Financial Management Strategies Flashcards
What is cash flow
The cyclical flow of cash in and out of the business. If more money goes out than comes in (i.e. more paid out than received), then there is a cash flow problem.
What does keeping records of cash flow show
By keeping records of cash flow, you know how much cash you have at a given time. However, this record does not tell you what debts you have
What does a cash flow statement do
Forecasts monthly inflows and outflows of business à which helps business managers meet financial obligations and respond to periods of cash shortages and surpluses
How can a cash flow statement help managers
- Can help identify trends and can be used as a useful predictor for change
- Helps managers plan
What are cash flow management strategies
- Distribution of payments
- Discounts for early payments
- Factoring
What does distribution of payments involve
Distributing payments throughout the month or year so that cash shortfalls do not occur
Whats an exmaple of distribution of payments
Pay insurance monthly instead of annually
What is factoring
Selling of accounts receivable for a discounted price to a specialist factoring company
How does factoring help businesses
- Get access to cash sooner
- Guaranteed funds
- Saves on costs of debt collection
What are discounts for early payments
Reductions in the price of the good or service if payment is made earlier than required
What does discounts for early payments do
Encourages quick payment from customers (debtors), improving cash flow
Example of discounts for late fees
Airline company’s offer cheaper fares for people who book sooner
Why is discounts for early payments better than late fees
Encourages positive relationship with customers (late fee may be necessary for stopping debtors consistently paying later)
What is working capital
Working capital is the term used to describe the funds available for the short-term financial commitments of a business and is essentially, the difference between current assets and current liabilities
What is working capital formula
Current assets - Current liabilities
Why is working capital needed
Needed so that a business can extend credit to customers (accounts receivable), buy stock/inventory and meet its own current debts
What does insufficient working capital mean
Means there are liquidity problems
What may liquidity problems lead to
May force the business to increase debt or sell off non-current assets à which may undermine the productivity of the firm
What does excess working capital mean for a business
Limits the options for growth, profit and expansion and some of the current assets should be converted to non-current assets to expand production capability.
What does working capital management involve
Determining the best mix of current assets and current liabilities needed to achieve the objectives of the business
What is working capital ratio
Same as current ratio Current assets/current liabilities
What does a high current ratio mean
May reduce long term profitability à since business is choosing to reduce risk of not being able to pay its debts by having more liquid assets
What does low current ratio mean
That the business is more profitable if it is investing its resources in longer term productive assets à but there is a risk that the business may not be able to pay its current liabilities
What are working capital management sections
- Control of current assets
- Control of current liabilities
- Leasing
- Sale and lease back
What are current liabilties
- Current liabilities are financial commitments that must be paid in the short term (within 12 months) and meeting these as they fall due and minimising costs is an important part of management of working capital
What are the different current liabilities
- Accounts payable
- Loans
- Overdrafts
What are payables
Amounts owed to other businesses who are suppliers – referred to as ‘trade credit’
What are strategies to control payables
- Payment on time (avoid late fee)
- Taking advantage of early payment discounts
- Maintaining good credit rating for continuing access to lines of credit provided by suppliers
- Hold off payment till date2 (not ethical)
What are strategies to manage short-term loans
Preparation of cash budgets and cash flow statements to help ensure cash is available to meet loan repayments
What are overdrafts
Convenient & relatively cheap form of short-term borrowing enabling a business to overcome temporary cash shortages (overdrawing bank account)
What are strategies to manage overdrafts
- Monitoring to ensure that the balance is not consistently above agreed limits, otherwise the bank may demand immediate repayment.
- Also, same strategies as for short term loans
What are strategies for managing working capital
- Leasing
- Sale and lease back
What does leasing involve
The payment of money for the use of equipment or property/land, that is owned by another party. A lease is a contract between the lessor (owner) and lessee (user of the asset)
What are advanatages of leasing
- An asset is obtained without the one-off large cash outlay. Therefore, leasing frees up cash that can be used elsewhere in the business to create revenue.
- Regular and fixed payments are made and can be planned to match cash flow.
- It essentially matches the cost of the equipment with the revenue benefit generated by the asset.
- The cost is an expense and is tax deductible.
- It allows the business the flexibility to upgrade to new and better assets
- Depending on the terms of the agreement, it reduces the risk of unpredictable costs associated with the repairs and maintenance of equipment (or property)
- No deposit is required (as for a loan a 5 or 10% deposit is required) and
- leasing is in effect 100% financing
*
What is sale and lease back
- The selling of an owned asset (a non-current asset on the balance sheet) to a lessor (landlord) and leasing the asset back through fixed payments for a specified number of years (usually real estate).
What does sale and lease back do
Increases a business’s liquidity because the cash that is obtained from the sale is then used as working capital and can be used to expand production
What is profitability management
- Profitability management involves the control of both costs (fixed and variable costs) and revenues.
What must business do to maximise profits
- keeps costs under control and
- increase revenues
Within cost controls what must business manage
- Fixed and variable costs
- Costs centres
- Expense minimisation
What are fixed costs
- Do not vary with level of output, e.g. insurance, rent
How should businesses keep fixed costs low
- Businesses should negotiate adequate arrangement at the outset or take advantage of early payment discounts
- Should also seek competitive quotes on costs such as insurance
What are variable costs
Vary with the level of output e.g. raw materials, labour, petrol
How can businesses save on variable costs
Savings may be able to be made through bulk purchases and careful monitoring and use of alternative suppliers à supply chain management
What are cost centres
Particular areas or departments of a business to which costs can be directly attributed and the manager will be held accountable for these à (and more likely to keep costs to a minimum).
What do cost centres allow managers to do
Allows managers to measure, budget and control costs for each specific function
What is expense minimisation
This is reducing expenses (in the longer term) to gain a competitive advantage and thereby maximise profit (this is a cost leadership approach)
What are expense minimation strategies
- Outsourcing
- Replacing full time with casual employees
- Improving labour productivity
- Reduce inventory
- Overheads
What are revenue control strategies
- Sales objective
- Sales mix
- Pricing policy
What does sales objectives involve
- Businesses must set clear, realistic objectives regarding sales targets and market share to give sales staff clear, realistic targets to work with which should motivate them to achieve these
What is the sales mix
The mix of products a business offers for sale
What should businesses do to manage sales mix
- Business should review each product’s profit margin contribution and develop those with the highest and phase out those with the lowest
What does pricing polciy affect
revenue and hence working capital
What are risks of pricing
- Overpricing could fail to attract buyers and under-pricing may attract higher sales but still result in cash shortfalls and low profits
What are factors influencing pricing
- Production costs
- Competitors pricing, quality image
- Long term objectives regarding market share
