topic 3 finance Flashcards
financial management & common financial managemenownt objectives (S/LT)
planning, monitoring, controlling of bus financial resources to acheive financial objs & broad goals
- achieve profits, ROI, LT stability & growth
- maximising profitability
- growth (profitability & growth –> bus success)
- efficiency
- liquidity
- solvency
financial planning for financial management
- determine HOW goals achieved
- begins w/ LT/strategic financial plans (include planned CAPITAL EXPENDITURE & investments)
- capital expenditure: spend on NC/fixed assets (plant, equip) to generate revnue –> returns to owners & SHs
- set goals & objs, determine strats to achieve, identify & evaluate courses action & choose best
- (planning cycle: needs, budgets…)
- LT plans cover debt & equity sources, spending on R&D, marketing & prod development) over 2-10yrs, guide development of ST, tactical & operational plans
- ST plans more specific, cover budgets for up to 2 years (week, month, quarter)
financial resources
resources of a bus that have monetary value
strategic role of financial management
ensure bus survives, grows in comp bus enviro & achieves goals & objs by managing finances effectively
- impacts other bus functions & contribute S< bus goals
- provide financial resources for strategic plan outlining goals, objs, future direction & strats to achieve goals & objs
- investment goals for capital (machinery & tech), training staff, marketing, expanding operations
managers
- set financial obj & ensuring bus can achieve goals
- sourcing finance
- preparing budgets & forecasting future finance
- prepare financial statements
- maintain sufficient cash flow
- distribute funds to other parts of bus
ongoing activities in strategic management of financial resources
- monitor cash flows
- set procedures & policies on cash & credit ocntrols
- pay S< debts
- balance mix of raising debt & equity finance
- budgeting (monitor actual & planned performance)
- record keep & analysis using financial statements & ratios
- develop & implement financial controls to minimise loss of assets/errors in record systems
- tax management
- ensure financial resources efficiently used to generate profits & ROI for owners & SHs
mismanagement of financial resources can lead to problems such as
- insufficient cash to pay suppliers
- inadequate capital for expansion
- too much stock (finished goods/raw materials)
- too many unproductive assets (Dont generate revnue)
- dealys receiving funds from credit sales
- unable to pay LT debts
- bus failure
2 important reasons why bus owners need financial plan. what must they include?
- if they intend on seeking finance
* FIs, investors, lenders need evidence that bus will likely make profit to make repayments - help owners predict bus performance
- whether bus viable/wasting time/money
must include
- financial projections (sales forecast, expenses budget, cash flow & income projection, balance sheet, breakeven analysis)
- continuously review, revise plan
- compare actual figures w/ projections
LT financial goals vs ST
determined for set period of time (>5 yrs)
* must have no. ST specific obj to achieve
- to achieve LT objs, must satisfy no. ST, specific objs
tactical (1-2 yrs) & operations (day to day) plans of bus
obj of financial management (maximising profitability)
ability to make financial return from bus activities (max profits [sell output] by ensuring revenues exceed expenses [spent on inputs]largest possible margin by ^ sales & decreasing costs)
- must monitor revenue & pricing policies, costs, lvls assets inventory
- close relation to efficiency
- satisfy owners & SHs ST but also attracting & maintaining investment for bus’ sustianabilityLT
obj of financial management growth
- ^ in size & value of bus LT by expanding product range, sales, profits, market share
- achieve internally through ^demand for product, new market opps( improve productivity & new products/outlets)
- externally by (purchase other bus’/through mergers & acquisitions
- depends on ability to develop & use asset structure (distribution of its assets across different categories)
- too much growth too fast can be unsustainable ( cash flow problems)
obj of financial management efficiency
ability to minimise costs & manage assets to achieve max profit w/ lowest possible lvl assets (value) (generate max returns w/ min costs)
- ^ outputs using same no. inputs/maintain current lvls output using fewer inputs
- production cost (wages, materials, marketing) w/ quantity final output produced –> potential for ^ profitability by ^ sales rev/reducing expenses
obj of financial management liquidity
ability bus can pay ST debts (<12 months)
- need control sufficient CF to meet financial obligations/convert CA to cash quickly eg. sell inventory (WC [CL-CA])
- need to determine optimal amt WC during diff periods (too much –> inefficiency eg. cash in bank/unsold stock dont generate returns other resources might (invest new equip)) (too little –> liquidity problems eg. unable pay emps, suppliers, costs –> bus failure, shortage WC –>unable to take adv market opps)
- avoid excess/shortfalls/idle cash ( lose profitability)
obj of financial management solvency
- ability bus can meet financial commitments <12 months (ST) & >12 months (LT)
- for owners, creditors, shareholders important bc indicate security/risk of investment
- if borrowed too much for cpaital investment (equip, machinery, premises)/to meet ST expenses (inventory, wages) & repayments exceed cash flow from sales, bus insolvent (bankrupt) & cease trading)
- measure via GEARING, measures prop(%) of debt (external finance) to equity (internal finance [source equity funds from new investors is external source]) to finance bus activities
- highly geared: high reliance on debt finance & higher risk of insolvency
- survival depends on solvency
ST & LT financial objectives
based on goals of strategic plan –> S/LT
ST: tactical (1-2 yrs) & operational (day to day) plans of bus
* regularly reveiwed to see if targets met & if resources used to best adv to achieve obj
eg. update old equip w/ new tech, expanding into new markets, provide new services
LT: strategic plans determined for (set period time) 5+ yrs
- to grow bus
- broad goals eg. increasing profits/market share –> st goals to achieve
- annually reveiw progress to decide how to finance investment (debt/equity financing)
potential conflicts betw ST & LT financial obj (eg. expansion, R&d
LT objs growth vs ST objs profitability, managing cash flow, repaying debt
LT growth vs ST debt repayment
- capital investment can boost growth LT by ^productivity but capital investment projects take time before generate revenue (R&D, investment sourced from debt, high gearing regular repayments of principal & interest, takeSTprofit, threaten liquidity and minimise ability ST financial obligations)
SHs vs Managers
- SHs willing ^risk w/ investment projects to ^profits LT.
- if dont pay SHs, sell shares & purchase equity other bus
- managers prioritise ST obj cash flow to operate
- too much ST discorage ^ profits but too mcuh LT –> insolvency before investment benefits
eg. to expand, supported by managers, employees, suppliers but increase costs & gearing –> lower profits ST conflict shareholders, owners, investors but LT most owners support if increase value bus
interdependence of finance w/ other functions
interdependence: mutual reliance of bus functions on one another to meet bus goals unsuccessful operating in isolation
- each help Finance generate sales & income, impact financial performance so must evaluate & control to achieve objs
- finance funds activities & provides other functions data to measure & evaluate performance (output volume, sales figures, absenteeism) & hence dependent on success ofo ther 3 to achieve financial objs
- raise finance –> ^capital –> ^efficiency
operations in achieving financial objs (interdependence)
- reduce prod costs/^output w/ existing input lvls, ops can help achieve EFFICIENCY –> improve PROFITABILITY via lower costs/higher revenue/both
- ^ scale ops by expanding –> ^ value (GROWTH) & INVESTORS receive ^ ROI (PROFITABILITY)
- **inventory management **–> improve EFFICIENCY (reduce costs via less waste & storage space used), PROFITABILITY (reduce COGS & expenses from storage & insurance) & LIQUIDITY (more cash to meet ST liabilities)
- LT, improve SOLVENCY by reducing bus’ dependence on debt as source of finance (maximise output w/ fewer inputs reduce need to fund purchase of physcial assets, max profits to pay debts & fund future purchases than borrowing)
marketing contribute to financial objs (interdepence_
- ^ sales revenue –> PROFITABILITY –> ^ bus’ value (net worth = owner’s equity/total assets - total liabilities) & share price (GROWTH)
- improve profitability –> ^ capacity to raise funds for expansion in futureby selling new shares sicne shares now mroe attractive to investors & can sell at higher price
- also boost cash flow –> improvce LIQUIDITY by providing ^ working capital to meet ST liabilities
hwo HR achieve financial objs
- find right staff, equips em w/ right skills through ongoing training & development –> motivated & likelier stay, proactive when replacing leaving staff –> boost labour productivity –> financial objs
- EFFICIENCY & PROFITABILITY by maximising output of given lvl staff/reducing no. staff to produce given output lvl, profit through ^ in revenue/reduce costs
- GROWTH - bus able expand market share & ops by lowering prices (lower labour costs per unit, quality existing products, developinnovative products)
- LIQUIDITY - effective, efficient staff ^ working cpaital by ^ revenue & minimising labour costs
- SOLVENCY - productive workforce can reduce bus’ dependence on debt as source of finance by ^ profits to pay existing debts & not debt finance in future
influences on financial management
ext factors
- (domestic gvt eco policy & legislation,
- global eco (all aspects of op)
internal factors
- ( directly controlled & monitored by management through
- S< planning
5 main influences on FM
- int sources finance
- ext sources finance
- FIs
- GM influences
- gvt influences
activities bus involved during its life cycle & how est stage can access funds –> growth stage + establishment stage
ESTABLISH NEW BUS/BUY EXISTING
initial set up
- est new bus/buy established
- expand range of products
- intro new product
- open outlets
- upgrade tech
- employ more staff
- build new warehouse
ESTABLISHMENT PHASE
owners/SHs contribute majority funds bc banks & FIs reluctant lend new bus (high risk)
growth stage, many sources of funds & ways used (int/ext)
financial decision making relevant info must be identified, collected, analysed to determine course of action
3 internal sources of finance
funds obtained within the business (owner’s equity & retained profits)
OWNER’S EQUITY
- funds invested into bus by existing owners
- sole trader/partnership/private company contribute more personal funds (via personal savings/personal loans)
- funds contributed by NEW owners/SHs under O’s E in balance sheet but ext source bc EXISTING owners only
RETAINED PROFITS
- cumulative net profits after tax, not paid to SHs as dividend. is a reinvestment from SHs
- kept as cheap, accessible source invested back into bus to fund future expenditures > borrow/sell new shares
- most common internal source esp AUS bus
- overreliance may inhibit growth of SMEs, could grow more by investing in capital
sale of assets
- can fund projects by sellign unproductive/surplus assets (building, plant, equip)
- often after takeover/merger, new entity may have duplicated assets
reasons why SME owners dont use ext sources of funds
- fearful of growth
- satisfied w/ current size
- dunno what to grow
- afraid unable to repay loan –> liquidation
- BIGGEST was bc hwo they funded bus in past, dont understand alternatives
external (sources of) finance
funds provided by sources outside bus (banks, FIs, gvt, suppliers)
- DEBT (funds borrowed from outside bus)
- risk due to interest & other charges but AUS tax system encourages via tax deductions for interest payments
or EQUITY (raise capital by selling shares to new owners) [internal when funds by existing owners]
- through creditors/lenders is debt finance
- make regular repayments on borrowings so firms must generate sufficient earnings
- ^ risk using debt as interest & bank & gvt charges must be paid on top of principal borrowed
- S< borrowing
- bus’ use combo od debt & equity to finance operational & tactical plans to achieve strategic objs
3 types of debt for short term borrowing (debt is S<)
borrowings from outside sources where interests regularly paid on top of principle
*(by banks & FIs to provide WC for temporary cash flow shortages due to lower inflows/higher outflows POT)
* funds repaid within 12 months
* recorded as CURRENT LIABILITIES on balance sheet
- (bank) overdrafts
- commercial bills
- factoring
overdraft as short term debt borrowing
bank allows bus to overdraw acc up to agreed limit for specified time to overcome temp cash shortfall
- able to operate w/ neg balance & withdraw moeny up to limit
- assist ST cash flow/liquidity problems eg. seasonal decrease in sales
- lower IRs than other borrowing but interest charged daily when balance neg (money not repaid)
- more flexible than loans
- IRs variable so interest paid on daily outstanding balance (moeny not yet repaid) of acc [as u pay off the overdraft (reduce the amount you owe), the amt of interest have to pay will also decrease bc calculated on remaining amt owed, ]
- banks require agreed limits to ovedrraft maintained at high lvl and un/secured by assets
- repayable on demand (not common)
- no regular repayment schedule, owners can pay money back when able
- most common source of funds for small bus
commercial bills as ST debt borrowing
ST loans issued by FIs (not banks) for larger amts (>$100 000) betw 30-180 days
- more suitable for larger bus
- usually secured against bus assets
- repiad w/ interest at end of term
- borrower received sum immediately & bill (promise)s to repay moeny w/ interest in future (?)
- full amt borrwed doesnt have to be repaid until end of term (flexible?)
resourse= help
factoring as ST debt borrowing
raise cash immediately by selling accs receivable at discount to factoring company
- factoring company pays 90% of amt of receivables w/n 48hrs of submitting its invoices & takes responsibility chasing debts
- for profitable bus w/ CF issues,
- adv boost CF immediate inject cash, disadv give up 10% owed to get sooner & save burden chasing unpaid accs
- improves liquidity [+cash flow & gearing] (even when current ratio worse since receiebavles fall mroe than cash ^) than waiting 30-60 days, chasing
- w/o recourse (factoring company assumes risk of debts remaining unpaid –> more adv to bus using factoring company’s services)
- w/ recourse (bus agrees to buy back any bad debts from factoring company)
- last resort but more common & accepted now
?
- greater risk than other ST borrowing bc likelihoodof unpaid debts
- relatively expensive source of finance bc bus responsible for unpaid debts & commission is paid on debt
- appealing to construction, manuf, agr & mining, transport & storage, due to longer payment cycles to clients
factoring vs invoice discounting (?)
ID ST bus uses accs receievable as collateral to borrow money, offer to established companies w/ high turnover rate (bank)
- bus, NOT LENDER, collects payments from customers –> wont be aware they took cash flow finance
- finance company pays 80-90% total invoice amt upfront (improve cash flow & WC) but bus collect payments & repay lender w/ fees & itnerest charges
- maintain standards of customer service & keep direct relation w/ debtors
DEBT: LT debt borrowing (4 types)
funds borrowed >12 months
- purchase major assets (buildings, equip, plant usually security on loan)
- non-current liabilities on balance sheet (except leasing –> recorded as expense on income statement)
- mortgage
- debenture
- unsecured notes
- leasing
diff to leasing
mortgage as LT debt borrowing
loan secured by property of borrower (bus)
- property cant be sold/used as security for further borrowing until mortgage repaid
- finance purchasing property eg. new premises, factory, office which become security for loan (bank can repossess asset if borrower default on repayments.)
- repaid w/ interest through regular repayments over agreed PoT often 15-20 yrs for large purchase
- diff is OWNERSHIP: borrower owns property during fixed schedule but leasing is after fixed schedule
debentures as LT debt borrowing
loanissued by large bus to investors to raise capital for fixed IR for fixed PIT, secured against bus assets (ext source LT debt finance issued by company at fixed IR for fixed POT)
- provide to raise funds from investors > FIs
- investor lends money & in return, company pays with regular fixed interest payments for fixed term & repay loan fully upon maturity of debenture, (12 months-10 yrs)
- as creditors, holders one of first to recover investment if bus insolvent bc secured against company’s assets
- need prospectus, tell investors abt company, how they’ll use funds & terms of investment (return compensate for risks) (?)
- finance companies raise funds debenture issues to prublic, they’re basically bonds
unsecured notes as LT debt borrowing
loan from investors/sold by bus(usually finance companies) to** raise capital** for set PIT, not secured against bus assets (unlike commercial bill/debenture)
- higher IR bc unsecured loan, msot risk to investors/lenders
- usually 3 months-3yrs at fixed IR (can be ST debt)
leasing as LT debt borrowing + 2 types of leases
payment of money to use equip owned by another party (plant, vechile, machinery)
- lessee uses equip & lessor owns & leases equip for agreed PIT
- can borrow funds & use equip w/o large capital outlay required
- costs & benefits of financial asset transferred from lessor to lessee
- usually used by finance companies
- corporations required by law to reveal sig leases in published financial statements
- bus choose equip, arrenge for finance company to purchase it & lease from finance company, retaining ownership for lease period!!
1. operating - assets leased for short periods (shorter than life of asset) & returned
- lessee doesnt gain ownership of asset at end of lease
- owner carries maintenance on asset
- can be cancelled often w/o penalty (?)
- financial
- lessor purchases asset on behalf of lessee
- often for life of asset
- lessee’s payment covers interest and eventual purchase of asset
- lease repayments fixed for life of asset 3-5 yrs, cover interest & eventual asset purchase
- plant, vehicle, equip, furniture
example of a motor vehicle leased for 2 weeks
leased as OPERATING lease
- leasing firm responsible for repairs to vehicle
- if vehicle returned < 2 weeks, adjust lease payment
- if leased for 3 yrs, FINANCIAL lease
- firm leasing vehicel responsible for insurance & maintenance of vehicle
- term close to life of vehicle
lessor vs lessee
lessor GRANTS lease to someone else, owns asset leased under agreement to lessee
lessee makes one time payment/series periodic payments to lessor for using asset
adv using leasing as source of finance
- assists cash flow bc cash outflows/payments spread over several years saving burden of one-off large cash payment (large capital outlay)
- (lower costs) easier to establish than large loan (also reduce bus’ lvl feating/debt to equity ratio)
- LT financing w/o reducing control of ownership
- lease payments are a tax deduction
- fixed repayments for period so cash flow easily monitored (dont fluctuate like IRs on loans)
- upgrades to new equip simpler & more cost-effective
- when only need ST/LT but constantly need updating (dont wanna buy & have new model, new one released & lease it instead)
- dont increase debt to equity/^ insolvency, can borrow more in future
- if IRs super high during life of loan, asset needs to earn relatively more revenue to make repayments –> leasing avoid exposure to rising IRs
disadv of leasing
IR charges can be higher than other forms of borrowing
equity as LT debt borrowing: ORDINARY SHARES as EXTERNAL source of funds (after, equity as internal)
raise finance by issuing ordinary shares/private equity (inviting NEW owners)
- disadv: ^no. owners dilute og owners’ share of bus –> smaller share profits & reduce control over decision-making
- issue shares to public via ASX (?)
- fewer risks than debt finance
includes:
* ordinary shares (new issue)
* private equity
funds contributed by bus owners eg. capital/reinvest net profit back into bus aka retained profits
extra: Crowd sourced equity funding CSEF
innovative type of fundraising allows many individuals to make small financial investments ≤ $10 000 in exchange for equity stake in company
- similar to other forms of crowdfunding, enables companies to raise funds through online portal
- can raise ≤ $ 5 mill/yr
ordinary shares as LT debt borrowing
msot commonly traded shares in AUS
- usual way investors buy part ownership of public company (listed on ASX)
SH entitled to vote at general meetings & receieve dividends from distributed profits - voting rights according to no. shares they have
- when SH purchases company shares (FROM company not existing shares from other SHs in 2ndary market) , providesource of equity finance for bus
- value of share determiend by company’s current/future perf (?)
- issued 4 ways
1. new issues
2. rights issues
3. placements
4. share purchase plans
4 types of ordinary shares commonly traded in AUS (1. new issue)
1. new issue
- shares issued & sold for 1st time on public market (ASX by public company)
- available to existing SHs & new investors
- company floats on ASX (become public comp), 1st share issues are IPOs to raise funds by selling shares to public
- must issue prospectus (doc w/ company details so investors make informed decisions)
hoping shares rise over time**
- rights issue as a type of ordinary share
offer existing SHs to purchase more, new shares in same company
- give existing shareholders securities called ‘rights’ to purchase new shares at discount to market price on future date, maintain their prop of company ownership if purchase more shares
- rights issued via predetermined ratio based on SH’s current prop ownership
- until set date new shares can be purchased, SH can trade rights on market as if trading ordinary shares (?)
- usually discount to current market price
- rights gives SH right NOT OBLIGATION
- (private) placements as a type of ordinary share
issue shares directly form company to outside investors w/o making public offering (acquire funds quick) **at discount to current market price
- usually to takeover another bus/expand existing company/improve gearing (^equity relative to debt)
- to protect existing SHs (placements dilute their ownership share & reduce share price ST since each share now smaller prop ownership) limited to raising 15% of their total market value w/o seeking approval of existing SHs/issuing prospectus(?)** –> quicker, cheaper (reduced regulatory requirements)
- but effectively using capital raised can ^dividends & share price/ensure survival LT
similar to rights issues
- share purchase plans as type of ordinary share
offer exisitng SH in listed company to issue up to 30k in new shares w/o issuing prospectus/paying brokerage fees
- usually offered at discount to current market price –> raise capital quick & cheap
- SPPs must be registered with ASIC
private equity as form of LT debt borrowing under EQUITY + 3 strats if cant raise funds this way
money invested in private company not listed on ASX
- like public listed companies who sell ordinary shares, can raise cpaital to financa expansion/investment of business usually by inviting new partner to purchase shares in bus & become part owner of company
STRATS
- LBO (leveraged buyout): private equity company buys majority control of bus using borrowed funds, convinced that bus will ^value & generate return
- venture capital: financial support provided to risky bus projects w/ potentially high returns. maybe loan but common for venture capitalist to become SH
- growth capital: not like VC bc usually sought by mature bus who’s expanding. bus profitable but not generate enough to fund expansion so part of bus sold to private investors who entitled to share of profits & can gain seat on the board
financial institutions list 7
- FMs source ext funds for est, growth, operations of bus w/ intermediaries accept deposits to make loans/investment in bus
- RBA &fed gvt incentives to encourage FIs ^amt credit supplied esp to SMEs ensure survival
- banks (comm, westpac, NAB, ANZ)
- investment banks
- finance companies
- superfunds
- insurance companies
- unit trusts (aka mutual funds)
- ASX(?)
banks
main providers of finance to bus’ (but dec due to financial dereg, ease AUS laws governing FMs –> ^comp by allowing foreign banks & FIs participate in AUS FMs)
- wide range of financial prod & services (credit cards, insurance, overdrafts, investment & savings accs) & lend money via…eugenia
- [receive savings as deposits from ind, bus & gvt and make investments & loans to borrowers
- bus wants to make profit accepting money as savings (Deposits) at LOWER IR and lends at HIGHER IR, differential is profit]
investment banks
FIs specialise in financial services (create capital) helping med-large bus grow, raise funds (borrowing & lending), manage financial risks.
- provide finance, bus make investments, advice on forex(overseas finance) & M&A’s
- [customise loans (eugenia)
- may impose conditions eg. require some equity in bus borrowing funds
- provide working capital]
finance companies
NBFI specialise OR make loans to bus, provide lease finance, some specialise in factoring
- provide mainly ST & medium term loans to bus
- can provide quicker access to funds
- less strict criteria than other creditors but usually charge higher IRs
- raise money through share issues (debentures)
- ]**lenders **have security over firms assets during liquidation
- finance company entitled to sell bus assets to recover initial loan if bus fails]
- provide quick access to funds but IRs higher
- loans, credit cards, leasing, factoring
insurance companies
NBFIs provide cover & lump sum payment occurs OR provide cover for damages/losses in return for payment of premiums
- to spread their exposure to risk, receipts of insurance premiums invest in other bus’/financial assets
- policy holders apy regular premiums & insurer guarantees to pay sum of money upon death of insured person specified in contract
- equity capital, LT loans
superannuation funds
scheme set by fed gvt requiring employers to make financial contribution to a fund for emp when they retire
- invest member contributions in shares & loans –> provide large amt finance for bus’
- LT nature –> invest LT securities –> provide sources LT finance for bus’
- equity capital, LT loans
- [employees 18-69 paid $450+ before tax every month
- contributions for ppl under 18 who work 30+ hrs/week and still earn more than 450….
- must pay 9.5% of employees salary into superfund acc on top of emp salary/wages
- invest money into company shares, property & managed funds so members earn investment **returns **on money
- takes pressure off age pension, most expensive welfare measures due to ^ life expectancy, wanna increase from 11.5% to 12% 2025
- have to if self-employed]
APRA
regulatory body oversees AUSFIs.
- ensure stability, safety, and soundness of the financial system by regulating and supervising banks, credit unions, insurance companies, superannuation funds
- protect lenders & depositers
- funded largely by industries it supervises,
unit trusts as a FI (mutual funds)
collective investment scheme pools money from many investors to invest in a diversified portfolio of assets, like superfund (stocks, bonds, real estate).
- investors earn larger returns than acting independently
- [managed by professional fund managers, make investment decisions on behalf of the investors.
- invest in mixture of cash, aus/international shares, fixed interest securities (eg. gvt bonds), property
- recently invest in gold, silver, oil, gas
- main adv diversification bc invests in variety of assets, individual investors reduce exposure to the risks with any one investment.]
- mortgage, share market funds
ASX, products & services it offers
imp source of funds for public companies created by merger of ASX & Sydney Futures Exchange 2006, (not direct investor in/lender to bus)
- AUS primary stock exchange market where shares bought & sold
- most imp role as PRIMARY market enable company raise new capital by issuing shares (securities) –> investors who purchase become part owners –> raise equity to grow, expand & improve liquidity & LT stability (solvency)
- companies can raise cpaital by selling shares publicly 1st time via IPO/float encourage EG, emp, create wealth by facilitating flow funds from investors (AUS & overseas) to companies
- also 2ndary market where existing shares traded/exchanged betw buyers & sellers, not directly generate funds for bus (SH sell own shares than bus selling new shares), demand for shares determine share price
- high demand ^price –> new shares sold by bus raise greater amt equity finance
- [oversees compliance with rules & promotes standards of corporate governance among AUS’ listed companies.]
offers products/services:
* shares, futures, exchange traded options, IR securities,
6 biggest stocks traded on ASX
- ‘Big Four’ banks (ANZ, NAB, Westpac, Comm)
- BHP Group (resources)
- Macquaries Group (investment banking)
- Wesfarmers (retail, chemicals, resources)
- Woolworths
- Telstra
primary vs secondary market (ASX)
public company raise new capital by issuing new ordinary shares
2nd hand securities from existing company eg. shares traded betw investors (ind, bus, gvt, FI)
- transactions dont increase total amt financial assets but increases LIQUIDITY of ifnancial assets, which influences primary market for securities
most common way to buy & sell shares (?)
on the share market using a full service broker, online trading acc, company itself when offers shares through public float
* online broking service allows investors to make investment decisions for lower fees
* full service broker charges more but gives advice on what to buy & sell
influence of gvt in financial management (decision making (2))
- roles of gvt bodies responsible for monitoring & admin (ASIC
- restrictions on imports & exports, –> prod costs, int competitiveness –> profitability
- ECO POLICIES MP –> IRs –>cost of borrowing money by changing cash rate
- FP (gvt spending & revenue) –> incoem for gvt bus & amt tax bus pay
- power to make laws for corps (incorp bus, impact choice legal structure bc diff obligations imposed for diff types bus) & AUS FMs & gvt agencies monitor financial sector
2 of most imp gvt influences on FM of bus in AUS: ASIC & company tax
ASIC as gvt influence on financial managmenet
independent (aus) gvt org regulates OR main gvt agency monitors AUS financial sector . independent AUS gvt org (fed gvt)
- role enforces & administers the Corporations Act 2001
- protects consumers, investors, creditors (bus provide financial services) in investment, insurance, super, banking (exccept lending)
- aim: reduce fraud & unfair practices in FMs and products
- issue licences to bus operate in FMs & ensure companeis adhere to law, collects info abt em and publicises it eg. financial info must disclose in annual reports
- if bus breaches law, investigate & determine remedies based on seriousness of misconduct (monetary penalties, imprisonment –> failure to comply= neg publicity)
- AUS’ corporate, FMs & services regulator contribute AUS eco reputation & wellbeing by ensuring AUS FMs fair, transparent, supported by confidence, informed investors & consumers
- ASIC 2001 (cwlth)
company taxation gvt influence on financial management
gvt influence by imposing taxes (sole traders & partnerships owners taxed at ind income progressive tax rate) all incorporated bus (private & public companies) need to pay CT on net profits before they’re distributed to shareholders as dividencds levied at flat rate (prop) 30% but 25% turnover <$50 mill
- relative tax rates can influence choice legal structure & others affect bus financial decisions (depending on which options better for tax purposes?)
- un/incorp, need adequate financial management to ensure adequate financial resources available when tax obligations due eg. GST bus collect from consumers behalf of fed gvt
- AUS tax laws callow companies deduct losses from previous yrs from taxable income (current profits)
- tax reform (dec CT rate successive gvts) improve AUS international competitiveness, more attractive to invest funds for LT eco growth & ^SOL
- OECD AUS marginal company tax rate one of highest (3rd 2020)
3 global market influences
- (global & domestic(?) eco outlook
- availability of funds
- IRs
- influences beyond bus control, ext** bus enviro, but financial management strats minimise neg effects
- GLOBALISATION sig influence ^interdependence betw ecos diff c’s ^movement g&s (trade), capital (investors not constrained by national borders), crises quickly spread –> global eco recession & halt strong EG
global eco outlook as global market influence (positive, neg is opp)
projected fluctuations to lvl EG global BC (lvl EG)
- AUS’ bus’ (esp export g&s) strongly influenced by global eco projections bc globalisation & eco interdependence of c’s –> financial decisions of bus
if positive (world eco growth upswing, usually early stages of ‘boom’ in BC), bus expect:,
- ^ DEMAND for G&S: bus need to^ production to meet demand & raise finance to expand, purchase new plant & equip, employ/train staff (FOP)
- more FAVOURABLE conditions for BORROWING FUNDS/RAISING EQUITY: likelier borrow funds to ^output & FIs & investors likelier provide funds anticipating ^revenues
neg outlook (global EG decline during early stages ‘bust’ in BC), bus expect:
- decrease DEMAND for G&S: try decrease production & reduce costs, anticipate lower demand & revenue –> finance identify possible cost savings (employees redundant, some plant & equip sold/shut down)
- less favourable conditions for borrowing funds/raising equity: seeking to borrow funds to cover expenses during falling revenues find FIs & investors reluctant to provide funds due to ^risk & IRs^
availability of funds as global market influence
ease bus can access funds for borrowing on international (&domestic) FMs
- FMs made up of FIs, companies, gvts who lend money to ind, comp, gvts who need to raise capital
conditions & rates based primarily on:
- risk, demand & supply, domestic eco conditions
aus financial system deregulated[?]
1970s and 1980s
* barriers to cross-border financial flows dismantled, aus eco more integrated with GF system
* aus can borrow & invest in financial assets overseas
* foreigners too, increase availability of funds
IRs as global market influence
cost of borrowing money: amt charged expressed as % of amt borrowed by lenders (creditors) to borrowers (Debtors)
- lower IR –> lower repayments –> attractive to borrow funds
- higherlvl risk in lending to bus, higher interest charged (good credit rating so lenders charge lower IR)
- high IRs maybe limited availability of funds for lending in eco
- aus IRs usually > other (developed) c’s, aus bus borrow finance from overseas source to take adv of lower borrowing cost (not recent tho bc record low now inflation
- BUT unpredictable ER movements risk adverse currency fluctuation (depreciate AUD relative to lender’s currency) –> pay more in debt repayments & eliminate adv cheaper overseas IRs so LT may cost more
- determining financial needs in planning & implementing to reduce financial risk (determined by 5 things)
determined by:
- bus size
- current stage business life cycle (est, growth, maturity, post maturity)
- current stage of BC (boom, recession, recovery..)
- future plans for growth & development
- ability to source finance (debt, equity)
how to do effective financial planning (plannign & implementing)
- situational analysis of current financial position –> forecast accurate sales, ops, marketing, HR expenses
- identify current financial issues & trends to develop budgets, strats, controls in planning cycle
- obtain from income & CF statements, BS
when is a business plan required?
- seeking debt finance from bank/FI, equity finance from potential investors
- sets goals & future direction (where expects be at end POT & strats to)
- identify amt & sources of finance need evidence investment will be successful (current, past, prjected income & CF stat, BS)
planning & implementing budgets
financial document/plan predicts revenue (from sales & investments) & expenses (of bus/deparments) over future PIT
- derived from strategic planning abt how resources used
- financial info for bus goals in strategic, tatical, operational planning
- provide figures for planning & decision making to constantly monitor progress and weak areas allocate resources for diff functions hire staff,cut expenses, purchase new assets
- (control: planned performance measure against actual, corrective action)
6 factors to considor when preparing a budget (prob dont need to know all)
- review past figures & trends, estimates from departments
- potential market share/actual, trends & seasonal fluctations in market
- proposed expansion/discontinuing projects
- proposals to alter price/quality of products
- current orders & plant capacity
- consider ext enviro eg. financial trends, availability of materials, labour
info budgets show
- funds needed for planned expenditure for period
- cost of capital expenditure (&other expenses) against potential revenue
- estimated use & cost of raw materials/inventory
- amt & cost of labour required to ops
- financial info for goals, used in strategic, tactical, operational planning
- use as control measure, can constant monitor objs & compare planned vs actual perf –> corrective action (adjust marketing strats/prod lvls, control prod costs..)
3 types of budgets
OPERATING
- day-to-day ops (sales, COGS, labour costs..)
PROJECT
capital expenditure (strategic plan includes info abt purpose of purchasing an asset, its life span and revenue it would generate) , R&D
FINANCIAL
- overall financial perf
- incorp data fram operating & project budgets to produce income & CF stats, BS
record systems for planning & implementing
processes & practices bus use to store data and ensure info rovided accurate, reliable, accessible, efficient (bc makes decisions on info)
- data: sales figs, expenses, assets, liabilities, info on customers suppliers, products
- w/ large volumes data need sophisticated systems to manage info –> tech adv range software
- if effective, can improve efficiency, monitor performance, timely produce financial reports, comply tax requirements, identify opps/issues & respond faster (theft, fraud)
* minimising errors in recoridng process & producing accurate financial statements - imp for decision making - w/o, owner has restricted understanding performing & where improvements needed
- maintaining accurate records time consuming task but having right systems & strats can cut down & simplify workload significantly
how to minimise errors in the record (system) process & produce accurate financial statements
double entry accounting system
- financial control measure
- record all items 2x, entries balance & check errors quick
- eg. bus buys stock on credit –> record ^CA (inventory) & ^CL (accs payable)
manual vs electronic record keeping
paper-based journals divied into separate sections for receipts, payments, wages, super, inventory
- managers record bus transactions manually in sections every month
- less expensive to set up
- lower risk of losing data
electronic spreadsheet
- more efficient way
- pc programs allow managers easily generate orders, reports, invoices, financial statements, pay records
- accounting programs allow users to email & send financial info to clients, suppliers, ATO
- less storage space, easier to meet tax & legal obligations
- must ensure records secure, create backup sstem to ensure records nt lose
- must be familiar with accounting principles, may need training to udnerstand hwo software works
- planning & implementing (minimising financial risks)+ 5 syllabus pts + 4 common risks
financial risk: risk unable cover financial obligations –> insolvency (debts through S< liabilities) possibility of financial loss (chance financial decision result in financial loss)
- bus’ take risks to achieve financial objs of profit & growth (greater risk, larger potential financial return but must minimise)
- biggest is inadequate cash flow to meet financial obligations. debt finance –> repaid in future
- higher bus debts related to equity, ^ risk
- to minimsie risk debt, consider amt profit likely generate –> must be suff to cover debt cost & ^returns to owners &SHs to ustify risk
- higher risk (/gearing), ^ expectation profits/dividends
- consider liquidity: if bus ST debt, need adequate amt liquid assets (quick convert cash/cash) so ST liabilites covered
- methods of risk minimisation: hedging, derivatives, insurance, diversification
-
every bus subject to, not all risks can be controlled eg. changesi n IRs
1. determine financial needs
2. develop budgets (see below)
3. maintain record systems
4. minimise financial risks
5. establish financial controls
- credit risk (???_)
- from borrowing money, need to ensure sufficient funds to meet repayments when due otherwise incur severe penalties
- risk when extending credit to customers unable to pay for g/s
- when borrow money, risk movements in IRs –> financial performance by ^ interest expenses
- market risk
- risk changing market conditions where company competes for bus
- increasing no. consumers shop online/^ comp
- affect profitability
- lqiudity risk
- bus cash flow, whether sufficient funds to meet ifnancial obligations
- how easily bus can convert assets to cash if need funds
- operational risk
- day to day management (when they have poor management)
- legal problems, fraud, HR issues, bus model risk( marketing/growht plans inadequate
factors bus’ consider for financia risk
- lvl debt acceptable for expansion
- willingness owners/SHs contribute equity funds
- hwo use excess funds (purchase assets, invest other bus, pay existing debts, pay higher dividends)
- how fast expand w/o CF issues
- future IR movements (^ cost existing loans & future borrowing)
- ER fluctuations (^ cost imported inputs, exports less comp, ^ cost liabilities denom in foreign currencies)
- how can protect from risks (insurance, hedging)
- financial controls in planning & implementing +3 ways + 6 common policies to promote w/n business
procedures, policies to ensure goals met (efficiently) & prevent financial problems & loss
- financial statements(???)
- financial ratios
- comparative analysis
- eg. bugets, income CF stat, BS, policies & procedures followed by management & emps are financial controls
- financial problems can be caused by management & emps, commonly theft & fraud (unnecessary stock purchases for personal use, misuse expense accs, false invoices, theft inventory/assets), damage/loss assets, errors record systems
- control vry important in assets eg. accs receivable, inventory, cash
- budgets (estimate resource requirements for future period) used eg. prepare cash budget enable bus to predict cash shortages
common policis promote control w/n bus:
- clear authorisation & responsibility for tasks in bus
- double entry system of accounting
- separate duties (one for ordering, one for receiving inventories)
- qualification restrictions & employing only qualified staff for roles
- control cash (cash registers, card > cash payments)
- protect assets ( regularly check inventory)
- control credit procedures (follow up overdue accs & consumer credit checsk)
factors to consider when determining how much debt bus take on, why important to balance how much debt to have
- industry risk
- projected income
- cash fow
- if bus struggling to survive/able to respond to changes in ext bus enviro
debt finance
S< borrowings from ext sources of bus. interest paid on top of principle through regular repayments
- liability to bus
- funds usually readily avaialbel & interest payments tax deductible, reduce cost
- carefully consider risk & return when determining debt/equity finance
- ^ risk when borrowing, impact on future profitability & financial stability
- if high lvl debt financ,e risk > equity finance
- amt risk affected by how much bus borrowed when loans have to be repaid & required lvl current assets for bus
- higher risk investment, higher return, determine share prices of corporations
- SMEs reluctant to seek
adv & disadv of debt finance
ADV
- funds often easier & quicker to obtain
- interest payments tax deductible
- profits not shared with lender
- wont dilute current ownership & CONTROL in bus
DISADV
- loans est costs, ongoing fees & charges, interest repayments
- IRs can ^ –> loan more expensive than anticipated
- regularly make repayments, less flexibility than dividends
- CF problems –> default loan & lose mortgaged assets
- debt to equity (gearing) ratio ^ –> threaten solvency & LT stability
- requires security by bus (??)
- lenders have 1st claim on money if bus in bankruptcy(??)
equity finance
finance raised by company by inviting new owners/SHs, diluting og owner’s share of bus funds contributed by owners (from int/ext sources)
- eg. sell new shares, retain profits/sell assets
- most important source of funds for companies,remain in bus for indefinite time, dont have to be repaid at set date
- safer than debt but requires sufficient profits made so bus can continue operating
- confidence to creditors & lenders more willign to lend if there are equity funds
- safety net for unexpected downturns/change bus activities
adv & disadv of equity finance
ADV
- dont have to be repaid w/n set time or w/ interest
- flexibility in timing dividend payments
- ^growth potential bc owners have interest in success
- owners ^returns through dividends & ^share value
- debt to equity (gearing) ratio decrease –> lower risk
- cheaper than other sources (no interest payments)
- low gearing (uses owner’s resources and not external sources) (??)
DISADV
- ^no. owners –> reduce control decision making for existing owners, share profits, ^time to make decisions
- can be more expensive than debt in LT, SHs pay dividends & expect higher returns on capital investment
- often hard to obtain, longer to organise , high legal & admin costs
- SH demands dividends can reduce lvl retained profits
- vulnerable to takeovers if other inds/bus’ acquire majority shareholding (51%)
2 most common types of finance obtained by small businesses
new credit cards & bank overdrafts
self-financing (extra)
entrepreneurs invest own money into bus w/o external source/credit aka bootstrapping
matching terms & source of finance to purpose
source of funds most appropriate influenced by 6 THINGS:
larger equity capital on bus, more secure financial structure, likelier opp to borrow]
- suit PURPOSE of requiring funds
- matching principle dictates term of loan should match eco life of asset purchased w/ loan
- ST assets should funded by ST finance
eg. ST finance to fund LT assets financial problems bc repayments due before LT assets have time to generate returns - using LT finance to fund ST assets bus **reapyments still required after asset’s productive life (no longer generate revenue to repay loan)
(inventory w/ trade credit, equip w/ lease, land w/ mortgage)
- COST of each SOURCE of funding
- issue shares –> share profits, loan –> est costs & interest repayments, retained profits –> lower dividends
- expected return rate balanced against cost
- bus STRUCTURE
- small bus fewer opps for debt & equity finance < large bus
- equity must be raised by private sources/take another partner, large bus sell new shares
- lenders more willing lend bc lower risk –> small bus ^reliance retained profits to expand ops
- unincorp
- FLEXIBILITY of SOURCE of finance
- prefer flexible bc requirements change w/ changes in bus enviro
- flexible loans –> larger, more frequent repayments favourable eco conditions when excess funds/^loans to fund expansion
- bank overdrafts & credit cards ST flexibility (careful tho)
- AVAILABILITY of finance
- diff obtain debt finance if current gearing high/credit rating (record meeting financial commitments) poor
- loans diff obtain due to circumstances beyond bus control (cautious lending downturn)
- depend too much on equity finance from few investors vulnerable if 1 leaves & cant meet financial commitments
- lvl CONTROL maintained by bus
- lenders may need security over asset –> reduce ability obtain finance in future (mortgage asset cant be uased as security on another loan)
- obtaining equity unds = reduce control over decision making
- use revenue asset generates to repay loan, if not generating enough revenue from asset & use cash from other sources to repay but if dont have, default on loan & lender possess assets that are security on loan
trade credit
agreement betw supplier & bus allows bus to delay payment for g&S already been delivered (manage cash flow)
* ST debt
monitoring & controlling finance + 3 main financial controls used for monitoring
inconsistent methods of review & systems of control in finance immediately impact viability of bus, management must monitor internal & ext factors financially impact operations
1. cash flow statements
2. incoem statements
3. balance sheets
- how effectively finance resources used, indicate bus has sufficient funds to meet contingencies (downturn, replace big capital equip)
cash flow statements for monitoring
operational flows
financial statement differences betw cash receipts & cash payments from transactions over PIT
- must have positive CF to survive (consecutive periods neg CF not sustainable LT)
- forecase & document bus monthly cash in & outflows –> prepare effective response –> can monitor & control spending to meet ST financial commits & take adv excess cash periods to assist growth & profitability
- cash flows CAN better health indicator than profitability
- CASH INFLOWS (sales rev, interest revs, dividends from equities of other firms)
- CASH OUTFLOWS (payments to suppliers, employees, gvt, other expenses, interest expenses)
- managers, lenders, creditors, owners, SHs, potential investors see if +CF over yrs (fluctuate = financial difficulties)
- prepared from income istatement & balance sheet (they summarise transactions) but only CASH ones included in cash flow statement
cash flow shows whether firm can do 5 things:
- consistently generate positive cash flow (inflow > outflow)
- pay financial commitments when due (interest, repayment of borrowings, accounts payable)
- sufficient funds for future expansion/change
- obtain finance from ext source when needed
- pay drawings to owners (funds by owners aka dividends for sole traders, partnerships, private companies)/dividends to SHs
cash flow statements format
- each period begins w/ openingbalance
- add cash inflows/receipts
- subtract cash outflows/payments
- resulting closing balance for period = opening balance next period
activities
preparing cash flow statement OIF
- operating activities
- cash inflows & outflows for main activities (providing g&s)
- income from sales (cash & credit) main operating inflows + dividends & interest
- outflows payments to suppliers, employees, operating expenses (insurance, rent, ads)
- investing activities
- cahs inflows & outflows relating to purchase & sale of NC assets & investments to generate income eg. purchase new plant & equip/property
3.** financing** activities
- cash inflows & outflows relating to borrowing
- borrowing inflows can relate to equity (issue shares/owner contirbutes capital)/debt (loans from FIs)
- cash outflows debt repayments & cash drawn from owner/pay dividends to SHs
3 expenses
income statement (what it shows)
summary of income earned & expenses incurred over period of trading usually 1 yr
- info see how much money come into bus as revenue (even if not receieved yet), COGS, expenses (even if not paid yet) over period* & resulting profit/loss
- compare w/ previous periods to identify & analyse trends –> decision making for all functions, identify sig change, why profits ^/dec, areas expenses too high, change suppliers, ^ prices, etc
shows:
- operating income earned from main function of bus (inventories sales, services & non operating revenue earned from other operations eg. rent, commission, interest)
- if income high enough to cover expenses
- if mark-up on purchases sufficient
SELLING expenses: costs associated w/ selling (wages, ads)
ADMIN expenses: costs general running (rent)
FINANCE expenses: debt repayments & risk minimisation (interest, lease payments)
steps of income statement
- record income earnedby bus
- record COGS (money spent on purchasing raw materials/finished goods for resale to calculate gross profit (revenue - COGS)
- calculate net profit (gross profit - operating expenses)
SAF
3 types of expenses on income statement
-
selling
costs related to selling g/s which can be directly traced to need for sales
- salaries, wages
- advertising
- delivery
- electricity
2.** admin**istration
costs directly related to general running of bus
- rent
-
financial
costs w/ borrowing money from outside ppl/orgs & minimising bus risk
- interest & lease payments
- dividends
- insurance payments
‘operating income’ means
gross profit formula
COGS formula
net profit
total value of all g/s sold aka sales/revenue
operating income/sales/revenue - COGS
opening stock + purchases - closing stock
gross profit-expenses
balance sheet 3 things it includes
bus’ S< assets & liabilities at PIT, & owner’s equity (funds contributed by owners) end FY June 30
- shows LT financial stability
- shows return on owners’ investment, sources & extent of borrowings, lvl inventories
- prepare at end of accounting period
- Assets = Liabilities + Owner’s Equity (OE=A-L)
- ASSETS (left)
- items of value owned by bus
- CURRENT (turn over within 12 months) eg. cash, accs receivable (Debtors), inventory (Stock)
- NON CURRENT (expect life > 12 months) eg. land, buildings, machinery, furniture
- can be financed by owners/external parties
- LIABILITIES (right)
- items of debt owed to outside parties
- CURRENT (debts expect to be repaid < 12 months) eg. overdraft, accts payable (creditors)
- NON CURRENT (LT items of debt) mortgage, debenture
- OWNER’S EQUITY (right)
- **funds ocntributed by owner/s,
- capital (funds by owners) and retained profits
- amt of money owner has left once assets used to cover liabilities –> net worth
what does analysing the balance sheet show?
- if it has enough assets to meet ST debts (CL) & continue makign profits in LT
- how assets of bus financed (using debt/equity)
- if owners good ROI (NP relation to capital)
- financial stability –> ability borrow more funds (amt liabilities related to owner’s equity)
- how financial position changed from previous yrs by comparing w/ BS from previous yrs to find trends
analysis (financial POV) + 3 main types VHT
- financial info into meaningful forms & highlighting relations betw diff aspects of bus
- compare similar items in income statement & balance sheet
- calculate figures, %s, ratios (R for profits, solvency, efficiency, growth, liquidity)
- BUT w/o INTERPRETATION meaningless need to make decisions using data from analysis
- VERTICAL
* compares figures w/n 1 financial year
* eg. gross profit as % sales, compare debt to equity - HORIZONTAL
* compare figures from diff financial yrs
eg. 2020 & 2021 - TREND
* compares figures for periods 3-5 yrs
analysis can provide hints of success/problems whcih can be (less important)
- how effectively assets used in bus
- why ^ advertising expenses havent generated more sales revenue than anticipated
- why sales decreased over past 2 years
- why overdrafts continue to increase
2 steps
financial ratios
- ANALYSIS important in accounting, financial info into mroe meaningful forms & highlight relations betw diff aspects of bus
- ratios: calculations comaparing data from bus financial statements to assess liquidity, gearing/solvency, profitability, efficiency
- main tools to analyse financial info & examine & evaluate performance to see if meeting financial objs
- INTERPRETATION: make judgements using data (gathered) from analysis
- analysis & interpret finacial stamtents using ratios help identify & predict trends, future planning & implementing corrective strats
type of comparative ratio analysis chosen depends on 3:?
- compare figures, %s, ratios for departments, diff products or against industry
- monitor trends over years/compare items w/n financial statement, expenses & sales
liquidity (financial ratio)
ability to meet CL/ST debt (financial commitments <12 months)
- aka current/WC ratio using BS info
- CA÷CL
- relation betw CA & CL –> liquidity position (how well liabilities covered by CA
- higher ratio more capable meeting ST obligations
- 2:1 (for every $1 CL, $2 CA) –> meet ST debts w/o large amt idle cash in bank (inefficient bc no returns, invest in expansion/stock better)
- acceptable depends on industry (1.5:1 if mainly cash, large bus <1:1)
how other firms in industry oerating, ext enviro - firms that sell finished goods & keep large lvls inventories need higher ratio than firms selling on credit > cash
- large bus in food industry use lower ratio 0.6:1
- service industries eg. doctors rely on cash payments for services dont need high ratio
strats to improve liquidity
- factoring
- sell unproductive NC assets to pay CL
- inject more equity into bus to pay off liabilities
- sell NC assets reducing capacity to earn profits/borrow ST w/ higher interest payments (avoid < 1.5:1)
ratio for gearing (solvency)
debt to equity ratio
- compares debt & equity lvls
- ~80% high depending on bus (every $1, 80c total liabilities/debt)
- high gearing ratio high risk unable repay debts –> insolvent
- total liabilities (current/NC)]/owner’s equity
- >100% (1:1) = debt >equity
- high gearing too low below ~30% –> miss opps to expand using debt (allow growth while ^risk LT stability)
- idela gearing ratio based on size, circumstances, (ownership?) industry, IRs many small bus 50-60%,
- industry w/ higher risk but likely generate large profits eg. mining higher debt: equity ratio (highly geared)
- manuf industries high debt (highly geared = higher prop debt to equity = greater risk = greater potential for profit)
- debt affects potential investors bc high risk can discourage investment (risk, return, deg of control)
- no optimal lvl but rare for company to have no gearing
what is solvency
bus LT financial stability
- ability to meet all financial commitments
how to balance gearing?
*reduce debt/^equity/both
* reduce liabilities by selling non-essential assets to pay debts/loans renegotiated to spread repayments over longer period, lease assets > purchasing
( ^equity by retainined ^% profits, inject more equity funding into bus by selling new shares (if public comp)/inviting new owners
- if funds unabailable to meet, & accs arent paid, lenders & creditors have right to claim payment from business
why is the financial sector as a whole have oneo f the highest debt to equity ratios
banks borrow large amts funds to loan large amts moeny
* higher than 2:1 common in industry
* other industries also high are capital-intensive eg. large manuf companies
profitability
ability to make financial return from bus activities(revenue-expenses)
- 3 main ratios to determine based on factors influencing profit & ways profit generated
- satisfy owners & SHs ST but also crucial for bus’ LT sustainability
- depends on revenue earned by bus & ability to ^ selling prices to cover costs & other expenses incurred in earning income
- MOST IMPORTANT FINANCIAL OBJ
- amt determined by volume of sales, mark-up on purchases, lvl expenses
which parties are interested in bus profitability
- owners & shareholders wanna know if firm earning acceptable ROI
- creditors wanan know if they’ll be paid & should offer credit in future
- lenders wanna know if principal on loan & interest will be repaid, if lend to firm in future
- management uses to decide policy adjustment
profitability/earning capacity measured by… 3 financial ratios
income statement
1. gross profit ratio
gross profit ÷ sales
2. net profit ratio
net profit ÷ sales
3. return on equity ratio
net profit ÷ total equity
gross profit ratio (profitability)
gross profit/sales(rev)
- measures % sales rev ends up as gross profit,
- whos mark-up on goods sold (diff betw whats paid for goods & whats sold)
- must be high enough to cover expenses & still NP
- no accepted but higher better
- fall GPfall amt NP, amt decrease depends on price reductions due to specials/sales, mark-downs on out of date stock, changes in mark-up policies
- only used by bus that sell stock (not service bus) who purchase goods from suppliers & sell at higherp rice to customers
- effectiveness of policies on pricing, sales, discounts, value of stock
- low ratio might need to source cheaper suppliers/raise prices
- other expenses eg. wage, electiricty, advertising deducted from GP for NP, NP ratio mroe accurate to indicate profitability
net profit ratio (profitability)
measures % of sales rev ends up as net profit
- NPR 30% = $0.3 net profit contributed by every $1 sales rev
- for soletraders & partnerships represents return on contribution to bus
- company usually return part of NP to shareholders as dividends and retain some for future expansion
- no set figure for profit ratios
- aim at higher G&NP ratio & compare w/ past perf, competitors, industry avg
industries w/ highest profit margins in AUS???
super funds, iron ore mining, car sharing providers, electricity distributors
return on equity ratio
measure how (much owner’s investment earning) effective funds contributed by owners been generating profit (ROI)
- if ROE 10%, for every $1 contributed by owners, receive $0.1 in return
- net profit/total equity
- return for owners must be better than return gained from alt investments
- if ROE rises due to ^ debt, carry ^ risk
- owners also compare current yr’s return w/ previous yrs & against industry avgs
- compare return w/ alt investment eg. interest earned via FI
- higher ratio/%, better return for owner, consider expansion/diversification
- if unfavourable return, owners consider selling bus
- most investors want ≥ 10% return bc wont risk investing when could get same return by investing moeny in bank/gvt bonds
efficiency (financial ratio)
ability of bus to use resources effectively to ensure financial stability & profitability
- management in directing & maintaining goals & obj of firm, greater profits & financial stability
- expense+ accs receivable turnover ratio
expense ratio (efficiency)
expenses/sales(rev)
- measre how much expenses bus made making every $1 sales rev
- expense ratio 30% = every $1 sales rev, $0.3 expenses
- amt sales allocated to ind expenses eg. selling, admin, COGS, financial expenses
- day to day efficiency
- determine where highest expenses from & why ratio inc/decreased eg. inc maybe ad costs not generated expected ^ sales/decline from lower IRs/less debt used
- no ideal, examine carefully by comparing results w/ past perf & industry avgs
- lower % better, if too high then need to monitor & control expenses
accs receivable turnover ratio (efficiency)
measure effectiveness of firms credit poliy & how efficient collects debts, credit sales/accs receivable
- avg collection time: 365/turnover ratio
- if turnover ratio 10 = accs receievable turned over 10 times during financial yr (avg is 36.5 days, standard time to repay credit 14-30 days)
- measure how many times accs receivable balance converted into cash/how quickly debtors pay their accs
- measure how long to receive cash for its credit sales from debtors
- divide ratio 365 to determine avg length time to convert balance into cash
- if credit policy shorter than accs receivable turnover, need to examine cash flow, credit policies, costs, credit colelction procedures
- if not efficient in collecting accs receiavable, charge interest on overdue payments, offer discounts for early payments, more selective when granting credit
assess business performance using comparative ratio analysis (how to have meaningful analysis)
- comparing ratio of bus over various periods helps identify trends & interpret results
- compare ratios against industry standards eg. industry avgs & benchmarks to assess bus’ financial state
- comparing ratios with bus’ in same industry & same structure, insight into bus’ perf relative to competitors
- figures, %s, ratios not complete analysis, need comparisons & benchmarks
- figures from VHT ratio analysis mroe meaningful
- can include budget figures so predicted figures can be compared against actual over short timr periods (month), info avaiable for interested parties w/n firm > ext stakeholders
how can bus mkake comparisons (bus perf using comparative ratio analysis)
compare ratios with previous yrs, w/ similar bus, against common idnustry standards/benchmarks
- over diff time periods,
- ensure same things compared, finding comparable firms difficult
- benchmarks merely guide
- aus bus mainly use aus standards but globalisation of bus, world standards more commonly used for benchmarking
- inter-bus comparisons access relevant bus statistics from many sources eg. ABS up to date & accurately reflect industry norms
NCVTDN
6 limitations of financial reporting
inconsistencies presented in financial report
-
misleading info impacts decision making and puts risk
1. normalised earnings
2. capitalisign expenses
3. valuing assets
4. timing issues
5. debt repayments
6. notes to financial statements
normalised earnings as limitation of financial reporting
earnings adjusted to account changes in eco cycle/to remove one-off items **affecting profitability **
- more accurate depiction of bus true earnings –> easier to compare profitability figures for bus from a year to next & against other bus’
- E.g. remove a land sale (large capital gain) substantial unrealistic profit for that year
- many one-off expenses (lawyer) or gains (sell asset) & affect bus ST cash flow, not indicators of LT performance
- normalised items arent totally ignored in financial reports (included in STATUTORY results but excluded from UNDERLYING results)
- diff bus’ define earnings differently –> comparing difficult
- may exclude items may reflect structural probls/opps
capitalising expenses in limitations of financial reporting + 2 options when adding a cost to their financial statmeent
accounting method (records transaction an expense on income statement as asset on balance sheet)
LIMITS:
- understate expenses & overstate profits
- ^ assets
- improve BS (assets appear higher & inflate OE)
- distort financial statements & misleading impression of perf & financial state
- not accurately represent true financial position
-
over multiple periods –> overstate profits ST –> , LT cash flow,
give investors & stakeholders false security of solvency
- expense it
- expense on income statement & subtracted from bus revenue to determine profit
2. capitalise it - capital expenditures
- on BS as asset
- income statement only feature depreciation of asset
valuing assets as limitation of financial reporting
estimating value of assets when recording them on balance sheet
HISTORICAL COSTS:
- if asset valued equal to price purchased, assumes value of AUD & ER remain unchanged throughout accounting period, overstate/underestimate value)
- market fluctuations: some NC assets (land) ^ value over time but others (vehicles, machinery) lose value (depreciate)
- depreciation rate is estimate & can give false impression how much bus worth
- if asset valued at historical cost, not reflect true present value
- other methods: current market value (value in terms future revenue will produce)
VALUE of INTANGIBLE:
- intagible assets (goodwill, trademarks, intellectual property) diff determine real value bcno formula for calculation
- if F manager includes, may overvalue
- esp difficult to estimate NC assets
incorrectly value assets –> mislead financial position
main adv & 2 disadv of using historical cost in valuign assets (limitations of financial reporting)
cost can be verified BUT value may distort bus’ balance sheet, not accurately represent true worth of bus’ assets bc original cost of asset can be diff from current makret value
also some assets very diff to value
- intangible assets items of value to bus but dont physically exist (trademarks, goodwill, brand name) not includedo n balance sheet bc value too diff to calculate (no formula) & if include on BS, overvalue to make bus appear more financially stable than reality
how do bus value NC assets that depreciate over time
estimate how much value they lose every year
* use accounting standards so value of assets on balance sheet more accurate
* can choose many methods but may mislead some investors
timing issues as limitation of financial report
financial reports cover activities over POT (usually 1yr)
- if shorter POT (quarterly) not truly represent financial position bc not account seasonal fluctuations
- major items occur outside dates of financial period (start end FY22 major sale not in profitability FY23 but huge loan in 366 days NCL, liquidity look worse)
- finance employees know financial statements used to evaluate perf - urgent to chase invoices for debtor payments end financial period –> accs receivable turnover ratio & CF statemtn dont properly reflect efficiency of managing accs receivable/CF position through yr
matching principle (accrual accounting): when revenue recorded in income statement, expenses directly relating to it must be recorded at same time (accounting period?) - revenue earned will match costs incurred to earn that revenue, more accurate representation of financial position
cash accounting: in income statement, transaction only recorded when bus receieves cash
debt repayments as limitation of financial reports. what info does financial reports themselves not have?
can omit:
- how long bus had debts
- how long been recovering debts owed to bus
- capacity debtors repay amts owed (maybe nearly insolvent & unable pay)
- effectiveness methods for recovering debts –> determine how much of moeny owed to bus likely receieve
- whether debt repayments delayed until next ifnancial period –> false impression of state
- some use lowkey weird accounting practices (continue record bad debts as accs receievable/record debts due within 12 months as NCL) to disguise real financial position & create favourable view at that time
notes to financial statement limitation of financial report
- include at end of financial reports (add details & info left out of main reports (BS, IS)
- eg. explain individual items, valuign systems for assets, how valued intangible assets, accounting methods
- mainly to make clearer & assist stakeholders analyse
may affect net profits
- influence** reported profits/losses affect overall financial perf & returns investors expect form investment, help stakeholders evaluate how calculated
ethical issues related to financial reports
managers & accountants ethical & legal obligation to ensure financial records accurate
- misues financal resources –> impact survival & owners wellbeing, SHs, employees
- financial management should reflect objs & interests of owners & SHs
- legislation guard against unethical activity but often time lag between recognising problem and implementing through law
6 (cut-off period, funds, revenues, liabilities & expenses, disclosure,
ethical issues (not limits) in financial reports: how might they arise?
asset valuation
- inappropriate cut-off periods
- manipulate timing of revenue & expenses by extending/shortening financial period to meet targets, to understate profits to avoid tax/overstate to attract investors
- misuse debt funds
- can use debt to ^ profits but extensive use to finance bus activitieis ^ risk for SHs –> ethical issue
budget estimates
- commonly overestimate expenditures & underestimate revenues for unexpected events
- managers can set budgets at easily achievable lvls to make perf better & qualify for bonuses
- fictitious revenues
- record sales/rev hasn’t occurred to inflate reported income (stakeholders make decisions based on misleading info)
- hidden liabilities & expenses
- omit/underreport make financial position apear stronger than is –> incorrect valuations compromise accuracy
- improper disclosures
- fail to disclose financial info eg. omit figures for stakeholders to make informed decisions
- fraudulent asset valuation (valuing assets)
- eg. inventories, accs receivable overvaluation (make no provision for bad debts) –> unrealistic high WC –> better position than truly for ST financial stability
vary historical value/reckless valuing of intangible assets
ethical issues related to financial reports (audited accounts)
audit independent check accuracy of financial records & accounting procedures
- include physical counts of assets eg. cash, inventory, accs receivable & NC assets –> control measure
- all bus’ required to adopt international financial reporting standards IFRS to improve transparency & accountability to public, globally standardised accounting hepled even TNCs
- info can be used by FIs, owners & SHs, potential investors rely on auditor independent check before makign decisions
- important part of control function
3 types of audits (ethical ifnancial reporting practices)
- internal audits
- conducted by employees to check accounting procedures & accuracy of financial records
- management audits
- review firm’s strategic plan & determine if changes should be made (employees, management consultants)
- external audits
- bus financial reports investigated by independent, specialised accountants/firms to guarantee authenticity, required by law to do periodically,
- under Corporations Act 2001 (cwlth), when company becomes a large proprietorship must have annual financial report audited
- small bus, external auditors only used if bus is for sale/check fraud
what do internal & external audits guard against, how do auditors check control procedures of the business?
waste, ineff use resources, misue of funds, fraud, theft
- auditors check control procedures of bus by physically checking assets eg. count cash, amt inventory, accs receivable, NC assets –> check records to see if match physical
record keeping as ethical issue related to financial reports (punishment)
accounting processes depend on how accurately & honestly data recorded in financial reports
- documents must be created for every transaction even cash - if not, reduce stated profits for year –>lower tax burden
- ATO regularly monitors, –> excessive fines & even jail time if found evading tax responsibilities –>
- prosecutions for tax evasion can harm reputation, alienate custoemrs who want honest & ethical bus
along with company tax/incoem tax if incorp, collect GST on behalf of Fed gvt to make more diff to avoid tax (taxed at each stage PP –> ethical & legal obligation comply GST reporting requirements)
stakeholders entitled to financial reports
- maybe bus try understate profits to avoid tax/exaggerate profits & value of assets to encourage investment from SHs/mislead potential buyer
negative consequences for bus adopting unethical reporting practices
- understate profits illegal attempt to defraud ATO –> severe potential penalties –> more diff to persuade FIs/investors to contribute debt/equity finance
- overstate profits & overvalue assets –> mislead financial state to FIs/potential investors –> audit provide more accurate rport on state –> dishonesty deter potential lenders & investors + damage reputation
