Finance

Financial management
Refers to the long term
Ensures a business achieves its goals and objectives
Strategic role of financial management involves a key number
of areas:
o Achieving long term profitability
o Achieving increased wealth for investors
o Achieving great efficiencies (cost reduction) within the
business. Increased efficiencies reduce costs. A
reduction in costs leads to increase in profit
Objectives of Financial Management
Profitability is the ability to maximize profits
Growth the ability to increase in size in the longer term
Efficiency cost minimization
Liquidity the ability to repay short term debt
Solvency the ability to repay long term debt e.g. mortgage
Profitability
The process of maximizing revenue (sales) and minimizing
expense
Maximize:
New promotional campaigns
Growth strategies such as the release of products/stores
Minimizing
Outsourcing e.g. products are made in other countries
Change in products
In 2013-14 Apple achieved a profit of $40 billion
- I-pad air/I-pad mini
- Released an I-phone 5s/5c
- 30% of the price of all apps go directly to Apple
Minimizing expenses
- Production based in Fox-con
- Manufacturing in Asia
- Minimal expenditure on marketing, customer loyalty and
strong brand awareness
Efficiency
Minimizing expenses
Achieving the lowest possible product cost
Reducing expenses

Strategies
Outsourcing production
Source cheaper supplies
How Apple achieves efficiency:
- Outsourcing production to Fox-con
- Achieve production costs between 45 75% of sale price
- I-pad costs Apple $400 to produce
- I-phone costs apple $210 to produce
- Achieves greater profit margins
- 85% of components are sourced in Asia, lowering distribution
costs
Growth
Is the ability of the business to increase in size in the
longer term
Increase in profitability
Increase in sales
Increase in market share (% of customers a business has
compared to its competitors)
Since 2004, Apple have released what is known as the I range
This includes:
o I-pad, I-phone, I-pod
o The products are all connected to each other
o In honored by I cloud
Criticism of Apples growth is the failure to release a low cost smart
phone. This has provided a competitive advantage for Samsungseven different not phones across a range of price categories
Solvency
Ability to repay long term debt
Does the business have the ability to repay long term financial
commitments (>12 months)
Gearing is used to measure solvency measures the
percentage of the assets of the business which are funded by
external sources indicates the businesss reliance on
external finance
If the business is unable to repay its non-current liabilities, it is
said to be insolvent
The assets of the business are then sold to repay creditors
Changes in interest rates, changing consumer preferences and
economic conditions
-

Apples debt sits at $8.36 billion

This compares to an annual profit of approx. $40 billion

Their most recent purchase was Dr Dre for $3 billion
It is a business that relies on debt
Measured by the gearing ratio

Liquidity
Ability of the business to repay short-term debt (current
liability) (< 12 months)
Includes utilities such as electricity, water, wages, supplies,
insurance
The importance of cash is significant, as expenses are paid
with cash
Need to have sufficient cash flow to meet financial obligations
& to convert current assets into cash quickly
For every $4 in current liabilities, the business has $7 to satisfy its
short term debt
Short term and Long term Financial Objectives
Short term
Strong cash flow to cover short term expenses
Maintain or increase profitability
Increase sales
Long term
Increased Market share
Cost savings/efficiency
Reduce long-term debt
Increase profitability
Interdependence with other key business functions
Human Resources
Influences the level of remuneration (income) paid to employees
Marketing
Finance allocates marketing a budget to work with
Marketing generates sales, which translate into profitability for
the business
Operations
The cost of production
Consider cost efficiency versus quality
E.g. Aldi pay for bags, dont have shelves
Influences on financial Management
Sources of finance (type of money a business can access)

All business require some sort of finance:

o Purchasing equipment
o To fund operations
o Purchase inventory
o To cover expenses

Internal Sources of finance:

Comes from the businesss owners (equity or capital) or from
the outcomes of business activities (retained profit)
Does not involve debt
Does not include borrowing
Retained Profit
Profit that is re-invested into the business
It is being retained (kept) for business use
The alternative is that this profit is distributed for the personal
use of its owners
Not relying on debt (less reliance on interest rate changes,
benefits solvency)
The funds are existent the business does not have to seek
additional investors
Restricts the owners personal use of the money
The amount of retained profit may be insufficient for the needs
for the business
Capital
- The funds invested by existing owners within the business
- Form of owners equity
The funds do not need to be repaid
Could give existing investors an opportunity to increase their
ownership within the business
Investors may loose their capital
The ownership structure could change as some investors
become more significant (because of their new investment)
than others
External Sources of Finance
External finance Funds that are accessible from sources outside
the business e.g. banks, financial institutions, government
Liabilities
- Form of borrowing funds
- Current <12 months

Non-current >12 months

Short Term borrowing (FOC)

Overdrafts, commercial bills and factoring
To finance temporary shortages in cash flow or working capital
<12 months

Overdrafts
A bank allows a business to overdraw its account to an agreed
limit and for a specified time
(This allows the business to withdraw more funds that actually
has in its account)
Assist businesss with short term liquidity problems
It allows a bank balance to go into negative territory up to a
particular amount of money
Advantages
Allows short-term expenses to be covered
Commercial Bills
Short term/ current liability
Sourced from non-bank lenders these include investment
banks/merchant banks and finance companies
*Banks/merchant banks that specialize in business finance/funding
*Finance companies small companies that specialize in leading to
high/risk consumers/businesses
- Lending time is between 30 to 180 days
- Usually over 100,000
- The lending time and repayment is determined between the
borrower and the lender
Factoring
Selling debt to gain immediate access to cash
Process of selling money to the business to gain immediate
access to cash
The business sells the right to collect the money to another
organization
That organization now assumes responsibility for collecting
the money owed
The money owed is sold at a discount
The business accesses cash and now the factoring company
assumes responsibility for collecting debt
Advantages

Gaining immediate access to cash the business improves its

cash flow and gearing
Disadvantages
Selling the debt causes the business to reduce the value of
the money owed
Greater risk than other sources of short term borrowing e.g.
overdrafts because of the likelihood of unpaid debts

Long term Debt/Non-current Liabilities

>12 months
Secured or unsecured
Used to finance real estate, plant (factory/office) and
equipment
Mortgage
Non-current liability
Is a loan secured by the property of the borrower (business)
The asset can be sold by the financial institution if the
mortgage is not repaid
The 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
Debentures
The organization seeks from the public/investment books,
smaller amounts of money
It is easier to raise money by borrowing less from more than
more from less
Is a promise made by a company to repay money that is lent
to a business
Investor lends money to a company the company issues a
debenture with a promise to make regular interest payments
for a fixed rate and period of time
The amount of profit has no affect on interest rates
debentures have a fixed rate of interest
Unsecured notes
Is a loan from investors for a set period of time
Are not secured against the businesss assets high risk to
investors
Leasing
Is where the business chooses not to purchase the asset

Involves the payment of money for the use of equipment that

is owned by another party
Advantages
Avoids an upfront payment to purchase the asset
Allows the business to access technology with updated
features this technology is usually outdated within a few
years
Disadvantages
The business does not own the asset, any damage incurred
must be covered by the business itself
It forces the business into constantly devoting funds to the use
of this asset
There are two types of leasing, operating and financial
Operating Leasing
Assets leased for short periods of time
The owner carries out maintenance of the asset
Leases can be cancelled without penalty
Financial leasing
Usually for the life of the asset
Repayments are fixed for the economic life of the asset 3-5
years
E.g. plant, vehicles, furniture
Cheaper than leasing them as operating leases
Usually penaltys for cancellation
Equity
- Refers to the finance raised by a company through inviting
new owners e.g. issuing shares to the public through ASX
- Funds invested into the business by new owners external
source of finance
Ordinary Shares
- Shares refer to the portion of ownership of the business
- When shareholders purchase shares in a company, they are
providing a source of finance (equity) for the business
- A business has a set number of shares
- Shares are valued and traded on the Australian stock
exchange (ASX)
- The number of shares X the value of each share = market
value of the business
- Fixed number of shares/unlimited number of investors
New issue
- When a company issues shares to the public for the first time
known as an Initial public offering (IPO)

As new shareholders enter the business, the structure of

ownership changes

Right Issue
- New shares are released but preference is given to existing
shareholders
- Occurs after IPO
- Provides existing shareholders with the opportunity to
purchase more shares
Placements *
- Allotment of shares made directly from company to investors
- Shares are offered at a discount to their current trading price
to special institutions or investors
- This discount is intended to persuade specific investors to
invest in their company
Share purchase plan *
- An offer to existing shareholders in a listed company to
purchase more shares in that company without brokerage fees
- Shares can also be offered for a discounted price
Private Equity
- Is the money invested in a private company that is not listed
on the ASX
- The aim of the company is to raise capital to finance future
expansion/investment
Financial Institutions
The main financial institutions are:
Banks
Investment banks
Finance companies
Life insurance companies
Superannuation funds
Unit trusts
ASX
Financial Institutions
- Collect funds and invest them in financial assets
- They provide financial services and their focus is dealing with
financial transactions e.g. investments, loans
Banks
- Accept deposits from the general public and provide funds for
loans
- Most important finance for a business
- They also provide services like legal and taxation advice and
risk management

Investment Banks
- They provide services in borrowing and lending, primarily to
the business sector
- Can provide a wide variety of loans which can be customized
to suit a businesss needs
Investment banks:
- Trade in money, securities and financial futures
- Arrange long term finance
- Provide working capital
- Arrange project finance
- Advise on mergers and takeovers
- Underwrite corporate and semi-government issues of
securities
- Operate unit trusts including cash management trusts,
property trusts and equity trusts
- Arrange overseas finance
Finance Companies
- Are non-bank financial intermediaries that specialize in
commercial finance
- Mainly provide short-term and medium-term loans to a
business through customer hire purchase loans, personal
loans and secured loans
- Main providers for lease finance
- Also raise money through share issues
- Can provide businesses with quick access to funds, however
interest is usually higher
Life Insurance Companies
- Provide insurance cover in the event of death
Superannuation
- Is a place where you put your money and the fund manager
invests the individuals money for investment return
Unit Trusts
- An organisation takes money from small investors and invests
in stocks and shares for them under a trust deed
- The investment is in the form of shares (units) in the trust
Australian Security Exchange
- Stock market
- Where shares are bought and sold
- Act as a market place
Primary Market
- This is where shares are traded for the first time

Shares have been sold in the company and the business is the
maturing into a public company
Purchased through IPO (initially public offering) where the
company sell shares to the public aka float
Accessing the shares at possibly discounted price as they
enter the secondary market the price of the share may
eventually increase

Secondary Market
- The purchase and sale of existing shares
- An existing share is one that has been traded on the ASX
before
- It is not the first tie this stock has been traded
Influence Of Government
This examines the extent to which the levels of government
influence financial management of business within Australia
AUSTRALIAN SECURITIES INVESTMENT COMISSION (ASIC)

Relates to all Australian businesses registered as companies

These companies can either be public or private companies
All insurance banking and financial organizations operating in
Australia
Require companies to provide financial reports and that the
process of calculating data in these reports is correct. This
process is known as auditing. The reports are independently
reviewed by an external organisation
These reports must then be submitted to ASIC
Seeks to regulate (control) the process of regulating equity
funds in a business. This involves the release of a prospectus
that outlines the strengths of the business and possible
threats affecting its profitability. This occurs only when a
business is changing from a private company to a public
company.
Provide license to all organisations providing financial advice
or lending in Australia

The aim of ASIC is to assist in reducing fraud and unfair practices

in financial markets and products
Ensure that companies adhere to the law, collect information
about companies and make it available to the public
Includes financial info that companies must disclose in their
annual report
Company Taxation

All private and public companies in Australia must pay a tax

rate of 30%. It is a flat rate and does not vary with profit levels
Income tax increases as the income of an individual also
increases
Increases businesses profitability, promotes increased
investment and greater spending/ employment
To encourage new businesses to emerge act as a financial
incentive for entrepreneurs to enter the market
Global market influences
Global Market Influences
Global market influences on financial management include
o Economic Outlook
o Availability of funds
o Interest rates
These influences are part of the external business
environment cannot be controlled by the business
Economic Outlook
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, North America
Impact upon the profitability of business operating in the
recessions
Australian businesses operating in Asia have benefited the
Asia is the strongest globally
Slow demand in north America and Europe could affect
lending demand by Australian businesses
Availability of funds
Refers to the ease in which a business can access funds on
the international financial markets
Some regions are likely to be access easier than others
Interest
This is the cost of borrowing funds
NOTE: interest rates are an expense and hence will affect
financial efficiency of the business together with net
profitability
Processes of Financial Management
Planning and Implementing
1. Determining financial needs

What are the goals of the business in both the short and long
term
Must consider projected revenue and projected expenses
Does the business have sufficient funds to achieve these goals
Ability to satisfy debt obligations
Existing profitability
Does the business have sufficient funds to fund
o Growth and development (release of new products)
o Expand locations
o Research and development
If the business does acquire additional funds
Does it have a long term ability to repay this debt
The business must also consider
o Future economic outlook
o Changing interest rates
o Changing consumer tastes and preference

2. Developing Budgets
A plan used to estimate revenue, expenses and cash flow over
a period of time
The Types of Budgets
Operating Budget
Relates to the expected revenue and expenditure of a business in
relation to its day to day operations
Includes sale revenue, and expenses such as wages, utilities and
rent
Project Budget
Relate to capital expenditure, and research and development
Financial Budget
Relate to financial data of a business and include the budgeted
income statement, balance sheet and cash flows
Record Systems
Is the process by which financial info is collated and recorded
Generally prepared by accountants
Often involves the use of financial budgeting software
3. Identifying Financial Risks
Financial Risks
Is the risk to a business of being unable to cover its financial
obligations e.g. debts that a business incurs through borrowing
If the business is financed from borrowings there is a higher risk

 To minimize financial risk, businesses must consider the amount

of profit they will generate
Profit must me sufficient to cover debt and
Need to consider the liquidity of assets
Does the business have the loan capacity to fund its debt?
Predicted revenue
Future economic conditions
Changing consumer preferences
Interest rate movements
Is the investment worth the risk?
Financial Controls
Policies and procedures that ensure that the plans of a business
will be achieved in the most efficient way
Common policies and procedures:
Separation of duties e.g. one person responsible for ordering and
another for receiving inventory
Rotation of duties e.g. staff are skilled in a number of areas
Protection of assets e.g. business are kept locked, security
surveillance systems are installed
Control of credit procedures e.g. following up overdue accounts
Debt and Equity Financing
Debt finance
- Funds that are sourced from external sources
- Must be repaid
Current Liabilities (debt that must be repaid within 12 months)
E.g. Credit card, Over draft, Commercial Bill, accounts payable
(money that the business owes to others), trade credit (when the
business owes money to its suppliers)
Non Current Liabilities (form of debt that is generally in a time
period longer than 12 months)
E.g. Mortgagae, debentures, unsecured notes, Leasing
Advantages
- Interest is recorded as an expense. Increased levels of interest
add to the level of expenses profitability then falls less
tax is paid
- Negotiate interest rates/ frequency of payments meet the
specific needs of the business
- Will not decrease ownership in the business
- Simple to acquire
- If the business cant pay long term debt (insolvency)
(advantage to lender) Creditor who has first right to seize
assets

Disadvantages
- Expensive interest must be paid
- Can be high risk if a business borrows money from financial
institutions because interest, bank and government charges,
may increase
- Regular repayments have to be made
- Increase responsibility on the owner of the business. It is not
the responsibility of the employees to manage financial
obligations
Equity Finance
- Funds invested by either existing or new owners
Retained profits
Capital (shares)
Advantages
- No obligation to repay the money
- Less risk for the business and owner
- No interest charges the savings on interest allows the
business to have increased cash
- Cash flow generated can be used for investment and
expansion
Disadvantages
- No tax deductions
- You are opening up your business to new shareholders
- Proportion of the profits for to additional new owners
- New investors often expect improved growth & performance
- Ownership is diluted i.e. the current owners will have less
control
Matching and controlling
Matching principle- Involves using the appropriate finance for
purchasing an asset
Short-term finance should be used to purchase short term assets
e.g. inventory
Long term finance should be used for long-term assets e.g.
mortgage loan
Monitoring and Controlling
The main financial controls used for monitoring are:
1. Cash Flow statements
2. Income Statements
3. Balance sheets

Cash Flow statements

Indicates the cash balance position at the end of an

accounting period e.g. at the end of the month

Shows us:
Cash receipts (Money coming into the business)
Cash payments (Money leaving the business)
The cash flow for each month into the future can be
estimated this is a Cash Flow forecast
Cash Flow management
Cash flow statements
Calculations
Opening or closing balances
The closing balance of one month is always to opening balance of
the next
Only cash transactions
Does not involve credit
Distribution of Payments
Payments made by the business are spread over a period of
time
The expenses are not paid in a lump sum rather they are paid
in installments
The expenses are spread out to manage cash flow
This could include payment by the month
It ensures that the cash of a business is not used to cover
large scale expenses at one point in time
Payments are spread over a period of time
Payments are normally smaller amounts of money
Discounts for early payments
The business offers discounts to customers for making early
payments
Encourages payments to be made on time
It promotes regular cash flow for the business
Factoring
The process of selling debt
Selling the collection of debt
In return for cash payment, the business allows a third party
to assume responsibility of collecting debt

Advantages
Instant cash
Disadvantages
Reduction in profit as the business does not receive the full
amount of debt
2. Income Statement
Indicates the level of Profit (or loss) for a business for a
particular period
Indicates level of sales, gross profit and net profit of the
business
Shows us:
How much the business sold
How much it cost to sell
Profits made
Important terms in a revenue statement
Sales Total value of goods sold
Closing Stock Value of stock at the end of the accounting period
Cost of goods Sold (COGS) Costs the business incurred in order to
sell products to customers
Gross profit The amount of profit calculated by subtracting the
cost of goods sold from the total sales revenue
Net profit The amount of final profit calculated by subtracting the
cost of expenses in running the business from the total gross profit
Important Calculations for the Revenue Statement
GROSS PROFIT = Sales Revenue COGS
NET PROFIT = Gross Profit expenses
COGS = Opening stock + purchases closing stock
3. Balance Sheet
Shows the net worth (total value) of a business on a particular
day usually the last day of the financial year i.e. 30 June
Net worth is the value of the Owners equity or the value of
the owners (shareholders) investment in the business
Indicates the assets and debts of a business
Is important when a business wants to borrow money or a
business is being sold
Accounting Equation

Owners Equity = Assets - Liabilities

The net worth of

the business if it
were to be sold

Financial Ratios
1. Liquidity Ratio
Liquidity Ratio
- Also known as the current ratio
- Also known as the working capital ratio
What does this ratio measure?
- The ability of the business to repay short term debt (current
liabilities)
- Does the business have significant current assets to repay
current liabilities
- There is emphasis on current assets as the assets of the
business could be turned into cash
- By turning these assets into cash, the business is able to pay its
current liabilities
FORMULA: Expressed as a ratio
Current Assets

Current Ratio = Current Liabilities

For example: Current assets = $50,000
Current liabilities = $30,000
5:3
If every $3 in current liabilities, the business has $5 in current assets
Working Capital
The dollar value of current assets remaining once all current
liabilities have been paid
e.g. Working acital = $60,000 - $30,000
= $30,000
-

A ratio of 2:1 indicates a sound position. That is, a business

should have double the amount of assets to cover its liabilities
Anything below 1 is dangerous

However, an acceptable ratio will also depend on factors such

as the type of firm, how other firms in the industry are operating
and external influences

Working Capital = Current AsesstsCurrent Liabilities

The dollar value of current assets remaining once all current
liabilities have been paid
Example: Working capital = $60,000 - $30,000
= $30,000
Working Capital (liquidity) management
Control of current assets
Cash
Offer incentives for customers to pay for stock in cash. This could
include discounts for cash payments
Factor debts provides immediate access to cash
Sale and lease back a business sets a non-current asset
(building). This generates cash. The asset is then leased back from
the new owner. Excess cash can then be used to repay debt or reinvest into the business.
Accounts Receivable (money owed to the business)
1. Charge interest for the payments
2. Factoring
3. Offering Discounts for early payments. This payment is in the
form of cash
4. Reduce credit terms limit the availability of credit to
supplies and restrict the term (amount of time) a customer
has to repay the business
Inventory
1. JIT (Just in Time) The stock arrives as the business requires
its use

Reduce storage costs

Perishable Products are fresh
Delays in transportation
There may be insufficient volumes of stock arriving

2. Promotions to Clear stock that may not be selling

Clears excess stock
Reduction in price = reduction in profits for the business
Control of current liabilities

Accounts Payable money that are owed to suppliers of the

business. The business has purchased a supply and is given a
specific time period to pay for its costs. It could also include
payments owed to cover such costs as electricity and insurance
Increase cash payments and rely less on accounts payable
Ask for discounts if the account is paid on time
Ask for discounts if cash is offered
Take advantage of suppliers that offer extended credit terms
(allow the business a great amount of time to repau)
Overdraft additional funds that a business can access from a
financial institution once its balance reaches zero

Minimise its use because of interest charges

Use on overdraft should the rate be less than a credit card
Pay the over draft as early as possible
Seek low cost alternative over-draft suppliers

Loans Short-term loans by the business

Pay installments
Pay before the due dates (avoids high interest charges)
Seek alternative finance
Negotiate improved terms (an extension on the loan or lower
rate)

Strategies
1. Leasing
The business accesses on asset through regular payments
At the end of the lease, the item is returned
The business who is paying to lease the asset does not assume
ownership at the end of the lease
Allows products to be updated regularly and take advantage
of new innovations
It allows the business to access the product without upfront
payments
Is identified as expense reduces profitability Less tax
2. Sale and Lease back
A non-current asset is sold and then released back to the original
owner
Provides a substantial amount of cash
Improves liquidity of the business
2. Gearing
Indication of solvency (ability to repay long term debt)

The proportion of assets financed from debt compared to the

proportion of assets through equity
The ideal result is 1:1, For every $1 in debt, there is $1 in
equity
The greater the proportion of assets financed through debt
indicates that the business is more highly geared
The degree of gearing depends on the type of industry and
management of the business
The more highly geared the business, the greater the risk for
the business but the greater potential profit

FORMULA
Debt to Equity =

Total Liabilties
Total Equity

100
1

Example:
Total Liabilities: $100,000
Total Equity: $150,000
100,000 100

=67
150,000
1
Therefore for every 67cents the business has in total debt, there is
$1 in owners equity
Example:
Assets = $300,000
Liabilities = $180,000 equity = $300,000 - $180,000
= $120,000
Debt
180,000
100=
=150
Equity
120,000
Therefore, for every $1.50 in debt, there is $1 in equity
-

If a business has a higher debt ratio than equity this could pose
some problems
These include
- Interest rates
- Changing economic conditions consumer spending patterns
- Action of competitors
- Investors may be less attracted to the firm as higher debt
indicates greater financial risk
Can impact on the ability to repay debt
If a business has a lower debt ratio than equity this may result in:

Reduced debt within the business (the business becomes less

susceptible to stocks. (increased interest rates, decreased
spending)
Increased levels of debt allow for growth e.g. expansion,
acquisition, refurbishments increased profitability

Strategies
Lower debt and increase input on equity funds
Measures to eliminate the immediate debts of the business
Profitability Ratios
1. Gross Profit
2. Net Profit Ratio
3. Return on Equity Ratio
These ratios are not known by any other name
Gross Profit Ratio
- For every $1 in sales, the percentage of Gross profit business
makes on selling a good
- Gross Profit (is the difference between how much the business
buys the good for and how much it sells the good)
FORMULA
Gross Profit
Sales
E.g.
67,000
100=67
100,000
Therefore, For every $1 in sales, the business has achieved a GP of
67 cents
Net Profit Ratio (NPR)
Net Profit
x 100
Sales
Net Profit = Gross Profit expenses

Return on Equity Ratio (ROE)

Capital + Retained Profits
FORMULA
Net Profit
100
Owners Equity
-

Answer is always expressed as a percentage

ROE measures the financial return an investor receives from
investing their own money into a business.
The higher the percentage, the better result
The investor is receiving a greater financial return

What information do we need?

1. Net Profit Return statement/ Profit = Loss statement
2. Owners equity Balance sheet
What is considered to be a good return?
- A comparison against the return of competitor

A comparison against other forms of investment (shares, bank

deposit, property)

For every $1 in owners equity, the investor receives a financial

return of (formula)

Profitability Management
Involves the control of both the businesss costs and its revenue
Cost Controls
This comprises of variable and fixed costs
Fixed Costs
- Fixed costs do not change when the level of activity changes
they are paid regardless of what happens in a business
E.g. rent.
Source
Source
Source

Insurance and fixed interest loans

less expensive location
alternative insurance providers
funds from low-cost financial institution

Variable Costs
- Costs that change as the level of production changes
E.g. Utilities (phone, electricity), stock, supplies, staff/wages
Reduce utilities
Seek alternative utility providers
Access less expensive costs/suppliers Low quality products?
Reduce wages most popular strategy used --> Reduced
customer service
-

Reduce the number of full-time staff and hiring casual staff

(avoid on-costs; sick leave, carers leave, holiday pay, long
service costs)
Reduce stock Purchases and use JIT. The stock arrives just as it
is needed: reduce wastage or less need for warehousing
Economies of sale (bulk purchasing)

Cost centres

Costs can be associated/identified with a specific area of the

business
Research and Development
Marketing
Stock purchases
Direct Costs
- These costs can be associated with specific areas of the
business
Examples:
Wages of staff
Marketing budget
Research and development
Indirect Costs
- These costs cannot be associated directly with a specific area
of a business
- Areas of the business that are shared amongst different groups
within the business
- Allocating costs is more difficult
Examples:
Common staff areas
Administration
- To reduce direct costs, the business must determine the
benefit that debt brings to the business
To make money, you must spend more
The cost of debt may be higher but it actually generates a
significant return for the business
Benefits: Profitability/sales, product development, customer
feedback
-

To reduce indirect costs, the business must consider the

support these areas provide to other areas of the business. By
reducing this support how do other functions of the business
operate?

Expense Minimisation
Wages, electricity, rent, insurance
Revenue Controls
- Revenue is also known as sales
- Revenue is the income generated for a business from selling
products
Marketing Objectives

Consider the cost of implementing a marketing plan versus the

projected benefit that the plan could deliver to the business
Marketing strategies and objectives should lead to an increase
in sales and hence increase revenue

1. Product
Re-brand the product (target market)
Produce extensions new flavoured coke
New products
2. Promotion
Adopt new means such as online methods
Celebrity endorsements
Sales promotion
3. Price
Lower price (may generate more sales) Loses prestige
perception of lower quality
Higher price (better quality/prestigious) restrict the ability of
consumer to purchase the item
Factors that influence pricing include:
- Production costs
- Price charged by competition
- Short and long term goals
- The image or quality consumers associate with the good or
service
- Government policies
4. Place
Increase the availability of the product across all stores
Efficiency
Is the ability of the business to use its resources effectively to
ensure financial stability and profitability of the company
The greater the efficiency the greater the profit and stability
Expense Ratio
- Also known as Accounts receivable ratio
FORMULA:
Expenses 100

Sales
1
The proportion of expenses of expenses a business has for every $1
in sales (For every $1 in sales, how much is devoted to expenses?)

The lower the result, the better for the business. The business can
achieve more sales by lowering expenses.
- Management uses this ratio to determine where the highest
expenses are from and whether the ratio has increased or
decreased
- E.g. a decline in financial expenses may be the result of lower
interest rates or less debt being used by the business
Example 1:
Expenses = $5000
Revenue = $15,000
Expenses 100

=
Sales
1
5000 100
=
15,000
1
For $1 in sales, the business has expenses of 33 cents
Example 2:
Sales = $100,000
GP = $70,000
NP = $20,000
Expenses 100

Sales
1
Gross profit Net profit = Expenses
= $70,000 - $20,000 = $50,000
50,000
100
=
100,000
= 50%
Expense Ratio =

Therefore, for every $1 in sales, the business has expenses of 50

cents
Example 3
NPR = 14%
GPR = 64%
Expenses Ratio = ?
Solution
Expenses = Gross profit net profit

ER = GPR NPR
= 64% - 14%
= 50%
Sales
450,000
=
Accounts receievable 170,000
Strategies to Improve Efficiency achieving the lowest possible
product cost
Monitor cost centres can be associated with a specific area
of the business
Outsourcing production
Source cheaper supplies
Accounts Receivable
- How often a business is paid its accounts receivable
- How often a business is paid money owing to it
FORMULA:
Sales
Accounts Receivable
1.
2.
3.
4.
5.
6.

Identify Sales
Identify Accounts receivable
Use formula
With the result, divide this by 365
This tells you the amount
This tells you how many days on average the business is paid

Example 1:
Sales = 100,000
Accounts receivable = 40,000
=

100,000
40,000

= 2.5
On average, the business receives cash payment for money owing
2.5 times per year.
365
=146 days
2.5

On average, the business is paid every 146 days. The lower the
result the better. Ideally between 30-60 days Money is coming in
regularly which is needed for expenses e.g. wages, rent etc.
Example 2:
Sales = $40,000
Accounts receivable = $150,000
Sales
40,000
=
Accounts Receiveable 150,000
= 2.66 times per year
=

365
=136.875
2.6

Example 3:
Sales: $450,000
Accounts receivable: $170,000
Sales
450,000
=
Accounts receievable 170,000
2.64per year
365
=every 137.8 days
2.64 ..
The lower the result, the more efficient the business.
Strategies to improve results
Careful in granting credit and monitoring accounts
Offering discounts for early payments and interest charges for
late payments encourage on time payments
Using outside credit facilities such as bank card or Visa card
may reduce returns to the business as costs are incurred, but
there will be a reduction in credit risk
Factoring
Comparative Ratio Analysis
Ratio analysis provides a business with key information on
liquidity, efficiency, profitability and solvency.
This in formation can be used to provide a comparison of the
performance of the business against industry standards, other
competitors and past years.

By comparing results, the business is better able to gain an

induction of how it is performing
Over Different Time Periods
The results should be compared over a period of time
It provides a more accurate indication of the overall performance
of the business
Allows the business to compare what time period the results
occurred
(Improved economic conditions, natural disasters, changing
consumer tastes and preferences)

Against Standards
It is also important to compare against what the industry believes
to be acceptable results. Their standards are considered to be the
norm.
Results that the business should be aiming to achieve
With Similar Businesss
It is the most suitable form of comparison
It allows the business to compare against other competitors (Myer
versus David Jones)
Advantages
Target similar markets
Sell very similar products
It allows the business to compare market share
Effective form of comparison as both businesses are operating
within the same economic context and competitive environment
Limitations of Financial Reports
1. Normalized earnings
- Relate to earnings specifically to the day to day operations
of the business and not the sale of non-current assets i.e.
property and equipment
- When reading the financial statement, observes need to
know one off events that may artificially inflated a
businesss revenue
2. Capitalizing expenses
- The business records an expense as an asset on the
balance sheet rather than as an expense on the income
statement
- Is not an accurate representation of the financial condition
of the business It understates the expenses and
overstates the profits as well as the assets of the business
- Examples: research and development, development
expenditure

3. Valuing Assets
- The issue of valuing intangibles (the name/reputation of
the business) is a difficult process
- Should assets be valued at their purchased price or their
valuation price?
- Should the business take into account how much the asset
has depreciated by?
4. Debt Repayments
- Financial statements indicate the value of debt. They also
reflect the cost of debt. They do not reflect how long the
business has held that debt for. Financial statements do not
give an indication of when the debt is due.
- Hence should a new owner take over the business, the
financial report does not reflect when the debt is due
5. Notes on Financial Statements
- Information that generally appears at the bottom of a
financial report in very small writing and is often ignored by
most investors
- An understanding of these notes often requires an
experienced accounting background
6. Timing Issues
- A business chooses not to declare their full income as a
result, less tax is paid
- In anticipation of less income next year, they may declare
more revenue (they are shifting their years in which they
declare their revenue)
They make the money the year before but they declare some it they
yeAR AFTER INCASE THEIR REVENUE IS LOWER AND DOES NOT
RAUSE ALARM BELLS WITH THE TAX OFFICE
Ethical Issues Related to Financial Reports
Failing to report or providing incorrect information in reporting
statements is unethical
Ethical issues related to financial reports include:
Audited accounts
Record Keeping
GST obligations
Reporting practices
Audited accounts
Audits independent check of the accuracy of financial records
and accounting procedures
There are 3 types of audits:
1. Internal audits conducted by employees
2. Management audits review the firms strategic plan

3. External audits a businesss financial reports are looked

at by independent and specialized audit accountants to
guarantee their authenticity
Record Keeping
Reporting Practices

Global Financial Management

Exchange rates
All countries have their own currency
When transactions occur on the global scale, one currency
must be converted to another
The foreign exchange market (forex or fx) determines the
price of one currency relative to another
Exchange rates
The foreign exchange rate the ratio of one currency to
another
It tells us how much a unit of one currency us worth in terms
of another

E.g. A$1 = US$0.70

Effects of currency fluctuations

Global Finance
When the Australian dollar depreciates, Australians buy less from
overseas.
Hence we import less
It costs foreigners less to buy Australian dollar
Hence we export more
When our dollar appreciates the value of the Australian dollar has
increased
As a result the Australian dollar is stronger and we can buy more
imports
So it costs more to export
Lower the dollar, the better
Summary
As Australian dollar appreciates it becomes stronger and we can
buy more imports
It now costs foreigners more to buy AUD
Hence we export less
When our dollar depreciates, we become weaker we import
less and it costs foreigners less to buy the AUD
Interest Rates
Global financial institutions now allow Australia businesses to
access/borrow funds from their organizations. This means that
Australian businesses can now access interest rates from
foreign banks if there rates are lower than Australian
competitors.
The downside is that the money is borrowed in the foreign
currency
Fluctuations in the foreign currency could add to the level of
repayments a business must
Methods of International Payment
There are 4 basic methods of payment from which a business can
select:
Advanced payment
Letter of credit
Clean payment
Bill of exchange
Advance Payment
- The buyer agrees to prepare the item before it is received

Once the seller receives payment, the item is then sent to the
buyer
Advantages
- The business is guaranteed payment
- The business does not over order on stock. It can sell stock
that has a guaranteed sale (Just in Time)
Disadvantages
- From a buyers perspective, there may be a delay in receiving
the product
- The product may not be sent
- Additional issues with damaged/lost property
Clean Payments
- The buyer pays for a good once it has been received
- The sender dispatches the item before payment has been
received
Advantages
- The buyer is guaranteed receipt of the product
- If the product is faulty/damaged, the buyer has greater
bargaining power
Disadvantages
- The business may not receive payment
- It is difficult to determine who is at fault if the product is
lost/damaged
The seller must also examine the buyers credit rating ability to
repay debt
Letter of Credit (Seller, Bank, Buyer)
The buyer makes use of the financial institution to handle the
transaction, once the f. l receives notification that the good has
either been sent or received then it will guarantee payment in the
event that the buyer does not follow through with this
1.
2.
3.
4.

The item is purchased

The buyer contacts a bank to issue a letter of credit
This involves the bank contacting the seller
The bank requests that it receives notification when the item
is sent or the item is received
5. Once the bank receives confirmation, it guarantees payment
of the good in the event that the buyer does not pay
Advantages
- Guaranteed Payment
- Guaranteed Receipt of the Goods
- Minimises possible disputes/issues
Disadvantages
- It costs the byer money to access the letter of credit

It adds additional time to the process

Bills of exchange
Is a document issued by the seller to the buyer, ordering that
the buyer pay a specified amount of money at a specified time
to the bank
When the bank is satisfied that the seller has shipped the
goods, it transfers that money to the seller
Hedging process of minimizing risk
Is the process of reducing risks using a range of financial
instruments
It is important for global financial management
international trading presents risks such as exchange rates
and interest rate fluctuations
These financial instruments cost money However they
minimise the risk for financial losses therefore they allow
more certainty for financial management decisions
Natural Hedging
Insisting both import/export contracts are paid in AUS $
Marketing strategies that reduce price sensitivity of exported
goods
Example: establishing off shore subsidiaries
Derivatives
Special contracts between global businesss that help manage
the risk of currency fluctuations
Example: Forward exchange contract is a contract to
exchange one currency for another currency at an agreed
exchange rate on a future date, usually after 30/90/180 days