FinanceStudy Notes
HSC Business Studies
Naomi Mendes
Business Studies- Finance Study Notes:
Role of FinanceStrategic Role of Financial Management
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Businesses need to develop a strategic plan as part of a business’s financial management as it
will ensure that the businesses services and grows in the competitive business world.
It will allow the business to achieve key goals such as profitability and growth.
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Qantas- the strategic role of Qantas financial management is liquidity, solvency, profitability,
efficiency, growth and return on capital.
Objectives of Financial Management
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The objectives of financial management are- Profitability- it is the ability of a business to maximise its profits. Profits satisfy shareholders
of a business in the short term and in the long term are important for the businesses
sustainability.
- Growth- the ability of a business to increase its size in the longer term. It ensures the
business is sustainable into the future. It depends on a business’s ability to develop and use
its asset structure to increase sales, profits and market share.
- Efficiency- the ability of a business to minimise its costs and manage its assets so that the
maximum profit is achieved with the lowest possible level of assets.
- Liquidity- is the extent to which a business can meet its financial commitments in the short
term. If a business cannot meet is financial obligations in the short term it will not be
sustainable in the long term.
- Solvency- is the extent to which the business can meet its financial commitments in the
longer term. It is important to the owners, shareholders and creditors of a business as it is an
indication of the risks to their investment.
Short Term and Long Term Financial Objectives
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Short term financial objectives- are the tactical (one to two years) and operational (day-to-day)
plans of a business. They are regularly review to ensure targets are being met and resources are
being used to the best advantage to achieve the objectives.
Long term financial objectives- are the strategic plans of a business. They are determined for a
set period time, usually for more than five years. They are broad goals- e.g. - to increase profit or
market share and require short-term goals to assist in their achievement.
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Business Studies- Finance Study Notes:
Role of Financial ManagementInterdependence with Key Business Functions
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Without finance there would be very little business. Finance flows to each functional area within
a business, which enables it to achieve its goals.
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Qantas- all KBFs at Qantas depend on finance. Qantas spends $275 million+ a year on staff
training. Qantas has budgeted $10 billion over the next 10 years on fleet renewal. Marketing
strategies need to be funded.
Human
Resources
Finance
Operations
Marketing
Influences on Financial ManagementExternal Sources
of Finance
Financial
Institutions
Influences on
Financial
Management
Global Market
Influences
Internal Sources
of Finance
Influences of
Government
Sources of Finance- Internal
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Internal Finance is the funds provided by the owners of the business (finance) or from the
outcomes of business activities (retained earnings).
Owners’ Equity is the funds contributed by owners or partners to establish and build the
business.
Retained profits is when the businesses profits are not distributed to shareholders or owners
but are kept in the business as a cheap and accessible source of finance for future activities.
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Business Studies- Finance Study Notes:
Influences on Financial ManagementSources of Finance- External
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External finance is the funds provided by sources outside the business, including banks, other
financial institutions, government, suppliers or financial intermediaries.
Debt: Short Term Borrowing•
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Short term borrowing is provided by financial institutions through bank overdrafts, commercial
bills and bank loans.
This type of borrowing is used to finance temporary shortages in cash flow or finance for
working capital, it will generally will be repaid within two years.
A bank overdraft is when the bank allows a business to overdraw its account to an agreed limit.
Bank overdrafts assist business with short term liquidity problems- e.g. - seasonal decrease in
sales. Their cost is lower and as are interest rates.
Commercial Bills are a type of bill of exchange (loan) issued by institutions other than banks and
are given for large amounts, usually over $100000 for a period between 90 and 180 days.
Factoring is the selling of accounts receivable for a discounted price to a finance or factoring
company. It is a short term source of finance as the business will receive up to 90% of the
amount receivables within 48 hours of submitting its invoices to the factoring company.
Debt: Long Term Borrowing•
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Long term borrowing refers to funds borrowed for periods longer than two years. It can be
secured or unsecured and interest rates are usually variable.
A mortgage is a loan secured by the property of the borrower (business). The property that is
mortgaged cannot be sold or used as security for further borrowing until the mortgage is repaid.
Debentures are issued by a company for a fixed rate of interest and for a fixed period of time.
An unsecured note is a loan for a set period of time but is not backed by any collateral or assetse.g. – house or stock. It presents a high risk to investors and therefore attracts a higher rate of
interest than a secured note.
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. Leasing enables an enterprise to borrow
funds and use the equipment without a large debt.
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Business Studies- Finance Study Notes:
Influences on Financial ManagementSources of Finance- External
Equity- Ordinary Shares•
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Equity refers to the finance (cash) raised by a company by issuing shares.
Ordinary shares are the most commonly traded shares, purchase of ordinary shares by
individual’s means they are part-owners of a publically listed company (e.g. - Westpac) and may
receive payments, called dividends.
The value of a share is determined by a company’s current or future conditions.
The following terms refer to variations in the type or issue 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). A share of a company sold for
the first time.
- Rights issue- the privilege granted to shareholders to buy new shares in the same company.
You are invited to buy the share.
- Placements- allocation of shares, debentures etc. 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. How much money is offered for the share?
Private Equity•
Private equity is money invested in a private company not listed on the ASX.
Financial Institutions•
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Banks are the major operators in financial markets and are the most important source of funds
for businesses. They receive savings as deposits from individuals, businesses and governments
and make investments and loans to borrowers. Since the GFC banks have more conservative
lending policies as loan defaults are expensive- they only provide loans to low risk customers
(with a good credit rating).
Investment banks provide services in both borrowing and lending, mostly to the business sector.
Investment banks- Trade in money, securities and financial futures.
- Arrange long-term finance for company expansion.
- Provide working capital.
- Arrange project finance.
- Advise clients on foreign exchange cover.
- Arrange overseas finance.
Finance and life insurance companies are non-bank financial intermediates (mediators) that
specialise in smaller commercial finance. These companies are regulated by the Australian
Prudential Regulation Authority.
Finance companies provide loans to businesses and individuals through consumer hire-purchase
loans, personal loans and secured loans (can sell assets of a business if they fail to repay the
loan) to businesses. They are the major providers of lease finance to businesses- some specialise
in factoring or cash flow financing.
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Business Studies- Finance Study Notes:
Influences on Financial ManagementFinancial Institutions
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Insurance companies provide loans to businesses through revenues from insurance premiums,
which provide funds for investments. Insurance companies provide large amounts of equity and
loan capital to businesses. They invest the funds they receive from customers into financial
assets (e.g. - loans to businesses or shares).
Superannuation Funds provide funds to businesses through investing funds received from
superannuation contributions. Superannuation funds invest in long-term securities such as
company shares, government and company debt because of the long-term nature of their funds.
Unit Trusts take funds from lots of small investors and invest them in specific types of financial
assets. Unit trust investments include shares, mortgages and property and public securities.
Australian Securities Exchange (ASX) is the primary stock exchange group in Australia. The ASX
offers products and services including shares and futures. It is a governing body that controls
trade sharing within Australia. It controls, regulates and monitors trading of shares.
Influence of Government
The Australian Securities and Investments Commission (ASIC)•
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The aim of ASIC is to assist in reducing fraud and unfair practices in financial markets and
financial products.
ASIC ensures that companies comply with the law.
It collects information about companies and makes it available to the public.
ASIC is a watchdog.
Company Taxation•
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Companies pay company tax on profits- it is levied at a flat rate of 30%.
It is paid before profits are distributed to shareholders as dividends.
The government controls tax levels by increasing or decreasing them.
Australia’s international competitiveness make it a more attractive place to invest.
Lowering the tax rate (36% to 30%) means the business will have more retained profit- allowing
them to achieve their business goals- a higher profit means businesses are more likely to put the
money back into their business to increase its growth.
Taxing companies allows governments to assist the development of a nation as it contributes to
the building of hospitals, schools etc.
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Business Studies- Finance Study Notes:
Influences on Financial ManagementGlobal Market Influences
Availibility
of Funds
Global
Market
Influences
Economic
Outlook
Interest
Rates
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 (world economic growth is to increase) then this will impact on the
financial decisions of a business. This may include- Increasing demand for products and services.
- Decrease the interest rates on fund borrowed internationally form the financial money
market.
è This results mainly from a decrease in the level of risk associated with repayments- as business
sales increase as do profits.
• A poor economic outlook will impact on financial decisions in an opposite way.
Availability of Funds•
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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 are primarily based on- Risk
- Demand and supply
- Domestic economic conditions
The GFC had a major impact on the availability of funds for all companies and institutions. It
caused a sharp increase in interest rates that was a reflection of the high level of risk in lending.
This will mean that businesses have more retained profit, allowing them to achieve more
business goals of profitability. Reducing tax allows businesses to have a higher profit, thus they
are more likely to put the money back into their business to increase its growth.
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Business Studies- Finance Study Notes:
Influences of Financial ManagementGlobal Market Influences
Interest Rates•
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Interest rates are the cost of borrowing money.
The higher the risk of lending to a business, the higher the interest rates.
The need to maximise profits may lead to business borrowing from an overseas source to gain
the advantage of a lower interest rate.
However, there is a risk in the exchange rate movements. Currency fluctuation could see the
advantage of cheaper overseas interest rates quickly eliminated. In the long term ‘cheap’
interest rates may cost more.
Qantas-global market influences have a big impact on Qantas and its profitability. Prior to
2009, Qantas benefited from a strong global economy, increasing demand for its services à
record net profit of $970 million (2008). The GFC caused rapid revenue declines- there was less
demand for air travel à 88% fall in net profit (2009). Qantas cut flying capacity and replaced
Qantas with Jetstar on some routes.
Processes of Financial ManagementPlanning and Implementing
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Financial planning is essential if a business is to achieve its goals as it determines how the goals
will be achieved.
It begins with long term or strategic plans. Long term plans include a business’s planned capital
expenditure (what is spent on a business’s non-current or fixed assets- used to generate
revenue) and/or planned investments.
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The planning cycleAddressing
present
financial
situation
Establishing
financial
controls
Identifying
financial
risks
Determining
financial
needs
Maintaining
record
systems
Developing
budgets
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Business Studies- Finance Study Notes:
Processes of Financial ManagementPlanning and Implementing
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Long term plans also cover planned sources of finance, spending on research and development,
marketing and product development activities.
Long term plans cover a period between two and ten years and guide the development of short
term tactical and operating plans.
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•
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Financial needs refers to how much finance will be needed to achieve the businesses objectives
and when it will be needed.
They determine where a business is headed and how it will get there.
Financial information needs to be collected before future plans can be made. This financial
information includes balance sheets, information statements, cash flow statements, sales and
price forecasts, budgets and bank statements.
The financial needs of a business are determined by- The size of a business
- The current stage of the business cycle
- Future plans for growth and development
- Capacity to source finance- debt and/or equity
A business plan might be used to help seek finance or support for a project as it sets out financial
commitment and proposed usage.
Financial information is needed to show that the business can generate an acceptable return for
the investment being sought and should include an analysis of financial performance.
Financial needs should incorporate all areas of the key business functions, and be tactical and
strategic (short and long term).
Budgets•
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Budgets are a financial forecast of the finance needed to achieve the objective and when the
finance will be needed.
Budgets plan but also monitor (they enable constant monitoring) and control (track actual
performance against planned performance) objectives.
They provide information in quantitative terms (facts and figures) about the requirements to
achieve a particular purpose.
Budgets reflect strategic planning decisions about how resources are used. They provide
financial information for a business’s specific goals and are used in strategies, tactical and
operational planning.
They can be classified as operating, project or financial budgets.
Operating budgets relate to the main activities of a business and include budgets relating to
sales, production, raw materials, direct labour, expenses and cost of goods sold.
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Business Studies- Finance Study Notes:
Processes of Financial ManagementPlanning and Implementing
Budgets•
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Project budgets relate to capital expenditure, and research and development. Capital
expenditure budgets in a business’s strategic plan include information about the purpose of the
asset purchase, life span of the asset and the revenue that would be generated from the
purchase.
Financial budgets relate to the financial data of a business. The predictions of the operating and
project budgets are included in the budgeted financial statements. Financial budgets include the
budgeted income statement, balance sheet and cash flow. The income statement and balance
sheet reflect the results of operating activities and the cash flow statements shows the liquidity
of a business.
Record Systems•
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Record systems are concerned with the gathering, storing and retrieving of all the information
that relates to strategies designed to achieve the objectives.
Minimising errors in the recording process, and producing accurate and reliable financial
statements are important aspects of maintaining record systems.
The double entry system of accounting is a method of recording all items twice to see if finances
balance and errors can be found quickly.
Financial Risks•
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Financial risk is the risk to a business of being unable to cover its financial obligations, such as
debts that a business incurs through borrowings (both short term and long term).
It can be transferred to other businesses specialising in risk (e.g. - insurance companies).
Financial risk is about predicting and minimising the risk of the external environment.
The risk of bankruptcy is evident if financial risks are not minimised.
Financial risks include- Interest rates increasing
- When borrowings are due to be repaid
- Meeting financial commitments
- Going into more debt
If the business is financed from borrowings there is a higher risk.
The higher the risk, the greater the expectation of profits or dividends.
Financial Controls•
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Financial controls are the policies and procedures that ensure that the plans of a business will
be achieved the most efficient way.
Common causes of financial problems are theft, fraud damage and errors in record systems.
Control is important in assets such as accounts receivable, inventory and cash.
Common policies and procedures that promote control within a business are separation of
duties, rotation of duties, control of cash, protection of assets and control of credit procedures.
Budgets and variance reporting are additional financial controls used in a business.
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Business Studies- Finance Study Notes:
Processes of Financial ManagementDebt Finance- Advantages and Disadvantages
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Advantages of Debt
Funds are usually readily available.
Increased funds should lead to increased
earnings and profits.
Tax deduction for interest payments.
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Disadvantages of Debt
Increased risk if debt comes from financial
institutions because the interest, bank
charges, government charges and the
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- Advantages and Disadvantages
Advantages of Equity
Does not have to be repaid unless the
owner leaves the business.
• Cheaper than other sources of finance as
there are no interest payments.
• The owners who have contributed the
equity retain control over how that finance
is used.
• Low gearing (uses the resources of the
owner and not external sources of finance).
è How much level of risk in borrowing.
• Less risk for the business and owner.
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Disadvantages of Equity
Lower profits and return for the owner.
The expectation that the owner will have
return on the investment (ROI).
Business Studies- Finance Study Notes:
Process of Financial ManagementMonitoring and Controlling
Cash Flow Statement•
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A cash flow statement is a statement that indicates the cash balance position at the end of an
accounting period.
It shows how much cash came into the business and how much cash was paid out by the
business.
Monitoring and controlling this is important as the cash cycle can determine the business
solvency.
Allows businesses to identify cash flow problems which may cause future liquidity and working
capital problems.
Cash flow forecasts predict the cash position of a business.
Cash Flow Statement-
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Business Studies- Finance Study Notes:
Processes of Financial ManagementMonitoring and Controlling
Income Statement (Revenue Statement)•
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The income statement shows how much the business sold, how much it cost to make these sales
and how much profit the business made.
It indicates the level of profit or loss) for a business for a particular period.
The income statement indicates the level of sales, gross profit and net profit of a business.
Net profit is the amount of profit made after deducting the expenses from gross profit it takes
into account the cost of goods sold and the level of expenses (TRUE REALITY).
Income Statement-
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Business Studies- Finance Study Notes:
Processes of Financial ManagementMonitoring and Controlling
Balance Sheet•
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The balance sheet is a statement showing the net worth (total value) of a business on a
particular day (last day of the financial year- 30th June).
It indicates the assets and liabilities of a business, which is vital information for analysis of a
business.
It shows what is owned and what is borrowed.
Provides information about the profitability and stability of the business.
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Qantas- The financial statements of Qantas summarise its financial transactions. They are
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issued to shareholders and are available to the public. KPMG audits Qantas’ financial statements
to ensure they give a true and fair indication of the company’s finances and comply with
accounting standards and corporate law.
Financial Ratios
Liquidity•
Liquidity is the extent to which the business can meet its financial commitments in the short
term (<12 months).
è Process of selling a company’s assets a quick as possible to meet short term debts.
• A business must have sufficient funds to meet debts and unexpected expenses.
• Ways to improve liquidity- Leasing (instead of buying)
- Reduce operations costs
- Collect accounts receivable (factoring)
- Sell non-current assets (e.g.) liquidity)
- Borrow funds
- Retained profits (put back into business- don’t distribute to shareholders)
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Business Studies- Finance Study Notes:
Processes of Financial Management
Financial Ratios
Liquidity•
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A ratio of less than 1:1 indicates insufficient assets to meet
current financial commitments.
A ratio of 1.5:1 is desirable (need to compare to industry
average).
If liquidity is too high (e.g. - 3:1) this indicates that working
capital is not being used effectively. Investment maybe an option.
Qantas- Qantas’ low rate indicates an inability to meet its short term debts. However, like
most other airlines it operates on a negative working capital position. Qantas holds little cash
reserves and uses the cash received to pay long term debt, reducing interest costs. Their liquidy
ration decreased in 2014 to 0.66:1 from 0.75:1 in 2013. Singapore Airlines- 1.4:1, Air New
Zealand- 0.98:1.
Current liquidity strategies employed Qantas include- Controlling current assets and liabilities
- Leasing more aircraft, buildings, plant and equipment- frees up cash.
- Considering selling and leasing back terminal buildings.
Gearing•
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Gearing is the proportion of debt (external finance) and the proportion of equity (internal
finance).
Gearing ratios determine the firm’s solvency- its ability to meet financial commitments in the
longer term.
Highly geared means that a company is working harder to repay its debts.
High debt to equity may discourage shareholders/investors due to the high risk.
The more highly geared the business is, the greater the risk for the business but the greater
potential for profit.
This ratio is an important control aspect for management because the relationship between
debt and equity needs to be balanced carefully.
There is no optimal level of gearing, it depends on- Return on investment
- Cost of debt
- Size & stability if business’s earning capacity
- Liquidity of business’s assets (and ability to quickly meet interest repayments)
- Purpose of short-term debt
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Business Studies- Finance Study Notes:
Processes of Financial Management
Financial Ratios
Gearing•
Qantas- Qantas is highly geared due to the capital intensive nature of the industry. Qantas’
source of funds include a mix of cash, equity, debt and lease finance. Two equity raisings 2001
and 2002, the decision to lease planes, the high value of the Australian dollar and improved
profitability helped decrease Qantas’ gearing from 2004-2007. However, a period of low interest
rates and the favourable operating environment and a fleet renewal program caused Qantas to
increase its gearing from 2008.
Profitability•
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Profitability ratios identify if the business is making profits.
There are three profitability ratios: the gross profit ratio, the net profit ratio and the return on
equity ratio.
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Qantas- Qantas must have a satisfactory level of profit to survive. It is also important for
stakeholders. Profitability in the airline is relatively poor on average. Qantas’ profitability
suffered due to terrorist attacks (2002), SARS (2004) and the rising cost of fuel (2006). Increasing
profitability in 2007 and 2008 was due to the success of Jetstar, the robust economic
environment and cost savings culminated in a net profit of $970 (million??) in 2008. The GFC and
Swine Flu led to an 88% fall in net profit in 2009. Qantas has struggled in recent years to make
profit due to high fuel prices, natural disasters and weaknesses in the domestic market. Qantas
has forecasted a pre-tax underlying profit between $300 and $350 million this year, due to their
cost cutting program and fall in oil prices.
Gross Profit Ratio•
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The gross profit ratio indicates what percentage of each sales dollar is gross profit.
It also helps determine if the sale price of goods and services of a business is adequate.
Gross profit is the difference between the sales revenue and the cost of goods sold (COGS) (the
cost of production) what were sold- it is profit before the expenses (e.g. - salaries) are taken in
to account.
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NB- Gross Profit = Sales – COGS
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The gross profit ratio should be greater than 0.5:1.
The gross profit ratio indicates what percentage of each sales dollar is gross profit.
The gross profit indicates effectiveness of planning policies concerning, pricing, sales, valuation
of stock etc.
The gross profit ratio can be improved by- Efficient operations
- Outsourcing
- Economies of scale
- Leasing (long term- disadvantage)
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Business Studies- Finance Study Notes:
Processes of Financial Management
Financial Ratios
Net Profit Ratio•
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The net profit ratio (return on sales) measures the percentage of each dollar of sales that is left
over to pay tax and returns to lenders (principal and interest) and owners (dividends and
shareholders) for the use of their capital.
Net profit is the amount of profit after the expenses involved have been deducted from the
gross profit ratio.
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NB: Net Profit = Gross Profit – Expenses
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The net profit ratio assesses a business’s profitability.
The net profit ratio should be between 10-18%.
The net profit ratio can be improved by- Efficient operations
- Outsourcing
- Economies of scale
- Leasing (long term- disadvantage)
Return on Equity Ratio•
The return on equity ratio measures the net profit before tax and compares it to the equity of a
business.
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The return on equity ratio will reflect its asset structure (nature of operations) and financial
structure.
The return on equity ratio is a measure of the owners reward for the risk involved in keeping the
business operating.
If returns compare favourably, owners might consider expanding the business. If the return is
unfavourable, the owners would consider alternative options including selling the business.
The ratio is also an indication to potential shareholders if it they will receive a return on their
investment. A high return on equity, means that people are more likely to invest in a business.
The return on owner’s equity ratio is calculated using the income statement and the balance
sheet.
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Business Studies- Finance Study Notes:
Processes of Financial Management
Financial Ratios
Efficiency•
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Efficiency is the ability of the firm to use its resources effectively in ensuring financial stability
and profitability of the business. It relates to the effectiveness of management in directing and
maintaining the goals and objectives of the firm.
The more efficient the firm, the greater its profits and financial stability.
Expenses Ratio•
The expense ratio compares total expenses with sales.
Total expenses
Sales
Expense Ratio =
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The ratio indicates the amount of sales that are allocated to individual expenses such as selling,
administration, cost of goods sold and financial expenses.
The expense ratio indicates the day-to-day efficiency of the business.
A business aims to keep expenses at a reasonable level- if the expenses ratio is too high or low,
the management needs to determine why this has happened.
Decline in the financial expense ratio maybe a result of lower interest rates or less debt being
used by the firm.
Qantas- Qantas’s expense ratio increased from 99% in 2013 to 125% in 2014. Qantas has
improved efficiently by- Introduction of new and more efficient aircraft (new airbus use 25% less fuel per passenger)
- Introduction of new crew and training bases
- Investment in new IT systems
- Reduced overhead costs due to improved economies of scale
Accounts Receivables Turnover Ratio•
This ratio shows the effectiveness of a business’s credit policy and how efficiently they collect
their debts (connected to factoring).
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The accounts receivable turnover ratio measures the effectiveness of a firm’s credit policy and
how efficiently it collects its debts.
Changing the credit policy
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Business Studies- Finance Study Notes:
Processes of Financial Management
Financial Ratios
Accounts Receivable Turnover Ratio•
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It measures how many times the accounts receivable balance is converted into cash or how
quickly debtors pay their accounts.
The accounts receivable turnover can be improved by- Factoring
- Invoicing customers earlier or more often (e.g.- twice a month instead of once a month)
Comparative Ratio Analysis•
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To make an effective judgement businesses need to compare ratios.
Comparison and benchmarks are needed.
Figures over time can indicate directions or trends and make ratio analysis more meaningful.
Analysis can also include budget figures so that predicted figures can be compared against actual
figures (usually over short periods).
Limitations of Financial Reports
Limitations of Financial Reports
Normalised Earnings
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The process of removing one time influences from the
balance sheets to show the true earnings of a company.
Capitalising Expenses
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Valuing Assets
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Timing Issues
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Debt Repayments
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Notes to Financial Statements
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Classifying expenses as assets which will increase profit
and the value of the business. Example- R&D costs are
classified investment in the future of the business à
considered an asset.
It is difficult to accurately value assets on the balance
sheet à market value can change over time due to
depreciation and depreciation. Example- vehicles and
equipment depreciate over time, so their value on the
balance sheet should be recorded at their market value
not at the original cost.
Financial reports only cover a specific period and don’t
include income or expenses occurring outside the time
period à these events may have a large impact on the
profitability of a business.
Financial reports contain little information about
businesses debt apart from its value. Other information
about debts may be important to the financial stability
of a business. *doesn’t show what type of debt.
Need to be read as they contain additional information
about how the report was prepared which can affect the
figures recorded. Example- Actual profit maybe different
to ‘normalised profit’ in the income statement.
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Business Studies- Finance Study Notes:
Processes of Financial Management
Limitations of Financial Reports•
Qantas- Limitations of Qantas’ financial reports maybe occur if the comprehensive notes
attached to the reports aren’t read by stakeholders- helps them understand better and gives
more clarity to financial position. Special circumstances may distort analysis of results- for
example natural disasters (in 2011- cyclone Yasi, Christchurch earthquake, Japan tsunami) affect
Qantas’ profitability. Financial reports don’t give an entire picture of their debt as it doesn’t
disclose when they have to be repaid. It can also be difficult to value Qantas’ assets because
they change over time. Qantas’ long term assets are depreciated over time but the value of
these assets may not always reflect their true market value.
Ethical Issues of Financial Reports•
Ethical principles relating to financial reports arise when- Current assets not being valued correctly creating a higher value for working capital.
- High levels of debt create unnecessary risk for the business.
- Unrealistic values are sued for non-current assets.
- Short term cost cutting strategies put at risk long term stability and growth.
• Another ethical issue involves deliberately manipulating the financial reports to reduce the
amount of tax a business has to pay as low as possible.
è Profits may be shifted to international tax havens such as the Caribbean, Ireland or Cyprus to
reduce tax liability in Australia.
v All public companies in Australia are audited by an independent accounting firm, ensuring
they’re an accurate, true and fair view of the company.
Financial Management Strategies
Cash Flow ManagementCash Flow Statements•
•
Cash flow is the movement of cash in and out of a business over a period of time.
If more money goes out than in there is a cash flow. Matching cash flow in and cash flow out is
essential.
Receipt of
accounts
recievable
Payment of
inventories
Credit sales (accounts
recievable)
Cash sales
•
Cash flow statements indicates the movement of cash receipts and cash payments resulting
from transactions over a period of time. It can also identify trends and can be a useful predictor
of change.
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Business Studies- Finance Study Notes:
Financial Management Strategies
Management Strategies•
•
Management must implement strategies to ensure that cash is available to make payments
when they are due.
Management strategies for cash flow include:
- Identifying when the distribution of payments can be and are made.
- Using discounts for early payments.
- Factoring.
Distribution of Payments•
This involves distributing 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
shortfall and surpluses.
Discounts for Early Payment•
•
•
This involves offering creditors a discount for early payments.
This is most effective when targeted at creditors who owe the largest amounts of money over
the financial year period.
This is not only beneficial for the creditors who are able to save money and improve their cash
flow but also positively affects the business’s cash flow status.
Factoring•
Selling of accounts receivable for a discounted price to a finance or specialist factoring company.
The business saves on costs involved in following up on unpaid accounts and debts.
Working Capital Management•
•
•
Working capital is the funds available for the short term financial commitments of a business.
Working capital management involves determining the best balance of current assets and
current liabilities needed to achieve the objectives of the business.
Management must achieve a balance between using funds to create profits and holding
sufficient funds to cover payments the more efficient a business is in organising and using its
working capital, the more effective and profitable it will be.
Control of Current Assets•
•
•
•
Management of current assets is important for monitoring working capital.
Excess inventories and lack of control over accounts receivable lead to an increased level of
unused assets, leading to increased costs and liquidity problems. Insufficient inventories and
tight credit control policies may lead to problems.
Control of current assets requires management to select the optimal amount of each current
asset held and raising finance required to fund these assets.
The cost and benefits of holding too much or too little of each asset needs to be assessed.
Working capital must be sufficient to maintain liquidity and access to credit (overdraft) to meet
unforeseen circumstances.
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Business Studies- Finance Study Notes:
Financial Management Strategies
Control of Current Assets- Cash•
•
•
•
Cash is critical for business success and the levels of cash receivables and inventories must be
considered carefully.
Supplies of cash also enable the business 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. Cash shortages can occur due to unforeseen expenses and are
a cost to the business.
Businesses try to keep their cash balances to a minimum and hold marketable securities as
reserves of liquidity. Reserves of cash and marketable securities guard against sudden shortages
or disruptions to cash flow.
Control of Current Assets- Receivables•
•
•
•
•
The collection of accounts receivables in important in managing working capital.
A business must monitor its accounts receivable and ensuring that their timing allows the
business to maintain adequate cash resources.
The quicker debtors pay, the better the firm’s cash position.
Procedures for managing accounts receivable include- Checking the credit rating of prospective customers
- Invoicing customers monthly and at the same time each month so debtors know when to
expect accounts
- Following up on accounts that are not paid by the due date
- Stipulating a period (usually 30 days) for the payment of accounts
- Putting policies in place for collecting bad debts such as factoring.
The disadvantage of operating a tight credit control policy is that customers might choose to buy
from other firms. The cots and benefits need to be weighed up carefully by management.
Control of Current Assets- Inventories•
•
•
•
Inventories make up a significant amount of current assets and their levels need to be carefully
monitored so that excess or insufficient levels of stock do not occur.
Too much inventory or slow-moving inventory will lead to cash shortages. Insufficient inventory
of quick selling items may also lead to loss of customers and lost sales.
Inventory is a cost of the business if it remains unsold- holding of too much stock means
unnecessary expenses (e.g. - storage and insurance). The rate of inventory or stock turnover
differs depending on the type of business. E.g. - a fruit and vegetable merchant has a high
turnover.
Businesses must ensure that inventory turnover is sufficient to generate cash to pay for
purchases and suppliers on time so they will be willing to give credit in the future.
Control of Current Liabilities•
•
•
Current liabilities are financial commitments that must be paid by a business in the short term.
Minimising the costs related to a firms current liabilities is an important part of the management
of working capital.
This involves in being able to convert current assets into cash to ensure that the business’s
creditors (accounts payable, bank loans or overdrafts) are paid.
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Business Studies- Finance Study Notes:
Financial Management Strategies
Control of Current Liabilities- Payables•
•
•
•
A business must monitor its accounts payables and ensure their timing allows the business to
maintain adequate cash resources.
Holding back accounts payable until their final due date can improve a firm’s liquidity position as
some suppliers allow a period of interest free trade credit before requiring payment for goods
purchased. Businesses should also take advantage of discounts offered by some creditors,
reducing costs and improving cash flows.
Accounts must be paid by their due dates to avoid extra charges imposed for late payment and
ensure that trade credit will be extended to the business in the future.
Control of accounts payable involves reviewing suppliers and the credit facilities they provide,
for example:
- Discounts
- Interest-free credit periods
- Extended terms for payment
Control of Current Liabilities- Loans•
•
•
•
Short-term loans and bridging finance are important sources of short-term funding for
businesses.
Management of loans is important as costs for establishment, interest rates and ongoing
charges must be investigated and monitored to minimise costs.
Short term loans are a more expensive form of borrowing for a business and their use should be
minimised.
Control of loans involves investigating alternative sources of funds from different banks and
financial institutions. Positive, ongoing relationships with financial institutions ensure that the
most appropriate short-term loan is sued to meet the short-term financial commitments of the
business.
Control of Current Liabilities-Overdrafts•
•
•
Bank overdrafts are a convenient and cheap form of short-term borrowing for a business.
Banks require that regular payments be made on overdrafts and may charge account-keeping
fees, establishment fees and interest. Interest payable for a bank overdraft is usually less than a
loan.
Bank charges need to be carefully monitored as charges vary depending on the type of overdraft
established. Businesses should have a policy for using and managing bank overdrafts and
monitor budgets on a daily or weekly basis so that cash suppliers can be controlled.
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Business Studies- Finance Study Notes:
Financial Management Strategies
Strategies for Managing Working Capital•
Businesses use a number of strategies to manage working capital which is required to fund the
day-to-day operations of a business. These include strategies include- 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 its ownership.
Leasing frees up cash that can be used elsewhere in a business so the level of working capital. It
is an attractive strategy for some businesses as it is an expense and is tax deductible. Firms can
increase their number of assets through leasing and this means that revenue and profit can be
increased.
Sales 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.
Sale and lease back increases a business’s liquidity because the cash that is obtained from the
sale is used as working capital.
Financial management needs to be dynamic and relevant to both internal and external factors
that will affect the overall success of a business. External factors (e.g. GFC) impact a business
profitability in all economies. The ability of a business to effectively implement appropriate
financial strategies will determine long-term success and growth.
Profitability Management•
Profitability management involves the control of both the business’s costs and its revenue.
Accurate and up-to-date financial data and reports are essential tools for effective profitability
management.
Profitability Management- Cost Controls•
Business decisions are influenced by costs. The costs associated with a decision need to be
examined carefully before implemented.
•
Qantas- recent strategies employed by Qantas to control costs include-
Cutting flying capacity by halting growth and cutting back services
Replacing Qantas with Jetstar on some international routes
Cancelling orders for new planes
Restructuring management/redundancies (5000 job losses planned over the next 3 years,
2200 actioned in 2014)
- Freezing executive pay
- Fuel conservation
v Qantas has cut costs by over $5 billion in the last 10 years, reducing its overall cost base by
between 20-25%. They have targeted a further $2 billion in costs savings by 2017.
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Business Studies- Finance Study Notes:
Financial Management Strategies
Profitability Management- Cost ControlsFixed and Variable Costs•
•
•
•
Businesses management need to have an understanding of what their costs
are.
Fixed costs are not dependent on the level of operating activity in a business
and are paid regardless of what happens in the business (e.g. - salaries,
insurance and rent).
Variable costs change proportionately with the level of operating activity in a
business.
Monitoring levels of both fixed and variable costs is important in a business.
Comparisons of costs with budgets, standards and previous periods ensure that costs are
minimised and profits maximised.
Cost Centres•
•
•
•
A business’s costs and expenses must be accounted for, and management needs to be able to
identify their source and amounts.
Cost centres are particular areas, departments or sections of a business to which costs can be
directly attributed.
A cost centre in retail store or service business would be called a service cost centre. A cost
centre in manufacturing would be called a production cost centre.
Cost centres have direct and indirect costs. Direct costs can be allocated to a particular product,
activity, department or region. Indirect costs are shared by more than one product, activity,
department or region.
Expense Minimisation•
Profits can be weakened if the expenses of a business are high as they consume valuable
resources within a business. Guidelines and policies should be established to minimise expenses
where possible. Saving can be substantial if wastage and unnecessary spending is eliminating.
Profitability Management- Revenue Controls•
Revenue is the income earned from the main activity of a business. In determining an acceptable
level of revenue business must have clear ideas and policies, particularly about its marketing
objectives including the sales objectives, sales mix or pricing policy.
•
Qantas-Total revenues in 2013 fell by 3.5% from falling domestic and international sales.
Recent strategies employed by Qantas to control revenue include- Setting clear sales objectives and setting up a sales reporting system that reports sales
figures regularly and breaks them down into business segments.
- Discounting of airfares to maintain loads in a shrinking market.
- Fuel surcharges in response to the rapid increase of the price of fuel.
- Increasing revenue from other services such as travel, catering and freight to protect it from
peaks and troughs of Qantas’ core airline business.
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Business Studies- Finance Study Notes:
Financial Management Strategies
Profitability Management- Revenue ControlsMarketing Objectives•
•
Sales objectives must be pitched at a level of sales that will cover costs (fixed and variable)
resulting in a 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.
Marketing Objectives•
•
•
Changes to the sales mix can affect revenue. Businesses should control this by maintaining a
clear focus on the important customer base which revenue depends on BEFORE diversifying or
extending product ranges or ceasing production on particular lines. Research should be
undertaken to identify the potential effects of sales-mix changes before decisions are made.
Pricing policy affects revenue and working capital. Pricing decisions should be closely monitored
and controlled. Overpricing may fail to attract buyers while under-pricing may bring higher sales
but may result in cash short falls and low profits.
Factors that influence pricing include- Costs associated with producing the goods or services
- Prices charged by competitors
- Short and long term goals
- Image or level of quality that people associate with the goods or services
- Government policies
Global Financial ManagementExchange Rates•
•
•
•
•
•
An exchange rate is the price of one currency in terms of another currency.
When transactions are conducted globally, this means that a business has to buy or sell foreign
currencies. The value of foreign currencies can change, introducing additional risk for a business.
If the value of the Australian dollar rises relative to a foreign currency, this is described as an
appreciation, if it falls this is depreciations.
An appreciating dollar means that is cheaper in AUD to purchase from overseas, but foreign
purchases find it expensive to buy from Australia.
A depreciating dollar means it is more expensive in AUD to purchase from overseas, but foreign
purchases find it cheaper to buy from Australia.
Qantas- Qantas generates about 38% of its revenue in other countriesàfinancially exposed
to changes in exchange rates (also purchases aircraft in foreign currency). Appreciationincrease in the value of $AUD reduces the price Qantas pays for fuel, lease and loan payments
and overseas capital expenditure. Australians are more likely to travel overseas but overseas
tourists are less likely to travel to Australia. Depreciation- decrease in the value of $AUD
increases the price Qantas pays for fuel, lease and loan payments and overseas capital
expenditure. Australians are less likely to travel overseas but overseas tourists are more likely to
travel to Australia.
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Business Studies- Finance Study Notes:
Financial Management
Global Financial ManagementInterest Rates•
•
•
•
Expanding overseas involves raising finance in global
markets.
Global interest rates can be lower than Australia’s
borrowing in a foreign currency can introduce exchange
rate risk into the business.
An appreciating exchange rate reduces the AUD cost of
financing a foreign currency. A depreciating rate will
increase the AUD cost of financing in a foreign currency.
Qantas-Qantas is exposed to movements in interest rates both in Australia and overseas. An
increase interest rates increase the interest payments Qantas pays.
Methods of International Payment•
•
•
An issue in global business is ensuring that payments and goods are received, it becomes more
difficult and expensive to initiate legal action between different authorities.
A way to address this problem is to get a third party (e.g. - a bank) to guarantee payment of a
transaction.
Methods of international payment include- payment in advance, letter of credit, clean payment,
bill of exchange.
Payment in Advance•
•
Payment in advance involves an exporter receiving payment before the goods are shipped.
This method has no risk for exporters, risk lies with the importers.
Letter of Credit•
A letter of credit is a commitment by the importers bank to pay the exporter when the
documents proving shipment of goods are presented.
Bills of Exchange•
•
A bill of exchange is similar to a cheque that is a written order to pay the exporter a specific
amount of money on demand or at a later date.
There are two main types- Document against payment- the exporter sends a bill of exchange and sends it to the
importers bank along with documents that will allow the importer to collect the goods. The
importers bank only hands over the documents once the payment is made.
- Documents against acceptance- the exporter sends a bill of exchange and sends it the
importers bank with documents that will allow the importer to collect the goods. The
importers bank hands over the documents once the importer accepts that it will pay.
Clean Payment•
Clean payment mean the importer is trusted to pay for the goods once they receive them.
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Business Studies- Finance Study Notes:
Financial Management
Global Financial ManagementBills of Exchange•
A bill of exchange is a document drawn up by the exporter demanding payment from the
importer at a specified time.
Hedging•
There are two types of hedging- Natural hedging which doesn’t involve using financial instruments. Natural hedges involve
using one part of the business to hedge the risk of another part of a business.
- Financial instrument hedging which involves the use of derivatives to reduce the risk of
changes in asset prices.
•
Qantas- Qantas has a successful hedging program outperforming many of its competitors.
Qantas has hedged about 94% of its fuel needs for 2015. Most of these hedges are in the form of
options à they aren’t totally locked in and can take advantage of falls in fuel prices. Qantas also
denominates some borrowings in net surplus currencies to provide a natural hedge.
Derivatives•
•
•
Derivatives are financial contracts whose value depends on an underlying asset (their value is
‘derived’ from this asset).
The main types of derivatives that are used by businesses include- Forwards which are an agreement to buy or sell an asset at some future date a specific price.
- Options- agreements that give the purchaser the right, but not the obligation to buy or sell
an asset at some time in the future at a specific price.
- Swaps which are agreements to swap the rights of specific financial assets with an
agreement to swap them back in the future.
Qantas- Qantas uses derivatives like forward cover and options to hedge future fuel
purchase, interest and capital expenditure payments. Qantas earns revenue in many currencies
and incurs costs especially fuel, maintenance and leasing in other currencies.
27