topic 3 part 2 finance Flashcards
starts with ethical issues related to financial reports (reporting practices) (57 cards)
1
Q
reporting practices as ethical issue related to financial reports(?)
A
- stakeholders entitled to access bus financial info
- SHs in private company y legally entitledcontrol CA to receive financial reports annually even if sompany small bus & SHs family members
- if pretend profit lower than it should, attempt to defraud ATO which is illegal and unethical - if bus wants to raise additional capital from existing SHs/from bank, understating profit more diff to persuade sources of finance to lend
- if bus decides to sell bus as concern, purchaser needs see financial reports for years prior sale
- under/overstating value of assets counterproductive when potential buyer scrutinise reports
2
Q
examples of bus inflows & outflows of cash
A
INFLOWS:
- sales
- cash payment for accs receivable
- sales of assets
- interest received from investments,, etc
OUTFLOWS:
- payments to suppliers (raw materials, finished goods)
- interest on loans/loan repayments
- operating expenses (wages, salaries, raw materiasl, finished goods)
- purchasing assets
3
Q
forecast
cash flow statements
A
movement of cash receipts & cash payments resulting from (only cash) transactions over PIT,
- identify trends & predict change
- prepare forecast to estimate amt money expect to flow in & out, usually covers next year but can (week, month)
- caash flow forecast manage cash flow easier, owners can predict surpluses/shrtages of cash to make informed decisions to see likely effect on cash flow
4
Q
overdrafts??
cash flow management strats (3)
A
temporary cash shortfalls use overdrafts (from banks to overdraw ACC to limit & pay IRs but if longer period, risk insolvency/bankruptcy)
- need to ensure cash available to make payments when due to:
- ATO
- SUPPLIERS FOR ACCS PAYABLE
- EMPLOYEES (wages)
- owners & SHs for profits & dividends
- bansk & FIs for interest on loans/overdrafts & leasing payments
- distribution of payments
- discunts for early payment
- factoring
5
Q
5 most common reasons SMEs experience cash flow problems
A
- slow paying debtors
- rapid/unsustainable growth
- failure to perform credit checks on debtors
- tightened lending restrictions more diff to get credit
- seasonality (companies that make/sell seasonal goods often run out of funds certain times of year)
6
Q
distribution of payments as common cash flow management strat
A
spread payments evenly throughout the period(year) rather than making lump sum payments so large expenses don’t occur at same time & prevent cash shortfalls
- more equal cash outflow each month > large outflows in some months
- forecast cash flow to identify periods potential shortfalls & surpluses
- deal w/ unexpected costs
- for bus whose inflows seasonal, make lump sum payments during high income periods instead
7
Q
discounts for early payment as cash flow management strat
A
offer debtors discount for early payment
- when bus offers customers % reduction on total invoice value when its settled before payment deadline
- most effective when used for debtrs who owe largest amts over FY
- encourage quick payment, ^CF, beneficial for debtors who able to save money and improvve cash flow & bus cash flow status
- maybe cheaper than overdrafts bc maybe interest charges higher than discounts offered
- late fees discourage debtors from late payments (but discounts better bc positive relations w/ customers)
8
Q
adv & disadv of offering discounts for early payment
A
ADV
- reduce risk of late payment & associated costs (late/unpaid invoices cost bus’ in debt interest, admin costs, waste time chasing payment
- ^ custoemr loyalty & improve customer relationships, discount incentive to choose bus over competitors
- improves owrking capital & provides extra liqudiity
DISADV
- decrease profit margins as discount offered paid directly from profits
- need to track cash flows carefully otheriwse may mistakenly give discounts to custmers who claim they’re paying sooner but arent. & recovering underpayment affect relationship w/ customer
- no guarantee customers consistent
- harder to forecast cash flow
9
Q
factoring as a cash flow management strat
A
selling accs receivable for discounted price to finance/specialiset factoring company
- quickly convert what’s owed into cash during tight CF
- instant CF & save costs chasing unpaid accs & collecting debts
- growing in popularity to improve WC too
10
Q
adv & disadv of factoring
A
ADV
- immediate cash injection (funds in acc within 24 hrs to improve working capital)
- isnt a loan so bus wont take debt/pay interest
- availability depends more on customers’ credit ratings than bus’ so firms with bad credit can access factoring
DISADV
- reduce bus’ profit margin on each invoice they sell
- can be more expensive than other ST finance
- damage bus relationship w/ customers as no longer deal exclusively w/ bus esp if factor uses aggressive colection mathods
- indicate to customers bus has cash flow problems, more cautious of dealing with em
11
Q
invoice discounting (very similar to factoring)
A
manage cash flow but bus chases own payments in usual way so customers arent aware of arrangement
* factoring, finance compayn responsible collect debts owed
12
Q
working capital management (strat)
A
funds available for the ST financial commitments of a business (liquidity, like CF managemetn) determine best mix CA & CL to achieve objs!
- WC: CA-CL
- WC needed bc time lag in operating (cash-conversion) cycle
- incur expenses in PP, purchase stock, deliver services often receieve payments from sales time after paying inputs –> need hold funds w/n to cover expenses during time lag –> WC differs a lot betw bus depending on duration of operating cycles (fresh food outles need less WC than manuf since stock (turn over quickl)
- too much WC –> assets not efficiently used (cash bank dont generate income eg. purchase new equip, new product line,)
- must balance betw using funds tocreate profits & holding sufficient funds to cover payments
13
Q
short term liquidity importance
A
means bus can take adv of profit opp when they arise, meet ST financial obligations, pay creditors on time,
- lack = sell NC assets, including (property, equip) to raise cash –> lower output & revenue –> LT reduce profitability & ability repay other liabilities LT, threaten survival
- sufficient WC can pay creditors early & claim discounts, make regular investments (update equip, R&D, expand ops to take adv profitable opps when arise)
14
Q
why does a business need sufficient liquidity
A
so cash available/current assets can be converted to cash to pay debts
- creditors guarantee their accs will be paid
- fail to pay debtso n time alienate creditors & suppliers who experience extra debt collection costs & lose confidence in bus
15
Q
working capital, net working capital, working capitalcycle
A
funds available for **ST finanical commitments
**
current assets - current liabilities
- funds needed for day to day operations of bus to produce profits & provide cash for ST liquidity
length of time takes bus to convert net current assets & current liabilities into cash (time takes when bus purchases inventory to resell/raw materials if manuf products to when receive cash once sold
16
Q
what happens if there insufficient & excess working capital
A
bus failure if poorly managed
- means cahs shortages/liquidity problems & forced to ^ debt/new sources of finance/sell NC assets
- EXCESS means assets earn < cost to finance them
17
Q
profitable business difficulty with cash because
A
many bus profitable but have cash flow problem bc profit doesnt equal cash (vice versa) bc they have a workign capital problem
18
Q
what does it mean when the current (working capital) ratio is 2:1, high vs low
A
current assets (2) : current liabilities (1)
- within next 12 months, 2x amt assets need to be sold to generate cash & meet ST debts of business for same period
- acceptable but ratios depend on industry, type bus, efficienct to convert CA into cash, relations w/ creditors & banks that (sources of cash)
HIGH = invested too much in CA bringing small return
- reduce profitability as bus reduce risk not being able to pay debts by having higher ratio
LOW = bus more profitable if investing its resources in LT assets & generating more profits but risk unable to pay CL
19
Q
3 types of strats
control of current assets in working capital maangement
A
- cash
- accs receievable
- inventories
- management select optimal amt each current assetheld & raising finance required to fund assets
- require planning & constant monitoring
- excess cash & stock & lack control over accs receivable –> ^unused assets –> ^ costs & liquidity problems (excess cash is cost if unused), inefficiency
- WC must be susficient to maintain liquidity & access to credit (overdraft) to meet unexpected circumstancs
20
Q
cash in control of current assets (working cpaital management)
A
- ensures bus can pay S< debts & survive LT
- cash reserves to take adv of investment opp (expansion)
- plan timing of cahs receipts, cash payments & asset purchases avoids cash shortages/excess
- cash flow shortages from unforeseen expenses may borrow money –> incur **interest ** costs
- try keep cash balances at minimum & hold marketable securities (high demand & liquid assets eg. shares, bonds) as reservces of liquidity guard against sudden shortages/disruptions to cahs flow
21
Q
(accounts) receivable (s) in controlling current assets for working capital management
A
Amts owed to business by its debtors that is expected to be received in a relatively short time
- outstanding invoices/payments bus has - money bus owed by customers
- discounts for early payments, late fee policy
- send invoices & reminders regularly (fortnight)
- factoring
- credit rating check before allowing large credit sales
- make sale (delivered g/s to customer) but customer owes payment still,
- collecting vital to ensure cash flow & managing working capital, ensure timing allows bus to maintain adequate cash resources
- quicker debtors pay, better cash position
22
Q
procedures for managing accs receivable
A
- check credit rating customers
- follow accs not paid by due date
- reasonable period (30 day) to pay accs
- policies to collect bad debts (debt collection agency)
- preapre debtors report (list customers (debtors) that owe bus money, how much owe, how long payment overdue easy to identify slow payers so dont issue them w/ additional credit until paid outstanding debts)
23
Q
DISADV OF OPERATING TIGHT CREDIT CONTROL policy
A
possibility customers may choose to byt from other firms
24
Q
inventories in controlling current assets under working capital managemnet
A
monitor lvls prevnt excess/shortage stock
- use JIT
- too much –> cash shortages,
- inventory turnover rate diff depending on type bus (fruit markets high turnover & pay inventory close to time of sale, cars opp
- ensure intenvtory turnover sufficeint tp gemerate cash to pay suppliers on time so they’re willing to give credit in ffuture
- obsolescent after PIT, esp perishable goods
- shortage –> lose customers & sales
25
processes of financial management (syllabus)
**planning & implementing** (financial needs, budgets, record systems, financial risks, financial controls)
* **debt & equity** finance
* **match terms & source of finance to purpose**
**monitoring & controlling**
* **cash flow** statement
* **incoem** statement
* **balance** sheet
financial **ratios**
* (**liquidity:** current,
* gearing: debt to equity,
* **profitability**: gross profit, net profit,
* **efficiency**: expense, accs receievable turnover,
* **comparative** ratio analysis (over **diff time periods**, against **standards**, with **similar bus)**
limitations of financial reports
ethical issues in financial reports
26
financial management strats (syllabus)
1. **cash flow** management
* cash flow statements
* distribution of payments
* discounts for early payment
* factoring
2. **working capital** management
* control **C**A (cash, accs receivable, inventory)
* control **CL** (accs payable, loans, overdrafts)
* **strats** **(leasing, sale & lease back)**
3. **profitability** management
* cost controls (fixed, variable, **cost centres, expense minimisation)**
* **revenue** controls (**marketing objectives)**
4. **global financial** management
* ERs, IRs,
* methods **international payment** (payment in advance, LOE, clean payment, BOE)
* **hedging, derivatives**
27
invenstory control
**system** to ensure **costs** **maintaining inventory** of **materials** kept minimum
* minimise costs by **not allowing materials to remain idle** and ensure **available for production** when needed
* **control (Physical)** inventory & through **(accounting) control** eg. using inventory recording system
* many use bar coding & computerised stock records
* **computerisation minimsie loss/theft stock** w/ precise up to date info abt stock lvls
* signals alert management when **time to order new materials + how much** to order
* conduct stocktakes, physcially **count stock and ocmpare against expected** to be available &diff means **stock control problems**
28
# define + 3 of the CL's
control current liabilities in working capital maangement (3)
| LOA
ST debts expected to be repaid within 12 months
* convert CA into cash to ensure creditors) paid on time
1. accs payable
2. loans
3. overdraft
29
**(accs) payable(S)** in **controlling current liabilities** under WC management what happens if fail to?
**amts bus owes to creditors who need to be paid in relatively short time**
* monitor **interest-free credit periods** (pay at later scheduled date) to **avoid late fee charges** (timing --> maintain adequate cash resources)
* can improve liquidiy by delaying accs payable until due
* take adv of **early payment discounts** (ensure **trade credit **extended to bus in future)
* **extend terms for payments** offered by established **suppliers** w/o interest/penalty
* can use floor plan finance (stock turnover slow) for extended period before payment due & consignment finance (payment not required until goods sold, & unsold items can be returned)
* **try pay accs on time avoid late payment penalties, damage reputation/ supplier relations**
30
what other **financing plans** should owners use when controlling accs payable?
investigate with suppliers eg. floor plan & consignment finance
* **slow stock turnover** often use 1. **floor plan/floor stock finance** so **suppliers agree to provide for PIT before payment due**
2. **consignment financing** where goods supplied for particular **PIT** and **payment** generally **not required until goods sold**
* goods supplied **can be returned if not sold within designated period**
31
loans when controlling current liabilities under working capital management
may need to **borrow funds in ST** ,
* prepare **cash budgets & cash flow statements**
* bridging finance (funds from sales not receieved but payment for purchases must be made) & ST loans sources ST funding
* **est costs, IRs** & **ongoing** charges **monitored** to **minimise costs**
* **ST loans expensive form borrowing** should **minimise use**
32
overdrafts when controlling current liabilities in working capital management (also CF management)
**convenient, relatively cheap** form of **ST borrowing** for business to overcome **temporary cash shortages** (bank allows you to access funds beyond your account's balance, up to a certain limit)
* can use to **overcome cash shortfalls forecasted by cash budget**
* **differ betw banks** but generally overdraw acc to limtied amt (charge fees daily/monthly depending on bank policy
* **carefully monitor bank charges** **bc vary depending on type overdraft**
* banks **can demand immediate repayment** of overdraft **(rare)** esp if bus has **good record**
* **bus** should have **policy for** using & managing **overdrafts & monitor budgets** on **daily/weekly** basis to **control cash supplies**
33
leasing as strat to manage working capital & advantages of leasing (other strats)
* free up cash to use eslewhere --> improve WC
* can **update capital machinery more often**
payment of money to use asset owned by another party (person/company)
* contract betw lessor (owner of asset) & lessee (user of asset) that lets lessee rent asset for PIT exchange for periodic payments
adv
* cash outflows (payments) related to it spread over several years than one-off large cash outflow if bus purchased asset outright, imporivng working capital
* considered as **operating expenses --> tax deductible**
* **flexibility to upgrade to new, better assets w/o making large cash outlay** purchasing new equip once **assets outdated**
* help **cash flow forecasting & budgeting (fixed payments for specified time)**
* bus will know what payments will be for duration of lease & **repayments wont fluctuate over time** like other forms borrowing
34
# common strategies
sale & lease-back as strat for managing working capital
**selling owned asset to lessor & leasing asset back** through **fixed payments** for specified **PIT**
* gives **large immediate** amts of **finance w/o incurring new debt
* only **pay fraction of asset value** to **lease it back from lessor**
* payments smaller bc spread over tme
* **lessor retained ownership** of asset for agreement
* biggest adv helps **improve liquidity** since bus received l**arge cash injection from sale** of asset which can be used as **working capital** if experiencing **cash shortfall**
* bus continues benefit from using asset
35
profitability management
strats to minimise costs & expenses & ^revenue to max profits
* **accurate, up to date financial data & reports** needed
* management must be dynamic to internal & ext factors impacting bus impacting profitability
* ability use strats determine LT success
* REVENUE controls (sales obj & mix, pricing strats) , EXPENSE minimisation, COST controls (cost centres, in/direct, fixed/variable)
36
what cost controls are, fixed & variable costs in costs controls under profitability management
* msot decisions (open store, buy machinery) influenced by costs (cash outflows) --> weigh against anticipated revenue (poor control costs reduce profits)
* COST CONTROLS strats improve efficiency by reducing operating costs to improve profitability (manage fixed & variable, cost centres, expense minimisation)
**FIXED** COSTS: **not dependent on lvl operating activities**/output (insurance, rent) of bus,
* **dont change** when lvl activity changes & **paid regardless** what happens to bus (salary, depreciation, insurance, lease) but **can change** eg. **new premises**, leasing costs increased then fixed
* minimise to find best deal entering arrangements/take adv discounts early payment
**VARIABLE** COSTS: **vary** in **direct relation(proportionally**) to **lvls production/operating activities** (labour, energy, materials, COGS)
* **changes in volume** of activitiy need to be managed and **csts compared with budgets, standards, previous periods** ensure
* buy bulk, budgets, industry standards, previous periods compare so costs minimised & profits mxed
37
cost centres in cost controls under profitability management
certain **departments**, sections **of bus for set activities (benefits org) costs directly attributed** (R&D, IT, HR)
* establish CC --> **review spending of each cost centre, find inefficient sections --> cut costs**
* treat as separate unit can **measure how much spending on function yrly**
* management can **measure, budget, control costs for each function**
* **track & monitoring** **expenses using cost centres** greater **control**of total costs
* **can have several cost centres within 1 deparment** eg. manuf each assmelby line cost centre also IT deparment, accounting dpearmtnet
38
# examples of ways
expense minimisation as cost control under profitability management
examine all **activities** & decide **where costs** in production/provision of service can be **cut** (w/o compromising quality, remain competitive)
* **balance cost savings & quality** must determine which area/s acitivties
* many **reduce costs and pass savings** on to **customers** **without significantly impacting value of product** to customers
* lower profits if **high expenses** bc they **consume valuable resources**
* eg. EoS purchase products in **bulk**, **short delivery routes, small store** sizes, replace FT to casual emps, limited **opening hrs** (reduce **staffing** & **utility** costs),, **JIT inventory** management, **capital-labour sub**stitution, **outsource**
39
# 3 ways
revenue controls
* ensure regular incoem inflows & ^revenues to improve profits
* manage though marketing objs(^ sales) must be clear acceptable lvls:** including **sales obj, sales mix, pricing policy**
* **budgets & cost-volume-profit analysis tools** used to **control** revenue
* Service bus rev from fees/commissions
1. sales objectives
2. sales mix
3. pricing strats
40
**marketing obj** in **controlling revenue** under **profitability management** **(sales obj, sales mix, pricing policy**)
**^ sales**
**SALES OBJECTIVES**
* **sales targets** to max sales, **^ stock turnover** --> max rev
* must cover **fixed & variable costs** and **result in profit**
* **cost-volume-profit analysis** determine lvl **revenue** suff to to **break even** & **predict** effect on **profit** of **changes** in lvl **output, prices, costs**
**SALES MIX**
* **range g&s sold** (sell to **large retail markets** --> develop **broad sales mix** to **appeal** to **widest market possible** while reducing **risk**bc its **variety**. consider **disecos of scale** when developing **new product lines)**
* products w/ greatest profit margins & growth potential developed, poor profit slow turnover items phased out
* **changes** to sales mix maintaining focus on **customer base** **(msot of rev) before diversifying/extending product ranges/ceasing production** on certain lines
**PRICING POLICY**
* **balance sales w/ profits & costs (low prices** encourage **sales & market penetration** but need to cover **LT costs)**
* affects **revenue --> WC & profits**
* closely **monitor & control pricing decisions**
* **overprice** deter buyers (reduce revenue bc lower volume sales), **underprice** higher sales can result in **cash shortfalls & low profits**
* influenced by prod costs, comp prices, S< goals(accept lower profits ST if ^MS LT ), perceieved quality customers associate w/ product, gvt policies (price floors & ceilings for some g&s, tax)
41
risks in global financial transactions
many **large FIs** offer range of **services** to facilitate **financial management** of **global bus**
* **currency fluctuations/ERs, IRs**, international payment methods, **hedging, derivatives** **risks** for F managers (**ext bus enviro**, not significantly controlled by bus) but can use **strats** to **minimise neg effects**
* **financial risks of global expansion > domestic**
42
exchange rates in global financial manachement
value of 1 currency expressed in terms of another
c's have own currency for domestic purposes - international transactions, 1 currency convert to nother trrhrough **foreign exchange market**, determines value of one currency (expressed in terms of) relative to another
* most exporters expect to be paid in own currency
* **appreciation, every unit AUD converted into more foreign currency** --> **benefit** AUS **importer but reduce int competitiveness** of AUS **exports**
* **depreciation pay more AUD for same amt imports**
* major **risk** linked to **int trade & investment flow**
* forex dealers constantly **buy & sell** each other's currency, **price/value** each c's currency established aka **exchange rate**
* **foreign exchange rate** ratio of one currency to another, shows h**ow much a unit of 1 currency worth in terms of another**
43
effects of currency fluctuations
**ER**s flucturate due to variations in **demadn & supply**
* **risk** for **global business** - when expenses transferred betw nations, exchange rate **inc/dec value**
* sig impact **profitability** of global bus, **ability to meet financial objs,**
1. appreciation raises value of AUD in terms of foreign currencies
* **each unit of foreign currency buys fewer AUD**
* 1 AUD buys more foreign currency
* **exports more expensive** on **international markets** but **import prices fall**
* **reduce international competitiveness** of AUS exporting businesses
2. depreciation lowers price AUD in terms of foreign currencies, **each unti of foreng currency buys more AUD**,m exports cheaper, prices imports rise
* improve international competitiveness of AUS exporting businesses
44
interest rates in global financial management eg. relocate offshore, expand domestic production facilities to increase direct exporting raise finance
global bus can borrow moeny from FIs in AUS/ borrow money from finanical markets overseas
* AUS IRs usually above other countries, AUS bus **borrow finance from overseas source gain adv lower IRs, reduce borrowing costs (if dom IRs rise/same whn overseas fall,)**
* **risk** **ER movements** - adverse **currency fluctuation**s
* LT 'cheap' IRs can cost more
* major impact on **profitability** if borrowed moeny from **finance markets overseas (risk ER depreciation)**
45
4 methods of international payment in global financial management (2 problems and 1 solution for them)
**not** being **paid** big **risk for exporting bus'**
* complicated **payment** when dealing w/ someone **never seen**, speaks another **language**, uses **diff monetary & legal system**,
* major concern for exporter is **if products shipped before payment receied, no guarantee importer will pay**
* **importer concerned if payment sent before products received**, no guarantee exporter will send products
* to SOLVE, use **3rd party both trust** eg. **bank as intermediary**
1. payment **in advance**
2. **letter of credit**
3. **clean** payment (**/open acc)**
4. **bill of exchange**
option **depends** on bus assessment of **importer's ability to pay** (creditworthiness), each method **varies risk** esp when credit payments involved
46
payment in advance as method of international apyment
**(importer sends** payment **before goods sent, exporter receive)**
* **exporter** **no risk,** used if **other party is a subsidiarybuyer's credit worthiness uncertain**
* very **few importers agree** to terms bc exposes **msot risk** for them with **no guarantee** they'll **receive** what they **ordered**
47
letter of credit as method of international payment
document **importer requests from** their **bank** **guaranteeing payment** of goods will be transferred to exporter when **conditions met**
* sometimes **exporters require importer to have letter of credit confirmed by secure bank** to ensure payment wil be received
* once bank makes commitment, cant withdraw
* if buyer(**importer)** **cant** make payment, **bank cover purchase** and only issue if know buyer will pay
* some banks require buyers to deposit/enough moeny to cover payment otherwise allow buyers to use a line of credit
* **popular with exporters** bc **relies on bank > importer** (**low risk for exporter, high** risk for **importer**, risk for **bank issuing** LOC)
48
bill of exchange as method of international payment 2 types
**document drawn up by exporter (drawer) demanding payment from importer (drawee) at specified time** (low risk for both)
* **exporter** can **maintain control over goods until payment made/guaranteed**
* **risk** of non/payment delays when using this always **greater than letter of credit**
* **docs agaisnt acceptance** (risk **importer** delay **payment**/not pay at all) expose **exporter greater risk than docs agaisnt payment** (risk **importer** may **not collect docs/pay** for goods)
1. **Document (billl) against payment**
* exporter shifps goods and submits BOE to their bank, who forwards docs to importer's bank. importer receieves docs when making payment
* **importer** can **collect goods AFTER paying**
* **exporter draws** up a BOE with **importer's bank** with docs allowing **importer to collect goods** if they **pay the BOE**
* **importer's bank** hands over docs after payment made & **transfers funds to exporter's bank**
* exporter instructs importer's bank to hand over shipping and BOE to importer only if they pay BOE
* **favourable for exporter** bc guarantees payment before importer receieves goods
2. **Document (bill) agaisnt acceptance**
* exporter submits BOE to their bank, sends to importer's bank but importer just ACCEPT BOE (promise to pay on future date)
* **importer** can **collect goods BEFORE paying**
* exporter instructs importer's bank to hand over shipping & BOE to importer only if they accept BOE
* **importer** only **sign** **acceptance of goods** & terms of **BOE** to **receive docs** --> can **pay for goods at later date**
* **exporter risks importer defaults** on payment
49
clean payment (open acc) as method of international payment
exporter **ships goods** directly to importer **before payment** received
* importer doesn't send **payment** until **after receive goods**, which usually shipped with **invoice requesting payment** at certain time **after delivery** (30, 60 or 90 days)
* time exporter gives buyer to pay for goods is **credit term**
* when **exporter confident** that **importer** will **pay by agreed time**
* super **risky for exporters** but very **advantageous** options for **importer**
50
hedging in global financial management (2)
**minimising risk** of **currency fluctuations (ER)** to **reduce** lvl **uncertainty** w/ **international financial transactions**
* **spot exchange transaction** when **2 parties agree** to **exchange currency & finalise deal immediately **
* **spot exchange rate** value of one currency in another currency on certain day
* **ERs constantly change**, currency fluctuations can **increase costs and reduce profits**
1. **natural** hedging
2. **financial** instrument hedging (**derivatives**/financial hedging)
51
natural hedging
structuring operations so natural flow of revenues and expenses offsets risks
* arrange **import payments & export receipts denominated in same foreign currency** so **losses** from **movement in ER offset** by **gains** from the other
* **marketing starts** to **reduce price sensitivity of exports**
* **import & export contracts denom in AUD** to **transfer risk to** buyer **(Importer)**
* establishing **offshore subsidiaries**
52
financial instrument (derivatives) hedging
| 4 types
**financial contract** based on **asset/share/currency's future market value**
* **FORWARD EXCHANGE CONTRACT**: **exchange 1 currency for another** at **agreed ER** on **future date** (30, 90, 180 days) --> eliminate risk ER volatility but cost **unable take adv favourable ER movements**
* **FUTURE CONTRACT** made on **trading floor** of future exchange to **buy/sell commodities** at **future date** for specified **price set in present,** prevent unfavourable **commodity price fluctuation** bc traders **certain of price** they **pay/receive**
* **OPTION CONTRACT**: trader **right not obligation** to **buy/sell assets at price agreed** in **present** over PIT. holders protected from unfavourable ER fluctuations but have **opp if ER movements favourable**
* **CURRENCY SWAP:**: exchange curency in the **spot market** w/ agreement to **reverse transaction in future**
53
derivatives + 3 main derivatives available for exporters `
simple financial instrumetns can be used to lessen exporting risks of currency fluctuations
* fixed IR on loan, hard to predict so can lock in rate on loan to protect themselves against future IR rises
* can plan finances bc know exactly how much repaying
* wont benefit from falling IRs
1. forward exchange contracts
2. option contracts
3. swap contracts
54
forward exchange contract
contract to **exchange one currency for another** currency at **agreed ER** on **future date** (30, 90, 180 days)
* **eliminates risk** associated with **ER volatility** but **unable** take adv **favourable ER movements**
55
options contract
gives **buyer** a(option **holder)** **right not obligation** to **buy/sell foreign currency** some time in **future**
* protected from unfavourable exchagne rate flucturations & maintain opp for gain if exhcange rate movemetns favourable
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# financial hedging
currency swap contract
agreement to **exchange currency** in the **spot market** & **reverse transaction in future**
* **exporter** receieved **foreign currency from importer** and **importer receieves home currency**, agree to **swap at future date w/ predetermined ER**
* also use when need to **raise finance** in **currency** issued by country **not well known** and forced to **pay higher IR** than available to better known borrower/local bus
* main adv allows bus to alter its exposure to exchange fluctations wuthout discarding original transaction
* despite being reputable bus w/ good credit rating if not known in foreign c.
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swap contract hypothetical
if finds broker/bank, Japanese bus wants AUD could swap: AUS bus borrow AUD in Aus (well known, can arrange loan at cheaper IRs), Japanese bus borrow yen in Japan same reason. agree to swap currencies & repay each others loan (AUS bus repay japanese yen loan)
