Finance HSC notes

8/9/2019 Finance HSC notes

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Finance

Financial management

Refers to the long term

Ensures a business achieves its goals and objectives Strategic role of nancial management involves a key number

of areas:o Achieving long term protabilityo Achieving increased wealth for investors

o Achieving great eciencies !cost reduction" within thebusiness# $ncreased eciencies reduce costs# Areduction in costs leads to increase in prot

%bjectives of Financial &anagement

'rotability is the ability to ma(imi)e prots

*rowth the ability to increase in si)e in the longer term

Eciency cost minimi)ation

+i,uidity the ability to repay short term debt

Solvency the ability to repay long term debt e#g# mortgage

Proftability

-he process of ma(imi)ing revenue !sales" and minimi)inge(pense

&a(imi)e: .ew promotional campaigns

*rowth strategies such as the release of products/stores&inimi)ing

%utsourcing e#g# products are made in other countries

0hange in products

$n 1234536 Apple achieved a prot of 762 billion5 $5pad air/$5pad mini5 Released an $5phone 8s/8c5 429 of the price of all apps go directly to Apple

&inimi)ing e(penses5 'roduction based in Fo(5con5 &anufacturing in Asia5 &inimal e(penditure on marketing customer loyalty and

strong brand awareness

Eciency

&inimi)ing e(penses

Achieving the lowest possible product cost

Reducing e(penses


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Strategies

%utsourcing production

Source cheaper supplies

;ow Apple achieves eciency:5 %utsourcing production to Fo(5con5 Achieve production costs between 68 < =89 of sale price5 $5pad costs Apple 7622 to produce5 $5phone costs apple 7132 to produce5 Achieves greater prot margins5 >89 of components are sourced in Asia lowering distribution

costs

Growth

$s the ability of the business to increase in si)e in thelonger term

$ncrease in protability

$ncrease in sales

$ncrease in market share !9 of customers a business hascompared to its competitors"

Since 1226 Apple have released what is known as the ?$@ range-his includes:

o $5pad $5phone $5podo

-he products are all connected to each othero $n honored by $ cloud

0riticism of Apples growth is the failure to release a low cost smartphone# -his has provided a competitive advantage for Samsung5seven dierent not phones across a range of price categories

Solvency

Ability to repay long term debt

Boes the business have the ability to repay long term nancial

commitments !C31 months" Gearing is used to measure solvency measures the

percentage of the assets of the business which are funded bye(ternal sources indicates the businessDs reliance one(ternal nance

$f the business is unable to repay its non5current liabilities it issaid to be insolvent

-he assets of the business are then sold to repay creditors

0hanges in interest rates changing consumer preferences andeconomic conditions

5 Apples debt sits at 7>#4 billion


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5 -his compares to an annual prot of appro(# 762 billion5 -heir most recent purchase was Br Bre for 74 billion5 $t is a business that relies on debt5 &easured by the gearing ratio

Liquidity Ability of the business to repay short5term debt !current

liability" ! 31 months"

$ncludes utilities such as electricity water wages suppliesinsurance

-he importance of cash is signicant as e(penses are paidwith cash

.eed to have sucient cash Gow to meet nancial obligations

H to convert current assets into cash ,uickly

For every 76 in current liabilities the business has 7= to satisfy itsshort term debt

Short term and +ong term Financial %bjectives

Short term

Strong cash Gow to cover short term e(penses

&aintain or increase protability

$ncrease salesLong term

$ncreased &arket share

0ost savings/eciency

Reduce long5term debt

$ncrease protability

$nterdependence with other key business functions

;uman Resources$nGuences the level of remuneration !income" paid to employees

&arketingFinance allocates marketing a budget to work with&arketing generates sales which translate into protability forthe business

%perations-he cost of production0onsider cost eciency versus ,ualityE#g# Aldi pay for bags donDt have shelves

$nGuences on nancial &anagement

Sources of nance !type of money a business can access"


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All business re,uire some sort of nance:o 'urchasing e,uipment

o -o fund operationso 'urchase inventoryo -o cover e(penses

Internal Sources o fnance:

0omes from the businessDs owners !e,uity or capital" or fromthe outcomes of business activities !retained prot"

Boes not involve debt

Boes not include borrowing

etained Proft

'rot that is re5invested into the business $t is being retained !kept" for business use

-he alternative is that this prot is distributed for the personaluse of its owners

.ot relying on debt !less reliance on interest rate changes

benets solvency" -he funds are e(istent the business does not have to seek

additional investors Restricts the owners personal use of the money

-he amount of retained prot may be insucient for the needsfor the business

!a"ital5 -he funds invested by e(isting owners within the business5 Form of owners e,uity

-he funds do not need to be repaid

0ould give e(isting investors an opportunity to increase their

ownership within the business

$nvestors may loose their capital -he ownership structure could change as some investors

become more signicant !because of their new investment"than others

E(ternal Sources of Finance

E(ternal nanceFunds that are accessible from sources outsidethe business e#g# banks nancial institutions government

+iabilities

5 Form of borrowing funds5 0urrent 31 months


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5 .on5current C31 months

Short #erm borrowing $%&!'

%verdrafts commercial bills and factoring

-o nance temporary shortages in cash Gow or working capital

31 months

&verdrats

A bank allows a business to overdraw its account to an agreedlimit and for a specied time

!-his allows the business to withdraw more funds that actuallyhas in its account"

Assist businessDs with short term li,uidity problems $t allows a bank balance to go into negative territory up to a

particular amount of moneyAdvantages

Allows short5term e(penses to be covered

!ommercial (ills

Short term/ current liability

Sourced from non5bank lenders these include investmentbanks/merchant banks and nance companies

IJanks/merchant < banks that speciali)e in business nance/fundingIFinance companies < small companies that speciali)e in leading tohigh/risk consumers/businesses5 +ending time is between 42 to 3>2 days5 Ksually over 3222225 -he lending time and repayment is determined between theborrower and the lender

%actoring

Selling debt to gain immediate access to cash

'rocess of selling money to the business to gain immediateaccess to cash

-he business sells the right to collect the money to anotherorgani)ation

-hat organi)ation now assumes responsibility for collectingthe money owed

-he money owed is ?sold@ at a discount

-he business accesses cash and now the factoring companyassumes responsibility for collecting debt

Advantages


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*aining immediate access to cash the business improves itscash Gow and gearing

Bisadvantages

Selling the debt causes the business to reduce the value of

the money owed

*reater risk than other sources of short term borrowing e#g#overdrafts because of the likelihood of unpaid debts

Long term )ebt*+on,current Liabilities

C31 months

Secured or unsecured

Ksed to nance real estate plant !factory/oce" and

e,uipment

-ortgage

.on5current liability

$s a loan secured by the property of the borrower !business"

-he asset can be sold by the nancial institution if themortgage is not repaid

-he asset is held as a form of security should the borrower

default on the loan

Repaid with interest usually through regular payments over

agreed period of time

)ebentures

-he organi)ation seeks from the public/investment books

smaller amounts of money

$t is easier to raise money by borrowing less from more thanmore from less

$s a promise made by a company to repay money that is lentto a business

$nvestor lends money to a company the company issues a

debenture with a promise to make regular interest paymentsfor a (ed rate and period of time

-he amount of prot has no aect on interest rates

debentures have a (ed rate of interest

.nsecured notes

$s a loan from investors for a set period of time

Are not secured against the businessDs assets high risk toinvestors

Leasing $s where the business chooses not to purchase the asset


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$nvolves the payment of money for the use of e,uipment thatis owned by another party

Advantages

Avoids an upfront payment to purchase the asset

Allows the business to access technology with updatedfeatures this technology is usually outdated within a fewyears

Bisadvantages

-he business does not own the asset any damage incurredmust be covered by the business itself

$t forces the business into constantly devoting funds to the useof this asset

-here are two types of leasing operating and nancial

%perating +easing

Assets leased for short periods of time -he owner carries out maintenance of the asset

+eases can be cancelled without penalty

Financial leasing

Ksually for the life of the asset

Repayments are (ed for the economic life of the asset 458years

E#g# plant vehicles furniture

0heaper than leasing them as operating leases

Ksually penaltyDs for cancellation

E,uity5 Refers to the nance raised by a company through inviting

new owners e#g# issuing shares to the public through ASL5 Funds invested into the business by new owners e(ternal

source of nance

&rdinary Shares

5 Shares refer to the portion of ownership of the business5 Mhen shareholders purchase shares in a company they are

providing a source of nance !e,uity" for the business5 A business has a set number of shares5 Shares are valued and traded on the Australian stock

e(change !ASL"5 -he number of shares L the value of each share N market

value of the business5 Fi(ed number of shares/unlimited number of investors

+ew issue

5 Mhen a company issues shares to the public for the rst timeknown as an $nitial public oering !$'%"


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5 As new shareholders enter the business the structure ofownership changes

ight Issue5 .ew shares are released but preference is given to e(isting

shareholders5 %ccurs after $'%5 'rovides e(isting shareholders with the opportunity to

purchase more sharesPlacements /

5 Allotment of shares made directly from company to investors5 Shares are oered at a discount to their current trading price

to special institutions or investors5 -his discount is intended to persuade specic investors to

invest in their companyShare "urchase "lan /

5 An oer to e(isting shareholders in a listed company topurchase more shares in that company without brokerage fees

5 Shares can also be oered for a discounted price

Private Equity5 $s the money invested in a private company that is not listed

on the ASL5 -he aim of the company is to raise capital to nance future

e(pansion/investment

Financial $nstitutions

-he main nancial institutions are:

Janks

$nvestment banks

Finance companies

+ife insurance companies

Superannuation funds

Knit trusts

ASL

Financial $nstitutions5 0ollect funds and invest them in nancial assets5 -hey provide nancial services and their focus is dealing with

nancial transactions e#g# investments loans

Janks5 Accept deposits from the general public and provide funds for

loans5 &ost important nance for a business5 -hey also provide services like legal and ta(ation advice and

risk management


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$nvestment Janks5 -hey provide services in borrowing and lending primarily to

the business sector5 0an provide a wide variety of loans which can be customi)ed

to suit a businessDs needs

$nvestment banks:5 -rade in money securities and nancial futures5 Arrange long term nance5 'rovide working capital5 Arrange project nance5 Advise on mergers and takeovers5 Knderwrite corporate and semi5government issues of

securities5 %perate unit trusts including cash management trusts

property trusts and e,uity trusts5 Arrange overseas nance

Finance 0ompanies5 Are non5bank nancial intermediaries that speciali)e in

commercial nance5 &ainly provide short5term and medium5term loans to a

business through customer hire purchase loans personalloans and secured loans

5 &ain providers for lease nance5 Also raise money through share issues

5 0an provide businesses with ,uick access to funds howeverinterest is usually higher

+ife $nsurance 0ompanies5 'rovide insurance cover in the event of death

Superannuation5 $s a place where you put your money and the fund manager

invests the individuals money for investment return

Knit -rusts

5 An organisation takes money from small investors and investsin stocks and shares for them under a trust deed

5 -he investment is in the form of shares !units" in the trust

0ustralian Security E1change5 Stock market5 Mhere shares are bought and sold5 Act as a market place

'rimary &arket

5 -his is where shares are traded for the rst time


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5 Shares have been sold in the company and the business is thematuring into a public company

5 'urchased through $'% !initially public oering" where thecompany sell shares to the public < aka Goat

5 Accessing the shares at possibly discounted price as they

enter the secondary market the price of the share mayeventually increase

Secondary &arket5 -he purchase and sale of e(isting shares5 An e(isting share is one that has been traded on the ASL

before5 $t is not the rst tie this stock has been traded

$nGuence %f *overnment

-his e(amines the e(tent to which the levels of governmentinGuence nancial management of business within Australia

AKS-RA+$A. SE0KR$-$ES $.OES-&E.- 0%&$SS$%. !AS$0"

Relates to all Australian businesses registered as companies

-hese companies can either be public or private companies

All insurance banking and nancial organi)ations operating inAustralia

Re,uire companies to provide nancial reports and that the

process of calculating data in these reports is correct# -hisprocess is known as auditing# -he reports are independentlyreviewed by an e(ternal organisation

-hese reports must then be submitted to AS$0

Seeks to regulate !control" the process of regulating e,uity

funds in a business# -his involves the release of a prospectusthat outlines the strengths of the business and possiblethreats aecting its protability# -his occurs only when abusiness is changing from a private company to a publiccompany#

'rovide license to all organisations providing nancial adviceor lending in Australia

-he aim of AS$0 is to assist in reducing fraud and unfair practicesin nancial markets and productsEnsure that companies adhere to the law collect informationabout companies and make it available to the public$ncludes nancial info that companies must disclose in theirannual report

0ompany -a(ation


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All private and public companies in Australia must pay a ta(rate of 429# $t is a Gat rate and does not vary with prot levels

$ncome ta( increases as the income of an individual alsoincreases

$ncreases businesses protability promotes increased

investment and greater spending/ employment -o encourage new businesses to emerge act as a nancial

incentive for entrepreneurs to enter the market

*lobal market inGuences

Global -ar2et In3uences

*lobal market inGuences on nancial management includeo Economic %utlook

o Availability of funds

o $nterest rates -hese inGuences are part of the e(ternal business

environment cannot be controlled by the business

Economic %utlook

Refers to the projected changes to the level of economic

growth throughout the world

All businesses are impacted by the economies they operate in

Recent downturns across Europe .orth America

$mpact upon the protability of business operating in the

recessions Australian businesses operating in Asia have beneted < the

Asia is the strongest globally

Slow demand in north America and Europe could aectlending demand by Australian businesses

Availability of funds

Refers to the ease in which a business can access funds onthe international nancial markets

Some regions are likely to be access easier than others

Interest

-his is the cost of borrowing funds

.%-E: interest rates are an e(pense and hence will aectnancial eciency of the business together with netprotability

Processes o %inancial -anagement

Planning and Im"lementing

3# Betermining nancial needs


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Mhat are the goals of the business in both the short and longterm

&ust consider projected revenue and projected e(penses

Boes the business have sucient funds to achieve these goals

Ability to satisfy debt obligations

E(isting protability

Boes the business have sucient funds to fundo *rowth and development !release of new products"o E(pand locations

o Research and development

$f the business does ac,uire additional funds

Boes it have a long term ability to repay this debt

-he business must also considero Future economic outlook

o

0hanging interest rateso 0hanging consumer tastes and preference

1# Beveloping Judgets

A plan used to estimate revenue e(penses and cash Gow over

a period of time

-he -ypes of Judgets

&"erating (udgetRelates to the e(pected revenue and e(penditure of a business inrelation to its day to day operations$ncludes sale revenue and e(penses such as wages utilities andrent

Pro4ect (udgetRelate to capital e(penditure and research and development

%inancial (udgetRelate to nancial data of a business and include the budgetedincome statement balance sheet and cash Gows

ecord Systems$s the process by which nancial info is collated and recorded*enerally prepared by accountants%ften involves the use of nancial budgeting software

4# $dentifying Financial Risks

%inancial is2s$s the risk to a business of being unable to cover its nancialobligations e#g# debts that a business incurs through borrowing$f the business is nanced from borrowings there is a higher risk


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-o minimi)e nancial risk businesses must consider the amountof prot they will generate'rot must me sucient to cover debt and.eed to consider the li,uidity of assets

Boes the business have the loan capacity to fund its debtP 'redicted revenue

Future economic conditions

0hanging consumer preferences

$nterest rate movements

$s the investment worth the riskPFinancial 0ontrols'olicies and procedures that ensure that the plans of a businesswill be achieved in the most ecient way

0ommon policies and procedures:Separation of duties e#g# one person responsible for ordering andanother for receiving inventoryRotation of duties e#g# sta are skilled in a number of areas'rotection of assets e#g# business are kept locked securitysurveillance systems are installed0ontrol of credit procedures e#g# following up overdue accounts

Bebt and E,uity Financing

)ebt fnance

5 Funds that are sourced from e(ternal sources5 &ust be repaid

0urrent +iabilities !debt that must be repaid within 31 months"E#g# 0redit card %ver draft 0ommercial Jill accounts payable!money that the business owes to others" trade credit !when thebusiness owes money to its suppliers".on < 0urrent +iabilities !form of debt that is generally in a timeperiod longer than 31 months"E#g# &ortgagae debentures unsecured notes +easing

Advantages5 $nterest is recorded as an e(pense# $ncreased levels of interest

add to the level of e(penses protability then falls lessta( is paid

5 .egotiate interest rates/ fre,uency of paymentsmeet thespecic needs of the business

5 Mill not decrease ownership in the business5 Simple to ac,uire5 $f the business cant pay long term debt !insolvency"

!advantage to lender" 0reditor who has rst right to sei)e

assets


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Bisadvantages5 E(pensive interest must be paid5 0an be high risk if a business borrows money from nancial

institutions because interest bank and government chargesmay increase

5 Regular repayments have to be made5 $ncrease responsibility on the owner of the business# $t is not

the responsibility of the employees to manage nancialobligations

Equity %inance5 Funds invested by either e(isting or new owners

Retained prots0apital !shares"

Advantages5 .o obligation to repay the money5 +ess risk for the business and owner5 .o interest charges the savings on interest allows the

business to have increased cash5 0ash Gow generated can be used for investment and

e(pansion

Bisadvantages5 .o ta( deductions5 Qou are opening up your business to new shareholders

5 'roportion of the prots for to additional new owners5 .ew investors often e(pect improved growth H performance5 %wnership is diluted i#e# the current owners will have less

control

&atching and controlling

&atching principle5 $nvolves using the appropriate nance forpurchasing an assetShort5term nance should be used to purchase short term assetse#g# inventory+ong term nance should be used for long5term assets e#g#mortgage loan

&onitoring and 0ontrolling

-he main nancial controls used for monitoring are:

3# 0ash Flow statements1# $ncome Statements4# Jalance sheets


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!ash %low statements

$ndicates the cash balance position at the end of anaccounting period e#g# at the end of the month

Shows us:

0ash receipts !&oney coming into the business"

0ash payments !&oney leaving the business"

-he cash Gow for each month into the future can beestimated < this is a 0ash Flow forecast

0ash Flow management

!ash 3ow statements

0alculations%pening or closing balances

-he closing balance of one month is always to opening balance ofthe ne(t%nly cash transactionsBoes not involve credit

)istribution o Payments

'ayments made by the business are spread over a period oftime

-he e(penses are not paid in a lump sum rather they are paidin installments

-he e(penses are spread out to manage cash Gow

-his could include payment by the month

$t ensures that the cash of a business is not used to coverlarge scale e(penses at one point in time

'ayments are spread over a period of time

'ayments are normally smaller amounts of money

)iscounts or early "ayments

-he business oers discounts to customers for making earlypayments

Encourages payments to be made on time

$t promotes regular cash Gow for the business

%actoring

-he process of selling debt

Selling the collection of debt

$n return for cash payment the business allows a third partyto assume responsibility of collecting debt


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Advantages

$nstant cashBisadvantages

Reduction in prot as the business does not receive the full

amount of debt

56 Income Statement

$ndicates the level of 'rot !or loss" for a business for aparticular period

$ndicates level of sales gross prot and net prot of thebusiness

Shows us:

;ow much the business sold

;ow much it cost to sell 'rots made

Im"ortant terms in a revenue statement

Sales -otal value of goods sold0losing Stock Oalue of stock at the end of the accounting period0ost of goods Sold !0%*S" 0osts the business incurred in order tosell products to customers*ross prot -he amount of prot calculated by subtracting the

cost of goods sold from the total sales revenue.et prot -he amount of nal prot calculated by subtracting thecost of e(penses in running the business from the total gross prot

Im"ortant !alculations or the evenue Statement

*R%SS 'R%F$- N Sales Revenue < 0%*S

.E- 'R%F$- N *ross 'rot < e(penses

0%*S N %pening stock purchases < closing stock

76 (alance Sheet

Shows the net worth !total value" of a business on a particularday < usually the last day of the nancial year i#e# 42 une

.et worth is the value of the %wners e,uity or the value of

the owners !shareholders" investment in the business

$ndicates the assets and debts of a business

$s important when a business wants to borrow money or abusiness is being sold

Accounting E,uation

%wners E,uity N Assets 5 +iabilities


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Financial Ratios

3# +i,uidity Ratio

+i,uidity Ratio5 Also known as the current ratio5 Also known as the working capital ratio

Mhat does this ratio measureP5 -he ability of the business to repay short term debt !current

liabilities"5 Boes the business have signicant current assets to repay

current liabilities5 -here is emphasis on current assets as the assets of the

business could be turned into cash5 Jy turning these assets into cash the business is able to pay its

current liabilities

F%R&K+A: E(pressed as a ratio

0urrent RatioNCurrent Assets

Current Liabilities

For e(ample: 0urrent assets N 782222 0urrent liabilities N 742222 8:4

$f every 74 in current liabilities the business has 78 in current assets

Morking 0apital-he dollar value of current assets remaining once all currentliabilities have been paide#g# Morking acital N 72222 5 742222N 742222

5 A ratio of 1:3 indicates a sound position# -hat is a businessshould have double the amount of assets to cover its liabilities

5 Anything below 3 is dangerous

-he net worth ofthe business if it

were to be sold


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5 ;owever an ?acceptable@ ratio will also depend on factors suchas the type of rm how other rms in the industry are operatingand e(ternal inGuences

Morking 0apital N Current AsesstsCurrent Liabilities-he dollar value of current assets remaining once all currentliabilities have been paid

E(ample: Morking capital N 72222 5 742222N 742222

Morking 0apital !li,uidity" management

0ontrol of current assets

!ash%er incentives for customers to pay for stock in cash# -his couldinclude discounts for cash paymentsFactor debts < provides immediate access to cashSale and lease back a business sets a non5current asset!building"# -his generates cash# -he asset is then leased back fromthe new owner# E(cess cash can then be used to repay debt or re5invest into the business#

0ccounts eceivable $money owed to the business'

3# 0harge interest for the payments1# Factoring4# %ering Biscounts for early payments# -his payment is in the

form of cash6# Reduce credit termslimit the availability of credit to

supplies and restrict the ?term@ !amount of time" a customerhas to repay the business

Inventory3# $- !ust in -ime" -he stock arrives as the business re,uires

its use

Reduce storage costs

'erishable 'roducts are fresh

Belays in transportation

-here may be insucient volumes of stock arriving

1# 'romotions to 0lear stock that may not be selling

0lears e(cess stock

Reduction in price N reduction in prots for the business

0ontrol of current liabilities


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0ccounts Payablemoney that are owed to suppliers of thebusiness# -he business has purchased a supply and is given aspecic time period to pay for its costs# $t could also includepayments owed to cover such costs as electricity and insurance

$ncrease cash payments and rely less on accounts payable Ask for discounts if the account is paid on time

Ask for discounts if cash is oered

-ake advantage of suppliers that oer e(tended credit terms

!allow the business a great amount of time to repau"

&verdratadditional funds that a business can access from anancial institution once its balance reaches )ero

&inimise its use because of interest charges

Kse on overdraft should the rate be less than a credit card

'ay the over draft as early as possible

Seek low cost alternative over5draft suppliers

LoansShort5term loans by the business

'ay installments

'ay before the due dates !avoids high interest charges"

Seek alternative nance

.egotiate improved terms !an e(tension on the loan or lower

rate"

Strategies

86 Leasing-he business accesses on asset through regular paymentsAt the end of the lease the item is returned-he business who is paying to lease the asset does not assumeownership at the end of the lease Allows products to be updated regularly and take advantage

of new innovations

$t allows the business to access the product without upfrontpayments

$s identied as e(pense < reduces protability+ess ta(

56 Sale and Lease bac2A non5current asset is sold and then released back to the originalowner 'rovides a substantial amount of cash

$mproves li,uidity of the business

56 Gearing $ndication of solvency !ability to repay long term debt"


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-he proportion of assets nanced from debt compared to theproportion of assets through e,uity

-he ideal result is 3:3 For every 73 in debt there is 73 ine,uity

-he greater the proportion of assets nanced through debtindicates that the business is more highly geared

-he degree of gearing depends on the type of industry and

management of the business

-he more highly geared the business the greater the risk forthe business but the greater potential prot

F%R&K+A

Bebt to E,uity NTotal Liabilties

Total Equity

100

1

E(ample:-otal +iabilities: 7322222-otal E,uity: 7382222

100,000

150,000100

1=67

-herefore for every =cents the business has in total debt there is73 in owners e,uity

E(ample:Assets N 7422222+iabilities N 73>2222 e,uity N 7422222 5 73>2222N 7312222

Debt

Equity100=

180,000

120,000=150

-herefore for every 73#82 in debt there is 73 in e,uity

5 $f a business has a higher debt ratio than e,uity this could posesome problems

-hese include5 $nterest rates5 0hanging economic conditions < consumer spending patterns5 Action of competitors5 $nvestors may be less attracted to the rm as higher debt

indicates greater nancial risk0an impact on the ability to repay debt

$f a business has a lower debt ratio than e,uity this may result in:


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5 Reduced debt within the business !the business becomes lesssusceptible to stocks# !increased interest rates decreasedspending"

5 $ncreased levels of debt allow for growth e#g# e(pansionac,uisition refurbishments increased protability

Strategies

+ower debt and increase input on e,uity funds

&easures to eliminate the immediate debts of the business

Proftability atios3# *ross 'rot1# .et 'rot Ratio4# Return on E,uity Ratio

-hese ratios are not known by any other name

*ross 'rot Ratio5 For every 73 in sales the percentage of *ross prot business

makes on selling a good5 *ross 'rot !is the dierence between how much the business

buys the good for and how much it sells the good"

F%R&K+A

Gross Profit

Sales

E#g#67,000

100,000100=67

-herefore For every 73 in sales the business has achieved a *' of= cents

+et Proft atio $+P'

Net Profit

Sales x100

.et 'rot N *ross 'rot < e(penses


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eturn on Equity atio $&E'0apital Retained 'rots

F%R&K+A

Net Profit

Owners Equity100

5 Answer is always e(pressed as a percentage5 R%E measures the nancial return an investor receives from

investing their own money into a business#5 -he higher the percentage the better result5 -he investor is receiving a greater nancial return

Mhat information do we needP

3# .et 'rot Return statement/ 'rot N +oss statement1# %wners e,uity Jalance sheet

Mhat is considered to be a good returnP5 A comparison against the return of competitor


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5 A comparison against other forms of investment !shares bankdeposit property"

For every 73 in ownerDs e,uity the investor receives a nancialreturn of !formula"

'rotability &anagement$nvolves the control of both the businessDs costs and its revenue

!ost !ontrols-his comprises of variable and (ed costs

%i1ed !osts5 Fi(ed costs do not change when the level of activity changes

they are paid regardless of what happens in a business

E#g# rent# $nsurance and (ed interest loansT Source less e(pensive locationT Source alternative insurance providersT Source funds from low5cost nancial institution

9ariable !osts5 0osts that change as the level of production changes

E#g# Ktilities !phone electricity" stock supplies sta/wagesT Reduce utilitiesTSeek alternative utility providers

TAccess less e(pensive costs/suppliersU +ow ,uality productsPT Reduce wages < most popular strategy used 55C U Reducedcustomer service

5 Reduce the number of full5time sta and hiring casual sta!avoid on5costsV sick leave carers leave holiday pay longservice costs"

5 Reduce stock 'urchases and use $-# -he stock arrives just as itis needed: reduce wastage or less need for warehousing

5 Economies of sale !bulk purchasing"

!ost centres


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5 0osts can be associated/identied with a specic area of thebusiness

Research and Bevelopment&arketingStock purchases

)irect !osts5 -hese costs can be associated with specic areas of the

business

E(amples:Mages of sta&arketing budgetResearch and development

Indirect !osts5 -hese costs cannot be associated directly with a specic area

of a business5 Areas of the business that are shared amongst dierent groups

within the business5 Allocating costs is more dicult

E(amples:0ommon sta areasAdministration

5 -o reduce direct costs the business must determine the

benet that debt brings to the business

To make money, you must spend more

-he cost of debt may be higher but it actually generates asignicant return for the businessJenets: 'rotability/sales product development customerfeedback

5 -o reduce indirect costs the business must consider thesupport these areas provide to other areas of the business# Jy

reducing this support how do other functions of the businessoperateP

E(pense &inimisationMages electricity rent insurance

evenue !ontrols5 Revenue is also known as sales5 Revenue is the income generated for a business from selling

products

&arketing %bjectives


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5 0onsider the cost of implementing a marketing plan versus theprojected benet that the plan could deliver to the business

5 &arketing strategies and objectives should lead to an increasein sales and hence increase revenue

3# 'roductRe5brand the product !target market"'roduce e(tensions < new Gavoured coke.ew products

1# 'romotionAdopt new means such as online methods0elebrity endorsementsSales promotion

4# 'rice+ower price !may generate more sales"+oses prestige perception of lower ,uality;igher price !better ,uality/prestigious"restrict the ability ofconsumer to purchase the item

Factors that inGuence pricing include:5 'roduction costs5 'rice charged by competition5 Short and long term goals5 -he image or ,uality consumers associate with the good or

service5 *overnment policies

6# 'lace$ncrease the availability of the product across all stores

Eciency

$s the ability of the business to use its resources eectively toensure nancial stability and protability of the company

-he greater the eciency the greater the prot and stability

E(pense Ratio5 Also known as Accounts receivable ratio

F%R&K+A:

Expenses

Sales

100

1

-he proportion of e(penses of e(penses a business has for every 73in sales !For every 73 in sales how much is devoted to e(pensesP"


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-he lower the result the better for the business# -he business canachieve more sales by lowering e(penses#

5 &anagement uses this ratio to determine where the highest

e(penses are from and whether the ratio has increased ordecreased5 E#g# a decline in nancial e(penses may be the result of lower

interest rates or less debt being used by the business

E(ample 3:

E(penses N 78222Revenue N 738222

Expenses

Sales 100

1 =

5000

15,000=

100

1

For 73 in sales the business has e(penses of 44 cents

E(ample 1:

Sales N 7322222

*' N 7=2222.' N 712222

E(pense Ratio NExpenses

Sales

100

1

*ross prot < .et prot N E(pensesN 7=2222 5 712222 N 782222

N50,000

100,000100

N 829

-herefore for every 73 in sales the business has e(penses of 82cents

E(ample 4

.'R N 369*'R N 69E(penses Ratio N P

Solution

E(penses N *ross prot < net prot


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ER N *'R < .'RN 69 5 369N 829

SalesAccounts receievable

=450,000170,000

Strategies to $mprove Eciency achieving the lowest possibleproduct cost

&onitor cost centres can be associated with a specic areaof the business

%utsourcing production

Source cheaper supplies

0ccounts eceivable5 ;ow often a business is paid its accounts receivable5 ;ow often a business is paid money owing to it

F%R&K+A:

Sales

Accounts eceivable

3# $dentify Sales1# $dentify Accounts receivable

4# Kse formula6# Mith the result divide this by 488# -his tells you the amount# -his tells you how many days on average the business is paid

E(ample 3:

Sales N 322222Accounts receivable N 62222

N100,000

40,000

N 1#8

%n average the business receives cash payment for money owing1#8 times per year#

365

2.5=146!ays


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%n average the business is paid every 36 days# -he lower theresult the better# $deally between 4252 days &oney is coming inregularly which is needed for e(penses e#g# wages rent etc#

E(ample 1:

Sales N 762222Accounts receivable N 7382222

Sales

Accounts eceiveable=

40,000

150,000

N 1# times per year

N365

2.6=136.875

E(ample 4:

Sales: 7682222Accounts receivable: 73=2222

Sales

Accounts receievable=

450,000

170,000

2.64per year

365

2.64 ..=every 137.8!ays

-he lower the result the more ecient the business#

Strategies to im"rove results

0areful in granting credit and monitoring accounts

%ering discounts for early payments and interest charges forlate payments encourage on time payments

Ksing outside credit facilities such as bank card or Oisa cardmay reduce returns to the business as costs are incurred butthere will be a reduction in credit risk

Factoring

0omparative Ratio AnalysisRatio analysis provides a business with key information onli,uidity eciency protability and solvency#-his in formation can be used to provide a comparison of the

performance of the business against industry standards othercompetitors and past years#


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Jy comparing results the business is better able to gain aninduction of how it is performing

&ver )ierent #ime Periods-he results should be compared over a period of time$t provides a more accurate indication of the overall performanceof the businessAllows the business to compare what time period the resultsoccurred!$mproved economic conditions natural disasters changingconsumer tastes and preferences"

Against Standards$t is also important to compare against what the industry believesto be acceptable results# -heir standards are considered to be the?norm@#Results that the business should be aiming to achieve

With Similar Businesss$t is the most suitable form of comparison$t allows the business to compare against other competitors !&yerversus Bavid ones"Advantages-arget similar markets

Sell very similar products$t allows the business to compare market shareEective form of comparison as both businesses are operatingwithin the same economic conte(t and competitive environment

+imitations of Financial Reports

86 +ormali;ed earnings5 Relate to earnings specically to the day to day operations

of the business and not the sale of non5current assets i#e#property and e,uipment

5 Mhen reading the nancial statement observes need toknow one o events that may articially inGated abusinessDs revenue

56 !a"itali;ing e1"enses5 -he business records an e(pense as an asset on the

balance sheet rather than as an e(pense on the incomestatement

5 $s not an accurate representation of the nancial conditionof the business $t understates the e(penses andoverstates the prots as well as the assets of the business

5 E(amples: research and development developmente(penditure


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76 9aluing 0ssets5 -he issue of valuing intangibles !the name/reputation of

the business" is a dicult process5 Should assets be valued at their purchased price or their

valuation priceP

5 Should the business take into account how much the assethas depreciated byP


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4# E1ternal audits a businessDs nancial reports are lookedat by independent and speciali)ed audit accountants toguarantee their authenticity

Record Weeping

Reporting 'ractices

*lobal Financial &anagement

E1change rates All countries have their own currency

Mhen transactions occur on the global scale one currency

must be converted to another

-he oreign e1change mar2et!fore( or f(" determines theprice of one currency relative to another

E(change rates

-he oreign e1change ratethe ratio of one currency toanother

$t tells us how much a unit of one currency us worth in termsof another


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E#g# A73 N KS72#=2

Eects of currency Guctuations

*lobal FinanceMhen the Australian dollar depreciates Australians buy less fromoverseas#;ence we import less$t costs foreigners less to buy Australian dollar;ence we e(port moreMhen our dollar appreciates the value of the Australian dollar hasincreasedAs a result the Australian dollar is stronger and we can buy moreimportsSo it costs more to e(port

+ower the dollar the better

SummaryAs Australian dollar appreciates it becomes stronger and we canbuy more imports$t now costs foreigners more to buy AKB;ence we e(port lessMhen our dollar depreciates we become weakerwe importless and it costs foreigners less to buy the AKB

Interest ates *lobal nancial institutions now allow Australia businesses to

access/borrow funds from their organi)ations# -his means thatAustralian businesses can now access interest rates fromforeign banks if there rates are lower than Australiancompetitors#

-he downside is that the money is borrowed in the foreigncurrency

Fluctuations in the foreign currency could add to the level ofrepayments a business must

&ethods of $nternational 'ayment

-here are 6 basic methods of payment from which a business canselect:Advanced payment+etter of credit0lean paymentJill of e(change

0dvance Payment5 -he buyer agrees to prepare the item before it is received


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5 %nce the seller receives payment the item is then sent to thebuyer

Advantages5 -he business is guaranteed payment5 -he business does not over order on stock# $t can sell stock

that has a guaranteed sale !ust in -ime"Bisadvantages

5 From a buyerDs perspective there may be a delay in receivingthe product

5 -he product may not be sent5 Additional issues with damaged/lost property

!lean Payments5 -he buyer pays for a good once it has been received5 -he sender dispatches the item before payment has been

receivedAdvantages

5 -he buyer is guaranteed receipt of the product5 $f the product is faulty/damaged the buyer has greater

bargaining powerBisadvantages

5 -he business may not receive payment5 $t is dicult to determine who is at fault if the product is

lost/damaged

-he seller must also e(amine the buyers credit ratingability to

repay debt

Letter o !redit!Seller Jank Juyer"-he buyer makes use of the nancial institution to handle thetransaction once the f# l receives notication that the good haseither been sent or received then it will guarantee payment in theevent that the buyer does not follow through with this

3# -he item is purchased1# -he buyer contacts a bank to issue a letter of credit4# -his involves the bank contacting the seller

6# -he bank re,uests that it receives notication when the itemis sent or the item is received

8# %nce the bank receives conrmation it guarantees paymentof the good in the event that the buyer does not pay

Advantages5 *uaranteed 'ayment5 *uaranteed Receipt of the *oods5 &inimises possible disputes/issues

Bisadvantages5 $t costs the byer money to access the letter of credit


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Documents

Finance HSC notes