Finance Processes (other than ratios)

Question 1

How do businesses plan and implement financial management?

Answer 1

• Determine financial needs
• Set budgets
• Use record systems
• Identify financial risks
• Set financial controls

Question 2

What are 2 examples of financial needs?

Answer 2

1) Growth (e.g. needing funds for new equipment)
2) Low cash flow (e.g. a fall in sales revenue)

Question 3

How do you set budgets and why would you do it?

Answer 3

• Work out how much will be spent on a project (such as a new factory) and how much money should be spent on it
• Setting a budget can help predict costs and prevent a cost blowout

Question 4

How do you use record systems?

Answer 4

Use physical or electronic records to track every time money is spent or received, so that no money goes missing

Question 5

What are 3 possible financial risks?

Answer 5

• Interest rate changes
• Exchange rate changes
• Customers don’t pay when due
• Recession leads to fall in sales

Question 6

What are financial controls, and what are some examples?

Answer 6

Ways to prevent unnecessary spending, e.g:

• requiring staff get approval for any purchase
• having a process for collecting overdue accounts receivable
• preventing theft by keeping cash in a safe or bank

Question 7

What are the main advantages of debt over equity?

Answer 7

1) Retains ownership and control
2) Retains all profits (no dividends)
3) Can be acquired quicker than external equity

Question 8

What are the main advantages of equity over debt?

Answer 8

1) Doesn’t need to be repaid
2) Doesn’t have interest
3) Doesn’t require security
4) Doesn’t worsen solvency

Question 9

Why is it important to match the terms of finance to business purpose?

Answer 9

Use short-term debt if funds can be paid back quickly to avoid unnecessary interest costs.

But use long-term debt if it will take a long time to repay to avoid being unable to pay when it is due.

Question 10

Why is it important to monitor the current ratio?

Answer 10

If a business has a low current ratio, it may struggle to pay bills on time, leading to late fees and the need to borrow more debt.

Question 11

Why is it important to monitor the gearing ratio?

Answer 11

If a business has a high gearing ratio, it is less likely to be able to repay its debts and therefore at risk of insolvency and liquidation (business closure).

Question 12

Why is it important to monitor the accounts receivable turnover ratio?

Answer 12

If a business takes too long to collect its accounts receivable, it is likely to be short of cash. This is inefficient because it will then have to borrow funds and pay interest on it

Question 13

What are normalised earnings on financial statements?

Answer 13

Smoothing one-off changes in revenue (e.g. from selling property) or expenses (e.g. buying property) across multiple years.

Question 14

Why are normalised earnings a limitation of financial reports?

Answer 14

If you don’t normalise earnings, the one-off event might make the business look more or less profitable in a given year than it actually is.

Question 15

What is capitalising expenses?

Answer 15

Removing expenses from the income statement, and adding them as assets on the balance sheet

Question 16

Why is capitalising expenses a limitation of financial reports?

Answer 16

If you capitalise expenses, it makes your profit look higher than it actually is and your assets look more valuable than they actually are

Question 17

Why is valuing assets a limitation of financial reports?

Answer 17

It is hard to know what some assets such as land or goodwill are actually worth.

The way a business estimates the value of these assets on its balance sheet will change how much it looks like the business is worth

Question 18

What are timing issues on financial statements?

Answer 18

Businesses often spend or receive cash in a different time period to the activity that incurred that expense or revenue.

For example:

• a business might buy stock in Year 1 but not sell it until Year 2. The cost of buying the stock should be recorded in Year 2.
• a business might sell stock in Year 2 but not receive payment until Year 3. The revenue should be recorded for Year 2.

Question 19

Why are timing issues a limitation of financial reports?

Answer 19

If you don’t record revenue and expenses in the period when the relevant business activity occurred, then some years will look more or less profitable than they actually were.

Question 20

Why are debt repayments a limitation of financial reports?

Answer 20

A business might include debts owed to it in its assets on its balance sheet, even if they are overdue and/or unlikely to be received.

Question 21

What are notes to the financial statement?

Answer 21

When businesses publish their financial reports for investors, they must include information explaining all the adjustments and calculation methods they made (e.g. how they normalised earnings, how they valued assets etc.)

Question 22

Why is it important to be ethical in financial management?

Answer 22

1) Maintain a good reputation
2) Avoid the government bringing in new regulations and potential penalties

Question 23

What are 3 unethical financial practices?

Answer 23

1) Profit shifting to other countries to minimise tax

2) Forecasting unrealistically to mislead investors

3) Managers having a conflict of interest (where they make decisions from which they could personally benefit)

Question 24

What are 3 ways to be ethical in financial management?

Answer 24

1) Make accurate financial reports

2) Use audits to check the accuracy of financial reports and use of funds

3) Use Triple Bottom Line reporting to also report the business’ impact on the environment and society

Question 25

What is the case study for unethical financial management?

Answer 25

Apple - profit shifting to Ireland

Question 26

How can a business improve its current ratio?

Answer 26

• Sale and leaseback
• Replace short-term debts with long-term debts

Question 27

How can a business improve its gearing ratio?

Answer 27

• Use cash to pay off some of its debt
• Sell shares to increase equity

Question 28

How can a business improve its profitability ratio?

Answer 28

Use any of the profitability strategies:
- Cost controls (fixed and variable costs, cost centres, expense minimisation)
- Revenue controls (marketing objectives)

Question 29

How can a business improve its expense ratio?

Answer 29

Use the cost control strategies (fixed costs, cost centres, expense minimisation)

Note: reducing the cost of stock will not reduce expenses (because stock is in COGS)

Question 30

How can a business improve its accounts receivable turnover ratio?

Answer 30

• Have a shorter time period for customers to pay
• Give customers reminders to pay
• Have late fees and a debt collection process if they don’t pay
• Use factoring

Question 31

Why is it important to monitor the return on equity ratio?

Answer 31

If a business has a low RoE ratio, shareholders are not receiving much profit on their investment. Therefore, they are likely to sell their shares and invest elsewhere.