BUSINESS STUDIES- TOPIC THREE

FINANCE
Students learn to:
o 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

o 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

Students learn about:

o role of financial management

strategic role of financial management

Strategy: major tool adopted by a B to achieve its goals.
Strategic plan: strategies that B will use to achieve its goals (may cover up to 10
years). Encompasses long-term view of where the B is going, how it will get there
and a monitoring process to keep track of progress along the way.

B objectives: break B operations into achievable and manageable outcomes that can
be measured and evaluated.

Financial resources: resources in a B that have a monetary value
Financial management: the planning and monitoring of a Bs financial resources to
enable the B to achieve its financial goals.
Management examples: monitoring cash flows, paying debts, auditing
financial accounts, continuing to make profits for shareholders/owners.
Mismanagement problems: insufficient cash to pay suppliers, inadequate
capital for expansion, delays in accounts payable, possible B failure,
overstocking.

Assets: property/items/effects of a B (eg. tangible: premises, machinery) (eg.
intangible: patents, goodwill).

objectives of financial management profitability, growth, efficiency, liquidity,
solvency short-term and long-term

profitability

profitability: ability of a B to maximise its profits.
Satisfy owners/shareholders in short-term and ensure sustainability in long-term.

growth

growth: ability of B to increase in size in longer term
depends on ability to develop/use asset structure to increase sales, profits, market
share. Ensures long-term B sustainability.

efficiency

efficiency: ability of a B to use its resources effectively in ensuring financial
stability and profitability. (minimise costs, manage assetsmaximum profit)

liquidity

liquidity: extent to which a B can meet its financial commitments in short-term.
(pay debts as they fall due, cash to meet financial obligations or be able to quickly
convert current assets into cash)

solvency

solvency: extent to which B can meet its financial commitments in long-term.

short-term and long-term financial objectives

short-term: tactical (1-2 years), operational (day-to-day) plans of a B. reviewed
regularly to see if targets are met/resources being used to best advantage.
Long-term: strategic plans of B. determined for set time period (generally 5+ years).
Tend to be broad (eg- increasing profit/market share). Progress reviewed annually
to determine if changes needed.

interdependence with other key business functions

Each B function is not able to operate in isolation successfully. It relies on other B
functions to perform its role in achieving broader B goals.
o influences on financial management

financial decision making requires relevant information to be identified, collected
and analysed to determine an appropriate course of action.

internal sources of finance retained profits

Internal finance: comes from either B owners (equity, capital) or the outcome of B
activities (retained profits).
*Owners equity: funds contributed by owners/partners to establish/build the B.

Retained profits

Most common source of internal finance- retained earnings. Approximately 50% of
profits are retained to be reinvested.

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

External finance: funds provided by sources outside the B (banks, financial
institutions, government, suppliers).
External finance provided by creditors or lenders is known as debt finance
increased risk.

Debt:

short-term borrowing (overdraft, commercial bills, factoring)

Short-term borrowing: generally repaid after 1-2 years.

Bank overdraft: bank allows a B/individual to overdraw their account to an agreed
limit for a specified amount of time to help overcome contemporary cash shortfall.
(costs are minimal and interest rates are lower than other forms of borrowing).

Commercial bills: type of bill of exchange (loan) issued by institutions other than
banks.
*Bill of exchange: document ordering the payment of a certain amount of money at
some fixed future date.

Factoring: selling accounts receivable for a discounted price to a factoring/finance
company. (enables B to raise funds immediately- B receives up to 90% of AR within
48hours of submitting invoices to the factoring company).
*Factoring can be:
-with recourse: bad debts will still be the Bs responsibility.
-without recourse: B transfers responsibility for non-collection to factoring
company.

long-term borrowing (mortgage, debentures, unsecured notes, leasing)

Mortgage: loan secured by the property of the borrower/B. used to finance
property purchases (eg- new premises/factory/office).
The property cannot be sold/used as further security for borrowing until
mortgage repaid.

Debentures: issued by a company for a fixed rate of interest and for a fixed period
of time.
Usually not secured to a specific property, but through company asssets. On
maturing company pays back amount of debenture by buying back
debenture.

Unsecured note: a loan for a set period of time but is not backed by any collateral
assets.
Because not backed by assets, it presents most risk to lenders, thus attracts
higher interest rate.

Leasing: long-term source of borrowing for a B. it involves the payment of money
for the use of equipment that is owned by another party.

Advantages:
-enables B to borrow funds and use equipment without large capital outlay
required, tax deduction, payment usually includes
maintenance/insurance/finance costs, doesnt reduce control of ownership.

Lessor: owns and leases equipment for set period of time.
Lessee: pays for use of equipment.

Operating leases: assets leased for short periods, usually shorter than the
life of the asset. Owner carries out maintenance on asset. Operating leases
can be cancelled, often without penalty.
Financial leases: lessor purchases the asset on behalf of the lessee. Usually
leased for the life of the asset (usually 3-5 years). Lease repayments are fixed
(but cheaper than operating leases) and penalties are usually incurred for
cancellation of financial leases. (eg- plant, vehicles)

Equity:

Dividends: distribution of a companys profits (yearly or half-yearly) to
shareholders and is calculated as a number of cents per share.
Equity: finance (cash) raised by company by issuing shares. Two types:

ordinary shares (new issues, rights issues, placements, share purchase plans)

Purchasing ordinary shares means the purchaser becomes a part-owner of the
publically listed company and may receive dividends.
Types of ordinary shares:
-New issue: security that has been issued and sold for first time on public market
(aka. primary shares, new offerings)
-Rights issue: privilege granted to shareholders to buy new shares in the same
company.
-Placements: allotment of shares, debentures, so on, made directly from
company investors
-Share purchase Plan: offer to existing shareholders in a listed company to
purchase more shares in that company without brokerage fees (fee charged by an
agent/company to facilitate transactions between buyers and sellers) or at a
discounted price compared to market price.

private equity

Private shares (equity) in companies not listed on ASX.

financial institutions banks, investment banks, finance companies,
superannuation funds, life insurance companies, unit trusts and the
Australian Securities Exchange

banks

receive savings as deposits from individuals, businesses and governments and, in
turn, make investments and loans to borrowers.
Largest form of financial institution in Australia. Perform a large range of roles.
Supervised by the Reserve Bank of Australia (RBA).

investment banks

One of fastest growing sectors in Australias financial system.
Trade in money/securities/financial futures, arrange long-term finance for
company expansion, provide WC (working capital), arrange project finance,
operate unit trusts.

finance companies

Finance companies are intermediaries in financial markets. They provide loans
and lease finance to Bs and individuals (hire-purchase/personal/secured loans).
Raise capital through share issues (debentures).

superannuation funds

Grown rapidly in past 20 years due to tax incentives and compulsory
superannuation introduced by government.
Provide funds to corporate sector through investment of funds from super
contributions.

life insurance companies

Non-bank financial intermediaries that specialise in smaller commercial finance.
Regulated by Australian Prudential Regulation Authority (APRA)
Funds received in premiums (reserves) are invested in financial assets. Premiums
paid by investors provide compensation if something adverse happens (eg.
injury/death)

unit trusts

(aka. Mutual funds) take funds from a large number of small investors and invets
them in specific types of financial assets
Investments include: short-term money-market (cash management trusts), shares,
mortgages/property and public securities.

Australian Securities Exchange (ASX)

ASX: primary stock exchange group in Australia.
Provides: shares, futures, exchange traded options, warrants, interest rate
securities
Primary markets: deal with the new issue of debt instruments by the borrower of
funds
Secondary markets: deal with the purchase and sale of existing securities.

influence of government Australian Securities and Investments
Commission, company taxation

Australian Securities and Investments Commission (ASIC)

ASIC: independent statutory commission accountable to the commonwealth
parliament.
Enforces and administers to corporations act and protects consumers (in
investments, life/general insurance, super, banking excluding lending)
Aim: assisting to reduce fraud/unfair practices in financial markets/products
(ensure companies adhere to laws)

company taxation

Companies/corporations pay tax on profits.
Levied at flat rate of 30%

global market influences economic outlook, availability of funds, interest
rates

economic outlook

global economic outlook: projected changes to level of economic growth
throughout the world.
(eg) A positive outlook (increasing economy growth): more product/service
demand (^production^need for funds)

availability of funds

Availability of funds: ease with which a B can access funds (for borrowing) on
international financial markets.
Funds have conditions and rates which vary depending on: risk, demand, supply,
domestic economic conditions.

interest rates

Interest rates: cost of borrowing money.
Higher riskhigher interest rate
Traditionally, Australia has higher interest rates, thus B may be borrow OS- very
risky due to exchange rate movements (cheaper OS rates then quickly eliminated)

o 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 business
purpose

capital expenditure: what is spend on Bs non-current or fixed assets.
(used to generate revenue and ultimately returns to owners/shareholders)
planning processes: involve setting goals/objectives, determining strategies to
achieve them, identifying/evaluating alternative courses of action and choosing
best alternative for B.

financial needs

financial information must be collected before future plans made (eg- balance
sheets, income statements)
financial needs are determined by: B size, B cycle phase, future
growth/development plans, capacity to source finance, management skills

budgets

budgets: provide information in quantitative terms (facts/figures) about
requirements to achieve a particular purpose
can show: cash required for B plans, capital expenditure costs, estimated use/cost
of materials/inventory, number/cost of labour
Considerations in making budgets: past figures/trends, market share, price
proposals, plant capacity, external environment (eg- availability of materials)

Three types:
1. Operating budgets: relate to main B activities (eg- sales, production, materials,
labour, expenses, COGS).
2. Project budgets: relate to capital expenditure, R&D.
3. Financial budgets: relate to financial data of B, include: income statement, balance
sheet, cash flows.

record systems

Record systems: mechanisms employed by a B to ensure data is recorded and
information recorded by record systems in accurate, reliable, efficient, accessible.

financial risks

Financial risks: risk to a B of being unable to cover its financial obligations (cannot
meet financial needs bankruptcy)
To minimise financial risk, B must consider profits generated (sufficient to cover
debt)
Common financial problems: theft, fraud, item damage, record system errors.

financial controls

Financial controls: policies/procedures that ensure B plans will be achieved in
most efficient way.
(eg) clear authorisation/responsibility for B tasks, separation of duties, control of
cash (cash register, banking), protection of assets (locked buildings, registry of
assets), control of credit procedures (follow up overdue accounts, customer credit
checks).

debt and equity financing:

Debt finance: short/long-term borrowing from external sources by a B
Equity finance: internal sources of finance in B
Safe debt to equity ratio: 60% or more equity to remaining debt (to equal 100%)

advantages and disadvantages of each

Debt:

Advantages of debt Disadvantages of debt
Funds are usually readily
available
Increased risk if debt comes from financial institutions
because the interest, bank charges, government charges
and the principal have to be repaid
Increased funds should
lead to increased
earnings and profits
Security is required by the business
Tax deduction for
interest payments
Regular repayments have to be made
Lenders have first claim on any money if the business
ends in bankruptcy

Equity:

Advantages Disadvantages
Does not have to be repaid unless the
owner leaves the business
Lower profits and lower returns for the
owner
Cheaper than other sources of finance
as there are no interest payments
The expectation that the owner will have
about the return on investment (ROI)
The owners who have contributed the
equity retain control over how that
finance is used

Low gearing (use resources of the owner
and not external sources of finance)

Less risk for the business and the
owner


matching the terms and source of finance to business purpose

Determining the most appropriate funds is influenced by:

1. Terms of finance: must be suitable for B structure and funding purpose
2. Cost of each funding source and expected return.
3. B structure: (eg) smaller Bgenerally fewer finance options
4. Costs: (eg) set-up costs, interest rates.
5. Flexibility: variable sources of funds so borrowings can be payed of quicker,
increased/renewed as conditions change. (eg) overdrafts are flexible
6. Availability of finance: (eg) if B has low credit ratinghard to source funds
7. Level of control: maintained once borrowing funds. (eg) the need for securities
when borrowingrestrictions in further financing

monitoring and controlling cash flow statement, income statement, balance
sheet

three main financial controls used for monitoring:

cash flow statement

cash flow statement: indicates movement of cash receipts/payments resulting
from transactions over a period of time (links between income statement and
balance sheet)
identifies trends, useful predictor of change, assess B ability to manage cash (pay
financial commitments, sufficient funds for future expansion/change, obtain
finance from external sources if/when needed, pay dividends)
( ) are used to show cash payments ( - $)

income statement

income statement: shows operating results for period- revenue earned, expenses
incurred (shows resultant profit or loss)

balance sheet

Balance sheet: represents a Bs assets and liabilities at a particular point in time,
expressed in money terms- represents net worth of the B.
Assets: items of value owned by B.
Current assets: can be turned into cash within 12 months
Non-current assets: not expected to be turned into cash within 12 months
liabilities: claims by people other than owners against the assets (items of debt).
Represents what is owed by the B.
current liabilities: must be repaid within 12 months
non-current liabilities: must be met sometime after the next 12 months
Owners Equity (OE): represents the owners financial interest in the B (net worth
of B) (aka. Capital)
Indicates if: B has enough assets to cover debt, interest/money borrowed can be
repaid, assets of B are being used to maximise profits, B owners are making good
return on their investment.
The accounting equation: (forms basis of accounting process) shows relationship
between assets, liabilities and OE.
Assets = Liabilities + Owners equity
Owners equity = Assets Liabilities
Liabilities = Assets Owners equity

Balance sheet- comparative balance sheet- balance sheet showing equation (A=L+OE)


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

Financial ratios:

analysis: involves working the financial information into significant and acceptable
forms that make it more meaningful, and highlighting relationships between
different aspects of a B.
methods of analysis: calculations of figures, percentages, ratios

Three main types of analysis-

1. vertical analysis: compares figures within 1 financial year (eg- expressing
Gross Profit as a percentage of sales and comparing with debt-to-equity)
2. horizontal analysis: compares figures from different financial years (eg-
comparing 2011 and 2012)
3. trend analysis: compares figures for periods of 3-5 years.

Analysis of financial statements is usually aimed at: financial stability,
profitability, efficiency.

interpretation: making judgements and decisions using the data gathered from
analysis.

Ratio Formula Which
aspect of
financial
statement
What does analysis of
this ratio show about a
business?
Interpretations of ratio
results
Current
ratio

Liquidity Shows the short-term
financial stability of a
business (i.e. its ability
to meet its short-term
financial commitments)
It is generally accepted that a
ratio of 2:1 indicates a sound
financial position (i.e. a firm
should have double the
amount of assets to cover its
liabilities).
Debt to
equity
ratio

Gearing
(Solvency/
leverage)
Shows the extent to
which the firm is relying
on debt or outside
sources to finance the
business
The higher the ratio, the less
solvent the firm (i.e. the
higher the ratio of debt to
equity, the higher the
business risk).
Gross
profit
ratio

Profitability Shows the changes from
one accounting period
to another and indicates
the effectiveness of
planning policies
concerning pricing,
sales, discounts, the
valuation of stock etc.
The higher the ratio the
better.

If the ratio is low, alternative
suppliers may need to be
sourced and competitors
investigated.
Net profit
ratio

Profitability Net profit ratio
represents the profit or
return to the owners.
A firm will be aiming for a
high net profit ratio.

A low net profit ratio
indicates that expenses
should be examined to look
for possibility of reductions.
Return on
equity
ratio

Profitability Shows how effective the
funds contributed by
the owners have been in
generating profit and so
the return on
investment (ROI)
The higher the ratio or
percentage, the better the
return for the owner.
Expense
ratio
Efficiency Each of the categories
of expenses is
compared with sales.
The ratio indicates the
amount of sales that are
allocated to individual
expenses such as
selling, administration,
COGS and financial
expenses.
Expense ratios indicate day-
to-day efficiency of the
business. Expense ratios
need to be kept at a
reasonable level, and
management must monitor
each type of expense in
relation to sales.

Higher expense ratios may be
the result of poor
management.
Accounts
receivable
Efficiency Measures the
effectiveness of a firms
High turnover ratios indicate
the business has efficient
turnover
ratio
credit policy and how
efficiently it collects its
debt.
debt collection.

comparative ratio analysis:

Figures, percentages and ratios do not provide a complete picture for analysis. For
analysis to be meaningful, comparisons and benchmarks are needed (before
judgements can be made).
Ratios provide a snapshot at a particular point in time and must be used
carefully alongside other information. (eg- sales and stock may vary throughout
the yearfinancial information will vary)
It is also important to look at trends in financial information over past several
years.

B should also compare their figures:

Over different time periods, against standards (aka. Benchmarking- used as a
guide) and with similar businesses (aka. Inter-business comparisons)

limitations of financial reports normalised earnings, capitalising expenses,
valuing assets, timing issues, debt repayments, notes to the financial statements

Normalised
earnings
The process of removing one time/unusual influences from the
balance sheet to show the true earnings of a company. (eg) the removal
of a land sale, which would achieve a large capital gain.
Capitalising
expenses
The process of adding a capital expense to the balance sheet that is
regarded as an asset (will add to the value of the company, thus
recorded on the balance sheet) rather that an expense (an expense
would be recorded on the income statement).

(eg)R&D, development expenditure
Valuing assets The process of estimating the market value of assets or liabilities. The
valuations can be used in a variety of contexts for a business, including
investment analysis, mergers and acquisitions and financial reporting.

Two main methods used for valuing assets:
1. Discounted cash flow method: estimates the value of an asset based
on its expected future cash flows, which are discounted to the
present (i.e. the present value).
2. Guideline company method: determines the value of a firm by
observing the prices of similar companies (guideline companies) that
sold in the market.
Timing issues Financial reports cover activities over a period of time (usually one
year). Therefore, the businesss financial position may not be a true
representation if the business has experienced seasonal fluctuations.
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 the business had/has been recovering the debt
The capacity of the business or its debtor to repay the amount/s
owed (What if a debtor is close to bankruptcy and will not be able to
repay a debt?)
The adequacy of provisions and methods the business has for the
recovery of debt. (Larger businesses have the ability to outsource
debt recovery by hiring an agent to undertake this process but
smaller business may not have the resources to do the same as it is
costly and time consuming.)
What provision does the business have in place for doubtful debts
and how is this evident in the financial reports?
Have debt repayments been held over until another accounting
period therefore giving a false impression of the situation?
The recording of debt repayments on financial reports can be used
to distort the reality of the businesss status and this may be
undertaken to provide a more favourable overview of the business at
that point in time.
Notes to the
financial
statement
Report the details and additional information that are left out of the
main reporting documents, such as the balance sheet and income
statement. They contain important information (eg- accounting
methodologies used for recording and reporting transactions) that can
affect the bottom-line return expected from an investment in a
company.

ethical issues related to financial reports

Bs have ethical/legal responsibilities in relations to financial management
Laws relating to corporations include: responsibilities of directors and
requirements for disclosure for corporationsduty to act in good faith, exercise
power for purpose, exercise discretion responsibly/properly, avoid conflicting
interests.
ASX lists requirements in regards to law, disclosure and transparency (openness)
of all listed corporations (shows public shareholders)
Financial management decisions must reflect on Bs objectives (eg- ethical
considerations: valuing assets [inventories, accounts receivable]influence WC
level, thus short-term stability)

Audited accounts

Audit: independent check of the accuracy of financial records and accounting
procedures. (used to examine financial affairs).
Potential audit users: institutions, owners, shareholders, investors

Three types of audits:

1. Internal: conducted internally by employees to check accounting
procedures/accuracy of financial records.
2. Management: conducted to review the firms strategic plan and determine if
changes need to be made. (factors affecting management audit: HR,
production process, finance)
3. External: (requirement of Corporations Act 2002 (Cwlth). These financial
reports are investigated by independent/specialised audit accountants to
guarantee their authenticity. Auditor issues a statement indicating the firms
records/financial reports are accurate (the best of auditors knowledge)-
giving a true view of state of the affairs and that they comply with auditing
standards. (used to provide annual audit, but small B usually only use
external auditors when B for sale or to check against theft/fraud)

Internal/external audits guard against unnecessary waste, inefficient resource use,
misuse of funds, fraud and theft.

Record keeping
Proper financial records must be kept minimum 5 years.
Every transaction must be recorded. Some B are tempted not to record cash
transactions to, often, try and lower tax burden. But, Australian Tax Office (ATO)
regularly monitors B operations and if found the B will receive a hefty fine (excess
of what B believe they saved)- ruining B reputationalienate customers.

Goods and Services Tax (GST)
Tax is collected at every stage in the production of goods and services sold to the
public. Hence Bs have ethical/legal obligation to comply with GST reporting
requirements.

Reporting procedures
Accurate financial reports are necessary for taxation purposes and for
stakeholders.
Business Activity Statement (BAS: records a Bs claim for input tax credits and
accounts for GST. (All B are obliged to complete a BAS quarterly)

o financial management strategies

cash flow management cash flow statements distribution of payments,
discounts for early payment, factoring

cash flow statements

cash flow: movement of cash in/out of B over period of time.
Cash flow statement: provides important information regards firms ability to pay
debts on time. (identifies periods of short-falls/surpluses)

(eg) B inflows/outflows
Inflows Outflows
Sales
Accounts receivable
Commissions
Sales of assets
Rents
Interest (investments/loans,
etc.)
Dividends
Payments to suppliers raw materials/finished
goods, etc.
Interest on loans
Operating expenses wages/salaries, raw
materials/finished goods
Drawings
Purchase of assets
Loan repayments

Management is required to make sure payments are made/received with cash flow
problem/s

Management strategies:

distribution of payments
Involves distributing payments throughout the month/year/period so cash
shortfalls dont occur.

discounts for early payment

Offering creditors a discount for early payments (helps creditor- less money, helps
B- improves cash flow)

factoring

Selling of accounts receivable for a discounted price to a finance/factoring
company.

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

current assets: assets a B can expect to convert into cash with 12 months (cash,
AR)
working capital (WC): funds available for the short-term financial commitments of
B.
working capital management: determining the best mix of CA and CL needed to
achieved B objectives. (must be balance between CA and CL to ensure sufficient
funds to cover payments, more efficientmore profitable)
networking capital: difference between CA and CL (represents funds needed for
day-to-day operations of B to produce profits and provide cash for short-term
liquidity.
current liabilities: liabilities that must be repaid in short-term (overdraft, AP)

control of current assets (cash, receivables, inventories)

important for monitoring WC- must be sufficient to maintain liquidity and access
to credit (overdraft) to meet unexpected circumstances.

Cash:
ensures B can repay debts/loans/accounts in short-term, thus survives long-term.
Enables B to take advantage of investment opportunities (short-term money
market)
Cash reserves/marketable securities (or overdraft) can protect against sudden
cash shortages.

Receivables:
Receivables: sums of money to a B from customers whom B has supplied
goods/services. (Recorded as AR).
Manage receivables by: checking customers credit ratings, sending customers
statements, payment follow-ups, stipulating a reasonable period (usually 30 days)
for payment of accounts, putting policies in place for collecting bad debts (or
using a debt collectors agency).

control of current liabilities (payables, loans, overdrafts)

Involves being ablt to convert CA into cash to ensure liabilities are paid.

Payables
Payables: sums of money owed by B to other Bs from whom it has purchased
goods/services. Recorded in AP.
Leaving payments to last minute (if interest free) can lead to improved liquidity)
OR creditors may offer early payment discounts (B can take advantage)
Not paying before due date= charges

Loans
Need to be managed as there are costs for: establishment, interest rates, ongoing
charges.
Loans from different sources need to be compared to find best alternative.

Overdrafts
Convenient, relatively cheap form of short-term borrowing (enable B to cope with
contemporary cash shortfalls)
Banks require regular payments be made on overdrafts, may include account-
keeping/establishment fees and interest.

strategies (leasing, sale and lease back)

leasing
Leasing: hiring of an asset from another person/company who has purchased the
asset and retains ownership of it.
Frees up cash that can be used elsewhere in Bimproves WC
Tax deductable
Regular/fixed payments are made
Allows 100% financing

Sale and lease-back
Sale and lease-back: selling of an owned asset to a lessor and leasing the asset
back through fixed payments for a specified number of years.
Increased liquidity as cash from sale is used as WC

profitability management

Profitability management: involves the control of both the Bs costs and revenue.

cost controls

B decisions are influenced by costs
Costs associated with decisions need to be examined before implemented.

fixed and variable

Fixed cost: not dependent of level of B activity (paid regardless of what happens)
(eg) salaries, insurance, depreciation, lease.

Variable costs: change proportionately with level of operating activity in a B
(eg) materials and labour which are directly attributed to a particular product.

cost centres

Cost centres: articular areas/departments/sections of a B to which costs can be
directly attributed.
Direct costs: can be allocated to a particular product (variable costs)
Indirect costs: costs shared by more than one product.

expense minimisation

Profits can be weakened if expenses are high as they consume Bs valuable
resources.
Guidelines/policies should be established to encourage staff to minimise expenses
where possible.

revenue controls

Revenue: income earned for main activity of B.
Goods Bs revenue comes from sales, service bs comes from fees for professional
services or commission.

marketing objectives

Must be pitched at level of sales that will cover fixed and variable costs to result in
a profit.
Low-cost-volume profit analysis: determine level of revenue sufficient for a B to
cover its fixed and variable costs to break even
Changes to sales mix can affect revenue
(eg) pricing policiesaffect revenueaffect WC
Factors that affect pricing policies: costs associated with production, prices
charged by competition, short/long-term goals, image/quality of
good/service, governmental policies.

global financial management exchange rates interest rates methods of
international payment payment in advance, letter of credit, clean payment, bill
of exchange hedging derivatives

financial risks for global expansion are greater compared to domestic, thus risk-
taking is necessary.
There are controllable (generally internal factors) and uncontrollable influences
(mostly external- currency fluctuations, interest rates)

exchange rates

The value/price of each countrys currency- changing of one currency to another
Foreign exchange market (forex or fx): determines the price of one currency
relative to another.
Foreign exchange rates: ratio of one currency to another- tells how much one unit
of currency is worth in terms of another. (eg- AU$1=US$0.90)
Appreciation: upward movement of the AU$ (or any other currency) against
another currency).
Effects of currency fluctuations:
1. Currency appreciation: raises value of AUD in terms of foreign currencies.
(AUD buys more currencyAustralias export prices rise/import prices fall)
2. Currency depreciation: (opposite impact), but improves competitiveness of
Australias exporting Bs.
Thus, exchange rates impact on B revenue and profitability.

interest rates

Traditionally, Australia has higher interest rates, thus B may be borrow OS- very
risky due to exchange rate movements (cheaper OS rates then quickly eliminated)

methods of international payment

Main methods of international payments:
1. Payment in advance: allows exporter to receive payment and then
arrange for goods to be sent.
2. Letter of credit: a commitment by importers bank, promising to pay
the exporter a specified amount when documents proving shipment of
goods are presented.
3. Clean payment: occurs when the payment is sent to, but not received
by, the exporter before goods are transported.
4. Bill of exchange: document drawn up by the exporter demanding
payment from the importer at a specified time.

hedging

Hedging: the process of minimising the risk of currency fluctuations.

Natural hedging: B adopting strategies to eliminate/minimise the risk of foreign
exchange exposure (eg- establishing offshore subsidies)
Spot exchange: when two parties agree to exchange currency and finalise a deal
immediately.
Spot exchange rate: the value of one currency in another currency on a particular
day.

Derivatives
Derivatives: simple financial instruments that may be used to lessen the exporting
risks associated with currency fluctuations.

Three main derivatives:

1. Forward exchange contract: contract to exchange one currency for another at an
agreed exchange rate on future date (usually after 30, 90 or 180)
2. Option: gives the buyer (option holder) the right (not obligation) to buy/sell
foreign currency at some time in future.
3. Currency swap: an agreement to exchange currency in the spot market with an
agreement to reverse the transaction in the future.