Financial Management Flashcards
Trading/retailing
Businesses purchase goods for resale at a profit
Maintain inventory of goods
Sales are the main forms of income
Selling and distribution expenses
Services
Do not usually maintain inventory as what they sell is the expertise and experience of staff
Income is earned by providing personal service
Management of non-current assets
- The purchase cannot be reversed over time
- It involves large sums of money
- It is geared to long term and so this results in a degree of uncertainty as to future economic conditions and the ability to pay the debt back
- the debt has to be paid and this decreasing cash reduces the firms ability to pay back other debts so the business must be sure it will be able to finance all its obligations
Management of accounts receivable
Means that customers may purchase immediately instead of delaying because of a lack of funds and customers may purchase more because they receive credit
Managing the level of accounts receivable involves:
- internal controls to minimise bad debts
- costs associated with accounting for accounts receivable
- maintaining an appropriate level of debtor turnover
- the delayed cash inflows and bad debts and their effect or liquidity
Inventory
A business must maintain an appropriate level of inventory turnover, not only to be profitable but also to create the cash inflows necessary to repay the debt
Managing inventory levels includes
Having internal controls that ensure that record keeping is complete and accurate, stock is secure and stock losses are prevented
If the type or quantity of inventory is incorrect this can result in slow-moving items or stock being out of date or deteriorating
Over investment
Can lead to oppourtunity cost in that the funds could have been better utilised in some other type of investment
Underinvestment
Can lead to a loss of sales or disruption to production
Cash
Sufficient cash must be held to meet normal operational demands so that debts can be repaid, expenses paid, assets acquired and advantage taken over discounts
Management of cash involves:
- maintaining liquidity: ensuring the business can pay debts as they fall due
- earning an appropriate rate of return on assets
- timing cash flow, setting a cash budget
- cost of cash: accumulating cash instead of using it in the business and the costs of keeping cash secure
Too much cash
In a cheque account is costly as there are fees and a very low interest rate applies
Too little cash
Lead to liquidity problems, important to arrange overdraft facilities in advance
Short term debt
Borrowing which needs to be paid within 90 days to 12 months
An inability to pay this back can leave a company insolvent
An appropriate level of short-term debt is one that will provide the funds necessary but one that will not impact on liquidity so that debts cannot be paid as they fall due
Managing short-term debt
Budgets and cash flow statements should be undertaken monthly so that management is aware of its ability to pay back short-term debt and correct any adverse trends before they occur leading to an inability to lay back the debt
Long term debt
Usually financed over a 10-20 year period
When taking on long-term debt, the costs of the debt should be compared to the income generated by what is done with the funds
Most common types are mortgages and debentures
Equity capital
Is money provided by the business owners (shareholders) to finance the business
If the business is unable to repay the debt, creditors may take control of the business
If equity capital is too high the business will find it difficult to secure debt financing
Ordinary shares
Are past-owners of the business and have voting rights, entitled to receive a dividend but is not guaranteed
Preference shares
Do not have voting right, entitled to a guaranteed dividend
Cash management trust
Raises money and invests this money in short term securities (treasury notes)
Investors are paid interest on the money they have invested
The money market
Is a place where banks and other financial institutions buy and sell debt such as, promissory notes, bank bills and commercial bills
The holder of the hill receives the face value of the bill when it matures
Term deposits
Is an amount of money that has been invested with a financial institution (bank) for a fixed period of time, at a fixed interest rate
Shares
Is the unit of ownership of a company
The ASX is a market place for the buying and selling of the shares of companies listed on the exchange
Debentures
A loan made to the company
An investor receives interest at a fixed rate on the money loaned
A debenture is backed by a right to sell the property of the company if the loan is not repaid on time
Unsecured notes
Is a loan to a company where the money borrowed is not secured by any right to sell the property of the company if the loan is not repaid
Unit trusts
Raises money that is invested in assets, such as fixed interest bank deposits, land or shares of companies listed on the ASX
Term deposits (long-term)
Is money invested with a financial institution (bank) for a fixed period of time, at a fixed interest rate
Management accounting
Area of accounting concerned with providing financial and other information to all levels of management in an organisation to enable them to carry out their planning, controlling and decision-making responsibilities
Financial accounting
Concerned with reporting information to users external to an entity in order to help them to make sound economic decisions about the entity’s performance and financial position
The financial accountant is heavily involved in the determination of an entity’s overall financial performance, position , financing and investing activities and information as to whether the entity is complying with the requirements of the law
Role of management accountant
Assistance in planning, controlling, organising, motivating and decision making
Assistance in Planning
Assists planning by providing information
May be about pricing, capital expenditure projects, product costs or competition
Assistance in controlling
Supplies performance reports which compare actual performance with the planned performance and which therefore highlight those activities which are not conforming to plan
Assistance in organising
By ensuring that the accounting system is tailored to the organisational structure
The management accountant reinforces the objectives of the organisational framework
Assistance in motivating
Budgets prepared by the management accountant serve to motivate managers and subordinates to attempt to achieve the organisations objectives
Performance reports produced by the management accountant for the control process also motivate by communicating performance information in relation to the targets which have been set
Assistance in decision making
The management accountant is a vital cog in the organisations decision making process
He/she collects and analyse data, and presents information to managers to help in the decision making
Internal users
The managers of the firm need information that will assist them to plan, coordinate and control the business on a day to day basis and make decisions that will maximise the profitability of the firm and secure the security and integrity of its assets
Most businesses would produce some sort of profit statement and cash flow statement at least monthly and perhaps more often than that
External users- owners
The shareholders need information to enable them to evaluate the performance of the business, compare it with alternative investments and identify trends that may impact on the future value of their investment
Members of the media are also users
ASX is a user of reports produced by companies whose shares are quoted on the ASX
External users: Customers and suppliers
Those relying on a business as a market for their product or as a source of stock or components for manufacture need to know whether that business is likely to remain in existence
Will therefore have a greater interest in its continuing profitability and stability
External users: lenders
Will rely on financial information to assess the financial viability of the borrowers and its capacity to repay the loan and meet interest payment obligations
External users- employees
Have an interest in the firms future viability and thus the likelihood that they will continue to be employed
External users: governments
The federal/state governments need financial information from businesses
In the form of specific reports used by the government to assess the income tax liability of the owners of the business itself
Business protection from exploitation (1st way)
The development of an accounting conceptual framework, with associated accounting standards, which sets out principles and rules with which all producers of financial reports are encouraged and some are required by law to comply
Business protection from exploitation (way 2)
Legislation governing the operation of certain forms of business entity, notably the Corporations Act 2001
Business protection from exploitation (way 3)
The requirement that certain entities must have their accounting systems and reports checked by an independent expert
SAC 1
Defines a ‘reporting entity’ which is an organisation that must comply with standards in the production of its financial reports
SAC 2
Defines a general purpose financial report
This is a report whose users rely on it as their sole or main source of information to assist their economic decision-making
The purpose of general purpose financial reports is to enable:
- users to assess the financial performance, position and liquidity of the business
- users to assess the financing and investing decisions made by the entity
- those charges with the responsibility of managing the entity to show compliance with statutory requirements
Type of financial reports
Financial accounting is highly regulated and subject to external audit and provides general purpose reports that are historical in nature and often out of date once issued
These general purpose finance reports are statement of financial position (balance sheet), statement of comprehensive income (income statement), statement of changes in equity and statement of cash flows
Purpose of internal control
- assets, current and non-current, need to be protected against loss or damage
- assets must be employed as efficiently as possible
- financial reports and records are valid: information must be available to management that is accurate to enable, compliance with the requirements of the first two purposes and to ensure adherence to the policies they have established
- the effectiveness and efficiency of business operations ate continually being monitored and improved
Internal audit
Is the continual review of the procedures, systems and policies of the business to ensure that they are being adhered to and working efficiently and effectively
Principles of internal control
- segregation of duties
- established lines of responsibility
- appropriate security of assets and records
- installation of mechanical and electronic devices
- adequate recording and documentation systems
- installation of verification and checking processes
- the existence of authorisation processes
- employment of competent and reliable staff
Errors of internal controls
- staff size: not enough staff limits workplace implementing a system of segregating duties properly
- humans can and do make errors, inaccuracy may lead to a seemingly perfect internal control system being not as effective as it was designed to be
- if two or more people conspire together to falsely report an activity to protect themselves then the internal control system will probably not pick up on this
- will not pick up on the unusual, out of the ordinary transactions
- people in management can override a control making the overall system vulnerable
- controls may need to be reviewed and changed if the business grows or changes the way it currently operates, otherwise could be ineffective and irrelevant
- businesses design internal control systems to be cost effective, this objective means that some errors may never be detected
Relationship to the external audit process
The external audit is independent of the internal audit with its main purpose being to report on the annual financial statements of the company.
The external auditors primary role is to decide whether the company’s annual financial statements:
- conform with the generally accepted accounting principles
- fairly present the financial position of the organisation
- accurately represent the result of operations for the given time period
- are free of material mis-statement
Bankruptcy
An individual who is unable to pay either private or business debts owing will be declared bankrupt
The bankruptcy act process
- the person gives up personal control of their assets and finances to a trustee, who is appointed to administer the persons financial affairs
- they will sell all realisable assets and use this money to repay creditors
Insolvency
Occurs when a businesses liabilities are greater than the value of its assets and it is unable to repay its debts as they fall due
To be insolvent you are unable to pay all your debts in full
People or businesses who are insolvent maybe able to get themselves out of this situation by refinancing the debt and paying it off gradually
Insolvency occurs due to
Poor financial management
- overstocking
- lack of poor budgeting
- poor credit policy resulting in excessively large amounts of accounts receivable
- lack of or poor record keeping
- excessive debts in relation to equity
- lack of internal control
- poor cash flow due to lack of sales
Voluntary administration
Occurs when an administrator is appointed by either a creditor owed money that the company will not or cannot pay or by a majority of the company directors to seek ways of solving a company’s financial problems
This may include the business trading its way out of the liquidity problem
Receivership
Is the position of a company when a secured creditor applies to the court for a receiver to be appointed when it is thought that the company may not be able to repay its debts
Liquidation
Occurs when a company’s affairs are wound up.
Its assets are sold and converted to cash, its creditors are repaid and the shareholders receive what remains
Order of repayments to creditors
- the trustee/liquidator fees and costs of conducting the liquidation
- secured creditors
- outstanding employee wages and superannuation
- outstanding employee leave entitlements
- employee retrenchments pay
- unsecured creditors
- shareholders
Undercapitalisation
An inadequacy of equity
Commonly caused by underestimating the initial capital needed when starting a business or excessively rapid expansion
Major reason for business failure
Consequences of undercapitalisation
- lack of working capital to effectively catty out day to day trading operations
- insufficient non-current assets, preventing the business from maximising its profit opportunities
- inadequate returns to equity-holders in times when the overall return on assets may fall below the cost of borrowing
- liquidity problems caused by the need to maintain interest payments and repay loans
- a higher rate of interest required by the lender because of the increased risk
Overcapitalisation and consequences
Having relatively too much equity
Consequences include:
- ineffective utilIsation of funds employed, leading to overall fall in returns
- lower returns to equity-holders who are unable to benefit fully from a situation, most commonly when overall return on assets exceeds the cost of borrowing
Manufacturing business
Business take raw materials and make finished products which are then sold
Inventory of finished goods and raw materials
Account for the typical operating expenses of a business such as selling, financial and administration expenses
