Processes of Financial Management

Question 1

What are some of the financial needs a business faces + McDonald’s example

Answer 1

A new business will have to determine its start-up costs

Once a business has begun operations additional funds will need to be available when necessary, or else liquidity problems will develop

Financial forecasts are needed based on information gained from market & product research

In 2020, McDonald’s planned to outlay US$2.4 billion in capital expenditure - with around $1 billion to be spent on updating 2000 US stores

Question 2

What is a budget?

Answer 2

A budget is a plan for achieving set outcomes and is based on forecasted figures and expectations of future operations

Budgets establish standards and can be used as a planning and control tool, as well as allowing comparisons between actual results and the initial plan

Question 3

What are record systems, and how does McDonalds utilise them?

Answer 3

These record data needed by the business, such as client accounts, employees’ wages, accounts payable and taxes

Accounting records of expenses and revenues must be kept by law and a company’s annual financial report is presented to shareholders, the ATO and ASIC

McDonald’s franchisees have to agree to use a Point of Sale system called NP6

NP6 is used by McDonald’s head offices to monitor sales at the store level and collect royalties and other associated payments from franchised stores

Question 4

How does McDonald’s prepare for financial risks?

Answer 4

McDonald’s uses foreign currency forwards and options to “lock in” an exchange rate and protect the company from adverse exchange rate fluctuations over the next 18 months

Question 5

What are financial controls, and how does McDonald’s use them?

Answer 5

These are used to establish if a business is achieving its objectives, as well as to manage risks

Include receipt payments, regular reporting of expenses and clear division of work duties

Budgets can be used to indicate the difference between original plans and actual results

McDonald’s uses an external auditor (Ernst and Young) to assess the effectiveness of its financial controls annually

Question 6

Advantages of debt finance

Answer 6

Interest rates are tax-deductible

It can be relatively simple to acquire

Question 7

Disadvantages of debt finance

Answer 7

Debt can be expensive

Repayments begin immediately and must be met regardless of cash flow

Question 8

Advantages of equity finance

Answer 8

It only has to be repaid if the business makes a profit

Cash flow generated can be used for further investment/expansion

Question 9

Disadvantages of equity finance

Answer 9

Dilution of ownership in the business

New investors expect improved growth and performance in the business

Question 10

What is the matching principle of finance?

Answer 10

Matching Principle - involves using the appropriate finance for purchasing an asset

Current assets should be purchased with short-term finance, and vice versa

Question 11

What is the purpose of financial reports?

Answer 11

To communicate relevant, reliable and understandable information about the business that can be used by managers to make decisions

Question 12

What are the key features of a cash flow statement?

Answer 12

Summarises cash transactions that have occured over a period of time

Gives management necessary details to budget, identifying periods of cash shortage/surplus

Enables the business to monitor and control its spending

Question 13

What are the key features of an income statement?

Answer 13

Summarises the income and expenses of a business over a specific accounting period

Shows the relationship between revenue and expenses to calculate net profit

Indicates the business’s profitability and efficiency

Question 14

What are the key features of a balance sheet?

Answer 14

Gives a snapshot of what the business owns and owes on a certain day

Helps the financial manager determine if the business is reaching its economic objectives

Can be used to determine the financial stability of a business

Question 15

What is the financial ratio used to determine liquidity?

Answer 15

Current Ratio = Current Assets/Current Liabilities

Used to measure a business’s ability to pay its current liabilities from its current assets

A business will want a ratio greater than 1:1, but not so high that it is inefficient

Question 16

What is the financial ratio used to determine gearing?

Answer 16

Debt to Equity Ratio = Total Liabilities/Total Equity

A measure of how the assets of a business were funded through a mix of debt and equity, and is thus a measure of the business’s long-term financial stability

As a general rule, a business should have more equity than debt

Question 17

What are the three financial ratios used to determine profitability?

Answer 17

Gross Profit Ratio = Gross Profit/Sales
Represents the money made from the core business activity, which is to sell inventory

Net Profit Ratio = Net Profit/Sales
Calculates how much profit the business makes for every $1 of sales after expenses

Return On Equity = Net Profit/Total Equity
Calculates the return that owners receive for their investment in the business

Question 18

What are the two financial ratios that can be used to calculate efficiency?

Answer 18

Expense Ratio = Total Expenses/Sales
Can be compared to similar businesses in the same industry, as well as past results

Accounts Receivable Turnover Ratio = Sales/Accounts Receivable
Measures how long, on average, account customers take to pay their invoices

Question 19

What are the three areas of a comparative ratio analysis?

Answer 19

Different time periods

Business standards

Similar businesses in the same industry

Question 20

Why are normalised earnings a limitation of financial statements?

Answer 20

Earnings adjusted to take into account cyclical up/downswings in the economy

These would show a more accurate representation of business earnings

Question 21

Why are capitalising expenses seen as a limitation of financial statements + McDonald’s example

Answer 21

The costs incurred when financing a non-current asset added to the asset

They are therefore treated as an asset and not as an expense

Expenses for a new McDonald’s restaurant site are recorded as an asset and depreciated over the useful life of that asset, therefore spreading the costs over period of up to 40 years

Although in line with standard accounting practices, it can overstate current year profit

Question 22

Why can valuing assets be difficult on financial statements + McDonald’s example

Answer 22

When an asset is listed on the balance sheet, is value is written at its historical cost

However, the original cost of an asset is different from its current market value due to factors such as depreciation

The financial manager also cannot record intangible assets such as goodwill, patents and brand name

When McDonald’s Australia purchases a business back from a franchisee, the amount it pays above the fair value of the tangible assets of the store is called goodwill

McDonald’s Australia has almost AU$273 million in goodwill on the 2019 balance sheet

Question 23

Why are timing issues considered a limitation?

Answer 23

Accountants may adjust the timing of revenue inflows and debt repayments to make the business appear more profitable

Information in the McDonald’s 2019 Annual Report became obsolete after the pandemic

Question 24

Why are debt repayments considered an issue on the financial statements?

Answer 24

A business may also roll over debt finance and thus put off repayments until a later date

Question 25

Why are the notes on the financial statements considered a limitation?

Answer 25

Inaccessible (in terms of language and time) to the general public

Question 26

What is an example of an ethical influence on financial reports?

Answer 26

Companies have to reveal the details of the salary packages of their directors and executives, forcing them to be more honest and transparent in their behaviour

Question 27

What is the importance of audits to the financial statements + McDonald’s example

Answer 27

An audit is an independent check of the financial records of a business to ensure that the financial reports represent a true and fair financial picture of the business

Audits are necessary because stakeholders need to be able to trust annual reports, owners need accurate profit results, businesses wish to minimise tax liability and managers need to be able to make informed decisions

McDonald’s has strong financial reporting policies and independent audits to lessen risk of financial managers deferring/capitalising expenses to increase profits & performance pay

Forbes argues that McDonald’s use of share buybacks keeps the company’s share price artificially high