Topic 2- Finance Flashcards
Strategic plan:
the future vision of the business for the next 5-10 years eg to expand into markets overseas.
Strategic role of financial management:
to provide the financial resources required to achieve the strategic plan(s) of the business
Objectives of Financial Management
GLEPS
1. Growth
2. Liquidity
3. Efficiency
4. Profitability
5. Solvency/ Gearing
Profitability
- the ability to make (or maximise) profits.
- Profits satisfy owner(s)/shareholders in the short term but are also important for the long-term survival of a business
MEASURED:
GROSS PROFIT, NET PROFIT RATIOS, RETURN ON
OWNERS EQUITY
Liquidity
- the ability of the business to pay its short-term debts on time.
- Short-term debts need to be repaid in a year (eg. Bank overdraft, Credit card debts, money owed to suppliers → called accounts payable/creditors).
MEASURED:
CURRENT ASSETS AND CURRENT LIABILITIES
LIQUIDITY RATIO
Efficiency
the ability of a business to minimise costs and manage
resources (assets) so that maximum profit is achieved
MEASURED:
EXPENSE RATIO, ACCOUNTS RECEIVABLE TURNOVER
Growth
- the ability of the business to increase its size in the long term.
- Growth ensures the business is sustainable into the future
Solvency/Gearing
- the ability of the business to pay its short and long-term debts on time.
- Long-term debts will take more than a year to be repaid (eg. A 30 year loan to buy property/land → called a mortgage or a 5 year loan used to buy a delivery truck).
MEASURED:
SOLVENCY RATIO
Short–term financial objectives:
are the tactical (1-2 years) and operational (day-today) plans of a business.
E.g. if management has a strategic plan to achieve a 15% increase in profit for the next 10 years,
-> tactical plans may involve buying additional machinery, updating old equipment with new technology, expanding into new markets and providing new services.
Long–term financial objectives:
are the strategic plans (for 5 years or more) of a business. They are broad goals
E.g. increasing profit or market share
-> each will require a series of short-term goals to assist in its achievement.
Finance & Operations
- operations department requires funds to purchase inputs (raw materials, machinery, energy/power) and carry out their transformation processes,
- finance department relies on operations; to produce the products at minimal cost (contribute to the achievement of the efficiency financial objective);
Finance & Marketing
- the marketing department requires funds to undertake market research, product development and various forms of promotion (eg. advertising)
- the finance department relies on marketing to promote the products so that sales targets (and profitability objectives) are achieved
Finance & HR
- the human resources department requires funds to recruit, train and pay staff (monetary and non-monetary rewards) & needs finance for redundancy packages
- the finance department relies on human resources to manage staff efficiently (to minimise costs) and effectively (to maximise sales revenue and achieve growth financial objectives)
Internal sources of finance
- comes either from the business’s owners (owners’ equity or capital) or from the outcomes of business activities (retained profits, sale of unproductive assets).
Owners Equity:
funds contributed to the business by owners or partners to establish and build the business
Retained profits (earnings):
Reinvesting the profits into the business instead of distributing them to shareholders. (dividends).
Sale of unproductive (unused) assets:
When a business sells assets it no longer uses. (eg. old machinery, equipment, buildings)
External Sources of Finance:
refers to funds provided by sources outside the business (eg. creditors, lenders) including banks, other financial institutions, government, suppliers or financial intermediaries. The business must also generate sufficient earnings to make loan repayments (i.e. the principal + interest).
Types of Short-Term Debt
(debt thats payed off within a year)
1. Factoring
2. Overdraft
3. Commercial Bills
4. Accounts Payable
What is Factoring
A business sells their accounts receivables/debtors to a firm that specialises in collecting debts (a finance or factor b.). The business will receive up to 90% of the (accounts) receivables within 48 hours of submitting its invoices to the factoring company.
What is an Overdraft
The bank allows the business or individual to overdraw their cheque account up to an agreed limit, to help overcome a temporary shortage of cash eg. from a seasonal decrease in sales. Interest is paid on the daily outstanding balance of the account.
What are Commercial Bills
Are a type of bill of exchange issued by institutions other than banks. Are given for larger amounts, usually over $100 000 for a period of between 30-180 days. The borrower receives the money immediately and promises to pay the sum and interest at a future date. Are usually secured against the business’s assets & are generally rolled over until the borrower has the funds to repay the loan in full.
What are accounts payable/trade credit
This is when a business buys goods and services from a supplier on credit. The business receives the goods/services but pays for them later (usually the b. will be given 30 days to pay the supplier).
Types on Long-Term Debt
(debts that will take longer than a year to be repaid).
(DULM)
1. Debentures
2. Unsecured Notes
3. Leasing
4. Mortgage
What is a Debenture
Companies provide them as a way to raise funds from investors, as opposed to financial institutions. Are issued by a company for a fixed rate of interest and for a fixed time. On maturity, the company repays the amount of the debenture (including interest) by buying back the debenture. The company’s assets are used as security for the loan.
What is an Unsecured Note
Is a loan for a set period of time but is not backed (secured) by assets and therefore presents the most risk to investors in the note (the lender). For this reason, an unsecured note attracts a high rate of interest.
What is Leasing (in terms of debt finance)
Is when a business rents or hires an asset (machinery, delivery vehicles, land, computers, software) owned by someone else. Leasing enables a business to use the asset (for an agreed period of time) without a large capital ($) outlay.
What is a Mortgage (in terms of debt finance)
Is a loan for the purchase of property (land, buildings, factory, office retail premises). The property is used as security and cannot be sold or used as security for further borrowing until the mortgage is repaid. The loan is repaid over many years.
How Ordinary Shares Work
the purchase of ordinary shares by individuals means they have become part owners of a public company (they are providing equity finance for that business) and may receive payments called dividends. The value of the share is determined by a company’s current and future performance.
Variations in Ordinary Shares
- New Issue
- Right Issue
- Placements
- Share purchase plan
The details of a New Issued Share
– a stock that is being issued and sold for the first time on a public market i.e. on the securities (stock) exchange; sometimes called primary shares or new offerings.
An Initial Public Offering (IPO)- or ‘float’ when a company issues shares to the public for the first time.
-> The company must first prepare a prospectus (document containing relevant details about b.) and lodge it with ASIC.
The details of a Right Issue
the opportunity given to existing shareholders to buy new shares in the same company at a discount. This occurs after the IPO & commonly done to raise additional funds or to pay down debt, especially if they are unable to borrow more money.
The details of Placements
allotment of shares, debentures etc. made directly from the company to investors. (additional shares are offered at a discount to special institutions or investors)
-> designed to persuade specific investors to invest in the company.
The details of a Share Purchase Plan
an offer to existing shareholders to purchase more shares without brokerage fees. (can also be offered at a discount)
-> allows a company to issue new shares without issuing a prospectus
What is Private Equity
is the money invested in a (private) company not listed on the Australian Securities Exchange (ASX). The aim of the private company is to raise capital to finance future expansion/investment of the
business.
Types of Financial Institutuions
(BISLUAF)
1. Banks
2. Investment Banks
3. Finance Companies
4. Superannuation Funds
5. Life Insurance Companies
6. Unit Trusts
7. ASX (Australian Securities Exchange)
Banks
Use savings deposits to lend to businesses.
Provide a range of business services eg. cheque accounts, fixed deposits, overdrafts, loans, & commercial bills.
Banks also trade in financial markets, stockbroking, insurance and funds management.
Investment Banks
Also known as merchant banks.
Long–term & Overseas finance
Advise on mergers and takeovers
Provide working capital ($) for the day-to-day operations of a business.
Arrange project finance and financial futures
Finance Companies
Non–bank financial intermediaries that specialise in smaller commercial finance.
Provide quick access to $ - but for higher interest rate
Provide secured (by assets) loans to businesses and individuals
Some specialise in factoring
Superannuation Funds
Employers must pay an amount equal to 11.5% of their employee’s salary into a super fund account (on top of the employee’s salary or wages)
Invests these funds in shares, property and debt
Life-Insurance Companies
Non - bank financial institutions that sell insurance policies to make a future payment if a particular event occurs.
Use the fees collected (from insurance premiums/fees) to invest in financial assets (shares, property etc) or to lend to the corporate sector.
Unit Trusts
Also known as mutual funds.
Take funds from a large number of small investors and invest them in specific types of financial assets
Usually connected to a management firm that manages a diversified investment portfolio for its investors
ASX
Acts as a primary market – enabling a company to raise new capital through the issue of new shares.
Also acts as a secondary market where existing securities are bought and sold (second-hand shares are traded).
-> Transactions in this market do not increase the total amount of financial assets – the secondary market increases the liquidity of financial assets
ASIC: (The Australian Securities and Investment Commission)
Enforces the Corporations act
Protects consumers (reduces fraud & unfair practices)
Collects financial information about companies to make public
Supervises retail and trading industries
Company Taxation
All b.s pay a flat rate of company tax (approx. 25%) on net profit.
-> paid before profits are distributed to shareholders as dividends.
The Australian Government has reduced company tax since 2015 to make Australia an even more attractive place to invest
-> thereby driving long-term economic growth = more jobs for Aussies.
Aspects of Global Market Influences
- Economic Outlook
- Availability of Funds
- Interset Rates
Global Economic Outlook
-> Projected changes to economic conditions throughout the world
E.g. If the outlook is good, economic activity increases -> increases demand for goods and services -> resulting in increased production (output). B.s will then require more funds to expand the b..
★decreasing global interest rates means that businesses can borrow $ internationally overseas (cheaper than domestically, in Aus).
Global Availability of Funds
-> How easy it is for a business to access funds (for borrowing) on international financial markets.
(Australians are free to borrow and invest in financial assets overseas, and foreigners can do likewise in Australian markets)
Conditions rely on:
Risk
- Demand + Supply
- Domestic economic conditions
Example: Global Financial Crisis
Decreased availability of funds due to sharp increase in interest rates
Global Interest Rates
-> the cost of borrowing (the higher the level of risk in lending to a business, the higher the interest rate)
Australia’s interest rates are generally higher than US & Japan
Overseas sourcing = lower interest rates
Exchange rate fluctuations can quickly eliminate the advantages of overseas sourcing
COVID caused ultra-low interest rates around the world
Role of budgets
are financial documents used to estimate future revenue and expenses over a period of time. Budgets can be drawn up to show: cost cutting measures, cash requirements for a particular project or activity, the cost of capital (machinery), the cost of raw materials or inventory and labour costs. -> used for both planning and controlling in a business.
What are financial controls?
are the procedures and means by which a business monitors and controls the allocation/usage of its resources. Businesses need to control accounts receivable (by following up overdue accounts and doing customer credit checks), inventory (by regularly checking inventory levels), cash (by requesting payment by cheque instead of cash to reduce risk) and other assets (by having building security procedures in place)
Advantages of Debt Financing
★ Can be acquired at short notice
★ Regular payments can be planed enabiking a business to effectively manage cash flow
★ Interests payments are tax deductible
★ Suppliers of debt (eg. banks) have no ownership rights.
Advantages of Equity Financing
★ There are no interest repayments
★ The money ($) does not have to be repaid unless the owner(s) leaves the business
★ Low gearing (dependence on debt) – the business is using the owner(s) resources (money) and not external sources of finance.
Disadvantages of Debt Financing
★Interest rates may change (increase) increasing loan repayments
★ Regular repayments have to be made and the debt must be repaid by a specific date
★ Security is required by the business. (secured by assets)
★ Lenders have first claim on any money if the business ends in bankruptcy
Disadvantages of Equity Financing
★ Profits are shared – dividend payments to shareholder
★ Ownership is diluted, i.e. the current owners will have less control.
★ Long, expensive process to obtain funds this way.
★ Expectations about ROI
What is gearing/leverage?
refers to the level of debt (external finance) a business has (compared to equity or internal finance).
-> Highly geared businesses have a high level of debt. The higher the gearing, the higher the risk (but greater potential for growth and profit).
Definition of Cash Flow Statement
a financial statement that shows cash receipts (cash inflows) and cash payments (cash outflows) over a period of time
Cash Flow Statement Equation
Cash Balance (Closing Balance) = Opening Balance + Cash Receipts (inflows) – Cash Payments (outflows)
What does a cash flow statement show a business?
generate positive cash flow (cash receipts > cash payments)
pay its expenses when they are due (eg. rent, wages)
obtain finance from external sources when needed
pay dividends to shareholders
finance future expansion
Definition of Income Statement (Revenue or Profit and Loss Statement)
show the revenue (income) and expenses of the business over the accounting period and whether the business is making a profit or loss.
Equations for Income Statement
Cost Of Goods Sold (COGS) = Opening Stock + Purchases – Closing Stock
————————————————————
Gross Profit (GP) = Sales Revenue (Income) – Cost Of Goods Sold (COGS)
————————————————————
Net Profit (NP) = Gross Profit (GP) + Other Revenue (Income) – Other Expenses
Definition of Balance Sheet
shows assets (what the business owns), liabilities (what the business owes) and net worth (what the business is worth) of the business at a specific point in time.
What does a balance sheet show a business?
- the business has enough assets to cover its debts
- the interest and money borrowed can be paid
- the assets of the business are being used to maximise profits
- the owners of the business are making a good return on their investment
Equations for Balance Sheet
Assets = Liabilities + Owner(s) Equity
————————————————————————————
Owner(s) Equity = Capital + Net Profit - Drawings
Owner(s) Equity = Capital - Net Loss - Drawings
What are Financial Ratios
are a way of analysing financial information. They are a tool used to analyse:
Financial stability (liquidity and gearing/solvency)
Profitability
Efficiency
What is Liquidity
measures the ability of the business to pay short term debts (i.e. debts the business is expected to repay within 1 year) when they are due.
indicates short - term financial stability or liquidity.
compares Current Assets with Current Liabilities.
Liquidity Ratio Name and Formula
Current Ratio ->Found on Balance Sheet
Current Liabilities
Usual acceptable ratio is $2 of Current Assets to cover $1 of Current Liabilities (2:1 or 200%).
What is Gearing/Solvency?
measures the ability of the business to pay short (i.e. debts that take less than 1 year to repay) and longer term debts (i.e. debts that take longer than 1 year to repay).
indicates long term financial stability or solvency
compares total external liabilities/debt (current and non – current liabilities) with
internal finance/owner(s) equity
Gearing Ratio Name and Formula
Debt to Equity Ratio -> found obn Balance Sheet
Owner(s) Equity
Shows reliance (dependence) on debt.
Higher the ratio → higher the debt → higher the risk → less solvent the business.
7:1 (700%) - high gearing, 1:2 (50%) – low gearing.
Usual acceptable level is 1:1 (100%) or slightly higher. But there is no optimal level of gearing for
a business
What are the profitability ratios?
measures the ability of the business to generate (produce) profits.
compares profit with sales (revenue) – Gross Profit and Net Profit Ratios
compares profit with owner(s) equity – Return on Owner(s) Equity Ratio
1st Profitability Ratio Name and Formula
Gross Profit Ratio -> Found on Income Statement
Sales
X 100 (%)
Indicates level of earnings/profit from sales after Cost Of Goods Sold (COGS) have been accounted for.
Higher the ratio (%) – greater the profitability from trading (selling products).
Usual acceptable level – 15 - 40%
2nd Profitability Ratio Name and Formula
Net Profit Ratio -> found on Income Statement
Sales
X 100 (%)
The NPR provides are more accurate indication of a business’s profitability because it considers BOTH the cost of inventory/stock + other expenses
(wages, electricity, advertising etc).
Higher the ratio (%) – greater the profitability from all business activities.
Usual acceptable level – 5-20% (varies across industries).
3rd Profitability Ratio Name and Formula
Return on Owner(s) Equity -> found on Income Statement and Balance Sheet
Owner(s) Equity
X 100 (%)
Compares Net Profit with owner(s) investment in the business - indicates how effective capital has been in generating (producing) profit.
Higher the ratio (%) – greater the profitability– higher the return on owner(s) investment.
What are the Efficiency Ratio
Measures the ability of the business to use its resources efficiently.
Increased efficiency = increased profits.
1st Efficiency Ratio Name and Formula
Expense Ratio -> found on Income Statement
Sales
OR
Specific Expense
———————–
Sales
X 100 (%)
Indicates level of profit (proportion of each sales dollar) left after expenses have been paid.
Lower the ratio (%) – greater level of earnings left.
Low ratios indicate good management (efficiency).
★ Note: the difference between the Gross Profit ratio and the Net Profit ratio = the Expense ratio.
2nd Efficiency Ratio Name and Formula
Accounts Receivable Turnover Ratio
OR Debtors
Turnover Ratio
-> Found on Income Statement and Balance Sheet
Receivable
-> 365 divided by this figure
(no. times a
year)
Indicates effectiveness of credit policy/ efficiency in collecting debts.
Usual credit period given to debtors is 30 days
-> Sooner debts collected the better – the money can be used to invest in new machinery (technology), product development and/or business expansion – these activities will increase the profitability of the business in the long term.
What is Comparative Ratio Analysis?
Ratios analyse financial information in a number of ways:
1. Over different time periods – a comparison of figures across a number of financial years (a comparison of income statements for a period over 3 to 5 years to identify trends/patterns in profit figures).
2. Against standards – a comparison to industry benchmarks (standards) – acceptable performance standards developed for businesses within an industry group – these may be Australian standards or international standards.
3. With similar businesses - a comparison with other similar businesses – interbusiness comparisons may use
Limitation of Financial Reports
- Normalised Earnings
- Capitalising Expenses
- Valuing Assets
- Timing Issues
- Debt Repayments
Explanation of Normalised Earnings
Normalised earnings: the process of averaging the earnings of a business over a number of years to remove inaccuracies created by changes in the economic cycle such as a recession or to remove one off or unusual events that affect profitability.
-> provide a more realistic indication of the earnings performance of a particular business. This makes it easier to compare profitability figures
E.g. Many businesses experience one-off expenses (large lawyer fees) or one-off gains (the sale of an asset) - even though the costs and revenues affect the business’s short-term cash flow, they are not indications of the business’s long-term performance.
Explanation of Capitalising Expenses
Capitalising expenses: is where expenses, such as putting in a new computer system to process sales, are considered as a capital item and put into the Balance Sheet (as an asset) rather than the Income Statement (as an expense).
-> This does not represent the true financial condition of the business as it understates expenses and overstates profits as well as the assets of the business.
E.g. of capitalising expenses include research and development expenditure.
Explanation of Valuing Assets
Valuing assets: is where the value of a particular asset is estimated. Assets such as land, buildings and equipment may be valued optimistically -> this will make financial reports inaccurate.
-> Historical cost is an accounting method where assets are listed on a balance sheet with the value at which they were purchased. The disadvantage is that this value may distort the business’s balance sheet, meaning that it will not accurately represent the true worth of the business’s assets. (Assets value changes over time)
-> Some assets are difficult to value. Intangible assets are of value to the business, but they do not physically exist e.g. goodwill, trademarks, patents and brand names.
- not included in the balance sheet because their value is too difficult to determine. If they are included, may be overvalued to make the business appear more financially stable than it really is.
Ethical issues related to financial reports
- Audited Accounts
- Record Keeping
- Misuse of Funds
Explanation of Audited Accounts
Audited Accounts: audits may be carried out internally (by employees to check accuracy), by management (to check plans and the need to make changes to plans) or externally (by an independent audit accountant employed by the business).
Under Corporations Law public companies and clubs must carry out annual external audits to ensure business accounts and financial procedures are accurate and comply (follow) with Australian and International Financial Reporting Standards (IFRS).
Explanation of Record Keeping
Record Keeping: Businesses may receive payment in cash, and not record the transaction. If cash received in this way is not recorded, it will not show up as business revenue, and will reduce the business’s profit for the year, possibly resulting in a lower tax burden.
Explanation of Misuse of Funds
Misuse of Funds: when managers or other employees steal money (eg. small change) or goods (eg. stationery items) from a business it is unethical, but it is unlikely to result in criminal charges. Major theft involves large amounts of money and is illegal.
Cash Flow Management Strategies
DEF
1. Distribution of Payments
2. Early Payment Discounts
3. Factoring
Distribution of Payments
-> Using cash budgets to predict periods of potential cash surplus and deficit – this enables a business to distribute payments across the period or year to reduce cash shortages
Early Payment Discounts
discounts for early payment to credit customers (debtors) and/or discounts for paying in cash
an effective strategy when targeted at debtors who owe the largest amounts of $ (as they are the ones able to save the most amount of $ by paying early).
late/ unpaid accounts cost businesses (debt interest, administrative costs, wasted time chasing payment)
increase customer loyalty as customers use the discount as an incentive
improves working capital/liquidity and reduces the risk of non-payment/bad debt
Factoring
-> the selling of accounts receivable for a discounted price to a finance or factoring company. Factoring reduces the costs of debt collection and following up unpaid accounts
Other ways to improve cash flow
Bank overdrafts - cover shortages
Delay payments of accounts payable
Keep minimum inventory levels - JIT, LIFO, FIFO
Leasing - avoids large initial payment and tax-deductible
What is Working Capital?
refers to the funds ($) used to operate (work) the business on a day to day basis. Also referred to a liquidity management.
- so that cash is available to pay short-term debts (current liabilities).
- deciding the best mix (combination) of current assets and current liabilities for the business
Net Working Capital = Current Assets – Current Liabilities
High Working Capital/Current Ratio
A ratio of 7:1 or 700% - $7 of Current Assets to cover
every $1 of Current Liabilities indicates that liquid
assets are not being used efficiently
i.e. Too much stock is being held, too much money is owed by debtors (high accounts receivable)
-> Not Using Cash Efficiently - could be used for:
- marketing
- research and development
Acceptable Working Capital/Current Ratio
Usual acceptable ratio – 2:1 or 200%($2 of Current Assets to cover every $1 of Current Liabilities)
Low Working Capital/Current Ratio
If a business has a < 1 (ie. 0.65:1 or 65% - only 65 cents of Current Assets to cover every $1 of Current Liabilities) is not satisfactory because the business is unable to meet its short term debts even if it changed all their current assets into cash immediately
What are ways to control current assets?
(CRI)
1. Cash (C) - Cash budgets can help businesses to plan and control cash so that they always have enough cash for the day to day operation
- Accounts Receivables/Debtors (R) - is money owed to the business by customers who have purchased on credit
- encouraging customers to pay in cash by giving discounts for cash sales or giving credit customers a discount for making early payments
- penalties (extra charges) for late payments
- checking the credit rating (or history) of customers before extending them credit.
- giving customers a credit limit - Inventory/Stock (I) - must carry enough stock to meet customer demand otherwise customers will go elsewhere and sales will be lost
Just - In - Time (JIT) inventory management is concerned with the elimination of waste
What are ways of controlling current liabilities?
(POL)
1. Accounts Payable/Creditors (P) - not paying accounts payable until final due date -> cheap way of improving a business’s cash position as some suppliers allow a period of interest- free trade credit before requiring payment for goods purchased
- Overdraft (O) - Bank overdrafts enable businesses to overcome temporary shortages of cash. (The interest payable on an overdraft is usually less than a loan)
- Loans (L) - Businesses may need to borrow funds in the short term (i.e. use bridging finance) because customer debts are not collected efficiently and the cash is therefore not available to pay suppliers and wages. (can increase risk to business)
What are the Working Capital Management Strategies?
- Leasing
- Factoring
- Sale and Lease Back
Describe the WCM strategy: Leasing
Leasing (L): renting or hiring assets (eg. land, machinery, vehicles) owned by another person or business.
Advantages
- Tax-deductible expense
- Frees up cash to use elsewhere
- Enables businesses to keep up with changes in technology
- Repair and maintenance of the asset may be included
Disadvantages
- The lease payment will increase expenses throughout the life of the lease
- No capital ($) gain if the leased asset
Describe the WCM strategy: Factoring
Factoring (F): the sale of accounts receivable/debtors to a factoring company at a discounted price.
Advantages
- Factoring enables business to receive cash as soon as it makes a sale. $ is not tied up while the business waits for its credit customers to pay
- Isn’t a loan (businesses won’t be taking on debt/paying interest)
Disadvantages
- Reduces a business’s profit margin on each invoice they sell
- Can damage a business’s relationship with their customers
Describe the WCM strategy: Sale and Lease Back
Sale and Lease Back (SL): the selling of an owned asset (eg. buildings, mineral mines, ships and aeroplanes) to a lessor, then leasing the same asset for an agreed period of time.
Advantages
- Increases a business’s liquidity as the cash received from the sale of the asset is used as working capital
Disadvantages
- Risk of losing premises
- No more Capital Gains
What are Cost Controls in Profitability Management?
(FVEC)
1. Fixed & Variable Costs
2. Cost Centres
3. Expense Minimisation
Describe the Cost Controls of Fixed and Variable Costs
Fixed costs: do not vary with output e.g. rent, salaries (paid to skilled labour – professionals such as teachers, executives, managers), insurance, lease repayments
-> hard to reduce – they are already paid before production & sales.
Variable costs: increase as output increases e.g. wages (paid to unskilled labour – workers trained on the job such as factory workers, sales assistants), electricity, raw material costs.
-> easier to reduce.
Describe the Cost Controls of Cost Centres
A cost centre may be a department (section/area), a factory or a retail shop – the idea is to separate it from the rest of the business in terms of its costs.
-> making someone (a manager) responsible for the costs. This person could identify areas of waste and do something about it so that costs are minimised. ★ Monitoring expenses through the use of cost centres allows for greater control of total costs
Describe the Cost Controls of Expense Minimisation
Labour - by employing people on a casual, part time or contract basis (to reduce on - costs such as sick and holiday leave), reducing staff and multi-skilling remaining staff and introducing self service
Inputs - by finding cheaper suppliers and negotiating discounts by buying in bulk through supplier rationalisation
Describe the Revenue Controls of Marketing Objectives
Marketing objectives (MOP) - Sales objectives need to be aimed at a level of sales that cover costs (fixed and variable) and result in profit.
Cost Volume Profit (CVP) analysis or Break Even Analysis: shows the level of sales and revenue necessary to cover costs and make profit.
Businesses change the sales mix (product range offered for sale) to maximise revenue.
Pricing decisions need to be monitored and controlled to avoid overpricing (lost customers) and underpricing (lower profits)
-> businesses need to check production costs, competitors’ prices, government policies, product image and quality, business goals.
Global Financial Management Strategies
MIHED
1. Methods of International Payment
2. Intrest Rates
3. Hedging
4. Exchange Rates
5. Derivatives
What are the Methods of International Payment
BLAC
1. Bill of exchange
2. Letter of Credit
3. Payment in Advanced
4. Clean Payment
Explain what a Bill of Exchange is (Method of International Payment)
Document drawn up by exporter demanding payment at specific time allows the exporter to maintain control over the goods until payment is made or guaranteed
2 types of bill of exchange:
- Document (bill) against payment (the importer can collect the goods only after paying for them)
- Document (bill) against acceptance (the importer may collect the goods before paying for them)
Explain what a Letter of Credit is (Method of International Payment)
Commitment by the importer’s bank to pay when documents showing goods have been shipped are sent
-> good for the exporter because the bank is taking on the risk of non - payment and the importer is satisfied because there is no risk of paying for goods that may not arrive
Explain what Payment in Advanced is (Method of International Payment)
allows the exporter to receive payment and then send the goods overseas
★ Best option for Exporter most risky for the Importer
-> E.g. Amazon
Explain what a Clean Payment is (Method of International Payment)
is an open account payment method. The exporter ships the goods before payment is received.
They have 30-90 days to pay
Explain Interest Rates as Global Finacial Management Strategy
Can increase cost of borrowing
Impact willingness to invest & purchase goods and services
Mostly Australian interest rates are higher than those in other countries such as Japan and the US
-> Businesses can opt to borrow overseas to take advantage of lower interest rates
- Risk of exchange rates
Explain Exchange Rates as a Global Financial Management Strategy
Is the price of one currency in relation to another.
Fluctuations occur due to variations in demand and supply
carried out in the foreign exchange (Forex) market
Spot contracts
Lock in a price for 48 hrs
Avoids risk of fluctuations (can affect profits)
Effects of Fluctuations:
Appreciation
- exports more expensive, imports cheaper
Depreciation
- exports cheaper, imports more expensive
-> Strategy - plan ahead, use spot contracts to minimise the exchange rate
Explain Hedging as a Global Financial Management Strategy
Process of minimizing risk of currency fluctuations
Natural Hedging:
- Trade in AUD (put in contracts)
- Insurance
- Marketing strategies - reduces price sensitivity, increases demand
What are Derivatives and the 3 main types?
financial tools used to reduce the exporting risks associated with currency fluctuations
3 Main Derivatives:
1. Forward exchange contract
2. Currency options contract
3. Swap contract
Explain Forward Exchange Contract (Type of Derivative)
- involving a bank guaranteed exchange rate for an exporter on a specific date (up to 6 months)
-> Allows profits to be calculated without changes
Explain Currency Options Contract (Type of Derivative)
- Buyer pays a premium to have the option to buy a currency at a cheaper price in the future even if currency becomes more expensive.
Explain Swap Contract (Type of Derivative)
- Agreement between two businesses to exchange their currencies with each other.
Eg. Australian business needs Japanese Yen but can’t borrow it
