HSC Summary Notes- Finance

10.3    HSC topic: Finance -> Planning, organising and controlling of the financial resources of a business to achieve the goals of the business  

                                                                                                                25% of indicative time

The focus of this topic is the role of interpreting financial information in the planning and management of a business.

Outcomes 

The student:

H2     evaluates management strategies in response to changes in internal and external influences

H3     discusses the social and ethical responsibilities of management

H4     analyses business functions and processes in large and global businesses

H5     explains management strategies and their impact on businesses

H6     evaluates the effectiveness of management in the performance of businesses

H7     plans and conducts investigations into contemporary business issues

H8     organises and evaluates information for actual and hypothetical business situations

H9     communicates business information, issues and concepts in appropriate formats

H10   applies mathematical concepts appropriately in business situations

Content

Students learn to:

examine contemporary business issues to:

·         explain potential conflicts between short-term and long-term financial objectives         

·         analyse the influence of government and the global market on financial management

·         identify the limitations of financial reporting

·         compare the risks involved in domestic and global financial transactions

investigate aspects of business using hypothetical situations and actual business case studies to:

·         calculate key financial ratios

·         assess business performance using comparative ratio analysis

·         recommend strategies to improve financial performance

·         examine ethical financial reporting practices

Key Concepts: hedging, derivatives, cost centres, factoring, matching principle, asset, liability, short-term, long-term, solvency, liquidity, accounting equation, accounts payable/receivable, debentures, equity, overdraft, working capital

Students learn about:

role of financial management

-          strategic role of financial management –crucial –business may fail more many reasons, often financial – Its strategic role is to give the business specific strategies needed to reach its long-term, big-picture goals

·         objectives of financial management –maximise the returns on the funds that the owners have invested into the business –objectives are used to generate SMART goals

–        profitability –earnings after expenses are paid , growth –size of the business compared to competitors in the same market, efficiency –amount of revenue spent on resources, liquidity –ability to pay short term liabilities w/ current assets, solvency-ability to pay short + long term liabilities as they fall due

–        short-term –within the year e.g. bills, credit cards and long-term – longer than a year e.g. mortgage

·         interdependence with other key business functions -> finance department needs marketing to be successful to gain profit which can be passed on to HRM to employ new staff required to produce the product -> all departmenets work together to achieve financil/bus goals

influences on financial management

·         internal sources of finance –comes from within the business’s owners (equity or capital) or from outcomes of the business activities (retained profits) – retained profits –cheap and accessable –in Aust. 50% profits are retained + re-invested (on average)

·         external sources of finance  -outside the business

–        debt – short-term borrowing –used for temporary shortages of cash flow –repaid within 1-2yrs (overdraft-ability to overdraw an account up to a certain amount –most common, commercial bills –bill exchange (loan) from financial institution other than a bank –represents business’s acknowledgement of a debt to another business, factoring –selling of accounts receivable for a discounted price *credit cards -> expenses, pay stock from banks, immediate, cost = interest *leasing* can be used for long and short term –loan repayments are tax deductible, cash isn’t tied up in assets), long-term borrowing –funds borrowed for longer than 2yrs (mortgage-loan secured by the property of borrower, debentures- issued by a company for a fixed rate of interest for a fixed time, unsecured notes-loan for a set period –not backed by a collateral/asset –highest risk for investors = high interest, mostly public companies, leasing-long-term source of borrowing –payment for equipment owned by another business)

-          equity –finance raised by a company issuing shares via ASX - A security is an exchangeable, negotiable instrument representing financial value. –cost = dividend payed out

– ordinary shares-most commonly traded-individuals become part owners (new issues-a security issued & sold for the first time AKA –primary shares/new offerings, rights issues-privilege granted to shareholders to buy new shares in the same company, placements-allotment of shares directly from company to investors, share purchase plans –offer for current shareholders to purchase more shares without brokerage or at a discount), private equity – money invested into a private company not listed on the ASX

·         financial institutions – banks –most important –receive savings as deposits and makes investments and loans to borrowers, investment banks –provide services in borrowing and lending primarily in the business sector, finance & life insurance companies –specialise in smaller commercial finance –finance to business + individuals through cosumer hire-purchase loans personal loans and securred loans, superannuation funds-provide funds to the corporate sector via inverstment of funds received from superannuation contributors, unit trusts-take funds from a large number of small investors and inverst them into specific types of financial assets e.g. gold and the Australian Securities Exchange-primary stock exchange group in Australia

·         influence of government-through  implementation of economic policies and current and chnaging legislation – Australian Securities and Investments Commission –aims to reduce fraud and unfair practices, company taxation –companies/corroporations in Australia pay company tax on profits

·         global market influences *globalisation has created more interdependence between business sectors + their economies relying on trade for expansion + increased profits – economic outlook-relate specifically to changes in economic growth rates of individual economies throughout the world, availability of funds-wider availability of funds when trading in a global market, interest rates-when sourcing funds overseas this needs to be considered along with risks

processes of financial management

 financial planning is the continual process that all business must go through to manage their finances efficiently and achieve their financial goals.

-          planning and implementing – financial needs-esential to determine where a bus. is headed and how it will get there -Drawing up a business plan ensures that the organisation knows what it aims to achieve, budgets-reflect strategic planning decisions on resources/their use –provide financial information for bus. goals - used for strategic, tactical and operational planning, record systems-ensure recorded info. Is accurate, reliable, efficient and accesable –e.g. budgets/cash flow, financial risks-should be planned –aware of what may cause them to be unable to cover obligations, financial controls-ensure plans will lead to achievement of bus. goals - Financial controls are the policies and procedures which will lead to the achievement of the organisation’s goals in the most efficient way.

–        debt and equity financing – advantages and disadvantages of each

–        matching the terms and source of finance to business purpose -> matching principle = current liabilities fund current assets & non-current liabilities fund non-current assets

There are many factors involved in financial considerations:

-          Costs, including set-up costs and interest rates – must also consider fluctuations in cost due to market and economic conditions.

-          Size and stability of business earning capacity.

-          Flexibility, so that businesses can pay off at certain time or increase/renew their borrowing.

-          Availability of finance and ease of access to finance

-          Level of control – if the lender requires security over an asset and other conditions of lending are imposed, a business’s ability to consider future financing possibilities is reduced.

Other benefits (e.g. tax benefits).

·         monitoring and controlling – cash flow statement –inflows/outflows, income statement –revenue, expenses, net income, balance sheet –assets = liabilities + owner’s equity (accounting equation) ensures the balance sheet balances

·         financial ratios –calculations that help managers examine bus. performance –allow comparison over time w/ industry averages + competitors and prediction of trends/assist in planning

*Interpret not just calculate*

–        liquidity – current ratio (current assets ÷ current liabilities) –short term stability –should have more current assets than liabilities IA= 2:1 -> working capital

–        gearing – debt to equity ratio (total liabilities ÷ total equity) –solvency –long term stability –IA=50% small 100% big

–        profitability –financial return – gross profit ratio (gross profit ÷ sales) -higher the percentage the better; net profit ratio (net profit ÷ sales)-takes expenses into account -13-20% good for a retail bus. ; return on equity ratio (net profit ÷ total equity)-how much the owner’s investment/risk in the bus. is earning –a figure below 10% would be a concern

–        efficiency –return on costs– expense ratio (total expenses ÷ sales)-relationship between sales and expenses –as low as possible , accounts receivable turnover ratio (sales ÷ accounts receivable) OR AR ÷ (sales ÷ days) –how long it takes to collect owed $  IA=14-60days

–        comparative ratio analysis – over different time periods, against standards, with similar businesses *covered be exercises in class,* the ability to understand meaning of ratios. E.g. high GP is good but doesn’t mean much if the bus. has high expenses or the better bus may have a lower ROOE but greater stability (solvency)

·         limitations of financial reports – normalised earnings-revoving of one time or unusual influences (to add to accuracy) e.g. land sale, capitalising expenses –adding a capital expense to the balance sheet that is reguarded as an asset e.g. R&D, valuing assets-the process of estimating the value –may be inaccurate , timing issues-reporting is over a year but –may not be accurate due to seasonal flutuations e.g rain for ice cream bus., debt repayments –info. On how long the bus. has been recovering debt e.g. debt unlikely to be paid creating an inaccuracy, notes to the financial statements

·         ethical issues related to financial reports –failing to report or providing incorrect information in reporting statements is unethical

-unethical behaviour is investigated by audits (independent check of the accuracy of financial records/accounting procedures –internal-by employees –management-review strategic plan –external-independent firms to guarantee the authenticity of financial reports

financial management strategies

·         cash flow management

–        cash flow statements –inflows/outflows to give net profit or loss from the period

–        distribution of payments –organizing expenses to match monthly/yearly inflows/outflows –can be aided by cash projection, discounts for early payment –offering creditors a discount for early payments –most effective when targeting creditors owing large amounts –improves cash flow, factoring –selling accounts receivable for a discounted price to a finance/specialist factoring company

·         working capital management

–        control of current assets – cash-*problem = too much/too little -> could be better invested or can’t pay debts *solution = can be managed with: budgets, cash reserves/overdrafts and investment options, receivables-*problem = poor credit policies, clerical problems, high acc/rec turnover ratio, aged accounts -> not sending out bills, *solution =  needs to encourage debtors to pay account quickly: monthly statements, discounts, factoring, charges on late payment, inventories-*problem = storage, transport, insurance *solution = J.I.T, stock takes -monitored –too much stock=cash shortage and not enough=customer loss/lost sales

–        control of current liabilities – payables-control of AP/ periodic reviews, consider: discounted periods avoid late payment fees, extended terms for payment, loans-management is important –interest rates/ongoing charges  -positive relationships w/ financial institutions to insure the most appropriate loans, overdrafts-fees/interest payments need to be monitored –overdraft policy should be in place –better cash flow management –budgets

–        strategies – leasing –hiring of an asset –‘frees up cash’ within the bus., sale and lease back-selling of an owned asset to a lessor/leasing the asset back –increase liquidity

·         profitability management

–        cost controls –monitoring of fixed and variable costs, using cost centres– fixed-not directly impacted by sales and variable-those allocated to a particular product –increase as sales increase (direct costs), cost centres-areas/departments of a bus. costs can be directly attributed –good for inventory management, expense minimization –reducing costs and expenses to maximize profits and be competitive e.g. outsourcing, sale & lease back, replacing labor w/ technology, improving budgeting and accountability

–        revenue controls- Sales objectives, pricing policy to balance sales with profits  marketing objectives –meeting marketing/sales targets to grow sales = increase in profit

·         global financial management

–        exchange rates –ratio of one currency to another –to find what a currency is worth divide by 1 –impact of fluctuations in rates

–        interest rates –may be cheaper to borrow overseas due to low interest rates –major risk is fluctuation exchange rates

–        methods of international payment – payment in advance-most secure/low risk exporter, letter of credit-importer is confirmed from a letter by the bank, clean payment-paid at point of sale, bill of exchange-written order from the seller requesting the importer pay a certain amount at a specified time

–        hedging-process of minimising risk

-natural hedging –insisting both import/export contracts are paid in AUS $ -marketing strategies that reduce price sensitivity of exported goods –establishing off shore subsidiaries

–        derivatives –special contracts between global business’s/suppliers that help manage the risk of currency fluctuations *forward exchange contract –contract to exchange one currency for another currency an agreed exchanged rate on a future date, usually after 30//90/180 days