Finance

The role of financial management

Strategic role of financial management
The strategies a business adopts work towards achieving its goals both in the
short and longer term.
Bus goals may include increasing dividends to shareholders, maximise profits
Goals are translated into business objectives that break the business operations
into achievable and manageable outcomes that can be measured and evaluated.
There must be a carefully determined process by which a business will achieve
its goals
The main elements of business planning:
Goals/purpose- business objective- strategic planning- tactical planningoperational planning
Strategic plans are the most important, encompassing a long term view of where
the business is going, how it will get there and a monitoring process to keep
track of progress. May be up to 10 years, include strategies to achieve goals.

Managing financial resources

Financial resources are those resources in a business that have a monetary or
money value.
Financial management is the planning and monitoring of a businesss financial
resources to enable the business to achieve its financial goals.
Mismanagement of financial resources can lead to problems such as:
Insufficient cash to pay supplier
Too many assets that are non-productive
Overstocking of materials
Strategies for monitoring the financial resources of a business should be in the
strategic plan:
Monitoring cash flows
Paying debts
Developing financial control techniques
Auditing of financial accounts
Continuing to make profits for owners and shareholders.

Objectives of financial management

For a business to achieve longer term goals it must have a number of short term,
specific objectives. The objectives of financial management are to maximise the
businesses:
Profitability
Growth
Efficiency
Liquidity
Solvency
Profitability

Profitability is the ability of a business to maximise its profits. Profits satisfy

owners/shareholders in the short term, and are important for longer term
sustainability
To ensure profit is maximised, a business must monitor revenue and pricing
policies, costs and expenses, inventory levels and levels of assets.
Growth
Growth is the ability of the business to increase its size in the longer term. A
businesss growth depends on its ability to develop and increase sales, profit and
market share.
Efficiency
Efficiency is the ability of a business to use its resources effectively in ensuring
financial stability and profitability. Involves minimising costs and managing
assets so that max profit is achieved with lowest possible level of assets. Bus
must monitor the levels of inventories and cash and the collection of receivables.
Liquidity
Liquidity is the extent to which the business can meet its financial commitments
in the short term. A business must have sufficient cash flow or be able to convert
current assets into cash quickly e.g. selling inventory.
Solvency
Solvency is the extent to which the business can meet its financial commitments
in the longer term (greater than 12 months). Important to owners, shareholders
and creditors- indication of the risks to their investment.
Short-term and long-term financial objectives: (based on the goals of the
strategic plan)
Short term objectives are the tactical (one to two years) and operational (day to
day) plans of a business. These would be reviewed regularly to see if targets are
being met and if resources are being used to the best advantage to achieve the
objectives
Long term financial objectives are the strategic plans of a business (usually more
than 5 years). They tend to be broad e.g. increasing profit, they require a series
of short term goals to assist in its achievement, constantly reviewed.

Interdependence with other key business functions

Influences on financial management
Internal sources of finance
Internal finance comes either from the businesss owners (equity or capital) or
from the outcomes of business activities (retained profits)
Owners equity

The funds contributed by owners or partners to establish and build the business.
Equity capital can be raised in a number of ways e.g. by taking another partner
or seeking funds from an investor who then becomes an owner or shareholder,
issuing private shares, etc.

Retained profits
Some profits are kept in the business as a cheap and accessible source of finance
for future activities.

External sources of finance

External finance is funds provided by sources outside the business, e.g. banks,
other financial institutions, government, suppliers or financial intermediaries. The
increased funds for the business should mean increases in earnings and hence
profits.
Debt short-term borrowing: usually repaid within one or two years
There is an increase for business using debt as interest and bank and govt
charges have to be paid on top of principal borrowed. However, tax deductions
are provided for interest payments.
Short term borrowing is used to finance temporary shortages in cash flow or
finance for working capital.
Bank overdraft
A bank overdraft is when the bank allows a business or individual to overdraw
their account up to an agreed limit and for a specified time, to help overcome
temporary cash shortfall, e.g. due to a seasonal decrease in sales.
Costs for bank overdrafts are minimal, and interest rates are lower than on other
forms or borrowing.
Commercial bills
Commercial bills are a type of bill of exchange (loan) issued by institutions other
than banks, and are given for larger amounts, usually over $100000 for a period
of between 90 and 180 days. The borrower receives the money immediately and
promises to pay the sum of money and interest at a future time.
A bill of exchange is a document ordering the payment of a certain amount of
money at some fixed future date.

Factoring
Factoring is a short-term source of borrowing for a business. It enables a business
to raise funds immediately by selling accounts receivable at a discount to a firm
that specialises in collecting accounts receivable. Business receive up to 90% of
the amount of receivables within 48 hours of submitting to factoring company.
A factoring company may offer services with or without recourse.
without recourse means the business transfers responsibility for non-collection
to the factoring company
with recourse means that bad debts will still be the responsibility of the
business

It is a relatively expensive source of finance because the business is usually

responsible for debts that remain unpaid, and commission is paid on the debt.
Debt: long-term borrowing
Usually used to finance real estate, plant and equipment.
Mortgage
A mortgage is a loan secured by the property of the borrower (business).
Mortgage loans are used to finance property purchases e.g. new factory. They
are usually repaid through regular repayments and over an agreed period.
Debentures
Debentures are issued by a company for a fixed rate of interest and for a fixed
period of time. Debentures are usually not secured to specific property.
Companies that borrow offer security to the lender over the companys assets.
On maturity, the company repays the amount of the debenture by buying back
the debenture. E.g. finance companies raise funds through debenture issues to
the public.
Unsecured notes
An unsecured note is a loan for a set period of time but is not backed by any
collateral or assets, therefore presenting the most risk to the lender.
Consequently, it attracts a higher finance rate than a secured note.
Leasing
Leasing is a long-term source of borrowing for businesses. It involves the
payment of money for the use of equipment that is owned by another party. The
lessee uses the equipment and the lessor owns and leases the equipment for an
agreed period of time. Long term lease usually cannot be cancelled.
Operating leases: assets leased for short periods, usually shorter than the life of
the asset. The owner carries out maintenance on the asset. Op leases can be
cancelled, often without penalty.

Financial leases: the lessor purchases the asset on behalf of the lessee. Financial
leases are usually for the life of the asset. Repayments are fixed for the
economic life of the asset, usually between three and five years. E.g. vehicles,
equipment, furniture. There are usually penalties for cancellation.
Cheaper than operating leases
Some advantages of leasing as a source of finance:
Costs of establishing leases may be lower than other methods of financing.
If some assets are leased a business may be in a better position to borrow funds
Provides long-term financing without reducing control of ownership
Repayments are fixed for a period so cash flow can be monitored easily.
Lease payments are a tax deduction.
Payment usually includes maintenance, insurance and finance costs
A disadvantage: interest charges may be higher than for other forms of
borrowing
Equity

Equity refers to the finance (cash) raised by a company by issuing shares to the
public through the Australian Securities Exchange (ASX).
Equity as a source of external finance includes:
Ordinary shares (new issue, rights issue, placements, share purchase plan)
Private equity
Ordinary shares
The purchase of ordinary shares means an individual becomes a part owner of a
publicly listed company and may receive payments called dividends.
Variations in the type of ordinary shares:
New issue: a security that has been issued and sold for the first time on a public
market; sometimes referred to as primary shares or new offerings
Rights issue: the privilege granted to shareholders to buy new shares in the
same company
Placements: allotment of shares, debentures, and so on made directly from the
company to investors
Share purchase plan: an offer to existing shareholders in a listed company the
opportunity to purchase more shares in that company without brokerage fees.
The shares can also be offered at a discount to the current market price.
Private equity
Private equity is the money invested in a private company not listed on the ASX.
The aim of the company is to raise capital to finance future
expansion/investment of the business.

Financial institutions
Banks
Banks receive savings as deposits from individuals, businesses and governments,
and, in turn, make investments and loans to borrowers.
Most of the funds provided through financial markets come from banks that
operate on their own behalf or on behalf of other corporations, although other
financial institutions also operate in the financial market.
Banks only provide loans with acceptable risk
Investment banks
Investment baknks provide services in borrowing & lending, primarily to business
sector. They:
-trade in money, security and financial futures
- arrange long-term finance for company expansion
-advise on mergers and takeovers
- arrange overseas finance
Finance & life insurance companies
Finance and life insurance companies are non-bank financial intermediaries that
specialise in smaller commercial finance. These companies are regulated by the
Australian Prudential Regulation Authority (APRA).
Finance companies provide loans to businesses and individuals through
consumer hire-purchase loans, personal loans and secured loans to businesses.
They are also the major providers of lease finance to businesses. Some finance
companies specialise in factoring or cash flow financing.

They raise capital through share issues (debentures). Debentures are for a fixed
term and carry a fixed rate of interest. Lenders have the security of priority over
the firms assets in the event of liquidation.
Insurance companies provide loans to the corporate sector through receipts of
insurance premiums, which provide funds for investment. They provide large
amounts of both equity and loan capital to businesses.
The funds received in premiums, called reserves, are invested in financial assets.
The premiums paid by investors provide for compensation should something
adverse happen, such as injury or death, or for savings for future needs.

Superannuation Funds
These organisations provide funds to the corporate sector through investment of
funds received from superannuation contributors.
Superannuation funds are able to invest in long-term securities as company
shares, govt and company debt because of the long term nature of their funds.
Unit trusts
Unit trusts take funds from a large number of small investors and invest them in
specific types of financial assets. Unit trusts investments include the sort-term
money market (cash management trusts), shares, mortgages and property, and
public securities.
Australian Securities Exchange
The Australian securities exchange (ASX) is the primary stock exchange group in
Australia.
The ASX offers products and services including shares, warrants, exchange
traded funds
The ASX acts as a primary market for businesses. Primary markets deal with the
new issue of debt instruments by the borrower of funds. The primary market
enables a company to raise new capital through the issue of shares and through
the receipt of proceeds from the sale of securities
The ASX also operates as a secondary market. The secondary market is where
pre-owned or second-hand securities, such as shares, are traded between
investors.

Influence of government
The government influences a businesss financial management decision making
with economic policies such as those relating to the monetary and fiscal policy,
legislation and various roles of government bodies or departments who are
responsible for monitoring and administration.
The Australian Securities and Investments Commission (ASIC)
It enforces and administers the Corporations Act and protects consumers in the
areas of investments, life and general insurance, superannuation and banking in
Australia.
The aim of ASIC is to assist in reducing fraud and unfair practices in financial
markets and financial products.
ASIC ensures that companies adhere to the law, collects info about companies
and makes it available to the public.

1998: responsibilities of ASIC broadened to cover supervision of the retail

inverstments industry as well as overseeing the Corporations Act. ASIC assumed
some of the previous functions of the Insurance and Superannuation
Commission, the Reserve Bank and the Australian Competition and Consumer
Commission.
2010: ASIC assumed responsibility for the supervision of trading on Austs
domestic licensed equity, derivatives and futures markets.
Company Taxation
Companies and corporations in Australia pay company tax on profits. This tax is
levied at a flat rate of 30%. Company tax is paid before profits are distributed to
shareholders as dividends.

Global market influences

Financial risks associated with global markets are greater than those
encountered domestically, but such risk taking is necessary for a business
strategy to be implemented. Largely uncontrollable external financial influences
include the availability of funds, interest rates and the global economic outlook.

Global economic outlook

Refers specifically to the projected changes to the level of economic growth
throughout the world.
If the outlook is positive (i.e. world economic growth is to increase) this will
impact the financial decisions of a business in the following areas:
Increasing demand for products and services. Business would need to increase
production to meet demands and would therefore require funds to purchase
equipment, employ or train staff, or expand the size of the business.
Decrease the interest rates on funds borrowed internationally from the financial
money market, as there is a decrease in the level of risk associated with
repayments (business sales and profits increase)
However, a poor economic outlook will impact on financial decisions of a
business in the opposite ways ^^
Availability of funds
The availability of funds refers to the ease with which a business can access
funds (for borrowing) on the international financial markets.
There are various conditions and rates that apply and these will be based
primarily on risk, demand and supply, domestic economic conditions.
Global financial crisis 2008-09, major impact of availability of funds; caused a
sharp increase in interest rates that was a reflection of the high level of risk in
lending.
Interest rates
Interest rates are the cost of borrowing money.
Higher level of risk= higher interest rates.

Businesses wishing to relocate offshore/expand domestic production facilities to

increase direct exporting will normally need to raise finance to undertake these
activities.
Traditionally Australian interest rates tend to be above those of other countries
such as US and Japan. Therefore, Aust businesses could be tempted to borrow
the necessary finance from an overseas source to gain the advantage of lower
interest rates. Risk; exchange rate movements. Any adverse currency
fluctuation could see the advantage of cheap overseas interest rates quickly
eliminated.
Chapter 11: Processes of financial management

Planning and implementing

Financial planning determines how a businesss goals will be achieved
The financial planning process begins with long-term or strategic financial plans.
Long-term plans include a businesss planned capital expenditure and/or planned
investments. Capital expenditure is what is spent on a businesss non-current or
fixed assets. It is used to generate revenue and ultimately returns to owners and
shareholders.
Long-term plans cover planned sources of finance, spending on R&D, marketing
and product development activities. Long term plans (between 2 and 10 years)
guide the development of short-term tactical and operating plans. Short term
plans are more specific and cover plans and budgets for periods of one to two
years or one year or less.
Planning processes involve the setting of goals and objectives, determining the
strategies to achieve those goals and objectives, identifying and evaluating
alternative courses of action and choosing the best alternative for the business.
Financial needs
Important financial info needs to be collected before furute plans made, including
balance sheets, income statements, cash flow statements, sales and price
forecasts, etc.
A business plan might be used when seeking finance or support for a project
from banks, etc or potential investors.
Financial info is needed to show the bus can generate an acceptable return for
the investment being sought.
Financial needs depend on the businesses size, phase of business cycle, future
plans for growth and development, etc.
Budgets

Budgets provide information in quantitative terms (facts and figures) about

requirements to achieve a particular purpose. Budgets can show:
Cash required for planned outlays for a particular period
The cost of capital expenditure and associated expenses against earning
capacity
Estimated use and cost of raw materials or inventory
Number and cost of labour hours required for production
Budgets reflect the strategic planning decisions about how resources are to be
used. They provide info for specific goals and are used in strategic, tactical and
op planning

Budgets enable monitoring of objectives, provide basis for control. As a control

measure, planned performance can be measured against actual performance
and corrective action taken as needed.
Factors considered in planning a budget:
Review of past figures and trends and estimates
Potential market or market share, and trends and seasonal fluctuations in the
market
Current orders and plant capacity
External environment- financial trends, availability of materials and labour
Operating budgets relate to the main activities of a business and may include
budgets relating to sales, production, raw materials, etc
Project budgets relate to capital expenditure and R&D
Financial budgets relate to financial data of a business and include the budgeted
income statement, balance sheet and cash flows.
Record systems
Record systems are the mechanisms employed by a business to ensure that data
is recorded and the information provided by record systems is accurate, reliable,
efficient and accessible.
Managements bases decisions off this info- minimising errors in the recording
process, producing accurate and reliable financial statements is crucial.
Control method: Double entry system- by recording all items twice, errors can be
identified.
Financial risks

Financial risk is the risk to a business of being unable to cover its financial
obligations, e.g. debt.
In assessing financial risk, the bus must consider:
Amount of borrowings & when they are due to be repaid
Interest rates
Required level of current assets needed to finance operations
Bus financed from borrowing=higher risk. The higher the risk, the greater the
expectation of profits or dividends.
The revenue generated must be sufficient to cover debt as well as increasing
profits to justify the amount of risk taken by owners and shareholders
If the business has short-term debt, it must have liquid assets so debt can be
covered.
Financial controls

The most common causes of financial problems and losses are:

Theft, fraud, damage or loss of assets, errors in record systems
Financial controls are the policies and procdures that ensure that the plans of a
business will be achieved in the most efficient way. Policies are designed to be
followed by management and employees.
Control is particularly important in assets such as accounts receivable, inventory
and cash.
Some common policies promoting control within a business are:
Clear authorisation and responsibility for tasks in the business
Separation of duties, rotation of duties

Control of cash, e.g. banking cash daily

Protection of assets e.g. buildings kept locked and security surveillance
Control of credit procedures e.g. following up overdue accounts
Budgets are also financial controls
Debt and Equity financing
Debt finance relates to the short-term and long-term borrowing from external
sources by a business
Equity finance relates to the internal sources of finance in the business
Debt finance

Appealing to a business as funds are usually readily available and interest

payments are tax deductible therefore reducing the cost of debt financing.
Adv:
Funds are usually readily available
Increased funds should lead to increased earnings and profits
Tax deduction for interest payments
Disadv:
Increased risk if debt comes from financial institutions because the interest, bank
charges, govt charges and principal have to be repaid
Security is required by the business
Regular repayments have to be made
Lenders have first claim on any money if the business ends in bankruptcy.
Equity finance
The highest proportion of equity finance comes from shareholders funds.
Equity funds provide confidence to creditors and lenders, who are more willing to
lend to a business if there are equity funds.
Table 11.2, 11.3
Matching the terms and sources of finance to business purpose
The terms of finance must be suitable for the structure of the business and the
purpose for which the funds are required. E.g. short term finance options should
be suitable to match the short-term purposes of the business. Long-term finance
for long-term purposes.
The cost of each source of funding (whether equity or debt) must be determined.
The required rate of return that can be expected is also taken into consideration
and balanced against the costs of each source
The structure of the business can influence decisions on finance. Small business
have fewer opportunities for equity capital than larger businesses. Equity for
unincorporated business has to be raised from private sources or by taking on
another partner. Corporate business can raise equity by issuing shares to the
public.
Costs, including set up costs and interest rates- costs fluctuate due to eco
conditions
Flexibility of the source of funding must be considered. Businesses often require
sources of funds to be variable so that, if firms have excess funds, borrowings

can be paid off more quickly, increased or renewed as conditions change. Bank
overdrafts provide greater flexibility for businesses than debentures and
factoring.
The availability of finance. Too heavy a dependence on a small number of
investors can increase risk if an investor pulls out and commitments cannot be
met.
The level of control maintained by a business is also an important consideration.
If the lender requires security over an asset and other conditions of lending are
imposed, a businesss ability to consider future financing possibilities is reduced.

Monitoring and Controlling

The main financial controls used for monitoring include:
1. Cash flow statements
2. Income statements
3. Balance sheets
Cash flow statements
A Cash flow statement is a financial statement that indicates the movements of
cash receipts and cash payments resulting from transactions over a period of
time.
It gives important information regarding a firms ability to pay its debts on time
can identify trends and can be a useful predictor of change.
-

A statement of cash flows can show whether a firm can:

Generate a favourable cash flow
Pay its financial commitments as they fall due
Have sufficient funds for future expansion or change
Obtain finance from external sources when needed
Pay drawings to owners or dividends to shareholders
Operating activities: the inflows and outflows relating to the main activity of the
business- the provision of goods and services. Inflows: sales, dividends, interest
received.
Outflows: payments to suppliers, employees, other operating expenses (rent,
insurance,advertsing)
Investing activities: the cash inflows and outflows relating to purchase and sale
of non-current assets and investments. These assets and investments are used
to generate income for the business. e.g. selling a vehicle, purchasing new
plant/equipment
Financing activities: inflows/outflows relating to the borrowing activities of the
business. Borrowing inflows can relate to equity (issue of shares or capital
contribution from owner) or debt (loans from financial institution). Cash outflows
relate to the repayments of debt and cash drawings of the owner or payments of
dividends to shareholders.
The cash flow statement, income statement and balance sheet are used to show
how effectively finance is being used in a business. They also provide information
on whether the bus has sufficient funds to met unforeseen circumstances.
Income statement

The income statement shows the operating results for a period/operating

efficiency. It shows the revenue earned and expenses incurred over the
accounting period with the resultant profit or loss.
By examining figures from previous income statements, managers can make
comparisons and analyse trends before making important financial decisions.
Balance sheets

A balance sheet represents a businesss assets and liabilities at a particular point

in time, expressed in money terms, and represents the net worth (equity) of the
business. It shows the financial stability of the business. The balance sheet is
prepared at the end of the accounting period.
The balance sheet shows CA, NCA, CL,NCL, OE.
Assets represent what is owned by a business
Liabilities are owed by the business (external debt)
Owners equity represents the owners financial interest in the business or net
worth of the business (internal debt)
Analysis of the balance sheet can indicate whether:
The bus has enough assets to cover its debts
The interest and money borrowed can be paid
The assets of the business are being used to maximise profits
The owners of the business are making a good return on their investment
Figures from previous years balance sheets can be analysed and presented to
show the decision makers the trends and changes in the bus that need to be
investigated.
A= L+OE
The revenue statement shows the resulting profit from revenue, less expenses,
the profit (or loss_ figure is transferred to the owners equity as part of capital in
the balance sheet.

Financial Ratios
Vertical analysis compares figures within on financial year
Horizontal analysis compares figures from different financial years
Trend analysis compares figures for periods of three to five years

Liquidity- Current ratio

Liquidity is the extent to which the business can meet its financial commitments
in the short term, which refers to a period of less than 12 months. The business
must have sufficient resources to pay its debts and enough funds for unexpected
expenses.
The firm must be careful to ensure it has enough current assets that could be
used to generate cash quickly, but not so much that the resources are not being
used for producing revenue.
Acceptable ratio of 2:1 i.e. $2 of current assets to cover $1 of current liabilities.
Shortfall: the firm may have to sell non-current assets to cover liabilities, which
will reduce its capacity to earn profits, or it may have to borrow in the short term
and incur higher interest repayments.
Gearing- debt to equity ratio

Gearing is the proportion of debt (external finance) and the proportion of equity
(internal finance) that is used to finance the activities of a business.
The ratio determines the firms solvency (extent to which a business can meet its
financial commitments in the long term).
The degree of fearing depends on the type of industry and management of the
business. An industry that carries higher risk but is likely to generate large profits
(for example, mining) may have a higher debt-to-equity ratio (highly geared).
Manufacturing industries with strong markets often have high debt as the
potential for profit is greater.
The more highly geared the business (using debt rather than equity), the greater
the risk but the greater the potential for profit.
Debt affects stakeholders & potential investors because the high risk involved
may discourage investment
In balancing gearing, must consider the level of control by owners. Profits earned
must be sufficient to cover interest payments.
A bus must consider:
Return on investment
Cost of debt
Size and stability of the businesses earning capacity
Liquidity of the businesss assets (the greater the cash flow and the more liquid
the assets, the more likely the interest charges will be paid)
Purposes of short term debt
Higher ratio- less solvent, higher risk. Investors less attracted
A business that is less influenced by eco fluctuations can be more highly geared.
Generally accepted ratio of 1:1 - $1 external debt (liabilities) for $1 of internal
debt (owners equity).
Profitability
The amount of profit is determined by a number of factors, such as the volume of
sales, the mark-up on purchases and the level of expenses.
The income statement is used to measure the profitability or earning capacity of
the bus.

Gross profit ratio

Gross profit represents the amount of sales that is available to meet expenses
resulting in net profit
Gross profit can change depending on factors such as price reductions due to
sales, mark-downs on out of date stock, theft of stock, errors determining prices,
changes in mark-up policies or changes in the mix of sales. COGS can also
increase.
Expressed as %, bus would aim for a high GPR
Net profit ratio
Net profit represents the profit or return to the owners.

The net profit ratio shows the amount of sales revenue that results in net profit.
A firm would be aiming at a high net profit ratio
Return on equity ratio
Shows how effective the funds contributed by the owners have been in
generating profit, and hence a return on their investment. The return for the
owners has to be better than any return that could be gained from alternative
investments, such as bank investments. If return on equity rises due to increased
leverage (debt) the improved result should be seen as carrying increased risk.
Around 10% is reasonable. Higher is better.
If returns are favourably compared to industry averages and previous years, the
bus may consider expansion or diversification of the business. If return is
unfavourable, the owners would consider alternative options including selling off
the business.
Efficiency
Efficiency is the ability of the firm to use its resources effectively in ensuring
financial stability and profitability of the business. Efficiency relates to the
effectiveness of management in directing and maintaining the goals and
objectives of the firm.
Expense ratio
The expense ratio compares total expenses with sales. The ratio indicates the
amount of sales that are allocated to individual expenses, such as selling,
administration, COGS and financial. The expense ratio indicates the day-to-day
efficiency of the business.
Total expense should also be compared with budget to find reasons for
differences.
Expense ratios should be at a reasonable level (i.e. low %).

Accounts receivable turnover ratio

Measures the effectiveness of a firms credit policy and how efficiently it collects
its debts. It measures how many times the accounts receivable balance is
converted into cash or how quickly debtors pay their accounts.
The ratio is measured in days. It indicates the efficiency for a business to collect
its debts (assuming the firm has a billing cycle of 30 days).
Comparative ratio analysis
For analysis to be meaningful, comparisons and benchmarks are needed.
Judgements are then made.
Ratio analysis taken for a firm over a number of years can be compared with
similar businesses and against common industry standards or benchmarks.

Analysis can include budget figures so that predicted figures can be compared
against actual figures, usually over short time periods such as per month. This
info is usually used within the firm rather than external stakeholders.
Care must be taken to make sure the same things are compared + finding similar
business is difficult.

Limitations of financial reports

Issues which must be considered when analysing financial information:
Normalised earnings- The process of removing one time or unusual influences
from the balance sheet to show the true earnings of a company. An example of
this would be the removal of a land sale, which would achieve a large capital
gain.

Capitalising expenses- the process of adding a capital expense to the balance

sheet that is regarded as an asset rather than an expense. Examples of
capitalising expenses include:
Research and development
Development expenditure

Valusing assets- The process of estimating the market value of assets or

liabilities. Two main methods used for valuing assets include:
1. Discounted cash flow method. This estimates the value of an asset based on its
expected future cash flows, which are discounted to the present (i.e. the present
value)
2. Guideline company method. This determines the value of a firm by observing the
prices of similar companies (guideline companies) that sold in the market.
Timing issues- financial reports cover activities over a period of time, usually one
year. Therefore, the bus financial position may not be a true representation if
the business has experienced seasonal fluctuations.

Debt repayments- financial reports can be limited because they do not have the
capacity to disclose specific information about debt repayment such as:
How long the bus has had the debt, the capacity of the business or its debtor to
repay amounts owed, etc.
Notes to the financial statement- report the details and additional information
that are left out of the main reporting documents, such as the balance sheet and
income statement. These contain info such as such as accounting methodologies
used that can affect the bottom-line return expected from an investment
company.

Ethical issues related to financial reports

Financial management decisions must reflect the objectives of a business and
the interests of owners and shareholders. An area in which ethical considerations
are important is in the valuing of assets, including inventories and accounts
receivable. Such valuations influence the level of working capital and, hence, the

short-term financial stability of the business. Bus. Must consider how true their
working capital report is
If debt funds are used extensively to finance activities, there is added risk for
shareholders, and this is an ethical issue that must be considered.
Laws relating to corporations include the responsibilities of directors and
requirements for disclosure for corporations. In relation to financial management,
directors have a duty to:
-act in good faith
-exercise power for propoer purpose in the name of the corporation
-exercise discretion reasonably and properly
-avoid conflicts of interest
Monitored by the Australian Securities Exchange corporate governance council
Audited accounts
An audit is an independent check of the accuracy of financial records and
accounting procedures. Potential users of info include financial institutions,
owners and shareholders and potential investors who rely on the check of the
auditor before making decisions about the business.
External audits are a requirement of the Corporations Act 2001- the firms
financial reports are investigated by independent and specialised audit
accountants to guarantee their authenticity.
Internal and external audits assist in guarding against unnecessary waste,
inefficient use of resources, misuse of funds, fraud and theft. Audits are carried
out on the financial records of a bus to see if they are prepared in line with
accepted accounting standards and that records provide accurate information for
users. They physically check assets, e.g. count cash and examine inventory, to
see if they match up with the records.

Record keeping
Source documents must be created for every transaction, even those in which
cash has changed hands. There is a temptation to use cash and not record the
transaction- wont show up as bus revenue=lower profits=lower tax. The
Australian Taxation Office regularly monitors this and can distribute fines for
avoiding tax.
Goods and services (GST) obligations
One of the purposes of GST was to make it for difficult for bus operating using
cash to avoid tax. While it is the final customer who bears the cost of the GST,
the tax is collected at every stage in the production of goods and services sold to
the public- consequently, bus have an ethical and legal obligation to comply
with the GST reporting requirements.
Reporting practices
Stakeholders in a private company are legally entitled to receive financial reports
annually. To pretend that profit is lower than it should be is to attempt to defraud
the ATO. Legal + unethical + lower profits makes it harder to attract investors/
raise capital.

Financial management Strategies

Cash Flow management

Cash flow statements
Can identify trends and be a useful predictor of change
Distribution of payments, discounts for early payment, factoring
Distribution of payments:
An important strategy is to distribute payments throughout the month, year or
other period so that cash shortfalls do not occur. A cash flow projection can assist
in identifying periods of potential shortfalls and surpluses.
The business can use stretching of payments (pay on the last day).
Discounts for early payment:
Offering creditors a discount for early payments.
Factoring:
Selling accounts receivable for a discounted price to a finance or specialist
factoring company. The business saves on the costs involved in following up on
unpaid accounts and debt collection.
Additionally, the business could consider introducing fines for late payment

Working capital management

Working capital is the funds available for the short-term financial commitments
of a business.
Short term liquidity means a business can take advantage of profit opportunities
when they arise, meet short-term financial obligations, pay creditors on time to
claim discounts, pay tax and meet payments on loans and overdrafts.
A business must have sufficient liquidity so that cash is available or current
assets can be converted to cash to pay debts. The lack of short-term liquidity
could necessitate the sale of non-current assets, including long-term investments
such as property and equipment, to raise cash. In longer term, this can lead to
reduced profitability for owners and shareholders.
Net working capital is the difference between current assets and current
liabilities. It represents those funds needed for the day-to-day operations of a
business to produce profits and provide cash for short-term liquidity.
Control of current assets
Excess inventories and lack of control over accounts receivable lead to an
increased level of unused assets, leading in turn to increased costs and liquidity
problems. Excess cash is a cost if left idle and unused.
Control of current assets requires management to select the optimal amount of
each current asset held, as well as raising the finance required to fund those
assets.
Working capital must be sufficient to maintain liquidity and access to credit
(overdraft) to meet unexpected and unforeseen circumstances.

Cash
Cash ensures the business can pay its debts, repay loans and pay accounts in
the short term, and that the business survives in the long term. Supplies of cash
enable management to take advantage of investment opportunities.
Planning for the timing of cash receipts, cash payments and asset purchases
avoids the situation of cash shortages or excess cash. Businesses try to keep
their cash reserves to a minimum and hold marketable securities as reserves for
shortages in cash.

Receivables (Accounts receivable)

The collection of receivables is important in the management of working capital.
A business must monitor its accounts receivable and ensure their timing allows
the business to maintain adequate cash resources. The quicker the debtors pay,
the better.
Procedures for managing acc receivable include:
Checking the credit rating of prospective customers
Sending customers statements monthly and at the same time each month so
debtors know when to expect accounts
Following up on accounts not paid by the due date
Have a reasonable period (30 days) for the payment of accounts
Putting in policies for collecting bad debts, e.g. using a debt collection agency,
penalty for late payment
Inventories
Inventory levels must be monitored so excess or insufficient levels of stock do
not occur.
Too much inventory or slow-moving inventory will lead to cash shortages.
Holding too much stock means unnecessary expenses (e.g. storage and
insurance costs).
Insufficient inventory or quick-selling items may lead to loss of customers and
lost sales.
Businesses must ensure inventory turnover is sufficient to generate cash to pay
for purchases and pay suppliers on time so that they will be willing to give credit
in the future.
To assist in inventory management a business could use the JIT method to order
stock as it is required and place in security measures to stop theft of stock such
as cctv cameras.
Control of current liabilities
Payables (accounts payable)
A business must monitor its payables (money owed to other businesses) and
ensure that their timing allows the business to maintain adequate cash
resources.
Holding back accounts payable until their final due date can be a cheap means
to improve a firms liquidity position, as some suppliers allow a period of interestfree trade credit before requiring payment for goods purchased. It may also be
possible to take advantage of discounts offered by some creditors. This reduces
costs and assists with cash flow.
*Control of acc payable involves review of suppliers and the credit facilities they
provide, e.g. discounts for early payment

Interest-free credit periods

Extended terms for payments, sometimes offered by suppliers without interest or
penalty.
Consignment financing- goods are supplied for a particular period of time and
payment is generally not required until goods are sold. Goods supplied may also
be returned if they are not sold within the designated period.
Loans
Management of loans is important, as costs for establishment, interest rates and
ongoing charges must be investigated and monitored to minimise costs.
Overdrafts
They enable a business to overcome temporary cash shortages. They are
convenient.
Banks require regular payments be made on overdrafts and may charge accountkeeping fees, establishment fees and interest.
Businesses should have a policy for using and managing bank overdrafts and
monitor budgets on a daily or weekly basis so that cash supplies can be
controlled
Strategies- leasing, sale and lease back
Leasing
Leasing is the hiring of an asset from another person or company who has
purchased the asset and retains ownership of it.
Leasing frees up cash that can be used elsewhere in a business, so the level of
working capital is improved. It is attractive for some bus as it is an expense and
is tax deductible.
Firms can increase their number of assets through leasing and this means that
revenue, and therefore profits, can be increased. Regular and fixed payments
made for the lease can be planned to match the businesss cash flow.
Sale and lease-back
Sale and lease-back is the selling of an owned asset to a lessor and leasing the
asset back through fixed payments for a specified number of years.
This increases the business liquidity because the cash obtained from the sale is
then used as working capital.

Profitability management
Cost Controls
Fixed and variable costs
Fixed costs are not dependent on the level of operating activity in a business.
Fixed costs do not change when the level of activity changes- they must be paid
regardless e.g. salaries, depreciation, insurance and lease.

Variable costs are those than change proportionately with the level of operating
activity in a business. e.g. materials and labour.
Monitoring the levels of fixed and variable costs is important- changes in the
volume of activity need to be managed in terms of the associated changes in
costs. Comparisons of costs with budgets, standards and previous periods ensure
costs are minimised and profits maximised.
Cost centres
Cost centres are particular areas, departments or sections of a business to which
costs can be directly attributed. Cost centres have direct and indirect costs.
Direct costs are those that can be allocated to a particular product. Direct costs
are also called variable costs. E.g. depreciation of equipment used solely in the
production of one good.
Indirect costs are those that are shared by more than one product, activity,
department or region. E.g. the depreciation of equipment used to make several
products would have indirect costs allocated on some equitable basis
Expense minimisation
Outsourcing, waste minimisation programs, replacing full time employees with
casual employees, sales and lease back, replacing labour with technology where
appropriate, improving labour productivity, using JIT inventory system to reduce
inventory overheads, improving budgeting.
Revenue controls
Marketing objectives
Sales objectives:
A key sales objective is to maximise market share so as to increase sales, thus
leading to increased profit
The level of sales must cover costs, both fixed and variable, and result in profit. A
cost-volume-profit analysis can determine the level of revenue sufficient for a
business to cover its fixed and variable costs to break even, and predict the
effect on profit of changes in the level of activity, prices or costs.
Sales mix:
Products with the greatest profit margins and high growth potential are
developed while slow moving and poor profit items are phased out.
Pricing policy:
The main aim is to balance sales with profits. Low prices will encourage sales and
market penetrations but long-term costs need to be adequately covered. Factors
influencing price include the costs associated with production, prices charged by
competition, short & long term goals.

Global Financial Management

Exchange rates
When transactions are conducted on a global scale, one currency must be
converted to another. This transaction is performed through the foreign

exchange market (forex or fx), which determines the price of one currency
relative to another.
The foreign exchange rate is the ratio of one currency to another; it tells how
much a unit of one currency is worth in terms of another.
Exchange rates fluctuate over time due to variations in demand and supply. Such
fluctuations in the exchange rate create further risk for global business.
Impact of currency fluctuations:
1. A currency appreciation raises the value of the Aust. Dollar in terms of foreign
currencies. One Aust dollar buys more foreign currency. An appreciation makes
our exports more expensive on international markets but prices for imports will
fall. Appreciation reduces the international competitiveness of Australian
exporting businesses
2. A depreciation lowers the price of the Aust. Dollar in terms of foreign currencies.
Each unit of foreign currency buys more Australian dollars. The result is our
exports become cheaper and the price of imports will rise. A depreciation
therefore improves the international competitiveness of Aust exporting
businesses.
Interest rates
Aust. Businesses could be tempted to borrow the necessary finance from an
overseas source to gain the advantage of lower interest rates. However, the real
risk here is exchange rate movements. Any adverse currency fluctuation could
see the advantage of cheaper overseas interest rates quickly eliminated.
Methods of international payment
Payment in advance
The payment in advance method allows the exporter to receive payment and
then arrange for the goods to be sent. This method exposes the exporter to
virtually no risk and is often used if the other party is a subsidiary or when the
credit worthiness of the buyer is uncertain.
Letter of credit
A letter of credit is a commitment by the importers bank, which promises to pay
the exporter a specified amount when the documents proving shipment of the
goods are presented.

Clean payment (clean remittance)

This is the easiest and quickest method of settling an international transaction.
Clean payment occurs when the payment is sent to, but not received by, the
exporter before the goods are transported.
Bills of exchange
A bill of exchange is a document drawn up by the exporter demanding payment
from the importer at a specified time. This is widely used & allows the exporter to

maintain control over the goods until payment is either made or guaranteed.
There are two types of bills of exchange:
1. Document (bill) against payment. The importer can collect the goods only after
paying for them.
2. Document (bill) against acceptance. The importer may collect the goods before
paying for them.
The risk of non-payment or payment delays when using a bill of exchange is
always greater than for a letter of credit. However, documents against
acceptance expose the exporter to much greater risk than documents against
payment.
Hedging
When two parties agree to exchange currency and finalise a deal immediately,
the transaction is referred to as a spot exchange. Exchange rates determining
such on-the-spot transactions are referred to as spot exchange rates. The spot
exchange rate is the value of one currency in another currency on a particular
day.
Hedging is the process of minimising the risk of currency fluctuations- it helps
reduce the level of uncertainty involved with international financial transactions.
e.g. of hedging strategies: establishing offshore subsidiaries + arranging for
import payments and export receipts denominated in the same foreign currencytherefore, any losses from a movement in the exchange rate will be offset by
gain from the other.
Derivatives
Derivatives are simple financial instruments that may be used to lessen the
exporting risks associated with currency fluctuations.
Forward exchange contract: a contract to exchange one currency for another
currency at an agreed exchange rate on a future date, usually after a period of
30,90 or 180 days. This means the bank guarantees the exporter, within the set
time, a fixed rate of exchange for the money generated from the sale of the
exported goods.
Options contract:
An option gives the buyer (option holder) the right, but not the obligation, to buy
or sell foreign currency at some time in the future.
Swap contract:
A currency swap is an agreement to exchange currency in the spot market with
an agreement to reverse the transaction in the future. The main advantage of a
swap contract is that it allows the business to alter its exposure to exchange
fluctuations without d