HSC Topic: Finance PDF

HSC TOPIC: FINANCE +-----------------------------------------------------------------------+ | **Role of finance** | +=======================================================================+ | - Strategic role of financial management...

HSC TOPIC: FINANCE +-----------------------------------------------------------------------+ | **Role of finance** | +=======================================================================+ | - Strategic role of financial management | | | | - Objectives of financial management | | | | | | | | - Profitability, growth, efficiency, liquidity, solvency | | | | - Short term and long term | | | | | | | | - Interdependence with other key business functions | +-----------------------------------------------------------------------+ strategic role of financial management ====================================== **Role of financial management**: ensure the efficient (↓ cost) and effective (achieving goals) management of funds to achieve the goals + objectives of the business. **Three elements:** 1. Financial planning (ST + LT strategic + tactical) 2. Financial control (planned vs actual performance- make assessment) 3. Financial decision making (co-ordination of strategies) #### Role of strategic financial management The strategic role of financial management involves the planning, monitoring and controlling of financial resources within the business to effectively achieve financial objectives of liquidity, solvency, profitability, efficiency and growth. Its function is to source (debt + equity) and allocate finance to support key business functions of operations, marketing + HR, in the overarching achievement of profit maximisation, wealth creation and financial stability. objectives of financial management ================================== #### why are objectives important? - serve as a target- management - serve as a benchmark to assess performance- planned vs actual - Provide direction to a business + facilitate business planning - Motivate employees to perform + Limit stress + maintain focus - Less wasted time objectives ---------- +-----------------------------------+-----------------------------------+ | **Objective** | **Info** | +===================================+===================================+ | *Profitability* | **Profitability**: the ability of | | | a business to use its resources | | - *SHORT TERM* | to generate revenues in excess of | | | its expenses. | | | | | | - Calculate profitability from | | | profit + loss statements | | | | | | Gross Profit= sales - COGS | | | | | | Net Profit= gross profit -- | | | expenses | | | | | | **COGS**: expenses directly | | | incurred because a production | | | process has taken place e.g. cup, | | | water, coffee beans | | | | | | **Expenses**: costs incurred | | | independent of the level of sales | | | they produce e.g. rent, utilities | | | | | | ***importance*** to a | | | business because impacts whether | | | the business can: | | | | | | - finance its activities, | | | | | | - secure financing from a bank, | | | | | | - attract investors to fund its | | | operations and grow | | | its business, | | | | | | - provide a return for its | | | owners.  | +-----------------------------------+-----------------------------------+ | *Growth* | **Growth** is the ability of the | | | business to increase its size | | - *LONG TERM* | physically and/or financially in | | | the longer term. | | | | | | 1. increase production capacity | | | | | | 2. geographical expansion | | | | | | - Growth depends on businesses | | | ability to develop/use asset | | | structure to ↑ sales, | | | profits + market share. | | | | | | - Growth ensures that the | | | business is sustainable into | | | the future. | +-----------------------------------+-----------------------------------+ | *Efficiency* | **Efficiency** is the ability of | | | a business to minimise its | | - *SHORT TERM* | expenses/costs and manage its | | | assets to achieve profit | | | maximisation. | | | | | | - Efficiency measures the level | | | of performance against a | | | standard | | | | | | - Assessing the contribution a | | | business's assets make to the | | | businesses profitability | | | | | | - High level of efficiency = | | | highest output with smallest | | | amount of inputs | | | | | | - Minimise wasted labour, | | | materials, energy + | | | processing time | | | | | | **Importance:** | | | | | | - indicates how efficiently the | | | business is able to generate | | | sales revenue from its | | | expenses. | | | | | | - Increases profit if | | | efficiency is maximized | +-----------------------------------+-----------------------------------+ | *Liquidity* | **Liquidity** is the ability to | | | pay short-term obligations. | | - *SHORT TERM* | | | | - Being able to keep enough | | | cash/cash equivalents on hand | | | to pay ST debts when they | | | fall due | | | | | | | | | | | | - Controls over the flow of | | | cash into and out of the | | | business ensure that it has | | | supplies of cash when needed. | | | Cash shortfalls and excess or | | | idle cash must be avoided as | | | both involve loss of | | | profitability for a business. | | | | | | ***IMPORTANCE:*** | | | | | | - Maintain positive | | | relationships with suppliers, | | | ensuring that they are paid | | | on time. | | | | | | - Meet loan repayment | | | obligations to banks and | | | avoid additional interest | | | charges or late fees. | +-----------------------------------+-----------------------------------+ | *Solvency* | **Solvency** is the ability of a | | | business to sustain its | | - *LONG TERM* | activities by being able to pay | | | long term total debts as they | | | fall due. | | | | | | - measure of businesses funding | | | structure + longer term | | | financial stability of a | | | business | | | | | | | | | | | | - INSOLVENT unable to meet debt | | | commitments | +-----------------------------------+-----------------------------------+ short and long term objectives ------------------------------ - ***Short-term financial objectives*** are the tactical (one to two years) and operational (day-to-day) plans of a business.\   - reviewed regularly to see if targets are being met + if resources are being used to the best advantage - E.G., if management has a goal to achieve a 15 per cent increase in profit for the next 10 years, the tactical plans might involve purchasing additional machinery, updating old equipment with new technologies, expanding into new markets and providing new services.\   - ***Long-term financial objectives*** are the strategic plans of a business.\   - They are determined for a set period of time, generally more than five years. - tend to be broad goals e.g. increasing profit or market share (each will require a series of short-term goals to assist in its achievement) - Typically linked to strategic plans + business will review progress annually to determine is changes are needed #### financial vs strategic objectives - Maximise short term financial objectives harms long term strategic objectives - Purse increased market share at expense of short term profitability - Trade-offs related to risk of actions concern for business ethics need to preserve natural environment social responsibility issues interdependence =============== \*\*\* NOT DONE +-----------------------------------------------------------------------+ | **Influences on financial management** | +=======================================================================+ | - Internal sources of finance- retained profits | | | | - External sources of finance | | | | | | | | - Debt- short term borrowing (overdraft, commercial bills, | | factoring), long term borrowing (mortgage, debentures, unsecured | | notes, leasing) | | | | - Equity- ordinary shares (new issues, rights issues, placements, | | share purchase plans), private equity | | | | | | | | - Financial institutions- banks, investment banks, finance | | companies, superannuation funds, life insurance companies, unit | | trusts and the Australian Securities exchange | | | | - Influence of government- Australian Securities and Investments | | Commission, company taxation | | | | - Global market influences- economic outlook, availability of | | funds, interest rates | +-----------------------------------------------------------------------+ internal sources of finance =========================== **Internal finance** refers to funds generated from inside the business. For example, profits can be retained to finance expansion. #### internal equity finance *[USED FOR: SOLE TRADER'S + PARTNERSHIPS]* **Retained earnings**- source of internal funds where owners of the business use their savings as a means of funding the business - Business retains some of the profits instead of spending/distributing them to owners/partners as a form of dividends to share holders **Past savings** **Superannuation-** form of savings where the employers have contributed to employees in the form of superannuation payments. Every employer has to contribute to an employee's superannuation fund e.g. 12.5% of salary - Business owners can liquidate their super fund **Profits from the sale of the owners/partners/business assets**- sole traders + partners sell off their private assets e.g. car/house and use that money to fund their business external sources of finance =========================== **External finance** refers to the funds provided by sources outside the business, including banks, other financial institutions, government, suppliers or financial intermediaries. debt ---- #### SHORT TERM borrowing +-----------+-----------+-----------+-----------+-----------+-----------+ | | **Make an | | | | | | | assessmen | | | | | | | t | | | | | | | on | | | | | | | financial | | | | | | | :** | | | | | +===========+===========+===========+===========+===========+===========+ | **Definit | **Source* | **Cost- | **Use** | **Stateme | **Objecti | | ion** | * | IR** | | nts** | ves** | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Bank | Banks + | Interest | Current | CFS ↑ | - 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*Grea | | | | | | | ter | | | | | | | risk* | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ #### long term borrowing +-----------+-----------+-----------+-----------+-----------+-----------+ | | **Make an | | | | | | | assessmen | | | | | | | t | | | | | | | on | | | | | | | financial | | | | | | | :** | | | | | +===========+===========+===========+===========+===========+===========+ | **Definit | **Source* | **Cost- | **use** | **Stateme | **Objecti | | ion** | * | IR** | | nts** | ves** | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Mortga | Banks + | IR- less | NCA | CFS ↑ | - Solve | | ge | NBFS's | than | | | ncy | | (NCL)-*** | | overdraft | Property | PLS ↑ | | | | | | purchases | expenses | - Profi | | A long | | | e.g. new | | tability | | term loan | | | premises/ | BS ↑ | | | secured | | | factory/o | liabiliti | - Growt | | against | | | ffice | es | h | | the | | | | | | | assets of | | | | | - Effic | | the | | | | | iency | | business | | | | | | | | | | | | | | - Loan | | | | | | | secur | | | | | | | ed | | | | | | | by | | | | | | | the | | | | | | | prope | | | | | | | rty | | | | | | | of | | | | | | | the | | | | | | | busin | | | | | | | ess | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Debent | Investors | Fixed IR | NCA | | | | ures | | | | | | | (NCL)-*** | Businesse | | Growth | | | | | s | | | | | | A long | | | Machinery | | | | term | Banks | | | | | | financial | | | Mergers + | | | | product | | | acquisiti | | | | aimed at | | | ons | | | | raising | | | | | | | finance | | | | | | | for | | | | | | | non-curre | | | | | | | nt | | | | | | | assets | | | | | | | | | | | | | | - Secur | | | | | | | ed | | | | | | | again | | | | | | | st | | | | | | | asset | | | | | | | s | | | | | | | of | | | | | | | the | | | | | | | busin | | | | | | | ess | | | | | | | | | | | | | | - Fixed | | | | | | | IR + | | | | | | | fixed | | | | | | | perio | | | | | | | d | | | | | | | of | | | | | | | time | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Unsecu | Investors | IR -- | Share | | | | red | | higher | repurchas | | | | notes | Businesse | than any | es | | | | (NCL)-*** | s | other | | | | | | | source | Acquisiti | | | | A loan | Banks | | ons | | | | from | | | + mergers | | | | investors | | | | | | | for a set | | | NCA | | | | period of | | | | | | | time. | | | | | | | | | | | | | | - High | | | | | | | risk | | | | | | | becau | | | | | | | se | | | | | | | it is | | | | | | | not | | | | | | | secur | | | | | | | ed | | | | | | | again | | | | | | | st | | | | | | | asset | | | | | | | s | | | | | | | of | | | | | | | the | | | | | | | busin | | | | | | | ess | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Leasin | | Lease | Financial | | | | g | | payment | /operatio | | | | (NCL)-*** | | | nal | | | | | | | use e.g. | | | | Involves | | | business | | | | a payment | | | cars, | | | | of funds | | | machinery | | | | for the | | | , | | | | use of | | | computers | | | | equipment | | | , | | | | that is | | | software | | | | owned by | | | | | | | another | | | | | | | party. | | | | | | | | | | | | | | - Risks | | | | | | | + | | | | | | | rewar | | | | | | | ds | | | | | | | incid | | | | | | | ental | | | | | | | to | | | | | | | the | | | | | | | owner | | | | | | | ship | | | | | | | of | | | | | | | the | | | | | | | lease | | | | | | | d | | | | | | | asset | | | | | | | are | | | | | | | trans | | | | | | | ferred | | | | | | | to | | | | | | | the | | | | | | | lesse | | | | | | | e | | | | | | | but | | | | | | | not | | | | | | | the | | | | | | | actua | | | | | | | l | | | | | | | owner | | | | | | | | | | | | | | - Opera | | | | | | | ting | | | | | | | lease | | | | | | | s | | | | | | | are | | | | | | | asset | | | | | | | s | | | | | | | lease | | | | | | | d | | | | | | | for | | | | | | | ST | | | | | | | | | | | | | | - Under | | | | | | | the | | | | | | | condi | | | | | | | tions | | | | | | | of a | | | | | | | finan | | | | | | | cial | | | | | | | lease | | | | | | | -- | | | | | | | lesso | | | | | | | r | | | | | | | purch | | | | | | | ases | | | | | | | asset | | | | | | | on | | | | | | | behal | | | | | | | f | | | | | | | of | | | | | | | lesse | | | | | | | e + | | | | | | | repay | | | | | | | ments | | | | | | | are | | | | | | | fixed | | | | | | | + | | | | | | | penal | | | | | | | ties | | | | | | | for | | | | | | | cance | | | | | | | llation | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ external equity --------------- **Equity finance** represents contributions made to the business by the owners. In the case of a public or private company, businesses offer shares in the company. This is known as share capital/owners equity. It is external finance. **Ordinary shares**- issued by the business that entitles the owner to a dividend which is a % of the profits earned by the company. +-----------+-----------+-----------+-----------+-----------+-----------+ | | **Make an | | | | | | | assessmen | | | | | | | t | | | | | | | on | | | | | | | financial | | | | | | | :** | | | | | +===========+===========+===========+===========+===========+===========+ | **Definit | **Source* | **DIVIDEN | **use** | **Stateme | **Objecti | | ion** | * | D** | | nts** | ves** | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***New | Investing | Dividend | LT | CFS ↑ | - Solve | | issues-** | public | | investmen | | ncy | | * | | | ts | PFS ↑ | | | | | | | expenses | - Profi | | *New | | | Mergers + | | tability | | issues of | | | acquisito | BS ↑ OE | | | shares is | | | ns | | - Growt | | more | | | | | h | | shares | | | Fund | | | | that have | | | explorati | | - effic | | been | | | on | | iency | | offered | | | | | | | to the | | | | | | | investing | | | | | | | public | | | | | | | e.g. | | | | | | | individua | | | | | | | ls/busine | | | | | | | sses* | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Rights | Investing | Dividend | | | | | Issue-*** | public | | | | | | | | | | | | | *A | | | | | | | financial | | | | | | | product | | | | | | | related | | | | | | | to buying | | | | | | | the | | | | | | | rights to | | | | | | | buy | | | | | | | ordinary | | | | | | | shares* | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Placem | Investing | Dividend | LT equity | | | | ent-*** | public | | finance | | | | | | | | | | | *This is | | | | | | | where a | | | | | | | business | | | | | | | offers | | | | | | | its | | | | | | | existing | | | | | | | sharehold | | | | | | | ers | | | | | | | additiona | | | | | | | l | | | | | | | shares at | | | | | | | a | | | | | | | discount | | | | | | | rate.* | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ | ***Share | | | | | | | purchase | | | | | | | plan-*** | | | | | | | | | | | | | | Refers to | | | | | | | existing | | | | | | | sharehold | | | | | | | ers | | | | | | | in a | | | | | | | listed | | | | | | | company | | | | | | | purchasin | | | | | | | g | | | | | | | newly | | | | | | | issued | | | | | | | shares in | | | | | | | that | | | | | | | company | | | | | | | without | | | | | | | brokerage | | | | | | | fees. | | | | | | +-----------+-----------+-----------+-----------+-----------+-----------+ #### private equity **Private equity** is the money invested in a (private) company not listed on the Australian Securities Exchange (ASX). The aim of the private company (like the publicly listed companies who sell ordinary shares) is to raise capital to finance future expansion/investment of the business. financial institutions ====================== **Financial institutions** collect funds and invest them in financial assets. They provide financial services and focus on dealing with financial transactions such as investments, loans and deposits. ***ALL FINANCIAL INSTITUTIONS:*** +-----------------------------------+-----------------------------------+ | ***[Processes + effects | ***[Effects on financial | | ]*** | objectives + goals | | | ]*** | +===================================+===================================+ | Supply EXTERNAL FINANCE (mainly | Solvency | | short-term + medium term) | | | | - ↑ in debt = ↑ risk | | C/F statement: | | | | - Can contribute to financial | | - ↑ cash | instability | | | | | - Outflow for interest payments | Efficiency | | | | | Balance sheet: | - Interest = expense affect | | | efficiency ratio = ↓ | | - ↑liabilities | efficiency | | | | | P/L statement: | Profitability: | | | | | Interest paid = expenses | Funds can be used to generate | | affecting NET PROFIT | revenue = ↑ profitability | +-----------------------------------+-----------------------------------+ ### banks Intermediary bring together lender + borrower by attracting deposits and then lending these out as funds *[Services provided:]* - consultancy services - credit cards/cheques - insurance/investment - foreign exchange - factoring - specialised lending *[Importance to business:]* provide a source of funds achieve goals/objectives. *[How:]* provide financial products e.g. bank overdrafts, commercial bills, term loans, mortgages. ### investment banks Intermediary provide services in borrowing + lending, primarily to the business sector. *[Investment banks:]* - Trade in money, securities + financial futures - Foreign exchange - Advice in mergers/takeovers - Arrange product finance + provide working capital - Underwrites share issues on behalf of public companies + government - operate unit trusts including cash management trusts, property trusts and equity trust ### finance companies Intermediary NBFI's that specialise in smaller commercial finance provide source of funds to enable achievement of goals/objectives - Charge IR comparatively higher than bank (2x) *Provide financial products:* - Consumer hire purchase loans - Personal loans - loans to businesses - Secured + unsecured loans - Factoring - Lease finance ### life insurance companies NFBI's intermediary provide cover + lump sum payments in the event of death - Provide equity + loans to corporate sector through receipts of insurance premiums ### superannuation funds Superannuation intermediary scheme set up by government requiring employers to make a financial contribution to a fund that will provide benefits to the employee when they retire (12% of pay) COST TO A BUSINESS -- EXPENSE - Superannuation funds collect deposits from workers (12% of pay) used as a form of investment to pay returns to people who deposited their funds *To generate income they invest in:* - Government bonds - Company shares - Company debt ### unit trusts Unit trusts (managed funds) manages + invests funds on behalf of small investors takes their funds + invests them in specific investments hence a source of funds for businesses ### Australian securities exchange ASX operates Australia's largest share market providing a transparent + regulated environment where companies + investors come together. - Market where shares are bought + sold - Almost 2,200 companies/issuers listed on ASX *[FUNCTIONS:]* - Acts as primary market- enabling public companies to raise new equity finance through the sale of new shares + from proceeds of selling securities - Acts as secondary market- marketplace for pre owned shares which are traded OFFERS SERVICES/FINANCIAL PRODUCTS: - Shares - Futures contracts - Exchange traded options - Interest rate securities influence of government ======================= Australian securities and investments commission ------------------------------------------------ ASIC is an independent Australian government body that acts as Australia's corporate regulator. ASIC's role is to enforce + regulate company + financial service laws to protect Australian consumers, investors and creditors. IMPORTANCE: - Maintain, facilitate, improve performance of financial system - Promote confident + informed participation by investors/consumers - Administer + enforce the law - Make information about companies available to public - Reducing fraud + unfair practices ***REGULATE + MONITOR BEHAVIOUR OF FINANCIAL INSTITUTIONS*** company taxation ---------------- All private + public companies are required to pay company tax on profits. This tax is levied at a flat rate. Tax= expense= ↓ owners equity= ↓net profit= ↓profitability - Australian government has undertaken this reform to tax system to improve Australia's international competitiveness + make Australia an even more attractive place to invest, thereby driving long-term economic growth. - This will mean more jobs and higher wages for working Australians. reserve bank Australia \*\* not in syllabus ------------------------------------------- RBA is responsible for Australia's monetary policy. They set interest rates on overnight loans in money market (cash rate). ↑Interest rates: - Businesses with existing loans which have flexible IR will now have to pay more for the use of ST + LT loans - Interest is an expense causing total expenses to ↑ in profit/loss statement - It is an outflow of cash not budgeted for by the business - Affect net profitability -- profit/loss statement - Efficiency + net profit ratios affected - ↓net profit will affect OE and be recorded in balance sheet global market influences ======================== economic outlook ---------------- **Global economic outlook**: projected changes to the level of economic growth throughout the world. If outlook is positive (world EG ↑): - ↑demand for goods/services- businesses need to increase production to meet demands and thus require funds to purchase equipment, employ/train staff + expand size of business - ↓ interest rates on funds borrowed internationally- ↓risk with payments availiability of funds ---------------------- **Availability of funds**: ease with which a business can access funds on the international financial markets. *Depends on:* - Risk involved in sourcing overseas - Types of funds availability - Demand + supply - Domestic economic conditions - Time to repay - Interest rates relative to domestic rates interest rates -------------- Interest rates: the cost of borrowing money. - ↑ IR= ↑risk - Australian businesses can borrow finance from overseas sources to gain advantage of lower IR - Risk= exchange rate movements- any currency fluctuation could see issues arise ### analyse influence of gov + global market on financial management ***[The government has a significant impact on businesses and their financial management. For example:]*** - Legislation introduced by the government will influence the decisions businesses make about their finances/cash flow - Government policies impact on the choice of legal structure as different obligations are imposed on different types of businesses. - Businesses that don't comply with government regulations can face a number of penalties, which in turn will impact on their finances as well as their reputation. - Taxation regulations will affect business's financial decisions. - New government policies can affect the amount of financial assistance businesses receive. ***[The government introduced a wide range of measures during the COVID-19 pandemic that significantly impacted on the financial management strategies of businesses:]*** - JobKeeper Payment --- businesses affected by COVID-19 may be eligible to access this payment to help them continue paying their employees - Boosting cash flow for employers --- the federal government provided temporary cash flow support to SMEs that employ staff during the economic downturn. The ATO provided eligible businesses with a tax- free cash flow boost of between \$20 000 and \$100 000 delivered through credits in the business activity statement system. - Supporting apprentices and trainees --- businesses that employ an apprentice or trainee may be eligible for a wage subsidy of 50 per cent of their wage. +-----------------------------------------------------------------------+ | **Processes of financial management** | +=======================================================================+ | - Planning and implementing- financial needs, budgets, record | | systems, financial risks, financial controls | | | | | | | | - Debt and equity financing- advantages and disadvantages of each | | | | - Matching the terms and source of finance to the business purpose | | | | | | | | - Monitoring and controlling- cash flow statement, income | | statement, balance sheet | | | | - Financial ratios | | | | | | | | - liquidity -- current ratio (current assets ÷ current liabilities) | | | | - gearing -- debt to equity ratio (total liabilities ÷ total | | equity) | | | | - profitability -- gross profit ratio (gross profit ÷ sales); net | | profit ratio (net profit ÷ sales); return on equity ratio (net | | profit ÷ total equity) | | | | - efficiency -- expense ratio (total expenses ÷ sales), accounts | | receivable turnover ratio (sales ÷ accounts receivable) | | | | - comparative ratio analysis -- over different time periods, | | against standards, with similar businesses) | | | | | | | | - limitations of financial reports -- normalised earnings, | | capitalising expenses, valuing assets, timing issues, debt | | repayments, notes to the financial statements | | | | - ethical issues related to financial reports | +-----------------------------------------------------------------------+ planning and implementing ========================= **Financial planning** is essential if a business is to achieve its goals. Financial planning determines how a business's goals will be achieved. #### financial needs - to determine where business is headed and how it will get there they must identify their needs - information must be collected- financial statements + ratio analysis - business plan can be used when seeking finance/support ***Financial needs determined by:*** - size of the business - current phase of business cycle - future plans for growth + development - capacity to source finance (debt/equity) - management skills for assessing financial needs and planning #### budgets A **budget** is a financial document used to estimate future revenue and expenses over a period of time. **Operating budgets** relate to the main activities of a business and may include budgets relating to sales, production, raw materials, direct labour, expenses and cost of goods sold. **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 + the revenue that would be generated from the purchase. **Financial budgets** relate to the financial data of a business. Financial budgets include the budgeted income statement, balance sheet and cash flows + predictions of operating/project budgets. The income statement and balance sheet reflect the results of operating activities and the cash flow statement shows the liquidity of a business. - Provide accurate picture of income/expenses + used to drive important business decisions - Reflect strategic planning decisions + help managers allocate resources, evaluate performance, formulate plans - Enable constant monitoring of objectives - Used in PLANNING AND CONTROL - Planned performance can be measured against actual performance #### record systems **Record systems** are the mechanisms employed by a business to ensure that data are recorded and the information provided is accurate, reliable, efficient and accessible. - Not only an obligation of the business BUT serves a valuable decision making tool for the business - Also required by law to be accurate for tax purposes - Without accurate records- restricted understanding of how business is performing + where improvements need to be made (also important for investors + financial institutions) #### finanical risks **Financial risk** refers to the possibility of financial loss to businesses. - **Credit risk**- danger associated with borrowing money. - Businesses must have sufficient funds to meet repayments - extending credit to customers who may be unable to repay - When businesses borrow money they are faced with IR risks - **Market risk**- involves risk of changing conditions in the specific marketplace of the business - E.g. increasing numbers of consumers shopping online increasing competition - **Liquidity risk**- businesses cash flow + sufficient funds to meet financial obligations - How easily a business can convert their assets into cash - Cash flow management is critical to business success - **Operational risk**- various dangers faced during the management of a business - Potential operational risks: legal problems, fraud risk, HR issues #### financial controls **Financial controls** are the procedures, policies and means by which a business monitors and controls the allocation and usage of its resources. *Control is particularly important in assets such as accounts receivable, inventory and cash. Some common policies and procedures that promote control within a business are:* - Clear authorisation/responsibility for tasks - Separation of duties - Placing certain qualification restrictions + only employing certified/qualified staff for certain roles - Control of cash - Protection of assets - Control of credit procedures - Budget + variance reporting debt and equity financing- advantages and disadvantages ------------------------------------------------------- +-----------------------------------+-----------------------------------+ | ***[DEBT]*** | | +===================================+===================================+ | ***ADVANTAGES*** | ***DISADVANTAGES*** | +-----------------------------------+-----------------------------------+ | - Funds are readily available + | - Increased risk if debt comes | | can be acquired at short | from financial institutions | | notice | because interest, bank | | | charges + government charges | | - Increased funds should lead | can increase | | to ↑ earnings + profit | | | | - Security is required by | | - Interest payments are tax | business | | deductible | | | | - Regular payments have to be | | - Flexible payment periods + | made | | types of debt available | | | | - Lenders have first claim on | | - Will not dilute the current | any money if business ends in | | ownership of the business | bankruptcy | | | | | | - Debt can be expensive e.g. | | | interest | +-----------------------------------+-----------------------------------+ +-----------------------------------+-----------------------------------+ | ***EQUITY*** | | +===================================+===================================+ | ***ADVANTAGES*** | ***DISADVANTAGES*** | +-----------------------------------+-----------------------------------+ | - does not have to be repaid | - lower profits + lower returns | | unless the owner leaves the | for owner | | business | | | | - expectation that the owner | | - cheaper than other sources of | will have about the return on | | finance as no interest | investment | | payments required | | | | - long expensive process to | | - owners who have contributed | obtain funds this way | | the equity retain control | | | over how finance is used | - ownership is diluted- current | | | owners will have less control | | - low gearing (use resources of | | | the owner not external | | | sources of finance) | | | | | | - less risk for the | | | business/owner | | +-----------------------------------+-----------------------------------+ matching the terms and source of finance to the business purpose ---------------------------------------------------------------- The terms of finance must be suitable for the purpose of which the funds are required. Financial managers should match the length/term of the loan with the economic lifetime of the asset the finance is being used to purchase. ST finance ST assets. LT finance LT assets *E.G. use of ST finance to fund LT assets causes financial problems because the amount borrowed must be repaid before the LT assets have time to generate cash flow* *E.G. use of LT finance to fund ST assets means business is still paying the mortgage after situation is resolved/stock is sold* Monitoring and controlling- cash flow statement, income statement, balance sheet ================================================================================ *Statements are important because:* - they indicate how effectively finance is being used in the business - provide information on whether the business has sufficient funds to meet unforeseen circumstances - allows the monitoring of internal/external factors that will financially impact the business operations cash flow statements -------------------- A **cash flow statement** indicates the movement of cash receipts and cash payments resulting from transactions over a period of time. - Can identify trends + useful predictor of change - USED BY: Creditors/lenders + owners/shareholders *A statement of cash flows can show whether a firm can:* - Generate a favourable cash flow - Pay its financial commitments as they fall due - Have sufficient funds for future expansion - Obtain finance from external sources - Pay drawing to owners or dividends to shareholders ***BUSINESS ACTIVITIES:*** 1. *Operating activities*- cash inflows/outflows relating to provision of G+S (income from sales) 2. *Investing activities*- cash inflows/outflows relating to purchase/sale of non-current assets + investments (generate income) 3. *Financing activities*- cash inflows/outflows relating to borrowing activities of the business (equity/debt) income statements ----------------- The **income statement** is a summary of the income earned and the expenses incurred over a period of trading. - Helps users of info see exactly how much money has come into the business as revenue, how much has gone out as expenditure and how much has been derived as profit ***SHOWS:*** - Operating income earned from the main function of the business e.g. sale of inventories, services, non-operating revenue - Operating expenses e.g. purchase of inventories, payment for services and other expenses (advertising, rent, insurance) - Difference between income and expenses is profit or loss - Record income, COGS gross profit gross profit- expenses net profit balance sheets -------------- A **balance sheet** represents a business's assets and liabilities at a particular point in time and represents the net worth (equity) of the business. - Prepared at the end of an accounting period *The balance sheet shows the financial stability of the business. Analysis of the balance sheet can indicate whether:* - the business has enough assets to cover its debts - the interest and money borrowed can be paid - the assets of the business are being used to maximise profits - the owners of the business are making a good return on their investment. *A balance sheet shows:* - financial stability of business - return on owners investment - sources/extent of borrowing - level of inventories **Typical items included in a balance sheet include the following:** - **Assets** are items of value owned by the business. Assets can be divided into: - *Current assets* --- assets that a business can expect to use up, or turn over, within 12 months, e.g. cash, accounts receivable (debtors) and inventory (stock) - *Non-current assets* --- those assets that have an expected life of longer than 12 months, e.g. land, buildings, machinery, vehicles, furniture, fixtures and fittings. - **Liabilities** are items of debt owed to outside parties. Liabilities can be divided into: - *Current liabilities* --- those debts which are expected to be repaid in less than 12 months, e.g. overdraft and accounts payable (creditors) - *Non-current liabilities* --- long-term items of debt, e.g. mortgage, debenture. - **Owners** equity is the funds contributed by the owner(s) and represents the net worth of the business. - *Owners' equity* can be comprised of capital (funds contributed by the owner/s) and retained profits. financial ratios ================ +-------------+-------------+-------------+-------------+-------------+ | **Ratio** | **Formula** | **Relevant | **What does | **Interpret | | | | objective** | it mean?** | ation** | +=============+=============+=============+=============+=============+ | *Current | \ | Liquidity | Shows | Ratio of | | ratio* | [\$\$\\frac | | ability to | 2:1 | | | {\\text{cur | | meet | indicates | | | rent\\ | | short-term | sound | | | assets}}{\\ | | financial | liquidity | | | text{curren | | commitments | (x2 amount | | | t\\ | | | of assets | | | liabilities | | | to cover | | | \\ | | | liabilities | | | }}\$\$]{.ma | | | ) | | | th | | | | | |.display}\ | | | | +-------------+-------------+-------------+-------------+-------------+ | *Debt to | \ | Gearing | Shows the | Higher = | | equity | [\$\$\\frac | (solvency) | extent to | less | | ratio* | {\\text{tot | | which the | solvent | | | al\\ | | firm is | | | | liabiltiies | | relying on | (↑ risk) | | | }}{\\text{t | | debt or | | | | otal\\ | | outside | | | | equity\\ | | sources to | | | | }}\$\$]{.ma | | finance the | | | | th | | business | | | |.display}\ | | | | +-------------+-------------+-------------+-------------+-------------+ | *Gross | \ | Profitabili | Shows | Higher = | | profit* | [\$\$\\frac | ty | percentage | better | | | {\\text{gro | | of sales | | | | ss\\ | | revenue | | | | profit}}{\\ | | that | | | | text{sales\ | | results in | | | | \ | | gross | | | | }}\$\$]{.ma | | profit | | | | th | | | | | |.display}\ | | | | +-------------+-------------+-------------+-------------+-------------+ | *Net | \ | Profitabili | Represents | Higher = | | profit* | [\$\$\\frac | ty | the profit | better | | | {\\text{net | | or return | | | | \\ | | to owners | | | | profit}}{\\ | | | | | | text{sales\ | | | | | | \ | | | | | | }}\$\$]{.ma | | | | | | th | | | | | |.display}\ | | | | +-------------+-------------+-------------+-------------+-------------+ | *Return on | \ | Profitabili | Shows how | Higher = | | equity* | [\$\$\\frac | ty | effective | better the | | | {\\text{net | | the funds | return for | | | \\ | | contributed | owner | | | profit}}{\\ | | by the | | | | text{total\ | | owners have | | | | \ | | been in | | | | equity\\ | | generating | | | | }}\$\$]{.ma | | profit + so | | | | th | | in return | | | |.display}\ | | of | | | | | | investment | | +-------------+-------------+-------------+-------------+-------------+ | *Expense | \ | Efficiency | Indicates | Lower = | | ratio* | [\$\$\\frac | | the amount | better | | | {\\text{tot | | of expenses | | | | al\\ | | required to | | | | expenses}}{ | | generate | | | | \\text{sale | | sales | | | | s\\ | | | | | | }}\$\$]{.ma | | Can | | | | th | | categorise | | | |.display}\ | | expenses as | | | | | | selling, | | | | | | admin, COGS | | | | | | or | | | | | | financial | | +-------------+-------------+-------------+-------------+-------------+ | *Accounts | [\$\\frac{\ | Efficiency | Measures | High | | receivable | \text{sales | | the | turnover | | turnover | }}{\\text{a | | effectivene | ratios | | ratio* | ccounts\\ | | ss | indicate | | | receivable\ | | of a firms | the | | | \ | | credit | business | | | }}\$]{.math | | policy and | has | | |.inline}= x | | how | efficient | | | | | efficiently | debt | | | [\$\\frac{3 | | it collects | collection | | | 60}{x}\$]{. | | its debts | | | | math | | | | | |.inline}= | | | | | | amount of | | | | | | days | | | | +-------------+-------------+-------------+-------------+-------------+ comparitive ratio analysis -------------------------- **CRA** is a means by which assessments + evaluations can be made of financial data for a particular period. - Figures, percentages and ratios do not provide a complete picture for analysis. - For analysis to be meaningful, businesses need to make comparisons with their past performance, similar businesses and against common industry standards. *The main types of analysis:* - **Vertical analysis** compares figures within one financial year; for example, expressing gross profit as a percentage of sales and comparing debt to equity. - **Horizontal analysis** compares figures from different financial years; for example, comparing 2020 and 2021. - **Trend analysis** compares figures for periods of three to five years. #### why would a business use financial ratios They are used to formulate strategies in response to what is being revealed in CRA. limitations of financial reports ================================ - caution needs to be exercised when reading financial reports as there are some issues regarding how the data is collected and treated +-----------------------------------+-----------------------------------+ | **Limitation** | **Example** | +===================================+===================================+ | *Normalised earnings* | A situation where earnings are | | | adjusted to remove | | | one-off/unusual/volatile | | | influences that distort the | | | normal earnings of a company. | | | | | | - Gives a more accurate | | | depiction of the true | | | earnings of a company | | | | | | - Easier to compare | | | profitability figures from | | | one year to the next | | | | | | e.g. choosing to exclude the | | | inflow of cash that comes from a | | | one-off sale of land and vice | | | versa. | +-----------------------------------+-----------------------------------+ | *Capitalising expenses* | Refers to how a cost is treated | | | on a businesses financial | | | statement. | | | | | | Business has 2 options: | | | | | | 1. Business expenses cost | | | included as an expense on | | | income statement and is | | | subtracted from the revenue | | | | | | 2. Business capitalises cost | | | balance sheet- COST=ASSET | | | (cost counts towards capital | | | expenditures) | | | | | | e.g. pharmaceutical company | | | invests \$30 million in R+D of | | | new drug -- placed as future | | | asset on balance sheet rather | | | than expense on revenue statement | | | (money is being used to add value | | | to the business) | +-----------------------------------+-----------------------------------+ | *Valuing assets* | Estimating the value of assets | | | when recording them on a balance | | | sheet. | | | | | | - *DEPRECIATING VS APPRECIATING | | | ASSETS (estimates)* | | | | | | - *Intangible assets*- e.g. | | | goodwill, brand names- value | | | is difficult to determine and | | | could be overvalued or | | | undervalued | | | | | | | | | | | | - *Historical cost*- assets are | | | listed with the value they | | | were purchased at (can be | | | verified BUT may distort | | | balance sheet as it is | | | different from current market | | | value) | +-----------------------------------+-----------------------------------+ | *Timing issues* | Matching principle- when revenue | | | is recorded, any expenses related | | | to that should be recorded | | | simultaneously | | | | | | - Business can exploit timing | | | of financial statements to | | | give a misleading impression | | | of financial stability | | | | | | - Revenues could be delayed or | | | accelerated ahead of time | | | | | | - Expenses could be delayed | +-----------------------------------+-----------------------------------+ | *Debt repayments* | Financial reports can be limited | | | as they do not have the capacity | | | to disclose specific information | | | about debt repayments such as: | | | | | | - How long business has has | | | debt | | | | | | - capacity of business/debtor | | | to repay amounts owed | | | | | | - Adequacy + methods of | | | business for recovery of debt | | | | | | - When the debts are due (can | | | be held over an extra period) | | | | | | | | | | | | - Can distort the meaning, | | | accuracy, and usefulness of | | | reports | +-----------------------------------+-----------------------------------+ | *Notes to the financial | Notes to the financial statements | | statement* | provide additional information | | | about the companys financial | | | position (can explain | | | irregularities/issues/specific | | | details) | | | | | | - Help reader get more | | | information about the | | | processes undertaken to | | | determine the data on the | | | financial statements | | | | | | - Notes are not regulated by | | | the law and therefore may be | | | misleading as they tend to be | | | subjective | +-----------------------------------+-----------------------------------+ ethical issues related to financial reports =========================================== **Ethics** refers to community standards that may be greater than the laws. In the case of financial statements + reporting practices the issue is about clarity and fairness that meets community standards. +-----------------------------------+-----------------------------------+ | *Audited accounts* | Audited accounts: Independent | | | check of the accuracy of | | | financial records + accounting | | | procedures. | | | | | | [Purpose]: to obtain | | | an independent opinion on the | | | financial statements to ensure | | | the information is accurate | | | | | | - Establish whether financial | | | statements are fairly | | | presented | | | | | | [Three types:] | | | | | | ***Internal***- conducted by the | | | business to check accounting | | | procedures | | | | | | ***Management audits***- | | | conducted by senior management to | | | assess strategic planning | | | performance | | | | | | ***External***- legal requirement | | | (usually private/public | | | companies)- under corporations | | | Act 2001- ASIC theft + fraud | +===================================+===================================+ | *Record keeping* | To ensure that ethical + legal | | | compliance occurs the basis for | | | compliance comes from having a | | | record system that meets | | | accounting standards. The | | | principle of accounting around | | | the world is known as double | | | entry bookkeeping. | | | | | | This means that every transaction | | | has two effects: ↑A = ↑L + OE | | | | | | - Sometimes payments are in | | | cash and then not recorded as | | | a transaction- can reduce | | | businesses profit- | | | potentially lower tax burden- | | | ATO regularly monitors | +-----------------------------------+-----------------------------------+ | *Reporting practices* | There are a set of laws that | | | require compliance to assure that | | | the financial statements | | | represent a true + fair value of | | | the business. These standards | | | reflect issues like the valuation | | | of assets e.g. depreciation. | | | | | | - Accurate reports necessary | | | for: Shareholders + taxation | | | purposes | +-----------------------------------+-----------------------------------+ | *GST obligation (not in | Every business in Australia has | | syllabus)* | to pay GST (10%) every month | | | | | | - A cheque is sent to the ATO | | | with the tax collected by the | | | business on the sales made | +-----------------------------------+-----------------------------------+ +-----------------------------------------------------------------------+ | **Financial management strategies** | +=======================================================================+ | - cash flow management | | | | | | | | - cash flow statements | | | | - distribution of payments | | | | - discounts for early payment | | | | - factoring | | | | | | | | - working capital management | | | | | | | | - control of current assets- cash, receivables, inventories | | | | - control of current liabilities- payables, loans, overdrafts | | | | - strategies -- leasing, sale and lease back | | | | | | | | - profitability management | | | | | | | | - cost controls -- fixed and variable, cost centres, expense | | minimisation | | | | - revenue controls -- marketing objectives | | | | | | | | - global financial management | | | | | | | | - exchange rates | | | | - interest rates | | | | - methods of international payment- payment in advance, letter of | | credit, clean payment, bill of exchange | | | | - hedging | | | | - derivatives | +-----------------------------------------------------------------------+ cash flow management ==================== The implementations of strategies of factoring, leasing, discounting or distribution of early payments work to improve the composition of current assets, increasing cash for t