Processes of Financial Management Flashcards
What are the 5 steps involved in Financial Planning and Implementing
- Determining Financial Needs
- Developing Budgets
- Maintaining Record Systems
- Identifying Financial Risks
- Establishing Financial Controls
Financial Needs
Identifying financial actions that need to be taken to achieve specific outcomes
What are financial needs determined by?
- Size of the Business
- Current Phase of the Bus. Cycle
- Future Plans for Growth and Development
- Capacity to source debt and/or equity finance
Examples of Financial Needs
- Purchase new equipment
- Renting a new premesis
- Hiring new staff
- Changing the marketing mix
- Increase in utility bills
Budgets
Provide information in quantitative terms to achieve a particular goal
What do Budgets show?
- Cash required to achieve goal
- Cost of capital and other expenses against their potential earning capacity
- Cost of raw materials
- # and cost of labour hours required for production
Potential Earning
How much money borrowed is going to make in return
Operating Budgets
Relate to the main activities of a business such as raw materials and production.
Keeping day-to-day running of the business
Project Budgets
Relate to the more strategic goals such as capital expenditure & research and development.
Weigh costs of expenses against potential revenue
Financial Budgets
Relate to the financial data of a business. Includes a combination of financial statements such as:
- Income Statement
- Cash Flow Statement
- Balance Sheet
Record Systems
Systems used by a business to record & file all data
What should record systems be?
Accurate, Reliable & Accessible -> ensures that managers are able to make informed decisions based on past data
Financial Risk
The risk of being unable to cover its financial obligations
Financial Control
Policies and procedures that ensure that parts of the plans of business will be achieved in the most efficient way.
Policies of Financial Control
- Separation of Duties
- Rotation of Duties
- Control of Cash
Cashflow Statements
Indicate the movement of cash receipts & cash payments from transactions over a period of time
What is the purpose of cash flow statements?
Potential investors can assess a business’s cashflow, or finance managers can identify trends and cashflow problems
What are the three main areas of cash flow?
- Cashflow from Operating Activities
- Cashflow from Investing Activities
- Cashflow from Financing Activities
Operating Activities (Cash Flow)
Inflows & outflows relating to the main activity of the business
Inflows: Sales (cash & credit)
Outflows: Payment to suppliers, wages
Investing Activities (Cash Flow)
Inflows & outflows relating to the purchase and sale of non-current assets and investments
e.g: buying and selling vehicles, property, equipment
Financing Activities (Cash Flow)
Inflows & outflows relating to the debt and equity financing of the business
Inflows: Capital contribution, shares, loans
Outflows: Repayment of loans
Opening cash flow
Opening Cash Flow = Opening Balance + Cash Inflow - Cash Outflow
Income Statements
A summary of the income earned, expenses incurred and the final net position of a business over a certain period of trading
Cost of Goods Sold
COGS = Opening Stock + Purchases - Closing StockF
Gross Profit
Gross Profit = Sales - COGS
Net Profit
Net Profit = Gross Profit - Expenses
Balance Sheets
Show the financial stability of a business at any given point in time, displaying assets and liabilities
Accounting Equation
Assets = Liabilities + Owners Equity (ALOE)
Assets
Items that can be given a monetary value that the business owns
Current Assets
Value expected to turn over within 12 months
e.g: Accounts receivable, cash, inventory
Non-Current Assets
Items with an expected life of 1-5 years or more
e.g: buildings, land, machinery, vehicles
Liabilities
Items of debt owed to other organisations
Current Liabilities
Items of debt that are expected to be repaid within 12 months
e.g: Accounts payable, Overdraft, short-term loans
Non-Current Liabilities
Items of debt that are repaid over a period of time greater than 12 months
e.g: mortgage, loans, leases
Liquidity
The extent to which the business can meet its financial commitments in the short term ( < 12 months)
Current Ratio (Financial Ratio)
Current Ratio = Current Assets / Current Liabilities
Liquidity - Rule of Thumb (Financial Ratio)
Should aim for 1:1 OR 2:1
< 1:1, not liquid enough -> cannot satisfy short-term debts
> 2:1, too liquid -> consider investing
Solvency
The ability of a business to meet its financial obligations in the long term
Gearing
The proportion of debt finance & equity finance that is used in the business’s overall finance
If a business had more borrowed funds than contributed funds, what does it mean?
There is less certainty that a business’s long-term debt can be repaid
If a business had more contributed funds than borrowed funds, what does it mean?
There is more certainty that a business’s long-term debt can be repaid
Debt-to-Equity Ratio
Debt-to-Equity Ratio = Total Liabilities / Total Assets
Profitability
Earning performance of a business & an indication of its ability to use resources to maximise profits
Gross Profit Ratio
Indicates what % of overall sales revenue has resulted in gross profit
Gross Profit Ratio = Gross Profit / Sales
Net Profit Ratio
Indicates what % of overall sales revenue has resulted in net profit
Net Profit Ratio = Net Profit / Sales
Return on Equity Ratio
Shows the effectiveness of owner equity in generating profit for the business
Return on Equity Ratio = Net Profit / Total Equity
Return on Equity - Rule of Thumb
- 10% = not bad
- 15% = good
- Higher ratio = better return for owner + High % will attract investors
Efficiency
the extent to which a business uses its resources to achieve profit maximisation.
Expense Ratio
Total Expenses / Sales
Accounts Receivable Turnover Ratio
Sales / Acc. Receivable
Average Length of Time for Debts to be Paid
365 / Acc. Receivable
Comparative Ratio Analysis
Indicates a business’s financial wealth & identifies areas for improvement
Comparing Overtime
Ratios can be used to compare a business’s current results with previous performance to identify trends
Comparing to a Budget
Financial figures can be compared with predicted/budgeted figures to assess and measure whether or not performance is hitting expectations
Comparing to Competitors
Compare current results against key competitors to give the business an idea of its performance in the market
Comparing to Industry Standards
Compare current results against standards developed for a particular industry -> benchmarks
Normalised Earnings
Processes of removing one-time/unusual influences from the balance sheet to show the true earnings of a company
(e.g: removal of land sale -> large capital gain)
Capitalised Expenses
Process of adding capital expense to the balance sheet, to be regarded as an asset
Valuing Assets
The process of estimating the market value of assets/liabilities
Discounted Cash Flow Method
A type of method used for valuing assets:
Estimates the value of an asset based on future cash flows which are discounted to the present
Guideline Company Method
A type of method used for valuing assets:
Determines the value of a firm by observing the prices of similar companies that sold in the market
Timing Issues
Financial reports cover activities over a period of time, therefore the business’s financial position may be inaccurate and therefore misrepresented
Debt Repayments
Financial reports can be limited as they cannot disclose information on debt repayment such as:
- How long had/has been recovering the debt
- Capacity of the business/debtor to repay
Notes to Financial Statements
Notes have additional information that is left out of the main documents
Australian Securities & Investments Commission (ASIC)
the official regulating body that enforces business laws to protect investors
Audited Accounts
An independent check of the accuracy of financial records and accounting procedures
Record Keeping
Accurately record transactions by providing receipts & invoices
Reporting Practices
Provide reports to investors & other stakeholders about the business’s financial position
