Financial Management Strategies Flashcards
Why are cash flow statements important to cash flow management?
Used to show the pattern of short-term management of cash inflow and outflow
Cash flow statements can prevent cash shortages by being used to plan ahead
It is possible to predict when cash will be needed and retain cash from earlier periods when cash inflow is much higher, thereby avoiding the need for more debt
How can the distribution of payments assist cash flow management?
A business can ensure that all large, predictable expenses do not occur at the same time
By spreading expenses over the whole year, the business will have a more equal cash outflow each month rather than one huge outflow during one month
A business can pay liabilities and expenses on the last possible due date, or alternatively choose to prepay expenses when it has cash
How can discounts for early payments improve cash flow?
Discounts to account debtors for early payment of their account may speed up cash flow
The business may also choose to shorten the credit terms it allows for account customers, or charge a late payment fee to cover its costs
How does factoring improve cash flow?
Accounts receivable can be sold to factoring businesses, creating an immediate cash flow
What strategy has McDonald’s recently employed to improve its cash flow?
Recently, McDonald’s have decreased the number of company stores and increased the number of franchised stores, thus generating cash from the initial sale and more stable income streams
In 2019, McDonald’s generated about US$8 billion in net cash from operations
What is the result of effective working capital management?
Working capital is the current assets used to fund the day-to-day running of a business
Effective working capital management will mean the business’s current assets will always be greater than its current liabilities
How can a business utilise cash to control current assets + McDonald’s example
The balance in the business’s bank account, cash is the most liquid asset
Needs to be available for unexpected expenses such as the repair of vital machinery
A business can increase the amount of cash it has through ‘sale and leaseback’ - the selling of non-current assets frees up capital, and makes it easier to budget for fixed installments
McDonald’s has contractual arrangements with franchisees for regular payment of rent and royalties (eg: royalty fees must be paid in full by the tenth day of the month)
This helps McDonald’s maintain significant cash flow from franchisees
How can a business utilise receivables to control current assets + McDonald’s example
The effectiveness of controls over accounts receivable is measured by the AR turnover ratio
Apart from factoring, discounting and late fees, businesses can increase turnover by:
imposing a credit limit on customers
checking the credit history of those who request credit
ask customers for a deposit on orders
Late payments of rent/royalties may attract high interest for franchisees
As a response to COVID-19, McDonald’s delayed the collection of around US$1 billion from franchisees in order to help maintain adequate liquidity
How can a business utilise inventories to control current assets?
Includes raw materials, work in progress and finished goods
Holding too much inventory will reduce cash to pay short-term debts, as well as involving costs for storage, insurance and monitoring
Methods for control over inventory include Just-In-Time (JIT) management, which reduced the costs of storing stock, and only invests cash in the bare minimum
McDonald’s relies 100% on external suppliers for inventory
McDonald’s stores use a FIFO inventory system
How can a business utilise payables to control current liabilities?
The money that a business owes to its suppliers
Paying bills too early is an inefficient use of cash, as the business should hold on to the money and use it to pay more urgent expenses first (unless early payments are discounted)
A strategy to control payables while keeping a good reputation and credit rating is to stretch accounts payable - pay invoices on the last day that they are due
How can a business use an overdraft to control current liabilities + McDonald’s example
Intended as a short-term finance, so should be used to fund short-term cash shortages
A business can control its overdraft by ensuring that all cash received is promptly deposited in the business’s overdraft account to reduce the amount owing
As a response to COVID-19, McDonald’s secured and drew upon a US$1 billion overdraft
It also has a further US$3.5 billion overdraft at its disposal should it be required
To keep this facility open, McDonald’s pays a fee of 0.08% ($2.45 million) per annum
What are two strategies for controlling working capital + McDonald’s examples?
Leasing
A method of obtaining an asset in return for a series of payments over a set period of time
Acquiring the asset will not use up cash available, and the expense will be spread
Additionally, the lease payments will be an expense and tax deductible
In 2018, McDonald’s was the lessee of 12,334 restaurant locations, and has built a further US$12.9 billion worth of buildings on land that it leases
This strategy allows more rapid expansion without large initial capital outlay
Sale & Leaseback
Will provide funds available to pay expenses as they fall due
The business can enter into a sales agreement that allows it to lease back the equipment and make monthly payments to the new owner
At its investor meeting in November 2015, McDonald’s specifically ruled out this strategy
What is the importance of fixed and variable costs to cost controls?
A business can increase profits by cutting costs in the areas of labour & inputs
Outsourcing of non-core functions has been the most popular method of reducing costs by larger organisations
Management’s control of costs will focus on variable costs, as there is more flexibility to eliminate waste; some strategies can include;
rationalising the supply chain
increasing customer self-service
using JIT inventory management
How does McDonald’s target variable costs?
McDonald’s adoption of an inventory system that responds to customer orders will assist in lowering the wastage of food and other inputs, which will lower the variable cost
Also, ensuring that the correct number of staff members are rostered on for varying demand patterns will assist lowering the variable component of wage costs
How can cost centres assist with cost controls?
These are centres that account for the expenses incurred by each key business function in providing a product to consumers
They do not produce a direct profit, and add to the cost of running a business
Management may provide the cost centres with a budget and monitor their expenses to minimise waste and achieve maximum use of resources
What are strategies for revenue controls?
Revenue controls include sales forecasts, analysing the sales mix and the pricing policy of a business, which can be used to track marketing objectives
Actual levels of sales can be compared to what was budgeted each month to determine whether the business is on track to reach its marketing objectives
A sales report can identify which products contribute most or least to total revenue
A price for each product will need to balance need for market share and profit
How does McDonald’s utilise revenue controls?
McDonald’s plan to go 95% franchised is seen by management as a way of creating more stable revenue streams, as McDonald’s derive large amounts of revenue from the renting of premises to franchisees
This ensures the company can earn stable income income with minimal outgoings and less risk and complexity than operating its own stores
How do exchange rates impact financial management?
Businesses that buy and sell goods overseas will closely monitor the value of the AUD
Currency fluctuations are a significant influence on the profitability and financial stability of global businesses
A business will need to use strategies such as hedging to eliminate the effects of currency fluctuations on the amount it receives or pays
How does McDonald’s deal with exchange rates?
In 2019, McDonald’s held US$12.8 billion worth of debt in countries other than the US, representing approximately 37% of long-term debt
It has a policy of financing local asset purchases with debt in local currency, as well as purchasing goods and services in local currency if possible, acting as a natural hedge
How do businesses use interest rates in financial management + McDonald’s example
A global business an borrow money from financial markets in other countries, and will often select the one with the lowest interest rate
However, if the value of the home country’s money depreciates, then interest repayments will increase
McDonald’s pays interest between 0.3% and 5.3% pa on its debt around the world
The company has an average interest rate of 3.2% pa and currently has 92% of debt fixed
What are the four methods of international payments?
Payment in Advance - goods are paid for before they are actually supplied
Letter of Credit - a document issued by the importer’s bank guaranteeing the payment
Bill Of Exchange - a written order from a seller requesting that an importer or buyer pay the seller a specified amount of money at a specified time; the bank, acting as a negotiating intermediary, ensures the importer receives their goods and the exporter is paid
Clean Payment - the goods are shipped before payment is received
What is hedging, and how is it used by McDonald’s?
Any strategy/financial tool used to reduce risk of loss resulting from financial transactions
This is used to deal with transaction exposure - the risk that exchange rates will change after companies have entered into an international financial transaction
Hedging using subsidiaries involves a global business avoiding changing currencies by having all transactions between its subsidiaries occur in the same currency
By doing business in local currencies, McDonald’s can use a natural hedge to minimise risk
This is because both revenues and expenses will either increase or decrease together relative to the US dollar
What are derivatives, and how are they used by McDonald’s?
A contract under which the buyer agrees to purchase something from the seller for a set price at a future point in time
It can be used to hedge financial risks created by currency fluctuations
Under a forward exchange contract the bank guarantees the exporter an exchange rate on a future date in the future
A currency option contract gives businesses the option to buy or sell foreign currency when the exchange rate movement is to its advantage
A swap contract allows two businesses to use an exchange rate on a particular future date
McDonald’s makes use of forward exchange rate contracts, options and cross-currency swaps to reduce the risk of loss to the company from unfavourable exchange rate movements
