term 1 yr12 - finance Flashcards
strategic plan
the future vision of the b. for the next 5-10 years
strategic role of financial management
to provide financial resources required to achieve the strategic plan of the b.
objectives of financial management
GLEPS
growth
liquidity
efficiency
profitability
solvency
profitability (objectives)
the ability to make/maximise profits
- gross profit, net profit, return on owners equity
- short/long term
liquidity (objectives)
the ability of the b. to pay its short term debts on time
- current assets and current liabilities
- short term
efficiency (objectives)
the ability of the b. to minimise costs and manage assets so that maximum profit is achieved
- expense ratio, accounts receivable, turnover
- short/long term
growth (objectives)
the ability of the b. to increase its size in the long term
- long term
solvency/gearing (objectives)
the ability of the b. to pay its short and long term debts on time
- solvency ratio
- long term
short term objectives
tactical (1-2 years) and operational (day-to-day) plans for a b
long term objectives
strategic plans (5+ years) of a b. (typically broad goals)
how do other business functions rely on finance
allocating funds
how does finance rely on operations
to produce the products at minimal cost (efficiency)
how does finance rely on marketing
to promote the products (profitability)
how does finance rely on human resources
to manage staff (maximising sales and achieve growth)
internal sources of finance
comes from either the owner or from business activities
- owners equity
- retained profits
- sale of unproductive assets
short term debt
can be repaid within a year (FOC)
- factoring
- overdraft
- commercial bills
overdraft
bank allows b. to overdraw their cheque account
commercial bills
larger amounts (usually $100k+) from 30-80 days. borrower receives money immediately and pays sum and interests at a future date (backed by assets)
factoring
b. sells debtors to a firm that specialises accounts receivable. in exchange, they receive up to 90% of the debt within 48 hours
long term debt
debts that will take longer than a year ot be repaid (DULM)
- debentures
- unsecured notes
- leasing
- mortgage
mortgage
loan for the purchase of property that is repaid over many years
debentures
like shares, issued to investors for a fixed rate of interest and period of time, and can later buy back the debenture
unsecured note
loan not backed by assets, attracting a high rate of interests (for shares and aquisitions)
leasing
when a b. rents or hires an asset, allowing them to use the asset without a large capital outlay
external equity finance can be obtained through
- ordinary shares
- new issue
- right issue
- placements
- share purchase plan - private equity
ordinary shares (external equity)
individuals become part owners of a public company, and receive payments called dividends. the value of the share is determined by the company’s current and future performance
new issue (external equity, ordinary shares)
stock that has been issued for the first time on a public market (IPO). the company must prepare a prospectus (document outlining details) and register it with ASIC.
right issue (external equity, ordinary shares)
shareholders can buy new shares in the same company at a discount to raise additional funds or pay down debt
placements (external equity, ordinary shares)
allotment of shares, debentures etc. made directly from the company to investors, offered at a discount to special institutions
share purchase plan (external equity, ordinary shares)
an offer to existing shareholders to purchase more shares without brokerage fees
private equity
money invested into a private company to raise capital to finance future expansion of the business
types of financial institurtions
(BISLAUF)
- Banks
- Investment banks
- Superannuation funds
- Life insurance companies
- Australian stock exchange (ASX)
- Unit trusts
- Finance companies
banks (financial institutions)
use savings deposited to lend to businesses
- eg. NAB, Westpac
Investment banks (financial institutions)
arrange long term finance for expansion, overseas finance, mergers and takeovers
- eg. deutsche bank, macquarie group
finance companies (financial institutions)
specialise in smaller commercial finance –> usually mortgages and leasing or factoring or cash flow financing
- eg. custom credit gorup, ING finance
superannuation funds (financial institutions)
employers must pay 9.5% of their employee’s salary into a super fund account for retirement
eg. AMP, NRMA
life insurance companies (financial institutions)
sell insurance policies to make a future payment if an accident occurs
- eg. AMP, NRMA
unit trusts (financial institutions)
take funds from a large number of small investors and invest them in assets
Australian stock exchange (ASX) (financial institutions)
enables companies to raise new capital through the issue of new securities
global market influences
- economic outlook
- availability of funds
- interest rates
global economic outlook (market influences)
forecast changes to economic conditions
- positive outlook increases demand, negative outlook decreases demand
- revenue and profitability strategies need to be implemented to compensate for increased compliance costs
availability of funds (market influences)
how easy it is for a b. to access funds
- impacts whether b.s can access the money they need to expand –> influencing growth
interest rates (market influences)
the cost of borrowing
legislation (influence of gov and global market on financial management)
influences the ability of a b. to raise finance
- ASIC can fine you –> impacting efficiency
- negative publicity –> impacting profitability
taxation regulations (influence of gov and global market on financial management)
influences a b. to implement expense minimisation strategies and cost controls so they can pay taxes when due
- affecting liquidity
the planning and implementing cycle
determining financial needs –> developing budgets –> maintaining record systems –> identifying financial risks –> establishing financial controls
financial needs (the planning and implementing cycle)
balance sheets, income statements, weekly reports, breakeven analysis and financial ratio analysis to make future plans for the b.
budgets (the planning and implementing cycle)
can be drawn up to show: cost cutting measures, cash requirements for an activity, the cost of capital, the cost of inventory, and labour costs
used for planning and controlling
record systems (the planning and implementing cycle)
the procedures that ensure that financial data is recorded and then information provided by record systems is accurate, reliable and accessible. businesses are required by law to keep records of their financial transactions for at least 5 years for tax purposes
financial risk (the planning and implementing cycle)
the possibility of financial loss/not being able to meet financial obligations
financial controls (the planning and implementing cycle)
procedures and means by which a b. monitors and controls the usage of its resources (accounts receivable, cash and other assets)
advantages of debt finance
- readily available and can be acquired at short notice
- flexible payment periods
- can be cheaper than equity finance
- interest payments are tax deductible
- suppliers of debt have no ownership rights
- increased funds should lead to increased profits
disadvantages of debt finance
- increased risk if debt comes from financial institutions because the interest, bank charges, and principal (loan amount) have to be repaid
- interest rates may increase
- debt can be expensive (interest)
- regular payments must be made and debt must be repaid by a certain date
- security is required by the b.
- lenders have first claim on any money if the b. ends in bankruptcy
- restrictions by lenders
advantages of equity finance
- funds are contributed by owners and they csn retain control over how that finance is used
- no interest
- less risk
- low gearing
- the money does not have to be repaid unless the owners leave the b.
- dividend payments not fixed – may vary according to profit
- no maturity date
- easy to obtain
- a good option in bad times
disadvantages of equity finance
- owners expect a higher return on investment
- profits are shared – dividend payments to shareholders
- ownership is diluted
- dividends are not tax deductible
- administration costs involved in organising a share issue
- long, expensive process
- shareholders may have decision making rights
- lower profits and lower returns for the owners
gearing/leverage
the level of debt a business has compared to equity (ratio)
considerations for determining types of finance
- finance term
- the cost of finance
- business structure
- flexibility of source
- availability
- level of control
cash flow statement
a financial statement that shows cash receipts and cash payments over a period of time
cash balance/closing balance formula
closing balance = opening balance + cash receipts - cash payments
income statement
shows the revenue and expenses of a b. over the accounting period and whether the business is making a profit or a loss
gross profit formula
GP = sales - COGS
COGS formula
COGS = opening stock + purchases - closing stock
net profit formula
net profit = gross profit + other revenue - other expenses
balance sheet + what does it indicate
shows assets, liabilities and net worth of the business at a specific point in time. it indicates
- the b. has enough assets to cover debts
- interest and money borrowed can be paid
- assets are being used to maximise profits
- good return on investment
assets formula
assets = liabilities + owners equity
owners equity formula
oe = capital + net profit - drawings
current ratio
CA/CL
- liquidity ratio
- acceptable ratio = 2:1
- balance sheet
debt to equity ratio
total liabilities/owners equity
- gearing/solvency ratio
- balance sheet
- shows dependancy on debt
gross profit ratio
gp/sales
- higher ratio = greater profitability
- indicates profit after cogs
- income statement
- profitability ratio
net profit ratio
np/sales
- higher ratio = greater profitability
- indicates profits all expenses considered
- income statement
- profitability ratio
return on owners equity ratio
np/oe
- higher ratio = greater profitability
- indicates how effectively capital is used to generate profit
- income statement and balance sheet
- profitability rato
expense ratio
total expenses/sales
- lower ratio = greater earnings
- indicates level of profit per dollar after expenses have been payed
- income statement
- efficiency ratio
accounts receivable turnover ratio/debtors turnover ratio
365 / (sales/accounts receivable (no. times per year))
- indicates effectiveness of credit policy
- usual credit period is 30 days
income statement and balance sheet
- efficiency ratio
limitations of financial reports
- normalised earnings
- capitalising expenses
- valuing assets
- timing issues
- debt repayments
- notes to the financial statements`
normalised earnings (limitations of financial reports)
the processing of averaging business earnings to remove inaccuracies created by changes in the economic cycle, or remove one off gains and expenses
capitalising expenses (limitations of financial reports)
when expenses are put into the balance sheet as capital rather than the income statement as an expense, understating expenses and overstating profits
valuing assets (limitations of financial reports)
when the value of an asset is estimated
- eg. historical cost is when assets are listed on the balance sheet with the value at which they were purchases, not accurately representing its true worth.
- some assets may be hard to value eg. intangible assets
timing issues (limitations of financial reports)
fluctuations throughout the financial year may not be reflected in financial reports
debt repayments (limitations of financial reports)
the recording of debt repayments can be used to present a more favourable appearance eg. debts may be “held over”
notes to the financial statements (limitations of financial reports)
they report additional information left out of the balance sheet and income statement
audit
a check on the accuracy of financial accounts and procedures
ethical issues related to financial reports
- audited accounts
- record keeping
- reporting practices
- inappropriate cut-off periods
- misuse of funds
audited accounts (ethical issues related to financial reports)
audits may be carried out internally or externally. under Corporations Law public companies and clubs must carry out annual external audits
record keeping (ethical issues related to financial reports)
businesses may receive payments in cash and not record them resulting in a lower tax burden
reporting practices (ethical issues related to financial reports)
pretending profit is lower to defraud the ATO
inappropriate cut-off periods (ethical issues related to financial reports)
the b. decided the cur off period, and if this is done dishonestly, it can give a false impression. the usual financial year is 01 July to 30 June
misuse of funds (ethical issues related to financial reports)
when managers or employees steal money from a b.
cash flow
the movement of cash in and out of the business over time
cash flow management strategies
- budgets
- discounts for early/cash payments
- factoring
- overdraft
- leasing
- shortening credit term
- prepaying expenses
- JIT management
advantages of discounts for early/cash payments
- late payments cost the b.
- creates customer loyalty
- improves liquidity
- reduces the risk of bad debt
disadvantages of discounts for early/cash payments
- decreases profit margins
- may impact ability to forecast cash flow
working capital/liquidity management
the funds used to operate the b. on a day to day basis
net working capital formula
current assets - current liabilities
current ratio/working capital ratio
current assets/current liabilities
shows if the b.’s current assets can cover their current liabilities
usual ratio 2:1
what does a high working capital ratio indicate
inefficient use of liquid assets that could be spent on
- research and development
- marketing campaigns
- paying off non current liabilities
what does a low working capital ratio indicate
the b. is unable to meet short term debts, even if all assets were immediately converted to cash. the b. needs to make sure it can pay
- suppliers
- rent
- wages
accounts receivable
money owed to the b. by customers who have purchases goods and services on credit
strategies to control accounts receivables
- discounts for cash/early payments
- penalties for late payments
- checking credit history of customers
- giving customers a credit limit
- sending out reminders to credit customers
- using a debt collection agency to collect bad debts
3 current liabilities
- accounts payable
- overdraft
- loans
leasing advantages
- money does not have to be used to purchase assets and is available for other investment opportunities
- enables b. to keep up with technological changes (prevents obsolescence)
- can use unaffordable good quality assets
- tax deductible
- payments can be matched to cash flow
- repair and maintenance may be included in the lease
- does not require a deposit
leasing disadvantages
- increases expenses throughout the life of the lease
- no capital gain if the leased assets appreciates in value
- cannot be used as security collateral to obtain loans
- can be reposessed by the owner
factoring advantages
- enables b. to receive cash as soon as it makes a sale
- working capital is not tied up while the b. waits t pay
- reduces cost of debt collection
- not a loan –> no interest
- easy to arrange
factoring disadvantages
- reduces profit margin on sales
- can damage relationship with customers
- could indicate to customers that they have cash flow problems
sale and lease back
the selling of an owned asset to a lessor, then leasing the same asset for an agreed period of time
- increases liquidity as cash from sale is used as working capital while the b. is still able to use the asset
how can b.s reduce debts (gearing management)
- sell non- essential non-current assets to pay off debts
- re-negotiate loans to spread payments over a longer period
how can b.s increase equity (gearing management)
- retain more profits
- inject more equity funding by selling shares or inviting new owners
profitability management
involves control of both revenue and expenses
cost controls
- fixed and variable costs
- cost centres
- expense minimisation
fixed and variable costs (cost controls)
- total costs = fixed costs + variable costs
- fixed costs are hard to reduce
- variable costs are easier to reduce
cost centres (cost controls)
a department, factory or retail shop – to separate it from the rest of the business in terms of its costs
- make someone a manager for the costs
- greater control over total costs
expense minimisation – businesses need to minimise costs of: (cost controls)
- labour
- inputs
- non-core functions
- inventory
expense minimisation – labour (cost controls)
- employ people on a casual/part time/contract basis
- reduce staff and multiskilling remaining staff
- introducing self service
expense minimisation – inputs (cost controls)
find cheaper suppliers and negotiate discounts by buying in bulk through supplier rationalisation
expense minimisation – non-core functions (cost controls)
outsourcing these functions
expense minimisation – inventory (cost controls)
JIT stock management to acoud the costs involved in storing stock, spoiled, damaged, redundant or stolen stock
revenue
the income received from the main activity of the business
marketing objectives (revenue controls)
- cost volume profit analysis/break even analysis
- change the sales mix
- pricing decisions
- budgets
marketing objectives (revenue controls) –> cost volume profit analysis/break even analysis
shows the level of sales and revenue necessary to cover costs and make a profit
- can be used to show effects on profit of changes to production, prices or costs
marketing objectives (revenue controls) –> pricing
- avoid overpricing –> lost customers
- avoid underpricing –> lost profits
depends on: - government policies
- competitor prices
- production costs
- product image and quality
- business goals
exchange rates (global financial management)
the value or price of another country’s currency
- changing from one currency to another is carried out in the foreign exchange market
- if the value of a dollar increases, the price of that country’s exports increase, and vice versa
interest rates (global financial management)
the price of borrowing
- Aus interest rates tend to be higher, so a business may borrow from overseas for cheaper finance
- any advantage gained from a lower interest rate is not eroded by an unfavourable exchange movement
- if interest rates are lower overseas, its good to invest. if interest rates are higher, its good to retain savings and receive more interest on them
risks of global businesses (global financial management)
- currency fluctuations/exchange rates
- interest rates and overseas borrowing
- methods of international payment
- hedging
- derivatives
methods of international payment
BLAC
- bill of exchange
- letter of credit
- payment in advance
- clean payment
payment in advance (methods of international payment)
allows the exporter to receive payment before they ship the goods overseas, exposing the exporter to the least risk and the importer to the most risk
letter of credit (methods of international payment)
a document that an importer can request from the bank that guarantees the payment of goods will be transferred to the seller. if the buyer cannot make the payment, the bank will cover it, benefitting the exporter because the bank is taking on the risk of non-payment and the importer because there is no risk of paying for goods that may not arrive.
bill of exchange (methods of international payment)
a document drawn up by the exporter demanding payment from the importer at a specified time. This allows the exporter to maintain control over goods until payment is guaranteed
clean payment (methods of international payment)
an open account payment method where the exporter ships the goods to the importer before payment is received. This benefits the importer
hedging
a strategy used to minimise the risk of exchange rate fluctuations. the b. can enter into a contract with a hedge fund to provide the currency it needs at the current price in say 6 months
spot rate (hedging)
the value of one currency in terms of another currency on a particular day
natural hedging
- establishing offshore subsidiaries
- arranging for import and export receipts to be denominated in the same currency
- insisting on both import and export contracts to be denominated in $AUD to transfer the risk to the buyer
- implementing marketing strategies (eg. loyalty programs) that attempt to reduce the price sensitivity of the exported products
derivatives (hedging) + types
financial instruments used to reduce the exporting risks associated with currency fluctuations
1. forward exchange contract
2. currency options contract
3. swap contract
forward exchange contract (derivatives - hedging)
a bank guaranteed exchange rate for an exporter on a specific date so both the buyer and seller can avoid the volatility of exchange rates, guaranteeing revenue
currency options contract (derivatives - hedging)
a b. has the option to but or sell currency at a specific time in the future at a specific rate
swap contract (derivatives - hedging)
2 b.s agree to use an exchange rate on a particular day in the future to swap currency
