Finance:

Strategic role:

To plan, monitor and control the allocation of a businesses' finances in order to link the
goals of the business with the resources it has.

Objectives:

 Profitability: maximising profits and making a financial return from business activities.

 Growth: increasing size and value of business in long term.

 Efficiency: maximising return while minimising inputs

 Liquidity: extent to which businesses can meet its short-term financial commitments i.e.
short-term debts / current liabilities.

 Solvency: whether the business can meet its long-term financial commitments and the
long-term stability of the business.

Short term and long term:

- Short term objectives are typically liquidity and solvency.

- Long term objectives are profitability, efficiency and growth.
Internal sources of finance:

- Internal- means within the business.

- Retained- means profits that are kept.

Retained profits are the profits that a business kept and reinvested back into the business
(they are not distributed to shareholders).

 Advantages:
- Doesn’t increase debt levels- because you’re using money you’ve already made.
- No new shareholders to share profits with- the ownership of the business is not
diluted
- No interest payments- because this is an internal source of finance

 Disadvantages:
- Pretty limited- unless you’ve been making a lot of profit every year, you can’t just
use retained profits.
- Might get wasted- if its just sitting there in the account without being used to invest
and spend for useful things, then what is the point.

External sources of finance:

External sources of finance are those obtained outside the business.

***

DEBT: money provided by an external lender, such as a bank, building society or credit
union.

 Short term (less than 12 months):

 - Overdraft: when your balance goes below 0, the bank allows the business to
overdraw its account to a certain limit.
- Commercial bills: Type of loan issues by non-bank institutions (cheaper way than
overdraft)
- Factoring: selling accounts receivable for a discounted price to a factoring company.

 Long term (longer than 12 months):

- Mortgage: Loan secured by the property of the business
- Debentures: issued by another company for a fixed rate of interest and time (either
done publicly on the ASX or privately between businesses)
- Unsecured notes: Loan for a set period of time but not backed by any assets
- Leasing: involves for the payment of money for the use of equipment owned by
another party

EQUITY: money sourced from within your business

 Public: Ordinary shares

- New issue: first issue of shares in the primary market (ASX). Secondary market is the
resale of this share (though this money doesn’t go to the business)
- Rights issue: When an existing shareholder who has already invested in the
company, is offered more shares. (like a VIP first in offer before they invite more
people to invest)
- Placement: this is different to rights issue- it is additional shares offered at a discount
price to persuade investors into the company and is usually done to raise funds.
- Share purchase plan: offer existing firms up to $5000 in new shares to each existing
shareholder. They are offered below current price rates to get funding quickly.

 Private: selling shares to private investors- you pick them yourself. You don’t have to
pay back dividends until profits are made.

Financial institutions:

 Banks: Major operators in the financial market. Businesses can receive loans and make
investments/loans.

 Investment Banks: Help to raise capital for acquisitions and provide working capital.

 Finance companies: Non-bank financial intermediaries that specialise in smaller

commercial finance. They raise capital through debentures.
 Superannuation Funds: Large investors of pooled money. They can provide loan funds
to the corporate sector.

 ASX: The Australian Securities Exchange. The market operator, clearing house and
payments facilitator. It is where shares in companies are offered for trading.

Influence on government:

 ASIC- Australian Securities and Investments Commission:

- Ensures Australia’s financial markets are fair and transparent, supported by

confident and informed investors and consumers.

 Company Taxation:

- Companies and corporations in Australia pay company tax on profits. For e.g. GST,
carbon tax, mining tax, etc.

Global market influences:

 Economic outlook: The projected changes to the level of economic growth throughout
the world. In a growing economy, businesses will experience increasing demand for
products and services and find it easier to borrow.

 Availability of funds: The ease with which a business can access (i.e. borrow) funds in the
international financial markets. The ability of a business to borrow will depend upon risk,
demand and supply and the domestic economic conditions.

 Interest rates: The cost of borrowing - rates reflect the risk of the loan and the economic
outlook. Currency fluctuations need to be considered when borrowing overseas.
Planning and implementing:

Financial management must plan, obtain and control the business’s finances for each
department to achieve objectives.

 Financial needs:

- could be determined by the size of the business, the current phase of the business
cycle and future plans for growth and development (where the business is and
where it is heading).

 Budgets:

- Plan for achieving set outcomes and is based on forecast figures or expectations of
future operations
- Budgets are drawn up to predict financial needs, they show (usually in dollar terms)
the costs and benefits of a proposal.
- Includes developing financial budgets and forecasts that allow the business to budget
for production, employment of human resources, raising appropriate funds from
appropriate sources as well as developing budgets for all the other operations
conducted by the business.

 Record systems:

o Record systems ensure that data is recorded and the information provided by
record systems is accurate, reliable, efficient and accessible.
o Accurate and reliable financial records are an essential part of financial decision
making.

 Financial risks:

o Financial risk is the possibility of the business being unable to cover its financial
obligations. Factors such as theft of goods, non-payment of accounts receivable
and interest raises must also be considered.

 Financial controls:

o Tools that provide feedback on the financial performance of a business. They can
include budgets, cash flow statements, income statements & balance sheets.
o These controls are vital for the continual and future planning and success of the
business.

***

DEBT AND EQUITY FINANCING:

  Debt financing:

Advantages Disadvantages
o Can be relatively simple to acqui o Regular repayments must be made
o re o Interest rates can increase
o Loan terms (length of loan) can be o Higher financial risk as debt to equity ratio
negotiated to meet the business’s increases
specific needs o If loan is secured, defaulting will lead to loss
o Debt repayment can be easy to of asset
plan as these are scheduled, o Debt can be expensive- interest, bank fees
regular payments (establishment fees)
o Profits not shared with lender of o Repayments begin immediately and must be
loan met regardless of business cash flow
o Interest payments are tax o Security is often needed to secure a loan
deductible business expenses o May require a good credit history for
borrowing

 Equity financing:

Advantages Disadvantages

o No impact on gearing (solvency) o Proportion of profits go to

or financial risk additional new owners
o No repayments, therefore the o Dividends not tax deductible
firm has more cash flow o More expensive- shareholders
o Does not incur interest charges require higher return due to
o Investors (shareholders) are higher risk
prepared to wait for some time o Diluted ownership and less
to get a return on their control
investment

Monitoring and controlling:

CASH FLOW STATEMENT

 Cash flow statement: we need to monitor the movement of money in (inflows) and out
of the business (outflows), in order to control it.

o Insolvency: when expenditure has exceeded income for an unacceptable length

of time and the firm is unable to pay debts

Cash inflows: money coming in, the receipts of cash to a business. These include:
  Payment for goods or services from customers
 Bank loan
 Interest on savings and investments
 Tax returns

Cash outflows: Any cash going out of the business. These include:
 Purchases of stock, raw materials, or equipment
 Wages, rents, daily operating expenses
 Loan repayments
 Taxes
 Asset purchases

CALCULATING CASH FLOW STATEMENT: Opening balance + cash in – cash out = closing
balance; this closing balance then becomes the opening balance for the next month.

If the opening balance for a business is negative (for e.g. expressed as (1000) which means
-1000 dollars), it means that the business is unable to pay for its short-term debts and are
therefore not ‘liquid’.

INCOME STATEMENT:

This is a summary of the income earned and the expenses incurred over a period of trading.

- It shows a business’ profitability and efficiency

- Also known as a revenue statement or profit & loss statement
- Categories of this statement include: total revenue, costs, net profits, expenses,
COGS, Gross profits.
- The income statement aids in managing market composition and trends, as well as a
prediction of cost of expenses and profits.

Profit: A financial gain or the difference between the amount earned and the amount
spent in buying, operating, or producing.
Revenue: income from sales
THREE EQUATIONS:
COGS = (opening stock + purchases) – closing stock
Gross profit = sales – COGS
Net profit = gross profit – expenses

*PRACTICE ANSWERING INCOME STATEMENT QUESTIONS

BALANCE SHEET:
The financial position of a business at a particular point in time. It consists of:

- Assets: items owned

- Liabilities: debts owed to others
- Owners’ equity: Value attributed to the owners
- Capital: amount owner puts into the business
- Retained profits: profits the business makes that are kept within the business.

Assets = Liabilities + Owner’s Equity (this is done to see if both sides of the balance sheet
are equal)
Owners’ equity = Assets – Liabilities
Liabilities = Assets – Owners’ equity
Profit = revenue - expenses

Financial ratios:

 Liquidity: the extent to which a business can meet its financial commitments in the
short-term (a period of less than 12 months).

o Accounts receivable: the money the business is owed by its debtors (For example:
customers buy off you now and pay later). The business needs to ensure there are
enough current assets to sell quickly to pay its creditors accounts payable (where you
buy now and pay later).

Current ratio: this is one way to measure liquidity. It measures the level of current assets
available to meet a business’s current liabilities. It shows the ability of business to meet its
short-term debts. For e.g. the ratio of 1:1 is too risky, and the ratio 4:1 is inefficient.

Current ratio= current assets/ current liabilities

Source: balance sheet

***

 Gearing (solvency): the ability of a business to meet its financial commitments, in the
long term. This ratio indicates the relationship between the long-term funds provided by
creditors, and those provided by the business owners.

Debt to equity ratio: Gearing ratios measure the degree of financial risk in that if a company
cannot meet its debts as the fall there is a risk of insolvency. The higher the number shows
more unstable financial stability.

Gearing= total liabilities/ total owner’s equity

Source: balance sheet

 ***

 Profitability: determines the earning performance of the business, which indicates its
capacity to use resources to maximise profit. There are three ratios used to show
profitability.

 Gross profit: The relationship between profit and sales helps determine how each
dollar of sales generates profit. It is measured using percentages.

(Gross profit / sales) * 100

Source: Income statement

 Net profit: The net profit ratio measures the operating costs or expenses of a
business. It is measured in percentages and means that each dollar is generating a
new profit of $X dollars.

(Net profit/sales) *100

Source: Income statement

 Return on Owner’s Equity: This ratio indicates how much the owner’s investment in
the business is earning. The return to owners is higher if most of the assets are
financed with borrowings. This is because debt is tax-deductable and is generally
cheaper than equity finance. It is higher risk option because interest must be paid
even when things go wrong. THIS IS HOW MUCH MONEY OWNERS RECEIVE FOR
INVESTMENT.

(Net profit/Owner’s equity) *100

Source: Income statement and Balance sheet

***

 Efficiency: Efficiency: the ability of the firm to use its resources effectively in ensuring
financial stability and profitability. A business improves its efficiency when it increases
their outputs from a given amount of inputs.

 Expenses ratio: A measure of the business’ capacity to contain aid allocate costs
effectively. THE HIGHER THE EXPENSES, THE MORE INEFFICIENT YOU ARE.

(Total expenses/sales) * 100

Source: Income statement

  Accounts receivable turnover ratio: How effective and efficient you are in collecting
the accounts receivable. How many days does it take for you to collect the money
that is owed to you. The higher the days the more INEFFICIENT you are.

Sales/ accounts receivable

Source: Income statement and balance sheet

Limitations of financial reports:

Limitations of financial reports are what you are not able to see in a report, for e.g. you
don’t know if a business is doing normalised earnings- because where’s the proof? You cant
see that in a report?

 Normalised earnings: The earnings adjusted to consider cyclical upswings or

downswings in the economy, or to remove one-time influences. When financial reports
sneakily try and make adjustments for ups and downs in the economy, to make the
company seem more profitable than what it is.

 Capitalising expenses: The costs incurred when financing a non-current asset and
added to the cost of the asset. For example: the purchase of a property would involve
payment for legal fees and stamp duty. When placed in the accounting framework these
expenses are capitalised (i.e. added to the cost of the assets). For e.g. you buy a
property for $1M, and it also costs you $1000 to hire a property lawyer to transact the
property. So, just because the property and you paid $1000, IT DOES NOT MEAN THE
PROPERTY IS NOW WORTH $1M AND $1000 TOGETHER. It is still only worth $1M. This
shows how people add costs of legal fees, taxes, etc- into the value of the asset making
it seem more valuable than what it actually is.

 Valuing assets: Original cost of an asset on the balance sheet is different from its market
value. Value of asset on balance sheet is always changing. Revalue through external
assessors. Some assets will appreciate over time (for example, real estate) and some will
depreciate over time (for example, tools or vehicles). Intangible assets are of value to a
business but do not physically exist. Patents, trademarks and brand names. For e.g. a
company values their copyright for $1M, but it’s not really actually worth this much in
the market value.

 Timing issues: Accountants may adjust the timing of revenue inflows and debt
repayments to make business appear profitable. Business can hold off a large expense or
revenue being recorded so it does not show up in the current accounting period. Delay
banking revenue until the start of a new financial year in order to decrease the
business’s current taxation commitment. They can delay an expense and incur a tax
liability for the following year. For e.g. they move certain expenses into the next financial
 statement, so you seem more profitable in the current financial year. TO AVOID THIS;
follow the matching principle- record transaction on time when it actually occurs.

 Debt repayments: Business needs to set aside funds to provide employees with
payment for holidays, entitled leave. It is difficult to determine exactly when a payment
for entitled leave will be required. For e.g. when looking at a financial statement you
don’t see whether employees are going on leave, are vacationing staff being covered, is
too much money being paid for loyalty programs, etc. Money owed to the business may
not be accurately recorded.

 Notes to financial statements: Additional information normally at the end of financial

reports. Notes provide additional information and details about items included in the
balance sheet and income statement. They may not be clear, explicit or not detailed
enough.

Ethical issues of financial reports:

 Businesses have ethical and legal responsibilities in relation to financial management.

 Financial management decisions must reflect the objectives of a business and the
interests of owners and shareholders.
 Laws relating to corporations include the responsibilities of directors and requirements
for disclosure for corporations.

Directors and managers have a duty to:

- Act in good faith

- Exercise power for proper purpose in the name of the cooperation
- Exercise discretion reasonably and properly
- Avoid conflicts of interest

 Professional associations require accountants to display integrity, objectivity,

confidentiality and high professional and technical ability.
 Audited accounts are a legal requirement of all public companies, clubs and associations
annually. An audit is an independent check of the financial records of a business by a
certified accountant to ensure financial reports represent a true and fair financial picture
of the business.
 The preparation of financial accounts is regulated by Australian accounting standards
 Businesses are not able to alter the accounting period to manipulate financial records to
make the business appear more profitable or more financially secure
 The Australian securities and investments commission ensures all companies comply
with company and financial services laws to protect consumers, investors and creditors.

How these ethical issues have been prevented:

- Corporations Act 2001 (Cth)- must reveal salary packages of directors.

- Triple bottom line- measuring FINANCIAL, SOCIAL and ENVIRONMENTAL impacts
 - Audit: independent checks by ATO (Australian Taxation Office; accuracy and
authenticity

Cash flow management:

To make sure we have enough money throughout the year and avoid negative balances.

 Cash flow statements:

- Show the pattern of short-term management of cash inflow and outflow

- Summarises how business will pay for short term liabilities from sales of inventory
- Period of 12 months
- Avoids cash shortage by planning ahead
- Predicting when cash will be needed and therefore avoiding the need for more debt.

 TO RESOLVE CASH FLOW POOR MANAGEMENT- Distribution of Payments, Discounts

For Early Payment, Factoring:

 Distribution of payments

- Businesses need to make sure their cash outflows are in time with their inflows.
- Planning out payments and ensuring that you will have enough cash to pay creditors
is essential.
- This will ensure liquidity.

 Discounts for Early Payments

 - Some businesses offer a cash discount if customers pay before their payment is due
as it improves cash flow.

 Factoring

- Factoring is the selling of accounts receivables 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.
- This is an important source of finance because the business is receiving immediate
funds to use and therefore helping their cash flow.

Working capital management:

To ensure that current assets are greater than current liabilities. More than 1:1, but not
too high.

o Working capital is the funds available for the short-term financial commitments of a
business.

o Short-term liquidity is important for businesses. It means a business can take

advantage of:

- Opportunities when they arise, maximising profit

- Meet short-term financial obligations
- Pay tax
- Meet payments on loans and overdrafts

TO RESOLVE:

 Control of current assets:

- Cash: sale and lease back (cars, machines, etc)

- Receivables: Bas debts/write off requires factoring, credit limits, discounts, send
reminders, reduce time to pay back and refuse those who don’t pay.
- Inventories: too much investment- long time to seel back, thus cheaper rate requires
security, accurate records, and better predictions.

 Control on current liabilities:

- Payables: pay on last day to use money in order investments

- Loans: compare costs/terms of loans, matching needs with cost
- Overdrafts: ensure cash is received before spending, and use online site to monitor

 Strategy; sale and lease back:

 - Sell non-current assets to attain cash, but then lease them back on monthly
repayments (or, if no assets to sell, just lease from the start)

Profitability management:

To maximise profits, you either have to reduce your costs or increase your sales.

o Profitability management involves the control of both the businesses costs and its
revenue.
o Effective profitability management refers to the minimisation of costs and
maximisation of revenue.

 Cost controls:
- Fixed and variable: reduce labour and inputs costs (variable easier), outsource non-
core functions, reduce waste, negotiate discounts, increase customer self-service,
‘casualise’ workforce, share firm resources.
- Cost centres: Use financial reports to see where wastage is coming from, for e.g.
which department is spending the most money. Helps identify improvement areas
and sets budgets to fix it.
- Expense minimisation: Find area which contributes highest cost, and minimise them
first via budgets, reducing cash flow.

 Revenue controls:

- Marketing objectives: Ensure plans achieve higher sales revenue via forecasts, sales
mix, pricing policy
- Adjust prices: According to demand, over stocking, quantity sold to maximise
revenue in any situation.

Global financial management: