business
Recall which financial information can only be prepared at the end of a financial year
A balance sheet can only be prepared at the end of a financial year
Define current items
Current Items are items that are expected to be resolved within a year
Define non-current items
Non-current Items are items that are expected to be resolved for more than a year
Define accounting equation
Accounting Equation is a equation that shows the relationship between assets, liabilities and owners’ equity, which forms the basis of the accounting process
Recall the accounting equation
Assets = Liabilities + Owners’ equity
Define financial ratios
Financial Ratios alters financial information into significant and acceptable forms that are more meaningful and consumable
Recall the types of analysis
The types of analysis are:
- Vertical
- Horizontal
- Trend analysis
Define vertical analysis
Vertical Analysis compares figures within one financial year
Define horizontal analysis
Horizontal Analysis compares figures from different financial years
Define trend analysis
Trend Analysis compares figures for periods of three to five years
Define current ratio
Current Ratio is a measure of a business’s ability to pay back its current liabilities with its current assets. The higher the current ratio, the more capable the business is of meeting its short-term obligations
Current asset / current liability
Define debt to equity ratio
Debt to Equity Ratio shows the extent to which the firm is relying on debt or outside sources to finance the business
total liabilities / equity
Define gross profit ratio
Gross Profit Ratio provides the percentage of sales revenue that results in gross profit, indicating the effectiveness of planning policies concerning pricing, discounts, valuation of stock etc
gross profit / sales
Define net profit ratio
Net Profit Ratio shows the amount of sales revenue that results in net profit and illustrates the amount of sales revenue that results in net profit
net profit / sales
Define return on equity ratio
Return on Equity Ratio shows how effective the funds contributed by the owners have been in generating profit, and hence a return on their investment
net profit / total equity
Define expense ratio
Expense Ratio compares total expenses with sales and indicates the amount of sales that are allocated to individual expenses, such as selling, administration, cost of goods sold and financial expenses
Indicates the day-to-day efficiency of the business
total expenses / sales
Define accounts receivable turnover ratio
Accounts Receivable Turnover Ratio is a measure of the effectiveness of a firm’s credit policy and how efficiently it collects its debts (how quickly debits pay their accounts)
sales / accounts receivable
Recall how a business can determine the average length of time it takes to convert the balance into cash
A business can determine the average length of time it takes to convert the balance into cash in days by dividing 365 by the accounts receivable turnover ratio
Recall what comparative ratio analysis can be compared against
Comparative ratio analysis can compare against:
- Time periods
- Standards and benchmarks
- Competitors and industry standards
Define normalised earnings
Normalised Earnings are earnings that have been adjusted to take into account changes in the economic cycle or to remove one-off or unusual items that will affect profitability, providing a more accurate depiction of the true earnings of a company
Define capitalising earnings
Capitalising Expenses refers to how a cost is treated on a business’s financial statement
Define valuing assets
Valuing Assets is the process of estimating the value of assets when recording them on a balance sheet and can be difficult for non-current assets
Recall the issues with valuing assets
Issues with valuing assets:
- Most assets are recorded as the historical cost and wild fluctuations in value, especially for non-current assets, cannot be properly valued
- Intangible assets hold subjective value and cannot be valued properly
Define matching principle
Matching Principle is a means of ensuring the revenue earned and costs incurred match up. It involves recording expenses incurred by a business on the income statement for the accounting period in which the revenue to which those expenses relate is earned. In other words, when an accountant records revenue, they should also record at the same time any expenses that were directly related to that revenue
Recall the purpose of notes to the financial statements
Notes to the financial statement are similar to footnotes, in that, they provide clarity and necessary information to potential investors
Recall what the notes to the financial statements may include
Notes to the financial statement may include:
- Accounting methodology
- Calculations of figures
- Procedures
Recall the types of audits
Types of audits:
- Internal audits
- Management audits
- External audits
Define internal audits
Internal Audits are conducted internally by employees to check accounting procedures and the accuracy of financial records
Define management audits
Management Audits are conducted to review the firm’s strategic plan and to determine if changes should be made. The factors affecting the strategic plan may include human resources, production processes and finance
Recall when an external audit must be conducted
Under the Corporations Act 2001 (Cth), when a company becomes a large proprietorship, an External Audit must be conducted
Under the Corporations Act 2001 (Cth), when a company becomes a large proprietorship, what must occur?
Under the Corporations Act 2001 (Cth), when a company becomes a large proprietorship, an External Audit must be conducted
Recall the criteria for the Australian Securities and Investments Commission (ASIC) to defines a company as being ‘large’
The Australian Securities and Investments Commission (ASIC) defines a company as being ‘large’ if, at the end of the financial year, the company meets two of the following three criteria:
- A consolidated revenue of $50 million or more
- Consolidated gross assets of $25 million or more
- 100 or more employees
Define cash flow
Cash Flow is the movement of cash in and out of a business over a period of time
Define inflow
Inflows consist of sales, cash payments for accounts receivable, interest received, and dividends
Define outflow
Outflows consist of payments to suppliers, interest on loans, operating expenses, drawings, and the purchase of assets
Define cash flow statement
Cash Flow Statement is a financial statement that indicates the movement of cash receipts and cash payments resulting from financial transactions over a period of time
Define distribution of payments
Distribution of Payments occurs when businesses or individuals spread out their payments across each month to ensure large expenses do not occur at the same time and cash shortfalls do not occur
Provide an example of discounts for early payments and explain why the business provides such inventices
An example of discounts for early payments is tuition centres and the incentives include:
- Acquire funds quicker
- Accelerate the rate of inflows
- Reduce the risk of non-payment or late payment
- Anticipate demand
Define working capital
Working Capital are the funds available for the short-term financial commitments of a business
Define net working capital
Net Working Capital is the difference between current assets and current liabilities
Define receivables
Receivables are sums of money owed to a business from customers to whom it has supplied
Define payables
Payables are sums of money owed by a business to other businesses from who it has purchased goods and services
Differentiate between a fixed and variable cost
A fixed cost is a regular cost that occurs regardless of business activity. On the other hand, a variable cost is an erratic cost that is dependent on the level of business activity
Define expense minimisation
Expense Minimisation is a financial strategy that aims to achieve the most cost-effective way of delivering goods and services to the required level of quality
Define exchange rates
Exchange Rates are the value of one country’s currency in terms of another currency
Explain the effect of net appreciation of a currency on international trade
A net appreciation makes:
- exports more expensive
- imports cheaper
Explain the effect of net depreciation of a currency on international trade
A net depreciation makes:
- exports cheaper
- imports more expensive
List the methods of international payment ordered in increasing risk to the exporter
The methods of international payment ordered in increasing risk to the exporter are:
- Payment in advance
- Letter of credit
- Bill of exchange
- Clean payment
Define payment in advance
Payment in Advance is a method that allows an exporter to receive payment first then arrange for the goods to be sent
Define letter of credit
Letter of Credit is a document that a buyer can request from their bank that guarantees the payment of goods will be transferred to the seller
Define bill of exchange
Bill of Exchange is a document draw up by the exporter demanding a payment from the importer at a specified time period
Differentiate between the bill of exchange
The difference is when the payment occurs.
Types of bill of exchange
- Document against payment (importer collects the goods after paying)
- Document against acceptance (importer collects the good before paying)
Define clean payment
Clean Payment is an open account method that involves the exporter shipping the goods directly to the importer before the payment is received
Define hedging
Hedging is the process of minimising the risk of currency fluctuations
Recall types of natural hedging
Natural hedges:
- Established offshore subsidiaries
- Arranging for import payments and receipts denominated in the same foreign currency
- Implementing marketing strategies that aim to reduce price sensitivity of exports
- Insisting on import and export contracts in local currency (AUD)
Define derivatives
Derivatives are simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations
Define forward exchange contract
Forward Exchange Contract is a contract to exchange a currency for another currency at an agreed exchange rate on a future date usually 30, 90, or 180 days
Define options contract
Options Contract gives the buyer (options holder) the right but not the obligation to buy or sell foreign currency at some time in the future
Define swap contract
Swap Contract is an agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future
Recall what the acronym ASIC is
Australian Securities and Investments Commission
Recall the role of the Australian Securities and Investments Commission (ASIC)
The Australian Securities and Investments Commission (ASIC) is an independent statutory commission accountable to the Commonwealth parliament that enforces and administers the Corporations Act 2001 (Cth)
Recall strategies to manage accounts receivable
Strategies to Manage Accounts Receivables include:
- Discounts for early payment
- Strict credit policies
- Checking the credit rating of prospective customers
Recall strategies to manage cash
Strategies to Manage Cash include:
- Budgets
- Cash flow statements
- Distribution of Payments
Recall strategies to manage accounts payable
Strategies to Manage Accounts Payable include:
- Discounts
- Interest free credit periods
- Extended terms for payment
Recall the derivatives
The derivatives are:
- Forward exchange contract
- Options contract
- Swap contract
Recall the aspects of the financial planning cycle in sequence
The aspects of the financial planning cycle are:
- (determining) financial needs
- (developing) budgets
- (maintaining) record systems
- (identifying) financial risks
- (establishing) financial controls
Recall what “matching the terms and source of finance to business purpose” referred to
“matching the terms and source of finance to business purpose” referred to the purpose of obtaining a source of finance and whether the duration matched with the source of finance and purpose
Recall the strategies to increase working capital
The strategies to increase working capital are leasing and sale and lease back
Provide an allegory of sale and lease back
Sale and lease back occurs in football when a team sells a talented youngster to a larger club but has the player loaned back
Recall the advantages and disadvantages of debt finance
Advantages:
- Funds are readily available
- Fuels growth
- Repayments are tax deductible
- Flexibility
- Does not dilutes ownership
Disadvantage:
- Security of some sorts is required
- Regular repayments
- Increases financial risk
Recall the advantages and disadvantages of equity finance
Advantages:
- No repayments unless owner leaves
- No interest
- Low gearing
- Low risk
Disadvantages:
- Lower profits and returns for owner
- Lengthy process to obtain funding
- Dilutes ownership
Compare and contrast the use of leasing and mortgage as a source of finance
Leasing:
- No ownership
- Payments cover insurance and other benefits
- Payments are tax deductible
- No significant outlay
- Lease could be terminated depending on terms
Mortgage:
- Ownership
- Payments are tax deductible
- Financial risk - may forcefully lose the building for a lower value
- Interest on repayments
Recall the cost controls
- fixed and variable costs
- cost centres
- expense minimisation
Recall the revenue controls
- marketing objectives
Recall the derivatives
The derivatives are:
- Forward exchange contract
- Swap contract
- Options contract
