Chapter 9: Role of Financial Management

The Strategic Role of Financial Management

Financial Management: the planning, monitoring and controlling of an organizations financial resources to
achieve the goals of the business

Financial management is crucial for a business to achieve its goals à a business success depends on the quality
of its financial management

The strategic role of financial management is the process of setting objectives throughout the business and
deciding what finical resources will be used to achieve these objectives

In achieving this role, business perform tasks such as:

- Setting realistic financial objectives
- Souring finance
- Maintaining sufficient cash flow

In short term, the role of finance is to:

- Release funds when needed
- Make sure that laws are followed
- Manage transactions

In long term, the role of finance is to:

- Maintain low levels of debt
- Allow growth for business
Objectives of Financial Management
A long-term objective of a business is to achieve profit

In order to maximize profits, businesses must aim to achieve a range of short-term and long-term objectives.

These specific objectives of financial management include:

 Growth
 Liquidity
 Efficiency
 Profitability
 Solvency

Growth:
Growth: refers to the aim of increasing the size of the business in the longer term.

Growth can be achieved either by:

- Increasing the physical size of the business by expanding

- Increasing the value of the assets
- Increasing sales and profits
- Increasing market share
- Opening more branches
- Taking over a competitor
- Merging

Liquidity:
Liquidity: a measure of how quickly an asset may be converted into cash and therefore the extent in which a
business may meet its short-term financial obligations.

To determine liquidity business, look at:

- Current Assets: cash and other assets that are expected to be used, sold or converted into cash within
12 months e.g., Cash in the bank, accounts receivable, inventory and prepaid expenses
- Current Liabilities: short term debt obligations that are due within 12 months e.g., Accounts payable,
bank overdrafts, short-term loans, interest payable

Businesses aim to be liquid so that their current assets are able to be converted into cash, so that they can
cover their current liabilities (short-term debt obligations)

Of all the business assets:

- Cash - is the most liquid
- Accounts Receivable - is relatively liquid due to debtors being expected to pay their accounts within
the short term
- Inventory - is less liquid as it takes time to sell and convert into cash
- Noncurrent Assets - are the least liquid as it takes time to advertise and sell non-current assets and
convert them into cash e.g., buildings, machinery
Efficiency:
Efficiency: the ability of a business to maximize its output from its given level of inputs OR to achieve
the same level of output using less input.

Increased efficiency is achieved when:

- more output is produced from the same level of inputs
- the same level of output is produced from a smaller level of inputs

Efficiency can also be achieved through reducing the size of the workforce by adopting better
technologies so the output per worker employed increases, leading to increased productivity.

Profitability:
Profitability: the ability of a business to maximize its profits.

If the business revenue is:

- Greater than its expenditure it is known as a profit
- Less than its expenditure its known as a loss

To be successful, businesses must continue to make profit over time

Sole Traders – receive all profits

Partnership – profit is shared amongst partners
Private/Public Company – profit is shared amongst shareholders and paid in dividends

Solvency:
Solvency: the extent to which the business can meet its long-term financial obligations (time period greater
than 12 months)

Solvency indicates whether a business will be able to repay its non-current liabilities

- If a business is able to meet its long-term obligations, it is solvent

- If a business is unable to meet its long-term obligations, it is insolvent

 If a business remains solvent, they will be financially secure

After businesses identify which financial objectives they wish to pursue, they must determine which objectives
are to be achieved in the short-term or long term

Short-Term
Short term objectives are the tactical (1-2 years) and operational (day-today) goals of a business
à these goals are reviewed regularly to see if targets are being met and if financial resources are being
used efficiently

Operational goals – daily calls to customers to request payment

Tactical goals – purchase new equipment

Long-Term
Long term objectives are the strategic goals (5+ years) of a business
à they tend to broad and require a series of short term goals to assist in its achievement

e.g., increase market share in the Chinese market by 5%

Some financial objectives are complementary, however some business short term and long-term goals will be
in conflict

Conflicts can include, conflicts between:

Long-term objective of growth and short-term objective of liquidity

 growth in long term requires business to buy fixed assets such as machinery, reducing the liquidity of
the business as cash will be used to purchase the machinery

Long term objective of growth and short-term objective of profitability

 Expansion is associated with increased costs, which lead to lower profits in short term
Interdependence with other Key Business Functions
1. Interdependence of Finance and Marketing

Marketing relies on finance to:

- fund their activities

- provide info on how much they can spend on advertising

- an appropriate price that covers production costs

Finance depends on marketing to generate funds

2. Interdependence of Finance and Operations:

Finance creates budget that operations use for inputs

Operations influences amount of funds coming into business e.g., by reducing costs which increases profit
margin OR increasing quality which increases revenue.

3. Interdependence of Finance and HR:

Finance restricts HR, as HR needs funding e.g., Employees need to be paid and training programs cost money,
which is acquired from finance. If the business is in a tough position financially, HR may be forced to make
difficult decisions such as cutting workers' pay

Finance depends on HR to manage the workforce effectively and boost productivity, which is important as
labour is a major expense of a business
 Chapter 10: Influences on Financial Management
There are both external and internal factors that influence a businesses financial management

The influences on financial management include:

- Internal Sources of Finance

- External Sources of Finance
- Financial Institution
- Influences of Government
- Global Market Influences

A business can source funds from either inside the business or from outside the business

Internal Sources of Finance

Internal sources of finance: finance generated from within the business itself

Internal sources of finance include:

Retained Profits
Retained Profit: net profit that is not distributed to owners but instead reinvested back into business

- Accessible and cheap (don’t have to pay interest)

- May increase gearing (immediately drain significant amount of business money)
External Sources of Finance
External sources of finance: finance generated from external sources outside the business

External Sources of Finance Include:

- Debt
- Equity

Debt
Debt: when business borrows money e.g., loans from banks

Debt can either be long-term or short-term agreement:

Short-Term
Short-Term Debt: finance required for less than 12 months

- Generally used for temporary shortages in cash flow or finance for workers

Forms of short-term debt that business could use include:

1. Commercial Bills
Commercial Bills: short term loan for large amounts of money, granted from other commercial business (over
$100,000 for period 30-180 days)

- Money is borrowed from other companies’ surplus funds

Advantage Disadvantage
Borrower receives money immediately and pays Secured against assets à risk
back in gradual repayments with interest à improves
cash flow

2. Bank Overdraft
Overdraft: agreement between business and bank, where business is allowed to overdraw more money than is
actually in their account, up to an agreed limit

Advantage Disadvantage
Interest paid can be claimed as a tax deduction Have high daily interest rate à increasing business
 Reduces expense costs

Funds can be obtained quickly and easily

 Allow business to overcome temporary
cash shortages

3. Factoring
Factoring: when businesses sell accounts receivable at a discount to specialist factoring firms

Advantage Disadvantage
Allows business to receive funds immediately à Business sacrifice portion of funds from accounts
improves cash flow and gearing receivable (by selling at discount)
 Reduces overall earnings
Long Term
Long-Term Debt: finance required for more than 12 months

- Generally used for purchase of major assets e.g., buildings and equipment

Forms of long-term debt that businesses could use include:

1. Mortgages

Mortgage: loan secured by the property of the borrower

Advantage Disadvantage
Repayments have low interest and are paid over Secured against assets à risk
long periods of time (up to 30 years)
 Improves cash flow and gearing due to low
interest rates

Have lower interest rates than short-term debt

2. Unsecured Loans

Unsecured Loan: a loan from investors to a business that isn’t secured against the business' assets

Advantage Disadvantage
Not secured against borrowing businesses’ assets High interest rates (due to risk of not being secured
to asset)
 Increases expense for borrowing business

3. Debenture

Debenture: loan from investors to a business, that is secured against the business’ assets

Advantage Disadvantage
Companies provide funds instead of financial Secured against asset à risk
institutions
 Allows ownership and profit not to be Require a prospectus from borrowing business
diluted  Timely and expensive

Interest rates are fixed

Make regular interest repayments for a defined

term, then after the term is over, they pay back the
rest of the loan interest free

4. Leasing

Leasing: the payment of money for use of equipment owned by another party

Advantage Disadvantage
Allows business to reduce cost of acquiring asset à Business does not have ownership of asset à unable
allows business to pay off asset over a period of time to make changes to asset or adopt it to keep up with
à allows them maintain to cash flow in short term demand
Equity
Equity: obtaining funds by giving investors a share of ownership of the business in return for money

Can be achieved through either ordinary shares or private equity:

Ordinary Shares
Ordinary Shares: the purchase of shares of a publicly listed company on the ASX
 Are the release of new shares

Types of ordinary shares include:

1. New Share Issues

New Share Issues: shares that are issued and sold for the first time on the ASX

Advantage Disadvantage
Business can raise funds from first time investors Require a prospectus from the listed business
 Timely and expensive

2. Rights Issue

Rights Issue: business releases new shares exclusive to only existing shareholders

Advantage Disadvantage
Quick and cheap method of raising extra funds Shares are offered at a lower price à reduces
potential extra funds for business

3. Placements

Placements: a private sale of shares exclusive to certain institutions or investors (private sale)

Advantage Disadvantage
Doesn’t require a prospectus à reduces costs and Shares are only offered to a limited number of
time people à reduces potential extra funds for business

4. Share Purchase Plan

Share Purchase Plan: offer to existing shareholders to purchase more shares without a brokerage fee

Advantage Disadvantage
Doesn’t require a prospectus à reduces costs and Shares are offered at a lower price à reduces
time potential extra funds for business

Private Equity
Private Equity: money invested in a company (private) not listed on the ASX

Advantage Disadvantage
Method of raising funds for business Investors gain business control, diluting ownership
and profit of business
Financial Institutions
Financial institutions: companies that provide financial services and access to financial markets

Businesses can turn to different types of financial institutions to take advantage of their specializing traits that
are most suitable for their needs

Major participants in the financial market:

Investment banks:

Investment banks: financial institution that offer funding to businesses

Provide wide variety of loans to businesses

 can customize loans to meet business needs

Assist in advising businesses involved in mergers and acquisitions

Might ask for part-ownership of business, in return for their loans

Superannuation funds:

Superannuation funds: manage individuals' money in superannuation accounts

9.5% of income paid is placed into a superannuation fund with the purpose of being a source of income once
individuals retire.

2 influences:

- Increase costs of business --> have to pay super on top of wages

- Pool of Superannuation funds can be invested into businesses in hope of increasing vale of
superannuation --> act as a source of finance for business

Banks:

Banks: provide short term finance such as overdrafts and long-term finance such as mortgages

Banks act as an intermediary where they receive deposits from individuals and in turn provide investments and
loan to borrowers

Unit Trusts

Unit Trusts: pool of funds from a large number of small investors, invested into a specific asset

 investors receive the percentage of funding they invested back as a percentage of the revenue earned

In putting money together and investing an increased amount, investors are able to generate a higher return
Finance Companies

Finance Companies: financial institutions that provide short and long term loans to business

Categorized as non-depositor institutions à They give loans without taking deposits

If businesses fail to pay back their loan, finance companies are entitled to sell the businesses assets à risk for
investing business

Charge relatively higher interest rates than banks

Life Insurance Companies

Life Insurance Companies: Provide lump sum of money to businesses in the event of death

Business must pay regular premiums to life insurance companies

 these payments are invested into assets, which increases the amount of money that was paid by
businesses, which is returned to the business as a profit, in the event of death

Australian Securities Exchange

ASX: where securities are bought and sold by investors

Allows businesses to sell equity/debt securities to raise large amounts of funds

 allows business to further expand business

Business can use the ASX in two ways:

New Shares – where business sells shares on the primary market to raise equity

Second Hand Shares – where the business invests their funds into to the market, in the hope of raising money
from dividends

However, to list on the ASX, business require a prospectus (timely and costly) and must constantly mange the
listing of their stocks (time consuming and will require more labor à additional costs)
Influence of Government
- Gov't influences financial management as it regulates what business can and can’t do
- The gov’t has bodies who monitor and control the business environment

Two primary gov’t regulatory bodies include:

Australian Securities Investment Commission (ASIC)

ASIC: independent commission that monitors companies through enforcement of the Corporations Act

Collect financial reports from businesses which they monitor, to ensure companies adhere to the law
 In doing so, they reduce fraud and unfair practices in financial markets

Influences how businesses operate their financial management (in abiding by the laws)
 consequences if they break the law (fines and negative publicity)

Company Tax - Australian Tax Office

Company Tax: tax that businesses must pay the gov’t on profits they earn

Businesses must pay tax on their profits before its distributed to shareholders
 reduces the profits and retained profits received by a business

30% for Large, 25% for small

Global Market Influences
Globalization allows businesses to access funding internationally, but exposes them to the risk of being
impacted by economic shocks
 as a result, businesses must monitor international developments, in order to organize financial
management in a way to meet objectives

Businesses must monitor the following global market influences on financial management:

Global Economic Outlook

Global Economic Outlook: refers to the projected changes to the level of global economic growth

The economic outlook of the economy influences the financial decisions a business makes

Positive Economic Outlook

Increases Funding - A positive economic outlook means there is an increasing demand for g/s
 as a result, business will be producing more to meet demand, requiring an increase in funds to buy
equipment/resources

Increase availability of funds –easier for business to access funds as banks are more willing to lend money
 however, interest rates may increase to try to slow down demand, potentially decreasing availability of
funds

Negative Economic Outlook

Decreases Funding – A negative economic outlook means there is a decreasing demand for g/s
 as a result, businesses will be producing less, causing businesses to reduce their funds as they need
less equipment/resources

Decreases availability of funds – difficult for business to access funds as banks are less willing to lend money
 however, interest rates may decrease to increase demand, potentially increasing availability of funds

Availability of Funds

Availability of funds: ease with which a business can access funds on the international financial markets

Financial markets consist of financial institutions

 these institutions lend money to business

Institutions offer different interest rates for borrowing, based off availability of funds in the economy

- Higher the availability of funds à less risk for lending à lower interest rate à business will pay less to
borrow
- Scarcer the availability of funds à high risk for lending à higher interest rates à business will pay more
to borrow
Interest Rates

Interest rates: cost of borrowing money

Globalization allows businesses to look globally when borrowing money due to lower interest rates in different
countries

High interest rates à more expensive to borrow money à increases business expenses

Low interest rates à cheaper to borrow money à reduces business expenses

Businesses may need to look to different financial institutions to find the best interest rates à find cheapest
cost of borrowing à reduces expenses
 Chapter 11: Processes of Financial Management
Financial processes monitor the financial health of businesses and ensure businesses meets its objectives

Financial Processes include:

Planning and Implementing

Financial planning determines how a business’s goals will be achieved

The steps in the planning process include:

1. Determining Financial Needs

Managers determine how much finance is needed, and to which parts of the business the money will be
allocated

 Determined through analyzing financial information e.g., balance sheets, incomes statements, cash
flow statements etc.

2. Developing Budgets

Budget: expected costs and revenues of business activities over set period of time

Budgets are used to determine how much each department of the business must contribute in order for the
business to achieve its goals

Types of budgets include:

- Operating Budgets – budget for just operation functions
- Project Budgets – relate to expenditure for capital, research and development
- Financial Budgets – look at overall financial data for businesses

3. Maintaining Record Systems

Record Systems: mechanisms employed by a business that records data that is accurate, reliable and accessible

The information stored in records systems is vital for businesses when making decisions
 Therefore, business must minimize errors in recording process to ensure data is accurate

Record systems also act as a financial portfolio for businesses which is analyzed by ASIC to ensure they are
meeting financial requirements à Corporations Act 2001
 4. Assessing Financial risk

Financial Risk: the risk to a business of not being able to meet financial obligations

If businesses are unable to meet financial obligations, they’ll go bankrupt

 As a result, business must research to identify any possible financial risks to the business
 Then they must develop a plan to avoid these risks and avoid bankruptcy

5. Establishing Financial Controls

Financial Controls: policies that monitor the usage of businesses financial resources

Include policies that apply to management and employees to ensure problems don’t occur, such as:
- Theft e.g., staff stealing cash
- Fraud e.g., staff using company funds for personal use
- Damage of Assets e.g., vandalism

Business use financial controls to avoid these problems, by implementing policies such as:
- Rotation of duties
- Separation of duties – allows business to identify who committed crime
- Protection of assets e.g., buildings are locked

Debt and Equity Finance – Advantages and Disadvantages

Businesses must carefully consider whether to use debt or equity finance as each positively and negatively
impacts the business

Debt Finance

Debt Finance: when the business borrows money

Advantages Disadvantages
Maintaining Ownership - debt finance doesn’t dilute Businesses often have to offer assets as collateral à
ownership of business à gives owners complete can result in loss of assets if business fail to pay back
control loan

Retaining Profits - only obligation to your lender is Reduced Cash Flow – through regular loan
making repayments and thus don’t have to share repayments, a businesses cash flow is reduced
business profits
Risk Bankruptcy – businesses need to generate
Tax Deductions - interest payments are tax enough cash to service debt à if not, business can
deductible. receive bankruptcy notice

Funds are easily accessible and can be acquired on Reduced Credit Rating – if a business fails to make
short notice à increase funds can lead to increase repayments, their credit rating will be affected,
revenue/profits affecting future chances of securing loans
Equity Finance

Equity: obtaining funds by giving investors a share of ownership of the business in return for money

Advantages Disadvantages
Freedom of Debt – business don’t need to make Diluted Ownership – current owners will give up
repayments on investments à releases burden of some ownership, reducing the dividends they
debt receive as well as some control of business à could
lead to internal conflicts
Increases Business Experience and Contacts –
investors often bring skills and experience, as well as
contacts and connections à can prove beneficial for Jeopardize Personal Relationships – accepting
business investment funds from family/ friends can affect
personal relationships if the business fails
Follow up Funding – investors often are willing to
provide additional funding as the business develops Time Consuming and Costly – approaching investors
for funds can be time consuming and costly.

Matching the Terms and Source of Finance to Business Purpose

Matching Principle: involves using the appropriate finance for the appropriate purpose
 The choice of finance to use by a business should directly link to the intended use of the finance

Good role to follow when matching principles:

- Current assets (inventory and supplies) should be purchased with short term finance
- Non-current assets (motor vehicles and supplies) should be purchased with long term finance

Applying the matching principles is an indication of good financial planning, hence, achieving the role of
financial management.
Monitoring and Controlling
Monitoring and Controlling: the process of measuring and comparing actual performance of business against
planned performance, and taking corrective action

Businesses use financial reports to monitor business performance, so that they can then take corrective action
based off the data

The main financial reports include:

Cash Flow Statements

Cash Flow Statement: financial statement that records all cash flowing in and out of the business
 allows business to know how much money they have in their business at any given time

Provides management with details needed for budgeting and control mechanisms
 Allows them to identify periods where they experience cash shortage and cash surplus, allowing them
to take corrective action

Reveals payment patterns throughout the year, helping businesses to plan ahead and ensure they have money
to cover payments

Cash flow statement can show businesses:

- If they have a favorable cash flow
- If they can meet financial commitments
- If they have enough money for expansion
- If they need to obtain finance from an external source
Revenue Statements (Income Statement or Profit and loss statement):
Revenue Statement: financial statement that shows the profitability of a business over a specified time frame.

Indicates the level of sales, gross profit and net profit of a business.

Through analyzing a revenue statement, businesses are able to:

- Identify unnecessary and costly expenses that are unproductive in producing profit.
- Better control business expenses and thereby potentially increase profits

A revenue statement is vital for:

- Evaluating changes in profit levels

- Evaluating if the income is high enough to cover expenses
- Evaluating if the business is making a good profit
- Making comparisons with previous year profits, sales and expenses

Shows:
Sales
Minus COGS (Opening Stock + Purchases – Closing Stock)
= Gross Profit
Minus Expenses
= Net Profit
Balance Sheet
Balance Sheet: represents a business’s assets and liabilities at a particular point in time and represents the net
worth of the business.

Represents the financial stability of the business.

Balance sheet is broken up into:

Assets
Asset: something that the business owns

Assets are broken up into:

Current Assets – assets that will be converted into cash within 12 months

o Cash
o Accounts Receivable
o Stock

Non-Current Assets – assets that won’t be converted into cash within 12 months

o Land and Buildings

o Plant and Equipment
o Furniture and Fixtures
o Motor Vehicles
o Intangibles e.g., goodwill

Liabilities
Liability: something that the business owes

Liabilities are broken up into:

Current Liabilities – debts expected to be repaid within 12 months

o Bank Overdraft
o Accounts Payable
o Accrued Expenses

Non-Current Liabilities – debts that will take over 12 months to be repaid

o Mortgage

Owners Equity – Money that the business owes its owners à considered a liability

Assets = Liabilities + Equity

 Means that the assets have been paid for by the businesses debt (liabilities) and shareholders money
(equity)
Financial Ratios
Businesses must analyse information from financial statements into forms that allow them to understand
business activities
 Businesses analyse information by calculating ratios/percentages
 Businesses them interpret this data to make judgements

Businesses can analyze:

- Liquidity
- Gearing
- Profitability
- Efficiency

Liquidity
1. Current Ratio – Balance Sheet
Liquidity is measured through the current ratio

Current Assets
Current Ratio=
Current Liabilties
Purpose:

- Ratio measures the extent to which a business can meet its financial obligations in the short term
(measures the ability to pay back its liabilities with its assets)

Appropriate current ratios:

e.g., 2:1 à For every $1 of current liabilities the business has $2 of current assets
 2:1 ration indicates a sound financial position
 A general rule is that the ratio should be greater than 1:1

Business can improve the current ratio (their liquidity) by:

1. Sell non-current assets and lease them back – increases available funds to better meet obligations
2. Leasing future non-current assets – don’t buy non-current assets but lease à reduces lump sum of
cash being wasted on non-current assets
3. Reduce Accounts Receivable by Factoring – increases available funds, which can be used to pay off
liabilities à reduces liabilities
4. Current Asset Controls – minimize amounts of accounts receivable (so payments are immediate à
increase access to funds)
5. Current Liability Control- reduces value of short-term obligations by paying off loans, accounts
payable and overdraft as quickly as possible.
Gearing/solvency (Debt to Equity) – Balance Sheet
Gearing: extent to which a firm relies on external debt and equity to fund business activities
 Shows solvency of business

Higher Gearing = Larger debt than equity à insolvent (bad)

Low Gearing = Larger equity than debt à solvent (good)

Gearing is measured through the debt to equity ratio

Total Liabilities
Debt ¿ Equity Ratio=
Total Equity
Purpose:

- Shows the extent to which the business is relying on debt or equity to fund its activities
- Ratio measures the extent to which a business can meet its financial obligations in the long term
à measures the ability to pay back its liabilities with its assets (solvency)

Appropriate current ratios:

e.g., 0.34:1 à For every $1 of equity there is 34c of debt

 Ratio between 0 and 1 is sound

Business can improve their debt-to-equity ratio (gearing) by:

- Sale and lease back of non-current assets à increases cash which can pay off liabilities
- Increase total profit à increases access to cash, which can pay off liabilities
- Increase owners contributions (through issue of more shares) à increases equity, improving debt to
equity ratio
Profitability
Profitability: the earning performance of a business and its ability to maximize profits

Improve profitability through:

- Increasing revenue (sales)

- Reducing costs

Ratios to measure profitability include:

- Gross Profit ratio

- Net Profit Ratio
- Return on Equity Ratio

2. Gross Profit Ratio

Gross Profit: difference between sales revenue and the direct cost of goods sold

Gross Profit
Gross Profit Ratio=
Sales
Purpose of Gross Profit ratio:
- Shows how much of sales turns into gross profit à shows how much business makes after taking into
account COGS
- Allows for cost control evaluation

e.g., 0.45:1 à For every 1 dollar received as sales, this business manages to retain 45c as gross profit.

Ratio should be higher than industry standard

Business can improve the GPR (their gross profit) by:

 Find cheaper suppliers à reduces COGS

 Produce stock offshore à reduces COGS
 Increase pricing on products through marketing à increases revenue
 Increase sales by using more effective marketing strategies à increases revenue
 3. Net Profit Ratio
Net profit: profit or return to the owners (gross profit minus expenses)

Net Profit
Net Profit Ratio=
Sales

Purpose of Net Profit ratio:

- Shows how much of the sales revenue actually goes to the owners of the business

e.g., 0.30:1 à for every $1 of sales, the owners earn 30c as profit

The higher the NPR the better the profitability of the business

Business can improve the NPR (their net profit) by:

 Find cheaper suppliers à reduces COGS

 Produce stock offshore à reduces COGS
 Increase pricing on products through marketing à increases revenue
 Increase sales by using more effective marketing strategies à increases revenue

4. Return on Equity

Net Profit
Returnon Equity=
Total Equity
Purpose:

- Shows how effective funds invested into the business have been at generating profit (shows return on
investment)

e.g., 0.10:1 à For every $1 of owners equity(investment), this business manages to retain 10c as net profit

Acceptable return is at least 10%

Business can improve their ROE by:

 Find cheaper suppliers à reduces COGS

 Produce stock offshore à reduces COGS
 Increase pricing on products through marketing à increases revenue
 Increase sales by using more effective marketing strategies à increases revenue

Action in finance to reduce costs and collect accounts receivable.

Efficiency
Efficiency: ability of a business to use resources in the most effective manner to maximize profit

Ratios to measure efficiency include:

- Expense Ratio
- Accounts Receivable Turnover Ratio

5. Expense Ratio

Total Expenses(excludes COGS)

Expense Ratio=
Sales

Purpose:

- Indicates how much of revenue is taken up by expenses

e.g., 0.80:1 à For every $1 of sales, 80c is spent on expenses

The lower the ratio the better

Business can improve their expense ratio by:

 Reduce expenses
 Increase pricing on products through marketing à increases revenue
 Increase sales by using more effective marketing strategies à increases revenue

6. Accounts Receivable Turnover Ratio (ARTR)

365
ATRT=
sales ÷ accounts receivable
Purpose:

- Determines how efficiently a business receives their account receivable

 shows the amount of days between each accounts receivable payment
à Lower number of days à more efficient

Businesses can improve their ATRT by:

1. Factoring à selling accounts receivable at a cheaper price to a third-party company to receive fund
immediately
2. Offering clients discounts for earlier payments
3. Adopting a Credit Policy à ensures customers are trustworthy and will fulfill accounts receivable
Identifying the Limitations of Financial Reporting
Financial reports provide information on the state of a business’s financial position

Businesses often use methods to mislead the value of their financial reports, in an attempt to make their
business look appealing to investors
 As a result, investors need to be cautious when examining financial reports because they may not be
an accurate representation of the businesses financial position

The following issues need to be considered by investors when examining a financial report, these are
considered to be limitations of financial reports:

1. Normalised Earnings – income statement

Normalized Earnings: technique that adjusts earning to take into account inflation and one-off factors that
boost earnings

 These normalized earnings allow business to attempt to provide a more realistic reflection of their
profits e.g., a business excludes the inflow of cash that comes from a one-off sale of land, as it doesn’t
happen often

Limitation à the adjustment of the earnings is based on businesses judgment, therefore can be misleading to
investors, limiting the usefulness of financial reports

2. Capitalizing Expenses – balance sheet

Capitalizing Expenses: technique that turns expenses into non-current assets

Treats certain expenses as a non-current asset, rather than an expense, reducing the overall expenses in the
business, making both their profits and assets seem larger than they may be

Limitation à total expenses of a business could be understated, whilst profits are being overstated, therefore
can be misleading to investors, limiting the usefulness of financial reports

3. Valuing Assets – balance sheet

Valuing Assets: the process of estimating the value of assets when recording them on the balance sheet

Business assets may appreciate or depreciate over time, so when business value their assets it is often
subjective and an estimate
 Limitation à financial report may give false impression of the value of a businesses assets

4. Timing Issues – all three statements

Businesses may use timing issues to exploit timing of financial statements to give a misleading impression of
their financial position

e.g., managers might delay the reporting of expenses until the next financial year, allowing them to have lower
expenses and higher profits in the current financial year

à this misleads investors

 5. Debt Repayment – balance sheet
Financial reports don’t indicate when debt repayments have to be made, which can create a misleading
impression about the business

e.g., business might have large sum of debt that has to be paid at once (which can make the business go
unstable), or they might have a large debt that they can pay off gradually

 Financial reports are limited in this sense, as they don’t disclose this information about debt
repayments, limiting their use to investors

6. Notes to the Financial Statements

Notes to Financial Statements: additional report to the financial statement that includes any information that
was left out on the financial reports

 They contain information that may help investors understand their financial reports

Limitation à these notes aren’t regulated by the law à businesses may use the notes to mislead stakeholders
Ethical Issues Related to Financial Reports
Businesses should ensure that the decisions they make when preparing financial reports are ethical

Ethical issues related to financial statements include:

Audited Accounts
Audited Account: independent check of the accuracy of financial reports by an external body

By law (Corporations Act 2001), businesses must be audited by an external party each year

 These audits determine if:

o The businesses financial accounts are accurate and true
o The business has complied with regulation

Record Keeping
Record Keeping: refers to recording of all financial data on financial reports

Businesses should avoid attempting to understate the value of their profits, in order to reduce tax

 If caught, business will receive fines and ruin reputation

Reporting Practices
Reporting Practices: refers to preparing financial reports truthfully and transparently

 Business must state profit truthfully

 Understating profits can:
o Result in business being fined
o Make the business appear to be less successful à reduces chance of getting more investors
 Chapter 12: Financial Management Strategies
Cash Flow Management Strategies
Cash Flow: movement of cash in and out of the business overtime

Business must manage cash flow to ensure they have sufficient cash cover operating costs and meet its debt

Strategies to manage cash flow include:

1. Distribution of Payments
Distribution of payment: businesses spread their payments across each month
 Ensures large expenses do not occur at the same time and cash shortfalls do not occur.

Can do this by:

- Delay payments to suppliers
- Pay in installments (paying off a large sum of debt gradually)
- Choosing monthly payments over quarterly

Advantage Disadvantages
Ensures large expenses do not occur at the same Money always moving minimizes contingency funds
time in case of unforeseen issues

2. Discounts for Early Payments

Discounts for early payments: businesses offer a discount to their customers if they pay within a specific time.

Can do this by:

- Offer discounts for early accounts receivable payments
- Scaling Discounts – larger discount for earlier payment

Advantages Disadvantages
Acquire funds at accelerated rates Full amount of money owed is not received

Reduces the risk of non-payments or late pay from May impact ability of business to forecast cash flow
customers

3. Factoring
Factoring: when businesses sell accounts receivable at a discount to specialist factoring firms
 allows business to gain cash flow within 48 hours

Advantages Disadvantages
Allows business to receive funds immediately à Business sacrifice portion of funds from accounts
improves cash flow and gearing receivable (by selling at discount)
 Reduces overall earnings

May indicate the business is desperate

Working Capital (Liquidity) Management Strategies
Working Capital: refers to funds available to pay short-term financial commitments

Working capital=Current Assets−Current Liabilities

 represents funds that are needed for day-to-day operations of a business to produce profit and
provide cash for short-term

Businesses must manage working capital to ensure they don’t have cash flow shortages and liquidity problems

Strategies to manage working capital include

1. Control of Current Assets
2. Control of Current Liabilities
3. Managing Working Capital

1. Control of Current Assets

Controlling current assets ensures there are enough current assets to cover liabilities

The current assets that businesses to control include:

- Cash
- Accounts receivable
- Inventory

Cash
Cash ensures businesses are able to pay off debts and survive

Businesses can control cash by:

 Cash Flow Forecasting – planning for the timing of transactions, to ensure there is never cash
shortages or excess cash
 Systems that ensure cash is treated with security – removes potential of fraud

Accounts Receivable
The quicker customers pay the accounts receivable, the better the businesses cash position

Businesses can control accounts receivable by:

 Checking Credit Rating of Customers – ensures customers have good history with paying back
debt
 Following up on accounts that are not paid by the due date
 Sending customers monthly reminders about what they owe

Inventory
Inventory must be stored, and secured à proves an expense to a business à business should aim to minimize
their amount of inventory

Businesses can control inventory by:

 Ensuring there is enough stock on hand to meet customer demand – avoid overstocking or
understocking
 Using just-in-time inventory control – avoids overstocking à reduces expenses
 2. Control of Current Liabilities
Involves managing a business’s short-term debts and payments

The current liabilities that businesses can control include:

- Accounts Payable
- Loans
- Overdrafts

Accounts Payable
Accounts Payable: money a business owes to its suppliers for g/s it has received but not yet paid

Business must manage accounts payable to ensure they have sufficient cash to cover bills
 Inability to cover bills will ruin a business’s reputation and credit rating

Businesses can control accounts payable by:

 Arranging payments to be made on the due date à avoids extra charges for late payments
 Looking for suppliers that offer attractive credit terms e.g., discounts and interest free periods

Loans
Businesses should avoid use of loans as they have high interest rates

Business can control loans by:

 Minimizing the use of loans (as they are expensive)

Overdrafts
Businesses should reduce overdrafts as they have high interest rates

Businesses can control overdrafts by:

 Not using overdrafts to fund large expenses (due to high interest rates)
 Compare the interest rates between financial institutions
 3. Strategies for Managing Working Capital
If business experiences insufficient working capital, they will have cash flow shortages and liquidity problems

Businesses can control working capital by:

 Leasing
 Sale and Lease Back

Leasing
Leasing: the hiring of an asset from another party

- Allows business access to non-current asset without having to pay high up-front cost à improves
working capital
- Allows business to pay off payments over several years à improves working capital
- Leasing payments are fixed à allows business to forecast budgeting

Sale and Lease Back

Sale and Lease Back: involves sale of non-current to a third party and then leasing it back immediately

- Immediately increases cash and liquidity à increases working capital

- Business still benefits from use of asset at a reduced monthly payment
Profitability Management Strategies
Businesses can improve their profitability through

- Cost Controls (minimizing costs)

- Revenue Controls (maximizing revenue)

Cost Controls
Business can improve their profitability by reducing their costs

Businesses can reduce their costs by:

1. Establishing Cost Centers
2. Fixed and Variable Costs
3. Expense Minimization

Establishing Cost Centers

Cost Centers: departments of a businesses where costs are monitored

Fixed and Variable Costs

Fixed Costs: costs incurred regardless of how much is produced

Variable Costs: costs of business influenced by levels in production

- Since fixed costs can’t be changed, businesses manage costs by reducing variable costs

Business can reduce variable costs by:

 Negotiating discounts with suppliers through bulk buying
 Switching to a cheaper supplier
 Using just-in-time inventory to reduce storage costs

Expense Minimization

Expense Minimization: the process of reducing expenses to boost profitability

Involves focusing on reducing the non-operating expenses of a business

Businesses can minimize expenses by reducing:

Administrative Expenses
- Policies to encourage staff to minimize expenses e.g., reduced use of stationary
- Outsourcing inefficient duties
- Reducing staff members

Financial Expenses
- Renegotiating loans to reduce interest expenses

Selling Expenses
- Using cheaper advertising e.g., social media
Revenue Controls
Revenue: income earned from activity of business

Businesses can improve their profitability by increasing their revenue

 Business can increase revenue by refining their marketing plan

Business can do this by following the marketing objectives of:

- Increasing Sales à marketing team improves strategies to increase sales and hence revenue
- Developing New Sales Mixes à business focuses on producing and selling their highest revenue
generating products
- Determining Pricing Policies à business must price products that maximize sales whilst maintaining a
significant profit margin

Global Financial Management Strategies

Businesses can implement financial management strategies to minimize the negative effects of the global
market

Global financial management issues/ risks include:

Exchange Rate
Exchange Rate: the value of one currency in terms of another

What is the financial risk?

Impact of currency fluctuation is twofold whether it is an appreciation or depreciation.

 Appreciation: Raises the value of the dollar in terms of foreign currency. Therefore:
- Makes our exports more expensive--> reduces international competitiveness of our businesses
- Means that prices for imports will fall
 Depreciation: Lowers the price of dollars in terms of foreign currencies
- Makes our exports cheaper--> improving international competitiveness
- Prices for imports will rise

Strategies to reduce the financial risk

 Take advantage of significant currency depreciation and bulk buy raw materials
 Hedging and derivatives
 Ensure business operations is adequately diversified geographically to protect themselves against
currency risk

Interest Rates
Interest rates: cost of borrowing money

What is the financial risk?

 Interest rates fluctuate

Strategies to reduce the financial risk

 Hedging and derivatives

Hedging
Hedging: process of minimising the risk of currency fluctuations using a range of financial instruments

Payment in Advance

Buyer pays supplier before goods have been shipped

Highest risk for buyer

Letter of Credit

Business arranges their bank to write a letter of credit, which promises to pay supplier once the goods have
arrived

 Letters cannot be withdrawn

 Risky for importer because they pay before they are able to see if goods are damaged/defective

High risk for buyer (better than payment in advance because this method still guarantees that they receive a
good)

Clean Payment

Buyer pays supplier when goods have arrived, and are a considered acceptable

Least risk for buyer

Bill of Exchange

Suppliers bank sends a letter to buyers banks

 Allows buyer to inspect goods for any damages, before paying

Low risk for buyer