Year 12 Business Studies: Financial Management

• Year 12 Business Studies notes cover the topic of finance in preparation for the half-yearly paper.

Strategic Role of Financial Management

• Involves planning, organizing, and controlling monetary resources.
• Ensures business operation, growth, and substantial profits for owners.
• Requires strong accounting skills to analyze data.

Objectives of Financial Management

• Profitability: Ability to make a financial return, ensuring maximized profit through careful monitoring of revenue, pricing policies, costs, expenses, inventory, and assets.
• Growth: Increase in size and value over time via increased assets, market share, or expansion. Monitor cash flow to ensure sustainability.
• Efficiency: Generating maximum returns for minimum costs by increasing output with the same inputs or achieving the same profit with fewer assets
• Liquidity: The ease with which an asset can be converted into cash, meeting short-term debt (current liabilities) by maintaining current assets greater than current liabilities.
• Solvency: Ability to pay both short-term and long-term liabilities, indicating long-term financial stability. Gearing shows the comparison of debt finance to equity finance, achieved through a mixture of the two.

Short-Term and Long-Term Objectives

• Long-term (strategic, 5+ years) goals are achieved through reviewed short-term (tactical, 1-2 years) objectives.
• The overall long-term aim is to increase owner wealth, dependent on short-term profitability from increased operating efficiency.

Interdependence with Other Key Business Functions

• Operations: Finance provides resources for value creation, while operations manages stock and outsourcing, with finance monitoring costs.
• Marketing: Generates sales for short-term cash flow goals; finance sets budgets and forecasts.
• Human Resources: Finance provides funds for wages, salaries, and HR strategies.

Internal Sources of Finance

• Owner's equity: Funds from owners/partners, or raised by taking on partners, issuing private shares, or selling unproductive assets.
• Retained profits: Earnings kept within the business instead of distributed as dividends; about 50% are retained and reinvested in Australia.

External Sources of Finance

• Short-term borrowing: Debt repayable within 12 months O, C, F
• Bank overdraft: Allows account overdraft up to an agreed limit for short-term cash shortfall, with variable interest on the daily outstanding balance.
• Commercial bills: Written instruction to repay a set amount on a future date. The bank guarantees repayment although funds are borrowed from non-bank institutions. Used for amounts exceeding $100,000 for 3-6 months
• Factoring: Selling accounts receivable at a discount to improve liquidity, where the factoring company manages collection, up to 90% of receivables are provided within 48 hours.

Long-Term Borrowing

• Loans are repaid over more than 12 months, secured or unsecured, for real estate, plant and equipment M, D, U, L, T.
• Mortgage: Funds property purchases, using the property as security, repaid with regular payments plus interest.
• Debentures: Secured loans from a fixed rate of interest and time period, where the lender has security over the business’s assets. Used to buy buildings and equipment.
• Unsecured notes (bonds): Issued by finance companies, unsecured, with higher interest due to higher risk.
• Leasing: Allows businesses to rent non-current assets, at the cost of paying rent but decreasing any acquisition fees.
• Term Loan: Loan that has a term of repayment longer than 12 months.

Equity

• Equity is finance raised by issuing shares: private and ordinary, through new issues, rights issues, placements, and share purchase plans.
• It is advantageous as there is no need to pay dividends but it is slower than debt finance.
• Ordinary Shares: Represents part ownership of a publicly listed company and entitles voting rights and dividends.

Aspects of Ordinary Shares:

• New issues are primary shares sold for the first time via a prospectus through a stockbroker.
• Rights issues allow shareholders to buy new shares.
• Placements arrange the sale of large blocks of shares to institutions.
• Share purchase plans allow companies to issue up to $5000 in new shares to shareholders without a disclosure document, that must be registered with ASIC.

Private Equity

• Money invested in a private company not on the ASX.
• The cost of finance can be postponed. Original owners have less control.

Financial Institutions

• Banks: The main providers of finance to businesses & consumers through savings, deposits, and investments in the form of loans. such as Commonwealth, Westpac, NAB
• Investment Banks: Specializing in services to corporations via international finance, mergers/takeovers advice, and portfolio management, such as Macquarie Bank.
• Finance and Insurance Companies: Finance and insurance companies offer both secured and unsecured loans to businesses. Insurance companies gain funds from policy & premium payments. Finance companies raise capital through debenture issue.
• Superannuation: Institutions provide long-term funds to the corporate sector by investing in shares, government securities, and property.
• Unit Trusts: Units offered to the public for investment, controlled by a trustee in the financial asset market, which comprises of property, equity, mortgage, & fixed-interest trusts.
• Australian Securities Exchange (ASX): Primary market for raising capital through new shares and secondary market for trading pre-owned securities.

Influence of Government

• Australian Securities and Investments Commission (ASIC): Enforces the Corporations Act, protecting consumers, investors, and creditors, assisting in reducing fraud and unfair practices.
• Company Taxation: Australian businesses pay 30% of net profit to the government before distribution to shareholders, with plans to reduce the rate to invite foreign investment.

Global Market Influences

• Economic Outlook: Expected economic growth affects product demand and international interest rates. A positive outlook increases production and decreases the risk for investment.
• Availability of Funds: The ease of accessing international funds. Australia may find it difficult to borrow, due to a global financial crisis.
• Interest Rates: The higher the level of risk, the higher the interest rate.
• Borrowing from overseas will be cheaper but there is risk of currency fluctuation.

Processes of Financial Management

• Financial Needs: Management understanding its future direction.
• Developing Budgets: Creating financial budgets and forecasts to manage resources, production, employment, and funding.
• Record Systems: Accurate accounting systems to reliably record expenses and revenues.
• Financial Risks: The possibility of not covering obligations due to theft, non-payment, and interest risks.
• Financial Controls: Tools providing feedback on performance, including budgets and financial statements.

Debt and Equity Financing

Debt Finance Advantages

• Easy to access funds
• Tax deduction for interest payments
• Increased funds increase earnings
• Profits not shared with lender

Debt Finance Disadvantages

• Regular repayments are necessary
• Interest may be charged or increase
• Higher financial risk
• There will be loss of an asset

Equity Finance Advantages

• No risk of interest
• No gearing, financial risk
• Flexible dividend payments
• Greater potential for growth and investment

Equity Finance Disadvantages

• The dividends are not tax deductible
• Expensive as shareholders require an income
• Diluted ownership, loss of control

Matching the Terms and Source of Finance to Business Purpose

• Matching Principle: The loan term should match the asset's economic lifetime, current assets with short-term finance while non-current assets with long-term finance.
• Business Structure: Smaller businesses have restricted equity capital options, thus they access private equity.

Monitoring and Controlling

• Cash Flow Statement: Documents cash transactions over time, indicating cash inflows and outflows.
• Indicates if a business can generate cash flow and pay financial requirements.
• Highlights trends, helps planning.
• Income Statement: Outlines income and expenses over time, indicating efficiency and profitability.
  • Outlines sales, cost and profits
• Gross Profit = sales – cost of goods sold
• Net Profit = gross profit - expenses

Balance Sheet

• It represents a business’s assets and liabilities at a particular point, and includes the worth, liquidity and solvency of the business.
• The balance sheets comprises of assets(current or non-current), liabilities(current or non-current) and the owner's equity.
• ASSETS - LIABILITIES + OWNERS EQUITY = ALOE

Financial Ratios

• Liquidity measures the financial commitments of the business over a period of time, with the ratio being 2:1
• Gearing ratios determine firm solvency using; total liabilities / owner’s equity, with an acceptable ratio of 0.5:1 or less
• Profitability uses three ratios; Gross profit ratio, return on equity and net profit ratio

Profitability Ratios

• Gross profit ratio: gross profit / sales x 100 measures the percentage of sales that is gross profit; the acceptable level is 50%.

• Return on equity ratio: net profit / total equity measures how effective the fund is generating profit.

• Net profit ratio: net profit / sales is a profit measure for every dollar of sales; acceptable value is 18%.

• Efficiency is shown by its expense ratio; total expenses / sales. The lower this value is, the better.

Comparative Ratio Analysis

• Determines a business's financial position in relation to its previous years.
• Time comparison involves comparing ratio data over the current period
• Australian Tax Office has created an industry avergae
• Benchmark against similar businesses

Limitations of Financial Reports

Normalized Earnings: Involves removing one-time influences from the balance sheets such as removing land sale, which is to provide a more realistic earning.

• Capitalizing Expenses: It turns expenses into assets which misleads shareholders and potential buyers.
• Valuing Assets: Its about recorded purchased prices that are recorded in the balance sheet, even with price changed. This can ditort the value of the busines Timing Issues
• Relates to Manipulating transactions to mislead about businesses financial position

Financial Repayments

• It discloses specific info about financial nature debt or statements
• Debt in a Historic cost and debt is not the same as revenue

Ethical Issues Related to Financial Reports

• Audits require business's accounting process depends on acurate and reliable data for records.
• Source documents must be created for every transaction for any business.
• Businesses must uphold ethical standards for taxation.

Financial Management Strategies

• Must ensure payments are made and received that don't create cash flow problems.
• It requires monthly inflows and outflows linked to liquidity.

Influx of Management Strategies

• It includes Bills paid in largest amounts and can range from being discounted
• Management refers to $80 commission to $100

Working Capital is CA - CL

• Management is determining assets and liabilities needed to paid
• It Requires cash (predictable)

Control of Liabilities will allow loans and interest to be paid on time

Management strategies:

• The lease is where the owner agrees to another party using the payments
• It increases the cash from the side of capital

Profitability management

• Allows more revenue and helps the pricing policy -Fixed Costs don't change such as salaries, but can be controlled by;
• Switching to a cheaper supplier
• Reduction in expenses can affect profit

Sales Revenue is the link between the marketing plan and financial plan

• Sales objectives is designed to ensure income flowing with better understanding of customer preferance.
• Allows increase of goods with maximum prices and discounts

Financial Management is global economy is at greater risks due to financial performence

• Exchange rates are dependant on good and the profits Australian depreciation increase the competitiveness with in the market.

Changes in interest rates

• Can cause business issue
• Australia likes to borrow from overseas when interest rates are low and fluctuate with other interest rates.

International payments

• payment can be received electronically as an advance or with letter of credit and contract.

Exchange for letters contracts.

• The bank guarantees the importers bank account.
• Export can make exports

Least risk for exporters

• Clean payments

Hedging- is how businesses overcome exchange rate variations

Deritivates help for hedging by the means of :

1. Foreword contracts- Locks bank accounts.
2. Option Contracts
3. Swap Contracts