Shane Daly Business Studies Financial Planning and Management

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Financial Planning and Management

The role of financial planning
Strategic role of financial management
A long term prospect that must be well planned if a business wishes to achieve its specific goals. The strategic plan is the long term view of where the organisation is going, how it will get there and the monitoring that needs to take place along the way Strategic plans = 10+ years and will be translated into smaller objectives called tactical plans = 1-2 years, these will be broken down into daily or operational plans of an organisation. Liquidity = the extent to which a business can meet its financial commitments in the short term. Can be seen on the balance sheet. The ability to pay debts when due. Profitability = The ability of an organisation to maximise its profits. Net profit can be compared to competitors, industry standards etc. Efficiency = the ability of a business to use its resources effectively in ensuring financial stability and profitability. Minimise costs, manage assets so that max profit can be achieved with low assets Growth = The ability of an organisation to increase its size in the longer term Return on capital = the amount of profit returned to owners/ shareholders as a percentage of their capital investment. Stakeholders receive a share in the profits.

Objectives of financial management

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The planning cycle

Minimise financial risk and losses Address present financial position

Plan financial controls

Determine financial elements of business plan

Maintain records systems

Develop budgets

Interpret financial records

Monitor cash flows

Addressing the present financial position To determine where a business id headed, how it will get there Financial info needs to be collected and examined Determining financial elements of the business plan Drawing up a business plan Determines aims to achieve, process to be used to achieve aims and benchmarks Used when seeking finance and support Developing budgets Provide quantitative info Provide financial info for achieving goals Monitoring cash flows Sufficient supplies of cash are essential to ensure financial objectives are met. Interpreting financial reports Shows what the organisation plans to achieve by the end of a aperiod Provides warning signals and a realistic assessment of how the business is going Maintaining record systems Ensure data is recorded and info is accurate, reliable, efficient and assessable. Planning financial controls The policies and procedures that ensure that the plans of an organisation will be achieved in the most efficient and effective way Minimising financial risk and losses

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The risk to a business of being unable to cover its financial obligations

Financial markets relevant to business financial needs

Financial markets are where businesses, individuals and systems can borrow the required funds from other businesses, individuals and systems that have excess funds Important as they provide funds, provide investment opportunities and contacts and provide expertise Involves borrowing short term funds for short term needs and long term funds for investment and capital projects (long term) Provide money pooled from a number of different resources and spread the risk over a large number of businesses and provide advice and protection. Type of institution Supervisor/ regulator Main characteristics Example Banks Aus. prudential - Most important source of Westpac regulation authority funds for a business ANZ (APRA) - Uses deposited funds to lend NAB borrowers in return for interest Etc. - Provide a range of financial services overdrafts, term finance, mortgage Finance companies Aus. Securities and - Specialise in smaller AGC investment commercial finance commission (ASIC) - Raise capital through shares Insurance companies APRA - Provide both equity and loan AAMI capital to a business QBE Merchant banks ASIC - Provide services of lending -Macquarie and borrowing Bank - Arrange long term finance for -Bankers company expansion trust - Trade in money, securities Superannuation - Use superannuation funds contributions to invest - Invest in long term company shares, government, company debt. Mutual funds - Take funds from a large number of small investors - Investments include money mkt, shares, mortgages, property etc. - Diversified portfolio

The role of the Australian Securities Exchange as a primary market

Is a secondary money market

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Comprises of stockbroker corporations and partnerships, and provides a marketplace for the trading of shares. Assists listed companies to raise funds from the public through share issues (equity) and trade in debt instruments Regulates and monitors its members and its activities and ensures that the listed companies meet the listing requirements. Primary markets Deal with the new issue of debt instruments by the borrower of funds. Enables a company to raise a new capital through the issue of shares and through the receipt of proceeds from the sale of securities Secondary markets Deal with the purchase and sale of existing securities. Where the pre-owed or second-hand securities, such as shares, are traded between investors who may be businesses, individuals, governments or financial institutions. Increases the liquidity of financial assets and therefore influences the primary market for securities.

Overseas and domestic market influences and trends in financial markets and their implications for business financial needs
Trends in financial markets Volume of activity in financial mkts continues to increase due to Aus. reliance on international trade and foreign inflows. New trading instruments developed to meet changing needs of businesses Changing technology = 24/7 business environment Steady investor interest in Aus. From China, India, Europe and Japan. Influences of financial markets on business The fluctuations in the business cycle require business managers to continually monitor how these factors will affect their business. E.g. In periods of economic downturn consumers delay purchases businesses like Harvey Norman offer loans to keep up turnover.

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Changes in gov policy

Changes in inflation rates

Domestic (internal) Influences

Employemnt patterns

Changes in interest rates

Level of economic growth

World events

Accounting regulations affecting foreign operations

Foriegn exchange rates

International (external) Influences

Tax Regulations for foriegn operations Foriegn governemnt intervention

Political risks

Interest rate differentials

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Management of Funds
Sources of funds
Internal
Equity Retained Profits

Mortgage

Long Term

Debentures

Sources of finance

Unsecured notes

Overdraft

Accounts payable

Bank bills

Short Term
Promissary notes

External
Leasing Factoring Trade credit Venture capital

Other

Grants

Internal finance (equity) The funds provided by the owners of the business (capital) or from the outcomes of the businesses activities (retained profits) Owners equity The funds contributed by the owners/ partners to establish and the build the business. Retained Profits Most common source of internal finance Cheap, accessible source of finance

Advantages Does not have to be repaid unless

Disadvantages May mean lower profits = lower

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owner leaves business No interest = cheap Owners who contribute have control over how finance is used Low gearing Less risk for business owner

returns for owner May leave owner short of funds in emergencies Money may earn higher return if invested elsewhere

External finance (debt) The funds provided by sources outside the business Short term Bank overdraft Most common short term borrowing Allows a business to overdraw its account to an agreed limit Always paying interest on this limit though Bank bills Period of 90-180 days Business receives money immediately and promises to pay back Long term Mortgage A loan secured by the assets of the business Regular repayments and interest Leasing Only small capital required Payment of money to use assets owned by another company Other Factoring Selling debt for discounted price for instant cash Advantages Disadvantages Can borrow more money = increased Added charges have to be paid e.g. earnings = increased profits interest, bank fees, govt. charges Can claim tax reductions on interest Security is required by lender (bank) payments Regular repayments must be made Lenders have first claim on money if business goes under

Financial considerations
Debt Set-up costs Interest costs Availability of funds Flexibility of funds (liquidity) Level of external control

Comparison Debt to equity

Interest = tax deductable

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Equity

Loan has to be repaid Provider of finance do not own any part of business No interest Payments are non-tax deductable Providers of finance own some of business

Using Financial information

The accounting framework
Provides most of the information for the decision making process Financial Statements Revenue statement = summarises the activities of an organisation over a period of time, showing operating results and revenue Balance sheet = represents the businesss assets and liabilities at a point in time The accounting equation Shows the relationship between assets, liabilities and owners equity Assets = liabilities + owners equity

Types of financial ratios

Liquidity Current ratio The ability of a business to pay short term debts as they fall due + ability to meet unexpected cash needs Information found on balance sheet Current ratio = Current assets/ Current liabilities (CA/ CL) Solvency Debt to equity ratio The ability of a business to pay its long term debts Information found on balance sheet Debt to equity ratio = Total liabilities/ Total equity (TL/ OE) Profitability Gross profit ratio, Net profit ratio, Return on equity The economic performance of a business and indicates the capacity to use its resources to maximise profits Gross profit ratio = Gross profit/ Sales (GP/ S) Indicates the initial profit gained information found on revenue statement Net profit ratio = Net profit/ Sales (NP/ S) Indicates final profit gained information found on revenue statement Return on owners equity = Net profit/ Owners Equity (NP/ OE) indicates return to owner information found on balance sheet + revenue statement Efficiency Expense ratio, Accounts receivable turnover ratio (ARTR) The ability of a firm to use its resources effectively in ensuring financial stability and profitability of a business. Expense ratio = Expenses/ Sales (E/ S) Information from revenue statement

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Accounts receivable turnover ratio = Sales/ Acc receivable (S/ AR) Answer/ 365 Effectiveness of the credit policy, how quickly it collects debt information from balance sheet + revenue statement

Ratio + what it measures

Liquidity current ratio

Formula

What it should look like

Higher = better e.g. 2:1 but no higher than 2.5-3 Lower = better Should be lower than 100% Higher = better

Strategies to improve ratio

-Sell then lease back equip -New capital from owners -Advertising -Sale at special price -Reducing debt -Increased use of equity financing -Advertising -Decrease COGS with cheaper supplier -Improve GP ratio -Reduce expenses -Advertising -Decrease COGS -Reduce Expenses

C.A. C.L. T.L. T-equity G.P. S.R. N.P. S.R. N.P. O.E.

Solvency debt to equity ratio Profitability gross profit ratio Profitability net profit ratio Profitability return of owners equity Efficiency expense ratio Efficiency accounts receivable turnover ratio

Higher = better Higher = better

-Reduce expenses reduce T-expense Lower = better Higher = poor staff, cut wages, S.R. control over expenses out/insource, new supplier SR AR 365 ANS Lower = better Higher = bad debt collection -Discounts for early payments -Improve credit policy -Encourage cash sales -Chase up slow paying ppl

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Comparative ratio analysis

Used to indicate trends, strengths, weaknesses and relationships between financial items Time comparison Compares current period with previous financial periods Industry average

Limitations of financial reports

Historical costs Process of valuing the businesses assets by their cost at the time the transaction took place Value of intangibles Rights rather than objects Not usually recorded on balance sheets unless business has been or will be purchased.

Effective working capital (liquidity) management

Liquidity = The ability of a business to pay short term debts as they fall due/ ability to meet unexpected cash needs Working capital = bizs CA used for day to day operations; cash, inventory

Working capital ratio

RATIO = WC = CA/CL High WC = good as biz can pay debts on time but bad as cash not being utilised Low WC = bad as biz cannot pay debts on time

Control of current assets (CA)

Important because excess inventories and lack of control over accounts receivables lead to an increased level of unused assets, leading to increased costs and liquidity problems. Controlling cash Budgets = detail expected inflows/ outflows Controlling acc receivable Credit checks on borrowers Invoice discounting = offering incentives for early payments Factoring = last resort Credit policy Controlling inventories Inventory policy Stock control (JIT)

Control of current liabilities

Acc payable Stretching acc payable (pay as late as possible)

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Choose supplier carefully Loans Capital budgeting = seeing how much money can be made on loaned money Overdrafts Online banking system

Strategies for managing WC

Problems Too much cash Cash shortfall Customers take too long to pay Too much money in inventory, high costs, stoke takes too long to sell Overdraft too high, used too much Cash flow problem (too much outflow) Strategies Pay off overdraft/ invest in a higher yielding acc Sell non-CA and lease back Factor/ offer discounts for quick payments, review credit policy Stock take/ cameras/ JIT stock control/ computerised system stock system Online banking system (more access, info to manager)/ pay off quickly Pay invoiced on last day due/ distribute payments across year/ month

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Effective financial planning

Refers to the flow of cash into and out of the business

Effective cash flow mgt

Cash flow is the movement of cash in and out of the biz over a period of time Matching cash flow in with cash flow out is essential Budgets = important tool for managing cash flows Cash inflows = sales, AR, commissions, sale of assets etc Cash outflows = payments to suppliers, interest, operating expenses, drawings Cash flow statements Link the revenue statement and the balance sheet Give an indication of a firms ability to pay debts on time Help identify trends Cash flow statement show: o Can the biz generate more inflows than outflows? o Can the biz pay its financial commitments as they fall due? o Has the biz got sufficient funds for future expansion Cash flow statements are divided into three sections: Operating activities: o Related to the main activity of a biz o Inflows = sales revenue, interest, dividends o Outflows = Payments to suppliers, employees etc Investing activities: o Related to the purchase and sale of non-current assets and investments o These assets and investments are used to generate revenue for the biz o E.g. Selling old car, purchasing new plant or equipment or property Financing activities: o Related to the borrowing activities of a biz o Inflows = can be equity (issue of shares, injected capital from owner) or debt (loans) o Outflows = debt repayments, cash drawings, payments of dividends Strategies for managing cash flows Problem Strategy Temporary shortfalls of cash Overdraft Cash flow not arriving when payments need Involve distributing payments across the to be made month/ year Bad debts and late repayments Discount invoices Negative cash flow Delay payments on bizs accounts as late as possible High accounts payable Take advantage of discounts offered by suppliers (stretching acc payable)

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Effective profitability management

With the objective of profits, mgt must control both costs and revenue Data & reports are essential tools for effective profitability mgt Cost control Fixed costs o Not dependent on the level of operating activities of biz o Must be paid regardless of what happens in the biz o E.g. salaries, insurance, lease Variable costs o Change proportionately with the level of operating activity o E.g. materials, labour Cost centres o Costs directly attributable to a particular department/ section of a biz o Direct costs = Can be allocated to a particular activity/ product o Indirect costs = Shared by more than one project/ activity/ department Revenue controls To determine an acceptable level of revenue and boost profits a biz must have clear ideas/ policies related to: Sales objectives o Must be equal and hopefully above costs o A cost-volume-profit analysis can determine the level of revenue needed Sales mix o Maintain a clear focus on the most important customer base on which the bizs revenue depends on before diversifying/ expanding Pricing policy o Decisions need to be closely monitored/ controlled o Factors that influence pricing include: production costs, bizs goals, level of quality/image of biz, Gov. policies

Ethical and legal practises

Audited accounts, inappropriate cut-off periods and misuse of funds
Audited accounts Audit: independent check of the accuracy (truth and fairness) of financial records and accounting procedures. External audits: a businesss financial reports must be investigated by independent audit accountants. They look for things such as inappropriate cut-off periods and misuse of funds.

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Inappropriate cut-off periods Profits need to be matched with the costs and revenues that generated it. It is possible to create a false profitability position by choosing a cut-off period where significant revenues are separated from the costs associated with them. Misuse of funds Control system would restrict the ability of people to misuse funds; measures include computer passwords, requirement of multiple signatures or certain types of expenditures. Make detection of errors more likely by regularly doing physical checks of things such as inventory levels. Introduce penalties.

Australian Securities and Investments Commission

Independent government body that enforces and administers corporations law and protects consumers in areas of superannuation, insurance and banking. Purpose: to reduce fraud and unfair practices in financial markets and financial products. Ensure companies adhere to the law. Market integrity regulation promoting market development by protecting participants from fraud. Consumer protection ensure investors have adequate information, are treated fairly and have avenues for redress. Corporate raiders used borrowed funds to buy underperforming companies. Asset stripping is the process of buying companies in order to sell, at market value, assets that are undervalued on the balance sheet. Poorly managed companies more likely to be victims of these practices.

Corporate raiders and asset stripping