ROLE (PLEGS)

ROLE OF FINANCIAL MANAGEMENT

Financial Management
strategic role of Deals with the analysis, interpretations and evaluation of all financial records of the
financial
management
business

Strategic role
Strategic = medium-long term
The strategic role of finance is to ensure a business can operate, grow and achieve their
goals through the management of financial resources
This involves
→ Setting financial objectives
→ Sourcing finance
→ Preparing budgets and forecasting future finances
→ Preparing financial statements
→ Maintaining sufficient cash flow
→ Distributing funds to other parts of the business

Objectives of financial management

objectives of
financial Short-Term and Long-Term Objectives
management
Short < 12-month period Long > 12-month period
profitability, The tactical (one to two years) and The strategic plans of a business. They are
growth, operational (day-to-day) plans of a determined for a set period, generally more
efficiency, business than 5 years.
liquidity,
solvency They are reviewed regularly to see if the Tend to be broad goals, such as increasing
targets are being met and if resources are profit or market share, and each will
short-term and being used to achieve the objectives require a series of short-term goals to
long-term assist in its achievement. The business
E.g., increase revenue by selling 400 pieces will review its progress annually to
of clothing a day determine if changes need to be
implemented

E.g. open 10 new clothing stores in the next

10 years
 ROLE OF FINANCIAL MANAGEMENT

OBJECTIVES PLEGS
Objective Definition Data from financial reports Analysis

Profitability The earnings of Income Statement Formulas are

the business after Gross profit → the revenue calculated as a %
expenses have remaining after paying the of sales.
been paid COGS
Generally
R - COGS = GP R > Ex = Profit
R < EX = Loss
Net profit→ final amount of
revenue remaining after all
expenses have been paid

GP - Ex = NP

EBIT→ Earnings before

interest and tax

Liquidity The ability of the Balance Sheet Compare CA and

business to pay Current Assets CL.
short-term Assets that are expected to be IF:
liabilities using its used, sold or converted to CA>CL = +
current assets cash within 12 months that Liquidity
include (Most L → Least L) CA<CL = - Liquidity
→ Cash in the bank account
→ Accounts receivable
(debtors)
→ Inventory
→ Expenses paid in advance
Current Liabilities Liquidity is
Debts that are due to be paid calculated
within 12 months include through the
→ Accounts payable liquidity ratio:
(creditors)
→ Bank overdrafts LR = CA / CL
→ Short-term loans
→ Interest payable on loans Working Capital
→ Salaries payable R = CA : CL

Net WC = CA - CL

Efficiency How much of the Expenses (Income The proportion of

total revenue is Statement) sales revenue that
 ROLE OF FINANCIAL MANAGEMENT

spent on expenses Can also be measured is used for

through accounts achievable expenses

Growth The size of the Can be measured through Compare

business → physical size business sales to
compared to its → value of assets total market sales.
competitors in the → Opening more stores The higher the %,
same market → Merging the larger their
→ Diversifying market share
It can be either → range of products
organic → arise
from reinvested
money
Acquisitive →
acquisition of
other businesses

Solvency The ability of the Balance Sheet Compare total

business to pay Current Assets assets and total
both short and Non-Current Assets liabilities
long-term Current Liabilities
liabilities as they Non-Current Liabilities If the business is
fall due able to pay S+L
debts as they fall
Reducing the level due = Solvent
of gearing (how
much debt finance
the business has
acquired to fund
its operations
compared to its
level of equity
finance)

interdependence Interdependence of Finance with 3 KBFs

with other key Interdependence: the mutual dependence that the key functions have on one another. The
business
functions key functions work best when they overlap, and employees work towards common goals.
Each function area depends on the support of the others if it is to perform at capacity.

F+O F+M F + HR
Finance and operations Finance management Finance management
work closely together to provides the necessary provides the funds
maximise profits. Finance funds for marketing required to pay for their
allocates funds for the management to establish employees and manage
 ROLE OF FINANCIAL MANAGEMENT

operations department to promotional activities. In the HR functions,

purchase inputs and carry return, marketing generates including redundancies
out transformation sales by promoting products, and cost cuts. In return,
processes. In turn, bringing revenue back to human resources ensure
operations are able to finance. Marketing can also the business has skilled
produce goods and provide essential employees who
services that generate information on sales and contribute to productivity,
sales, contributing to the profit forecasts, giving ultimately driving revenue
business's financial market research in which and supporting financial
performance. finance can allocate stability.
money for operations.
Cost to reduce production
costs,
Quality produces
high-quality products that
can be sold at a higher
cost,
Investment uses new
technologies that improve
efficiency
INFLUENCES (SIGG)
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

Internal Source of Finance

internal sources of Internal sources of finance are funds generated from within the business
finance – retained -​ They are recorded under EQUITY in the balance sheet because they represent the
profits owner’s financial claim on the business’s assets
-​ These sources do not require repayment, do not involve interest, and do not reduce
the owner’s control
Owner’s Equity (Capital)
This is money invested by the owner when starting or expanding the business. It may
come from:
-​ Personal savings
-​ Inheritance
-​ Gifts from family
-​ Redundancy payouts
-​ Personal loans or mortgage loans
→ For sale traders and partnerships, this is called capital, proprietorship, or proprietor’s
funds
→ For companies, it is referred to as shareholders’ funds
→ It is recorded under EQUITY because it represents the owner’s claim on the business

Retained Profit
Retained profit is the net profit that is reinvested back into the business instead of being
taken fully by the owner
-​ Also called undistributed profits
-​ Increases equity
-​ Provides internal funding for growth
-​ Does not require repayment
This allows the business to expand using profits it has already earned

Sale of Unwanted or Unproductive Assets

A business may sell:
-​ Outdated machinery
-​ Scrap materials
-​ Duplicate assets (e.g. after a merger)
The money received becomes available for business use
Advantages
-​ No interest to pay
-​ No repayment required
-​ No loss of ownership or control
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

External Sources of Finance

external sources of External Sources of finance:​
finance DEBT, Refers to the fund provided my sources outside the
business such as banks, other financial institutions or
government suppliers.
Debt
-​ Debt finance is any money that has been borrowed
-​ Can be a cheap source of funding while IR are very
low
-​ Can help a business to invest in new technology, plant and equipment
-​ Restrict a business; the IR payments must be repaid
Interest
-​ Cost of borrowing or holding debt
-​ Fixed → regular and predictable
-​ Variable → Increase from time-to-time

Distinguishing between short-term and long-term sources of funds

Funding term
-​ The term of debt means the period over which the borrowing must be repaid
-​ Short-term is debt that must be repaid within 12 months or the term may also
extend to borrowings with terms of up to three years (also known as current
liabilities/debt)
-​ Long-term borrowing or long-term debt is a reference to debt that is to be repaid in
a time period of 12 months or greater than 12 months (also called non-current
debt)

Short-term borrowing (FOC)

-​ Businesses should use short-term borrowing to solve short-term problems such
as a cash flow shortages to help maintain the liquidity of a business
-​ Funding for short-term assets such as inventory

Factoring
What it is
-​ Source of short-term finance used to quickly improve cash flow
-​ Involves the cash sale of accounts receivable (trade debtors) to a factoring
company at a discount
How it works
Factoring company
-​ Takes over management and collection of unpaid accounts
-​ Pays the business the value of receivables minus a commission/fee
The fee varies depending on
-​ Amount of credit sales
-​ Credit rating of customers
-​ Level of risk (higher risk = higher fee)
Debtors pay the factoring company directly, not the business
Effects
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

-​ Improves liquidity (cash flow quickly) while reducing profitability

-​ Reduces working capital slightly due to the discount/fee
-​ No traditional loan repayment required

ADV DISADV
-​ Immediate access to cash -​ Only receives 80-90% of the full
-​ You save on time and effort valueof accounts receivable
chasing customers (legal bills -​ May impact upon customer
too) relationship with the involvement
-​ Improves cash flow of a 3rd party

Trade Credit (Related Short-Term Finance)

-​ Trade credit is finance provided by suppliers
-​ Business receives g/s now and pays later
-​ Acts like a short-term loan from the supplier
-​ Usually allows 30-90 days before payment is due
-​ Requires
➔​ Strong supplier relationships
➔​ Effective monitoring of accounts receivable by suppliers to maintain
profitability

Overdraft
What it is
-​ Is a loan arrangement with a bank that allows a business to withdraw more
money than is in its transaction account
-​ The bank sets a maximum limit agreed with the business
-​ The account can have a negative balance (overdrawn)
How it works
-​ Business withdraws funds beyond its account balance
-​ When cash from sales is deposited, it reduces the overdraft
-​ Interest is charged daily on the overdrawn amount
-​ Interest is only charged for the period the account remains overdrawn
Purpose
-​ Provides short-term finance
-​ Commonly used for
➔​ Wokring capital needs
➔​ Managing seasonal fluctuations (e.g. seasonal businesses like ski
resorts)
ADV DISADV
-​ Very flexible and accessible at short -​ Can have high interest
notice rates
-​ Interest paid is tax deductible (a -​ Daily interest charges can
business expense) make it expensive
Credit Card (Alternative to Overdraft)
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

-​ A credit card provides a line of credit for business purchases and expenses
-​ Allows borrowing for
➔​ Payments to merchants
➔​ Cash advances
-​ Acts as a buy now, pay later system
-​ Banks now offer business credit cards with
➔​ Lower interest rates
➔​ Loyatly programs

Commercial Bills
-​ A commercial bill (bill of exchange) is a written order for a loan amount
guaranteed by the business’s bank
-​ Businesses and governments sell commercial bills to raise short-term funds
-​ Money is borrowed from investors or companies with surplus funds
Key features
-​ Funds plus interest are repaid on a specified future date, term: 30–180 days
-​ Usually large amounts (often hundreds of thousands of dollars)
-​ Used to finance:
➔​ Payments to suppliers
➔​ Materials
➔​ Wholesale goods
Rollover → extended at maturity
-​ Each time it matures it must be reassessed and terms and interest are
recalculated
-​ Classified as short-term finance because of its short maturity periods
ADV DISADV
-​ Only interest is paid (until the end) -​ Usually secured
-​ Flexible (lenght of time; amount of interest) against assets
-​ Funds received immediately -​ Pay interest
-​ Interest rate may be cheaper than other sources of -​ Establishment
funds fees need to be
-​ Often considered the cheapest form of short-term paid
fiance
-​ Sutiable for large, short-term funding need

Long-term borrowing (MULD)

-​ Term of repayment longer than 12 months
-​ Also knows as non-current liability
-​ Business may take out term loans for 3,5 or
10 years or longer
-​ To fund non-curent assets such as plant
and equipment
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

Mortgages
Definition
-​ A mortgage is a long-term loan obtained from a bank or lender to purchase
non-current assets (e.g. land, buildings)
-​ The property itself is used as security (collateral) for the loan
How it works
-​ Business borrows a large sum from a lender
-​ Uses funds to buy assets like a factory or building
-​ Makes regular (usually monthly) repayments
➔​ Includes principal + interest
-​ Loan terms are typically long-term (25-30 years)
-​ If repayments are not made
➔​ The lender can sell the property to recover the loan
-​ Some businesses use interest-only loans
➔​ Only pay interest during the term
➔​ Plan to sell the property later for capital gain
ADV DISADV
-​ Allows purchase of expensive -​ High total cost due to long-term
long-term assets interest payments
-​ Long repayment period → smaller, -​ Risk of losing the property if
manageable payments unable to repay
-​ Can benefit from capital gains if -​ Requires security (collateral)
property value increases -​ Long-term commitment reduces
-​ Provides stability (owning financial flexibility
premises instead of renting) -​ Interest-only loans can be risky if
property value does not increase
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

Debentures
Definition
-​ Debentures are long-term loans raised by large companies by borrowing from
investors (e.g. finance companies or other firms)
-​ Investors who lend money are called debenture holders
How it works
-​ Company issues debentures to raise funds
-​ Investors lend money for
➔​ A fixed amount
➔​ A fixed time period (3-5years)
➔​ A fixed interest rate
-​ Funds are typically used to purchase
➔​ Buildings
➔​ Equipment
-​ A trustee is appointed to
➔​ Monitor the company’s financial position
➔​ Ensure it can repay the loan and interest
-​ Loan is secured by company assets
➔​ Fixed charge → security over specific assets (e.g. property)
➔​ Floating charge → security over assets that change daily (e.g. inventory)
-​ Debentures can be
➔​ Private issue (offered to selected investors)
➔​ Public issue (available to the public, requires a prospectus lodged with
ASIC)
-​ Public debentures can be traded on the securities exchange

ADV DISADV
-​ Raises large amounts of -​ Requires regular interest
long-term finance payments regardless of profit
-​ Fixed interest rate provides -​ Legal obligations and strict
certainty in repayments conditions (e.g. trustee
-​ Does not reduce ownership or monitoring)
control of the business -​ Assets are used as security,
-​ Can be secured, making it more increasing risk if default occurs
attractive to investors -​ Public issues require compliance
costs (e.g. prospectus,
regulations)
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

Unsecured notes
Definition
-​ Unsecured notes (bonds) are long-terms loans issued by companies to raise
funds without using assets as security
-​ Investors rely on the company’s creditworthiness and reputation
How it works
-​ Company issues unsecured notes to investors to borrow money
-​ No collateral/security is provided
-​ Investors receive
-​ Typically offer a higher interest rate than debentures due to higher risk

ADV DISADV
-​ No need to provide assets as -​ Higher interest rates due to
security increased risk for investors
-​ Allows access to large amounts -​ Must make regular interest
of finance payments, regardless of prof trong
-​ Does not dilute ownership or reputation/creditworthiness
control -​ Risk of default consequences
-​ Flexible for companies with (damage to reputation, legal action)
strong credit ratings

Leasing
Definition
-​ Leasing is a form of finance where a business rents non-current assets (e.g.
cars, machinery, buildings) instead of buying them
-​ The asset is owned by the leasing company, not the business
-​ Operating: less than the asset’s useful life, where the owner handles
maintenance and it can usually be cancelled without a penalty
-​ Finance lease: a long-term lease running close to the asset’s entire useful life,
where the lessee handles maintenance and faces a penalty for cancelling early
How it works
-​ Business enters a lease agreement with a leasing company
-​ Pays regular payments (rent) over an agreed period
-​ Gains use of the asset without paying full cost upfront
-​ Lease payments are treated as a business expense
-​ At the end of the lease, the busines can
➔​ Return the asset
➔​ Upgrade to a newer asset (operating lease)
➔​ Purchase the asset at a residual value (finance lease)
ADV DISADV
-​ No high initial cost → improves cash -​ Businesses does not own the
flow asset (unless purchases later)
-​ Tax deductible payments (reduced -​ Can be more expensive over
taxable income) time than buying outright
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

-​ Does not appear on balance sheet → -​ Ongoing contractual payment

does not increase gearing/deb obligation

Equity (NIRIPS)
The owner’s share of the business, made up of their
investment plus any profits earned
External Equity
-​ The purchase of shares from parties that are not
current owners

New Issue of Ordinary Shares

Definition:
Ordinary shares are the basic form of equity in a public company, giving investors part
ownership
How It Works:
-​ Shares are sold to the public via the Australian Securities Exchange
-​ Investors buy shares and become shareholders
-​ Shareholders may receive dividends from company profits
-​ Shareholders can buy/sell shares on the stock market

ADV DISADV
-​ Raises large amounts of -​ Loss of control (ownership spread
capital across many shareholders)
-​ No obligation to repay funds -​ Dividends may be expected by
-​ Dividends are not shareholders
compulsory -​ Can be expensive to issue and manage

Rights Issues
Definition
A rights issue offers existing shareholders the option to buy more shares
How It Works
-​ Shares offered in proportion to current holdings
-​ Shareholders can:
➔​ Buy the shares
➔​ Reject them
➔​ Sell/transfer their rights
-​ Usually no new prospectus needed (just a proposal)
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

ADV DISADV
-​ Raises additional funds quickly from -​ Shareholders may not
existing investors take up the offer
-​ Maintains current ownership structure (if -​ Ownership can still be
shareholders participate) diluted if not all
-​ Lower cost than public share issues participate

Placements
Definition
Placements involve selling shares to specific sophisticated investors or institutions
How It Works
-​ Shares are offered to selected investors only
-​ No need for a formal prospectus
-​ Can raise up to 15% of current capital base
-​ Funds can be raised quickly (often within 24 hours)
-​ May involve underwriters (who buy unsold shares)

ADV DISADV
-​ Fast way to raise large funds -​ Dilutes ownership
-​ Lower regulatory requirements (no -​ May favour large investors
prospectus) over existing shareholders
-​ Useful for quick expansion or takeovers -​ Possible underwriting costs

Share Purchase Plans (SPP)

Definition
A share purchase plan allows existing shareholders to buy additional shares at a
discounted price
How It Works
-​ Existing shareholders can buy up to $30,000 worth of shares
-​ Shares are offered at below market price
-​ No prospectus required, but needs approval from Australian Securities and
Investments Commission
-​ Quick and relatively low-cost to implement

ADV DISADV
-​ Cheap and fast way to raise funds -​ Limited to existing shareholders
-​ Benefits both: only
➔​ Company (raises capital) -​ Smaller amounts raised
➔​ Investors (discounted compared to other methods
shares)
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

Private equity
Definition
-​ Private equity is when a private company sells shares to selected individuals to
raise finance, without offering them to the general public
How it works
-​ Business invites specific investors (e.g. friends, family, private investors) to buy
shares
-​ Investors provide money and become part-owners (shareholders)
-​ Shares are not traded on the ASX
-​ Company is usually a Pty Lts
-​ Funds raise are used to start or grow the business
-​ Dividends may be paid later, not immediately required
ADV DISADV
-​ Raises funds without increasing -​ Ownership is diluted (original
debt owners own less)
-​ No immediate obligation to pay -​ Reduced control over business
dividends decisions
-​ Can access significant capital -​ Can be expensive and complex to
from investors organise share sales

Financial Institutions
What are financial institutions?
financial Financial institutions are organisations that provide financial services and help
institutions – businesses obtain finance.
banks, investment -​ Businesses use them to
banks, finance
companies, ➔​ Borrow money
superannuation ➔​ Invest funds
funds, life ➔​ Raise capital
insurance ➔​ Manage financial risk
companies, unit
trusts and the
Australian Banks ,
Securities Banks are authorised deposit-taking institutions that accept deposits from the public
Exchange and provide loans and financial services to businesses and individuals. E.g.
Commonwealth Bank, National Australia Bank (NAB), St George
IFUBSAL Characteristics
-​ Accept deposits from customers
-​ Provide loans and overdrafts
-​ Offer online banking and business credit cards
-​ Provide EFTPOS and BPAY services
-​ Offer business insurance and superannuation
-​ Give legal and taxation advice
-​ Assist with international trade finance
-​ Provide risk management and economic reports
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

Benefits to business Disbenefits to business

-​ Easy access to loans and finance -​ Strict lending requirements
-​ Lower IR compared to other lenders -​ Interest repayments increase
-​ Manage cash flow through overdrafts expenses

Investment Banks
Investment banks provide specialised financial services to businesses and governments,
mainly helping them raise large amounts of capital. E.g. HSBC, Barclays and Deutsche
Bank
Characteristics
-​ Do not deal with individual consumers
-​ Underwrite share issues
-​ Find buyers for bonds
-​ Assist with mergers and takeovers
-​ Customise loans
-​ Provide financial advice
-​ Arrange large-scale finance

Benefits to business Disbenefits to business

-​ Access to large amounts of -​ Expensive fees and charges
capital -​ Mainly suitable for medium and large
-​ Expert financial advice businesses
-​ Helps businesses raise money -​ Can increase business debt and
through shares and bonds financial risk

Finance Companies
Finance companies provide secured and unsecured loans to businesses and consumers
but do not accept public deposits. E.g Esanda, GE Finance
Characteristics
-​ Offer secured loans and unsecured loans
➔​ Secured: loan backed by an assets as security
➔​ Unsecured: loan without security; usually has higher interest
-​ Charge higher IR than banks
-​ Provide leasing finance
-​ Arrange commercial bills and debentures
-​ Offer factoring and hire purchase agreements

Benefits to business Disbenefits to business

-​ Easier access to finance -​ Higher IR
-​ Useful for businesses unable to get -​ Risk of losing secured assets if
bank loans repayments fail
-​ Leasing allows use of assets -​ Unsecured loans can become
without buying them expensive
-​ Flexible repayment options -​ Leasing may cost more overtime
 INFLUENCES OF FINANCIAL MANAGEMENT (SIGG)

Life Insurance Companies

Life insurance companies provide insurance against risks such as death or disability and
invest premium payments to provide loans and investments. E.g. Zurich Australia ltd
Characteristics
-​ Customers pay regular premiums
-​ Provide guaranteed payments after death or disability
-​ Invest collected premiums
-​ Offer loans to businesses

Benefits to business Disbenefits to business

-​ Additional source of finance -​ Higher IR than banks
-​ Access to long-term funding -​ Loans may have stricter conditions
-​ Can provide investment capital -​ Less flexible than other lenders

Superannuation Funds
Invest compulsory retirement savings contributed by employers on behalf of employees.
E.g. Hesta, First Super, AustralianSuper
Characteristics
-​ Employers must contribute superannuation
-​ Funds invest in shares, bonds and property
-​ Large pools of investment capital
-​ Employees can choose funds and make voluntary contributions

Benefits to business Disbenefit to business

-​ Large source of investment funds -​ Investors expect strong returns
-​ Businesses can raise money -​ Businesses face pressure for good
through shares and debt securities performance
-​ Encourages long-term investment
in businesses ​

Unit Trusts
A unit trust pools money from investors and invests it according to a trust deed. E.g. MG
Unit Trust, MLC MasterKey Unit Trust
Charactersictics
-​ Managed by a trustee
-​ Investors buy units
-​ Profits shared among unit holders
-​ Can invest in
➔​ Property
➔​ Shares
➔​ Mortgages
➔​ Fixed-interest assets
PROCESSES (PIMFLE)
 Financial Management Process

Financial Needs
planning and Financial management involves planning, sourcing and controlling a business’s finances
implementing – so each department can achieve its objectives
financial needs, Financial needs are determined by
budgets, record
systems, Factor Description
financial risks,
financial Size of the business Larger businesses require more complex financial planning
controls
Business life cycle Start-ups need start-up costs; established businesses need
Debt and equity phase operational funds
financing –
advantages and Future growth plans Expansion requires additional sourcing of finance
disadvantages of
each
Capacity to source Ability to attract investors or obtain loans
finance
matching the
terms and source
of finance to the Financial managers must
business -​ Determine financial needs
purpose
-​ Set budgets
-​ Instigate record systems
-​ Determine financial risks
-​ Develop financial controls

Budgets
Budget: A plan for achieving set outcomes based on forecasted figures and expectations of
future operations

Budgets can show

Information Example

Cash required for planned expenditure Utility bills, wages

Cost of capital expenditure New equipment purchases

Estimated use and cost of raw materials/inventory Stock levels needed

Number and cost of labour hours Staffing requirements

 Financial Management Process

Types of Budgets

Budget type Description Use

Operating Budget Estimates revenue and Produces budgeted income

expenses based on statement; labour and raw
forecasted sales from the materials (short-term, day-to-day)
main business activity

Project Budget Focuses on specific projects Plans capital expenditure for new
and their associated costs projects

currency Uses operating budget data Produces budgeted cash flow

to forecast funds required statement; highlights cash
and anticipated inflows shortages/surpluses and need for
short-term finance (e.g. overdraft)

Key benefits of Budgets

-​ Provide a framework for internal decision-making
-​ Establish standards for planning and control
-​ Allow comparison of planned vs actual performance
-​ Enable corrective action when needed
-​ Used in operational, tactical and strategic planning

Record Systems
Record systems: Mechanisms employed by a business to ensure data is recorded and
information provided is accurate, reliable, efficient and accessible

Quality Meaning

Accurate Free from errors; reflects true financial position

Reliable Consistent and trustworthy data

Efficiency Quick and easy to process and retrieve

Accesible Available to authorised personnel when needed

Key points

Aspect Detail

Legal requirement Accounting records of expe nses and revenues must be kept by
law

Annual reporting Financial reports must be presented to shareholders, ATO and

ASIC
 Financial Management Process

Double-entry system Acts as a control mechanism - balances entries and finds errors
quickly

Electronic systems Software such as MYOB generates invoices, financial

statements, pay records and inventory details

Security Confidential information protected by privacy laws; security

systems control access

Fraud prevention Record systems help prevent theft and fraud by employees

MIS Management Information Systems allow managers to access

organised information relevant to their department

Financial Risks
Financial risks: The risks to a business of being unable to cover its financial obligations,
potentially leading to bankruptcy or insolvency

Type of Risk Description

Theft of stock Loss of inventory reduces assets and cash

flow

Fraud Misuses of funds by employees (e.g. ING

Case - $45 million misappropriated)

Non-payment of accounts receivable Customers failing to pay reduces cash

inflow

Interest rate increases Higher repayment costs affect profitability

Increased taxes Increases costs, may decrease sales and

cut profit levels

Consequences of Unmanaged Financial Risk

Short-term Long-term

Liquidity problems Solvency issues

Cash inflows shortages Difficulty paying bills and loan repayments

Disruption to the day-to-day operation Potential bankruptcy or insolvency

To minimise financial risk, businesses should

-​ Continuously research the business environment
-​ Analyse the profitability of alternative decisions
-​ Ensure profits are sufficient to cover the costs of debt AND generate a return
 Financial Management Process

Financial Controls
Financial Controls: policies and procedures that ensure that the plans of a business are
achieved in the most efficient way

Common Causes of Financial Problems

Cause Example

Theft and fraud Employee misuse of funds or stock

Damage or loss of assets Equipment breakdown, natural disaster

Errors in record systems Incorrect data entry

Financial Control Mechanisms

Control Purpose

Clear authorisation and Ensures accountability for tasks

responsibility

Separation of duties Prevents one person from having full control over
transactions

Rotation of duties Reduces the opportunity for ongoing

Control of credit procedures Manages accounts receivable and minimises bad debts

Control of cash Monitors cash inflows and outflows

Two signature required on Prevents unauthorised payments

cheques

Regular expense reporting Tracks spending against the budget

Budgets Compare planned vs actual performance; identify

variances

Debt and Equity Financing

Debt-financing: short-term and long-term borrowing from external sources - requires
repayment of principal plus interest

Equity-financing: Internal source of finance - money provided in exchange for ownership

in the business
 Financial Management Process

Advantages
Debt Financing Equity Financing

Interest payments are tax-deductible Does not have to be repaid

Funds readily available and can be No interest repayments - more cash

acquired quickly available

Does not dilute ownership Less risk - does not add to debt levels

Loan terms can be negotiated Cash flow can be used for further
investment

Regular repayments are easy to plan for Investors may wait for returns

Disadvantages
Debt Financing Equity Financing

Can be expensive (IR and fees) Ownership is diluted

Repayments must be met regardless of cash Proportion of profits goes to new owners
flow

Collateral/security is often required Dividends are not tax-deductible

Good credit history may be required Shareholders have voting rights

Secured creditors are paid first in bankruptcy Investors expect improved growth and
returns

Key Consideration - Gearing

-​ Highly geared businesses = significant debt compared to equity → greater risk of
liquidity and solvency problems

Matching the Term and Source of Finance to Business Purpose

Matching Principle: the source and term of finance must be matched to the purpose and
economic lifetime of the asset being purchased

Asset Type Finance Type Example

Current/Short-term Short-term finance Inventory financed with

assets trade credit or overdraft

Non-current/Long-term Long-term finance Premises purchased with a

assets 15-20 year mortgage
 Financial Management Process

Short-Term vs Long-Term Debt Finance

Short-term
Instrument Term

Bank overdraft Indefinite; rolled over monthly

Credit card Indefinite; rolled over monthly

Trade credit 7-90 days

Commercial bills ~90 days; can be rolled over

Long-term

Instrument Term

Term loan Fixed number of years

Debentures Set by the issuing company

Mortgage loan Up to 20 years (commercial); up to 35

years (individual)

General Factors Affecting Finance Choice

Factor Impact

Legal structure Companies can carry higher debt-to-equity; sole traders risk
personal bankruptcy

Profitability More profitable firms can afford interest → more likely to use debt

Share price Companies with rising share prices more likely to issue equity
growth

Interest Rates Low rates make debt finance more attractive

Retained profits Forward planning allows businesses to build retained profits for
asset purchases

Credit rating Low credit rating makes loans harder to obtain or more expensive
→ equity may be a better option

Key rule: Using short-term finance for long-term assets = repayments required before the
asset generates sufficient cash. Using long-term finance for short-term assets = paying
debt long after the need has passed. ALWAYS MATCH THE TERM OF THE LOAN TO THE
ECONOMIC LIFE OF THE ASSET
 Financial Management Process

Monitoring and Controlling

monitoring and Accounting information is used by managers to monitor and control the business’s
controlling – cash functions through three key financial statements
flow statement,
income Financial Statement Purpose
statement,
balance sheet Cash flow statement Shows movement of cash in and out of the business over time

Income Statement Summarises income earned and expenses incurred over a

period

Balance Sheet Snapshot of assets, liabilities and equity at a specific point in

time

Qualities of Financial Data for Better Decision-Making

Quality Meaning

Relevant Data can be used to make plans and forecasts

Reliable Data is accurate and unbiased

Comparable Data can be compared to previous years and other businesses

Understandable Users can understand what the data means

Cash Flow Statement

Definition: A financial report illustrating the movement of cash receipts and cash
payments resulting from financial transactions over a period of time

Purpose - A Cash Flow Statement Shows Whether a Business can:

Capability Detail

Generate favourable cash flow Maintain positive cash balances

Pay financial obligations when due Avoid liquidity problems

Fund growth or expansion Have surplus funds available

Obtain external finance when needed Identify periods requiring short-term

finance

Pay creditors or dividends to shareholders Meet obligations to stakeholders

 Financial Management Process

Three Sections of a Cash Flow Statement

Section Description Examples

Operating activities Cash inflows and outflows from Cash sales, wages, rent,
the business’s main activity advertising, supplier
payments

Investing activities Cash inflows and outflows from Asset purchases, proceeds
the purchase/sale of non-current from asset sales
assets and investments

Financing activities Cash inflows and outflows Loan receipts, loan

relating to borrowing activities repayments, dividends paid

Structure of a Cash Flow Statement

Component Description

Opening Cash Balance Bank balance at the beginning of each period

Cash inflows All cash coming INTO the business during the period

Cash outflows All cash going OUT of the business during the period

Closing Cash Balance Cash balance at the end of the period = opening balance for
the next period

Key risk: if expenditure exceeds income for an unacceptable length of time →

insolvency → business unable to pay debts → potential closure

Income Statement
Definition: a summary of the income earned and expenses incurred over a period of time -
used to determine the business’s profitability and efficiency
Also known as: profit & loss statement/revenue statement
Purpose - The Income Statement Helps Assess
Aspect Detail

Revenue sources How money has come into the business

Expense How much has gone out as expenses

management

Profitability How much profit has been derived

Trends Comparisons between current and previous years

 Financial Management Process

Key Formulas
Formula Calculation

COGS Opening stock + purchases - closing stock

Gross Profit Sales - COGS

Net Profit Gross profit - Expenses

Categories in an Income Statement

-​ Total sales revenue: total value of g/s sold during the financial year
-​ COGS: direct cost of producing/purchasing the goods sold
-​ Gross Profit (GP): sales revenue minus COGS
-​ Operating Expenses: selling, administration and financial expenses
-​ Net Profit (NP): Final result - gross profit minus all expenses (tax is levied on this
amount)
Types of Operating Expenses
-​ Selling & administration: advertising, cartage outwards
-​ General expenses: wages, phone, lease payments, electricity
-​ Financial expenses: interest paid, discounts allowed

Balance Sheet
Definition: represents a business’s assets and liabilities at a particular point in time -
shows the net worth of the business
Also known as: statement of net worth/statement of financial position

Key definitions
-​ Assets: future economic benefits controlled and owned by the business as a result
of past transactions
-​ Liabilities: future sacrifices of economic benefits the business is obliged to make
to others as a result of past transactions
-​ Owner’s Equity: the owner’s claim on the business = Assets - Liabilities

Accounting Equation: Assets = Liabilities + Owner’s Equity

Structure of the Balance Sheet

Category Type Examples Timeframe

Current Assets Short-term assets Cash, account Converted to cash

receivable, within 12 months
inventory

Non-CA Long-term assets Furniture, vehicles, Generate revenue

computers, over more than 12
buildings months
 Financial Management Process

Current liabilities Short-term Accounts payable, Due within 12

obligations overdraft months

Non-CL Long-term Bank term loan, Due beyond 12

obligations mortgage months

Equity Owner’s claim Capital contributed, Net worth of the

retained profits/net business
profit

What the Balance Sheet Can Indicate:

Question What it reveals

Does the business have enough assets to Short and long-term financial stability
cover its debts?

Can interest and borrowed money be paid? Solvency position

Are assets used to maximise profits? Efficiency of asset use

Are owners receiving a good return on Return on equity

investment?

Key Check: Total Assets must always equal TOTAL LIABILITIES + OWNER’S EQUITY - this
confirms the accounting equation A = L + E is balanced

Summary Comparison of the Three Financial Statements

Feature Cash Flow Statement Income Statement Balance Sheet

Purpose Shows cash movements Shows profitability Shows financial

in and out and efficiency position/net worth

Time period Over a period of time Over a period of At a specific point

time (usually a in time
financial year)

Key output Closing cash balance Net profit Net worth/equity

Key risk Liquidity/insolvency Unprofitability Over-leveraging /

identified instability

Used by Managers, creditors, Investors, Investors,

lenders shareholders, managers, and
managers creditors
 Financial Management Process

Financial Ratios & Comparative Analysis

financial ratios Financial ratios provide more information than financial statements alone. They allow
managers to:
-​ Monitor and control the business’s financial position
-​ Identify trends over time
-​ Compare performance against competitors and industry standards
-​ Make informed decisions to improve financial performance
Four objectives measured by financial ratios

Objective Financial Statement Used

Liquidity Balance Sheet

Gearing Balance Sheet

Profitability Income Statement

Efficiency Income Statement

Liquidity
Liquidity: The extent to which a business can meet its financial obligations in the
short-term
Current Ratio (also known as the Working Capital Ratio) measures whether the business
can pay its short-term liabilities using its current assets
Current Ratio = CA/CL
Acceptable ratio: 2:1
Result Interpretation

Greater than 2:1 Business can comfortably meet short-term obligations

Too high (e.g. 4:1) Inefficient use of working capital - too much cash sitting idle

Less than 1:1 Business is at risk of not meeting financial obligations - liquidity
problem
Cash to pay liabilities can come from the business’s bank account, the sale of inventory
and payments received from accounts receivable customers

Gearing
Solvency: the extent to which a business can meet its financial obligations in the
long-term
Gearing: the proportion of debt (external finance) vs equity (internal finance) used to
finance the business
Gearing Ratio = Total Liabilities / Total Equity

Acceptable ratio: Small businesses = 0.5:1 | Large businesses = 1:1

 Financial Management Process

Result Interpretation

Greater than 1:1 More debt than equity - higher financial risk

Between 0 and 1 More equity than debt - lower risk

Over 80% debt funded Poor solvency - difficult to obtain further credit

Less than 25% debt funded Low gearing - considered financially stable

Key considerations for gearing:

-​ Higher gearing = higher risk BUT possibility of higher profits
-​ When interest rates are low → higher gearing is more acceptable as borrowing is
cheaper
-​ When interest rates rise → businesses should reduce gearing by paying off debt
-​ If gearing is not reduced during economic downturns → risk of insolvency and
bankruptcy
-​ Acceptable gearing levels vary by industry, legal structure and economic conditions

Profitability
Profitability: The earning performance of the business and its capacity to use resources to
maximise profits

The income statement is used to determine profitability. Financial managers want returns
from the business to be better than safer alternative investments (e.g. a savings account)

Three Profitability Ratios

1.​ Gross Profit Ratio: GP (Total Revenue - COGS)/Total Sales
-​ Measures profitability before expenses
-​ Represent the markup between wholesale cost and selling price
-​ A result of 70% means that for every $1 in sales, $0.70 is made in GP
-​ Preferred: as high as possible (over 50%)
-​ Low ratio → need to find cheaper suppliers or review pricing strategy
2.​ Net Profit Ratio: NP (GP - Expenses)/Total sales
-​ Measures profitability after all expenses have been paid
-​ A result of 25% means that for every $1 in sales, $0.25 is made in net profit
-​ Preferred: 13-20% or higher
-​ Comparisons should be made before tax, as tax liabilities vary between
businesses
-​ Low ratio → need to address expense management and efficiency
3.​ Return on Equity (ROE): NP/Total Equity
-​ Measures the return owners receive for their investment in the business
-​ Uses figures from both the income statement and the balance sheet
-​ Preferred: as high as possible - must exceed alternative investment
returns
-​ Higher ROE → easier to raise funds for future growth
-​ If ROE increases due to increased debt → greater returns but higher risk
-​ Should be compared within the same industry, as asset requirements vary
 Financial Management Process

Efficiency
Efficiency: The ability of a business to minimise costs and manage assets so that
maximum profit is achieved with the lowest possible level of assets

Two Efficiency Ratios

1.​ Expense Ratio: Total expenses/Total sales
-​ Indicates the amount of sales allocated to expenses
-​ Preferred: as low as possible (30-50%)
-​ Can be calculated for individual expense categories:
-​ Declining ratio → lower IR or less debt being used
-​ Increasing ratio → business must find ways to monitor and reduce
unnecessary expenses
2.​ Accounts Receivable Turnover Ratio
Sales/Accounts receivable → (How many times A/R is collected per year)
365/accounts receivable ratio (Sales/AR) → (How many days it takes to collect A/R and
convert it into cash)
-​ Measures how effectively the business collects its debts
-​ Indicates how many times the accounts receivable balance is converted into cash
per year
-​ Preferred turnover: 12 times per year
-​ Preferred collection period: 30 days or less
-​ High turnover ratio → efficient debt collection system
-​ If avg collection days exceed the credit policy (e.g. 34 days vs 21-day policy) →
unsatisfactory and corrective action is needed

Comparative Ratio Analysis

Businesses must constantly monitor their financial situation through comparative ratio
analysis to determine if financial objectives have been met

Three Ways to Compare Ratios

1.​ Over Time (trend analysis)
Comparing current year results to previous years allows the financial manager to
identify trends in profit, costs and financial stability - determining whether the
business is improving or declining
2.​ Against Similar Businesses (benchmarking)
Comparing results to other businesses and industry standards. If results are below
the industry standard → the business plan needs to be reviewed and new
strategies introduced
3.​ Against Standards/KPIs (best practice)
Comparing results against key performance indicators (KPIs) or the world's best
practice standards. This tells managers how their business compares against the
best possible result globally
 Financial Management Process

Generalised Ideal Ratio Standards

Ratio Ideal Standard

Current ratio (Liquidity) 1.2 to 2.5 times (Current assets vs current liabilities)

Return to Equity Must be greater than the current interest rate

Gearing (Debt to Equity) No higher than 60%

Key principle: ratios should never be assessed in isolation. They must be compared
against past performance, industry standards and competitor results to provide
meaningful insight and guide corrective action

Limitations of Financial Reports

limitations of Financial statements do not tell the whole financial story of a business. The rules used to
financial reports produce them can create a misleading impression of profitability and value (DNNACT)
– normalised
earnings, Normalised Earnings
capitalising Earnings adjusted to remove one-off items or account for economic cycle changes that
expenses, valuing may distort profitability (e.g. sale of land).
assets, timing
issues, debt Financial statements may include unusual one-time events that inflate or deflate reported
repayments, profits, making it difficult to compare profitability across years or against other
notes to the businesses. Normalising earnings removes these distortions to show a more accurate
financial picture of ongoing earnings from core operations.
statements
Capitalising Expenses
Recording an expense as an asset on the balance sheet rather than as an expense on the
income statement.

Instead of being deducted immediately, capitalised expenses are written off through
depreciation over time. This understates expenses and overstates profits and assets,
giving a false impression of the business's financial condition. Common examples include
R&D costs and training expenses.

Asset Valuation
Estimating the value of assets when recording them on the balance sheet.

Assets are recorded at historical cost (original purchase price) for consistency, but this
creates limitations:
-​ Historical cost may differ significantly from the current market value
-​ Depreciation rates are only estimates and may not reflect the actual value decline
-​ Intangible assets (goodwill, patents, trademarks) are difficult to value and may
overstate the business's worth
-​ Some future liabilities (e.g. warranty costs) must be estimated, adding further
uncertainty
 Financial Management Process

Timing Issues
The matching principle requires expenses to be recorded in the same period as the
revenue they helped generate.

Accountants may manipulate the timing of revenue and expenses to distort profitability:
-​ Delaying revenue to reduce current tax obligations
-​ Prepaying expenses to claim early tax deductions
-​ Using shorter accounting periods to avoid unfavourable transactions
-​ Financial statements also do not show seasonal variations or peak demand periods

Debts Repayments
Financial reports have limited capacity to disclose specific details about debt repayments.
Key issues include:
-​ The balance sheet does not show how long liabilities have been carried
-​ Businesses may roll over debt (accrued liabilities) to hide financial pressure
-​ Future obligations like loyalty programs and employee entitlements are difficult to
estimate
-​ Bad debts may be left on books as accounts receivable — overstating working
capital and understating real financial risk

Notes to the Financial Statements

Additional information at the end of a financial report provides further detail on items in
the main statements.
Notes can include accounting methodologies, inventory valuation techniques and how
figures were calculated. However:
-​ They can be numerous and complex, making them difficult for non-accountants to
understand
-​ Important information may be buried in the notes rather than clearly presented in
the main statements

Ethical Issues Related to Financial Reports

ethical issues Financial managers need to ensure their decisions are ethical and of a high standard.
related to Therefore, the decisions of financial management must reflect the objectives of the
financial reports business while being ethical, feasible, and cost-effective

Audited Accounts
ARRP Audit: an independent check of the financial records of a business by a certified
accountant to ensure financial reports represent a true and fair financial picture

Three Types of Audits

Type Description

Internal Audit Conducted internally by employees to check accounting

procedures

Management Audit Reviews the firm's strategic plan and determines necessary
changes
 Financial Management Process

External Audit Required by the Corporations Act 2001 (Cth) for all public
companies, clubs and associations annually
Why audits are necessary
-​ Stakeholders need to trust annual reports
-​ Owners need accurate profit results
-​ Businesses need to minimise tax liability legally
-​ Managers need accurate information for informed decision-making

Auditors may uncover serious issues such as

-​ Inappropriate cut-off periods to avoid tax
-​ Misuse of business funds by executives
-​ Overstated expenses or inappropriate asset valuations
-​ Businesses claiming R&D spending as an investment asset rather than an
expense

Internal and external audits also guard against waste, inefficient use of resources, fraud
and theft. The International Financial Reporting Standards are incorporated within
Australia's Accounting Standards to increase transparency and accountability.

Record Keeping
Businesses must create source documents for every transaction, including cash
payments

Businesses operating primarily on a cash basis may be tempted to only record revenue
when an invoice or receipt is issued — understating income and avoiding taxes. This
constitutes tax evasion, which is illegal.

Mechanisms that make tax evasion more difficult:

-​ The introduction of GST and the Business Activity Statement (BAS) requirement
-​ The ATO regularly monitors and audits businesses sporadically to catch tax
offenders
-​ The ATO's Project Wickenby recouped over $2.2 billion in tax liabilities with 46
convictions up to 2015
-​ The Serious Financial Crime Taskforce (from 1 July 2015) focuses on international
tax evasion
-​ Most cases are heavily publicised to act as a deterrent

Reporting Practices
Stakeholders in a private company are legally entitled to receive financial reports annually.
Businesses that misrepresent their financial position engage in illegal and unethical
practices.

Common unethical reporting practices include:

-​ Understating profits to reduce tax liability
-​ Overstating asset values to appear more financially stable
-​ Using business credit cards for personal expenses
-​ Undervaluing businesses — making them targets for corporate raiders who take
 Financial Management Process

over and strip assets for profit

Consequences of unethical reporting:

-​ Prosecution by the ATO
-​ Loss of trust with customers and investors
-​ Difficulty obtaining finance from external sources
-​ Since 1 July 2004, amendments to the Corporations Act 2001 (Cth) require
companies to publicly disclose the salary packages of directors and executives —
forcing greater transparency and accountability

Promoting ethical reporting:

-​ Triple Bottom Line (TBL) reporting — measures financial, social and environmental
performance, providing a more balanced and transparent picture of the business
-​ Directors have a legal duty to act in good faith, and their decisions must be
transparent to shareholders and the general public
-​ Decisions of financial management must be ethical, feasible and cost-effective
while reflecting the objectives of the business
STRATEGIES (CWPG)
 FINANCIAL MANAGEMENT STRATEGIES

Cash Flow Management (FDD)

cash flow Cash flow: The movement of cash in and out of a business over a period of time
management
Strategic financial management involves managing financial resources to achieve business
goals and maximise the business's value. Good financial management helps a business make
effective use of resources, achieve objectives, gain competitor advantage and prepare for
long-term financial sustainability.

A business must always maintain adequate liquidity — having enough cash to pay expenses
such as rent, wages, phone bills and leasing costs. A business can have plenty of non-current
assets and high accounts receivable but still go bankrupt if it lacks liquidity, as creditors can put
the business into receivership for failing to meet loan repayments.

Sources of Cash Flow

Cash Inflows Cash Outflows

Sales/fees/commission Payments to suppliers

Collections of accounts Payments to employees

receivable

Receipt of bank loans Payment of expenses (electricity,

insurance)

Issue of shares Interest paid on loans

Dividends/interest received Loan repayments and drawings

Sale of assets Purchase of non-current assets

Cash Flow Statements

A financial statement indicating the movement of cash receipts and payments over a period of
time — sometimes referred to as a rolling or continuous cash budget.

The cash flow statement links the income statement and balance sheet, providing information
on a firm's solvency. It allows the business to identify trends and predict future changes to its
financial position, showing whether a business can:
-​ Generate favourable cash flow
-​ Pay financial obligations when due
-​ Fund growth or expansion
-​ Obtain external finance when needed
-​ Pay creditors or dividends to shareholders

By creating a projected cash flow statement, managers can:

-​ Predict when cash will be needed and retain cash from profitable periods
-​ Avoid unnecessary debt by planning ahead
-​ Shop around for the cheapest short-term finance (e.g. overdraft)
 FINANCIAL MANAGEMENT STRATEGIES

Distribution of Payments
Spreading large expenses across the year so that significant outflows do not occur at the same
time — ensuring a more equal and predictable cash outflow each month.

ACRONYM: PPPL

Strategies include:
-​ Paying insurance premiums monthly rather than annually
-​ Paying liabilities on the last possible due date to keep cash in the business for as long as
possible
-​ Prepaying expenses (e.g. rent or interest) when cash is available to avoid future
non-payment issues — often resulting in a better deal
-​ Leasing equipment instead of purchasing outright — spreads the cost into smaller,
predictable monthly payments over the life of the asset rather than one large cash outflow
Discounts for Early Payment
Offering customers a discount (typically 2–5%) if they pay their accounts within a specific period
of time — accelerating cash inflows into the business
Benefits:
-​ Speeds up cash inflow from credit sales
-​ Reduces the risk of non-payment or bad debts
-​ Most effective when targeted at customers who owe significant amounts
Additional strategies to speed up collections:
ACRONYM: SLS
-​ Shorten credit terms — reducing the number of days customers have to pay invoices
-​ Late payment fees — charging account holders who exceed the payment period,
encouraging earlier payment
-​ Small gifts or discounts on future orders as incentives for early payment
Factoring
Selling the business's accounts receivable to a specialist factoring firm at a discount to create
immediate cash inflows.
How it works:
-​ The factoring firm pays the business the value of accounts receivable less a fee or
commission
-​ The business typically receives up to 80–90% of the invoice value within 48 hours
-​ The factoring firm then collects the money from account holders as payments fall due
Adv vs Disadv
ADV DISADV

Immediate access to cash → improving Relatively expensive — commission/fee is

liquidity charged

Improves cash flow, working capital and Business may be responsible for unpaid
gearing debts

No mortgage security required (e.g. NAB Invoice Reduces the total value of current assets
Finance)

Approval can be made within one business day Loss of control over debt collection process
 FINANCIAL MANAGEMENT STRATEGIES

Working Capital Management

working Working Capital: The funds available for the short-term financial commitments of a business.
capital Net Working Capital = Current Assets − Current Liabilities
management Working capital management involves determining the best mix of current assets and current
liabilities to achieve business objectives. Short-term liquidity is critical as it allows businesses
to:
-​ Meet short-term debts and loan payments
-​ Take advantage of profit opportunities when they arise
-​ Avoid cash shortages that lead to increased debt and gearing
Working Capital Ratio: CA/CL
-​ Results must be greater than 1:1 for the business to be financially stable
-​ Ideal ratio is 2:1 — $2 of current assets for every $1 of current liabilities

Control of Current Assets

The three most common current assets are cash, receivables and inventories.
Cash
Cash is the most liquid current asset — it must be available for unexpected expenses and
investment opportunities. Strategies to manage cash include:
-​ Budgets — plan and compare actual vs expected cash needs
-​ Cash flow statements — identify periods of shortage and surplus
-​ Distribution of payments — spread large expenses evenly across the year
-​ Sale and leaseback — sell non-current assets to free up cash immediately
-​ Bank overdraft — organise before cash runs short to cover temporary shortfalls

ACRONYM: BBCDS

Receivables (Accounts Receivable)

Receivables are amounts owed to the business by customers from credit sales. The faster
debtors pay, the better the business's cash position. Strategies include:

ACRONYM: CCDFLS

Strategy Description

Discounts for early Offer 2–5% discount to speed up cash inflow

payment

Shorten credit terms Reduce the number of days customers have to pay

Late payment fees Charge customers who exceed the payment period

Credit policy review Check credit history, impose credit limits, send reminder
notices

Factoring Sell accounts receivable to a factoring firm for immediate

cash (less a fee)
 FINANCIAL MANAGEMENT STRATEGIES

Cash on delivery (COD) Require immediate payment from slow-paying customers

Key notes:
Bad debts occur when customers can no longer afford to pay. These must be written off as an
expense in the income statement, reducing profitability.
Inventories
Too much inventory ties up cash and creates storage, insurance and monitoring costs. Too little
risk running out of stock. Strategies include:
CESJR
-​ Regular stocktakes — physical counts to monitor stock levels
-​ Just-in-time (JIT) inventory management — order only what is needed, reducing storage
costs and freeing up cash
-​ Computerised inventory systems — use barcodes to track stock movement and
automatically contact suppliers
-​ Security measures — cameras, security tags and limited staff access to prevent theft and
loss
-​ Eliminating slow-selling items — review the sales mix to free up cash

Control of Current Liabilities

The most common current liabilities are accounts payable, short-term loans and overdrafts.
Payables (Accounts Payable)
Payables are amounts the business owes to suppliers. Key strategies:
MFCS
-​ Stretch accounts payable — pay invoices on the last day they are due to keep cash in the
business as long as possible
-​ Take advantage of discounts for early payment when offered by suppliers
-​ Maintain a good credit rating and reputation with suppliers to preserve favourable credit
terms
-​ Consider floor plan funding (finance company pays supplier; business repays finance
company) or consignment inventory (supplier retains ownership until item is sold)

Key note:
Paying too early = inefficient use of cash. Paying too late = risk damaging supplier relationships
and losing credit terms
Short-Term Loans
C
-​ Compare costs and terms across different lenders to find the most appropriate and
cost-effective finance
-​ Useful for businesses with seasonal variations in demand to even out cash flow
-​ Business credit cards offer up to 55 days interest-free — a flexible short-term option
-​ Always make repayments on time to protect future access to debt finance
 FINANCIAL MANAGEMENT STRATEGIES

Overdrafts
-​ An overdraft allows the business to overdraw its account up to an agreed limit for a
specified period
-​ Interest is charged on the daily outstanding balance at a variable rate
-​ A convenient form of short-term borrowing — deposit all cash received promptly to reduce
the amount owing
-​ Online banking gives financial managers 24/7 access to monitor and manage the
overdraft

Leasing
Leasing: The hiring of an asset from another person or company who retains ownership of it, in
return for regular fixed payments over a set period.
Benefits of leasing:
FFTP
-​ Frees up cash — no large upfront purchase cost, improving working capital
-​ Tax deductible — lease payments are an expense, reducing taxable income
-​ Predictable payments — fixed instalments make budgeting easier
-​ 100% financing — allows businesses to acquire assets without using equity or taking on
large debt
-​ Flexibility — lease only for the time the asset is needed; upgrade to latest technology each
period
-​ Leasing company organises maintenance and repairs

Sale and Leaseback

Sale and Leaseback: Selling an owned asset to a lessor and immediately leasing it back through
fixed payments for a specified period.
-​ Provides an immediate cash injection to the business — improving liquidity and working
capital
-​ The cash obtained can be used to pay debts and short-term liabilities
-​ The business retains use of the asset despite no longer owning it
-​ Lease payments are tax deductible

Profitability Management
profitability Profitability Management: The control of both a business's costs and its revenue to maximise
management profit
Financial managers must keep accurate and up-to-date records of all expenses and revenues to
assess profitability. Effective profitability management ensures the business:
-​ Does not overspend and minimises costs
-​ Maintains accurate financial records
-​ Maximises revenue
Profitability management is divided into two key areas: cost controls and revenue controls

Cost Controls
Fixed and Variable Costs
Fixed Costs: Costs that do not change regardless of the level of business activity
Variable Costs: Costs that change proportionately with the level of business activity
 FINANCIAL MANAGEMENT STRATEGIES

Fixed Costs Variable Costs On-Costs (Labour)

Salaries, rent, lease payments Wages, raw materials, electricity Superannuation

Loan repayments, insurance Advertising, phone, freight Annual and sick leave

Government fees and rates Cost of goods sold, petrol Workers compensation

Strategies to reduce variable costs:

DSCOJ
-​ Negotiate discounts through bulk ordering or supplier rationalisation (reducing number
of suppliers)
-​ Switch to cheaper suppliers
-​ Replace full-time staff with casual staff (no on-costs such as holiday/sick leave)
-​ Increase customer self-service (e.g. self-serve registers, ATMs)
-​ Use JIT inventory management to reduce storage costs
-​ Share resources with other businesses (e.g. delivery costs)
-​ Multiskill the remaining staff to reduce headcount
-​ Outsource non-core functions (e.g. payroll, cleaning, security, call centres)
Key note:
Fixed costs are harder to reduce as they are often contract-based. Management focuses on
variable costs as these offer more flexibility

Cost Centres
Cost Centres: Particular areas, departments or sections of a business to which costs can be
directly attributed.

Cost centres do not produce a direct profit — they add to the cost of running the business.
Financial managers use budgets to monitor and limit spending in each cost centre.

Examples of Cost Centres

Department Cost Centre Examples

Operations Manufacturing, transport and storage

Marketing Market research, promotional activities

Human Resources Recruitment, training

Finance Debt servicing, administration

-​ Direct costs — allocated to a specific product

-​ Indirect costs — shared across more than one product
-​ Cost centres are often targets for downsizing and outsourcing to reduce expenses
-​ Some businesses tie manager bonuses to staying within or below budget
 FINANCIAL MANAGEMENT STRATEGIES

Expense Minimisation
Expense Minimisation: A financial strategy that aims to deliver goods and services at the lowest
possible cost while maintaining quality.
Since most fixed costs cannot be changed, variable costs are the primary target for
minimisation. Strategies include:
-​ Introduce JIT inventory management to reduce warehousing costs
-​ Decrease packaging costs
-​ Substitute machinery for labour (e.g. automation in manufacturing)
-​ Downsize middle management
-​ Multiskill the workforce to increase efficiency
-​ Casualisation of the workforce to reduce on-costs
-​ Outsourcing non-core functions
-​ Relocating operations to cheaper premises
-​ Bundle pricing to increase sales volume while reducing per-unit costs
Expense minimisation reduces cash outflow and increases productivity and efficiency —
ultimately achieving profit maximisation.

Revenue Controls
Revenue: The money a business receives during a specific period from sales, fees and
commissions — after accounting for discounts and returns.

Revenue controls are used alongside marketing objectives to maximise income. The three
key revenue controls are: MSP
Marketing Objectives & Sales Forecasts
Sales Forecast: A prediction of future sales based on internal and external factors.
A sales budget predicts future sales based on:
-​ Patterns from previous years
-​ Effectiveness of marketing strategies
-​ Economic conditions and level of competition
-​ Stage in the product's life cycle
-​ Market research results
Actual sales are compared to budgeted sales regularly (monthly, weekly or daily) to determine
whether the business is on track to meet its objectives. This links the marketing plan to the
financial plan — increased sales = increased revenue

Sales Mix
Sales Mix: The combination of different products and services that make up the total sales of a
business.
-​ Sales reports identify which products contribute most or least to total revenue
-​ Financial managers use this data to decide which products to concentrate on or eliminate
-​ Changes to the sales mix may involve diversification, extending product ranges or
ceasing production lines
-​ Any changes must maintain a clear focus on customer orientation and target market
needs
-​ A cost-volume-profit (CVP) analysis can determine the level of sales needed to cover all
fixed and variable costs and break even

Pricing Policies
 FINANCIAL MANAGEMENT STRATEGIES

A business's pricing policy directly affects both revenue and working capital and must be
constantly monitored
-​ Cost-based pricing — sets price based on cost of supply plus a fixed percentage mark-up,
ensuring a set profit on each sale
-​ Reducing or discounting prices on slow-selling products may increase sales volume but
can reduce profit margins
-​ To increase total revenue through discounting, the business must sell a significantly
higher volume to compensate for the lower margin
-​ Pricing must balance maintaining market share while achieving profitability objectives

Global Financial Management

global When a business enters the global economy, it faces additional financial risks from the external
financial environment. Global financial managers must manage four key variables:
management -​ Exchange rates
-​ Interest rates
-​ Methods of international payment
-​ Hedging and derivatives

Exchange Rates
Exchange Rate: The value of one country's currency in terms of another currency, determined by
supply and demand on the foreign exchange market (forex)

Currency fluctuations directly impact the profitability and financial stability of global
businesses, affecting their ability to meet revenue and cost objectives

Appreciation (AUD increases in Depreciation (AUD decreases in

value) value)

Exports More expensive overseas → demand Cheaper overseas → demand

falls → less competitive internationally increases → more competitive
internationally

Imports Cheaper to buy → reduces input costs More expensive to buy → increases
input costs

Overall effect Reduces international competitiveness Improves international

of Australian exporters competitiveness of Australian
exporters

Key note:
Currency fluctuations can make carefully prepared financial budgets useless and unreliable for
business planning — making hedging essential.
 FINANCIAL MANAGEMENT STRATEGIES

Interest Rates
Interest Rates: The cost of borrowing money — the higher the risk of lending, the higher the
interest rate charged.

Global businesses can borrow from financial markets in other countries, often at lower interest
rates than those available in Australia. However, this creates additional risk:

Advantages of overseas borrowing:

-​ Lower interest rates available in developing economies
-​ Fewer restrictions on loan amounts, repayment periods and conditions
-​ Finance may be acquired more quickly and easily
-​ Currency appreciation can make repayments cheaper
Risks of overseas borrowing:
-​ Transaction exposure — exchange rates may change after entering into financial
obligations
-​ If the AUD depreciates, interest repayments increase as it costs more AUD to obtain the
same foreign currency
-​ Any adverse currency fluctuation can eliminate the advantage of cheaper overseas rates
and increase debt repayments long-term
Key note:
Businesses must thoroughly research overseas economies, foreign government policies and
political stability before borrowing internationally.

Methods of International Payment

International payments are complicated by language barriers, cultural differences, currency
fluctuations, time zones and lack of physical meetings. Both importers and exporters use third
parties and intermediaries to minimise these risks.

Risk spectrum for the exporter:

Method How it works Risk to Exporter Risk to Importer

Payment Exporter receives full payment Lowest risk Highest risk — no

in Advance before goods are sent guarantee goods will
arrive

Letter of Importer's bank guarantees Low risk — relies on Medium risk —

Credit payment to exporter once bank not importer cannot withdraw
conditions are met once committed

Bill of Written order from exporter Medium risk — Medium risk — two
Exchange demanding payment at a exporter retains types: payment
specified time; bank acts as control of goods before or after
intermediary until payment receiving goods

Clean Goods shipped before payment is Highest risk — Lowest risk

Payment received; invoice requests relies entirely on
payment 30–90 days after delivery importer's trust
 FINANCIAL MANAGEMENT STRATEGIES

Key Notes:
Clean payment should only be used when there is a long track record of promptly paid
transactions and a high level of trust between the parties.

Hedging
Hedging: The process of minimising the risk of currency fluctuations on international financial
transactions.

Currency fluctuations can increase costs and reduce profits — transaction exposure refers to the
risk that exchange rates change after a business has already entered into a financial contract.

Natural Hedging Strategies

-​ Establishing offshore subsidiaries — conducting transactions between subsidiaries in the
same currency to avoid currency conversion (e.g. a US parent company and its Malaysian
subsidiary always transact in USD)
-​ Arranging for import payments and receipts to be denominated in the same foreign
currency
-​ Insisting on import/export contracts in AUD — transferring the exchange rate risk to the
other party
-​ Implementing marketing strategies that reduce price sensitivity of exports

Derivatives
Derivatives: Financial instruments used to minimise or spread the risk of exchange rate
fluctuations.
The three main types of derivative contracts are:
1.​ Forward Exchange Contract
-​ A contract to exchange one currency for another at an agreed exchange rate on a
future date (typically 30, 90 or 180 days)
-​ The bank guarantees a fixed exchange rate for the exporter regardless of what the
actual rate is on that date
-​ Allows both exporter and importer to make accurate financial forecasts
Key Notes: Cannot take advantage of favourable exchange rate movements — locked into the
agreed rate

2.​ Currency Option Contract

-​ Gives the buyer the right but not the obligation to buy or sell foreign currency at a
set rate at a future date
-​ Protects the holder from unfavourable exchange rate movements
-​ Unlike forward contracts, allows the holder to benefit from favourable movements
if they choose not to exercise the option
3.​ Swap Contract
-​ An agreement to exchange currencies at the spot rate today, with an agreement to
reverse the transaction at a specified future date
-​ Allows businesses to alter their exposure to exchange rate fluctuations without
discarding original transactions
-​ Useful when a business has one currency available but needs another (e.g. an
Australian business with euros needing USD to pay a US supplier)