Business Studies HSC Lectures Len Nixon Finance 1
Finance Role of financial management strategic role of financial management objectives of financial management profitability, growth, efficiency, liquidity, solvency short-term and long-term interdependence with other key business functions Influences on financial management internal sources of finance retained profits external sources of finance debt short-term borrowing (overdraft, commercial bills, factoring), long-term borrowing (mortgage, debentures, unsecured notes, leasing) equity ordinary shares (new issues, rights issues, placements, share purchase plans), private equity financial institutions banks, investment banks, finance companies, superannuation funds, life insurance companies, unit trusts and the Australian Securities Exchange influence of government Australian Securities and Investments Commission, company taxation global market influences economic outlook, availability of funds, interest rates Processes of financial management planning and implementing financial needs, budgets, record systems, financial risks, financial controls debt and equity financing advantages and disadvantages of each matching the terms and source of finance to business purpose monitoring and controlling cash flow statement, income statement, balance sheet financial ratios liquidity current ratio (current assets current liabilities) gearing debt to equity ratio (total liabilities total equity) profitability gross profit ratio (gross profit sales); net profit ratio (net profit sales); return on equity ratio (net profit total equity) efficiency expense ratio (total expenses sales), accounts receivable turnover ratio (sales accounts receivable) comparative ratio analysis over different time periods, against standards, with similar businesses limitations of financial reports normalised earnings, capitalising expenses, valuing assets, timing issues, debt repayments, notes to the financial statements ethical issues related to financial reports Financial management strategies cash flow management cash flow statements distribution of payments, discounts for early payment, factoring working capital management control of current assets cash, receivables, inventories control of current liabilities payables, loans, overdrafts strategies leasing, sale and lease back profitability management cost controls fixed and variable, cost centres, expense minimisation revenue controls marketing objectives Len Nixon Finance 2
Budgets Cash flow, P and L Balance Sheet Planning and implementing Monitoring and controlling Processes Role of finance management Strategic role Objectives long term role affecting all parts of the business Profitability Growth Efficiency Profitability Gearing( Slovency ) Liquidity Efficiency Financial Ratios Limitations valuing,timing, Ethical issues related to financial reports Finance Interdependence Between Human Resources, Marketing Operations Liquidity Solvency Distribution of payments Cashflow statement Current assets and liabilities Cashflow Working capital Financial Strategies Influences on Financial Management Internal Sources External Sources Financial institutions Influence of government Equity Debt Banks and NBFI's ASIC Australian Securities Exchange Taxation Cost controls and revenue Profitability Global financial Global market influences Availability of funds,interest rates, economic outlook Exchange Rates, Interest rate hedging,derivatives Len Nixon Finance 3
The role of Financial Management to ensure there is sufficient finance to meet the financial needs of the business Profits and Losses Surplus or deficit generated from business activities Financial objective: Profitability Vision Financing decision Source of finance-debt and or Equity Financial objective: Solvency Mission Statement Long term Goals The perimeter of the cycle is the flow of funds. These are funds to finance strategies such as marketing, HR and operations. Objectives Minimisation of costs and an indicator of how assets are contributing to generating revenue and profits Financial objective: Efficiency Strategies Current assets and current liabilities Ability to pay short debts Financial objective: Liquidity Len Nixon Finance 4
Role of financial management continued Objectives of financial management There are a number of financial objectives to be established in order to achieve the business s strategic or long-term financial goal. Long term E.g. 5 years Strategic or long-term goal. E.g. to increase Profitability Short term Within a year Interdependence with other key business functions The key business functions are: Human Resources Marketing Finance Operations All these functions or activities must interact with each other if a business is going to achieve the business s strategic, tactical and operational goals and objectives. In other words, they are dependent on each other. Profitability Increase Net profit Growth Increase Market share Efficiency Decrease expenses Liquidity Control cash flow Solvency Ability to pay off long term debt Finance Profitability Growth Efficiency Liquidity Solvency Marketing Operations Human Resources Outline how finance is related marketing Len Nixon Finance 5
Finance Internal and external sources of funds and financial objectives HSC 2012 Section 4 Extended response How can different sources of funds help a business achieve its financial objectives? Answers could include: Objectives of financial management profitability, growth, efficiency, liquidity, solvency short-term and long-term Sources of funds internal sources of finance retained profits external sources of finance debt short-term borrowing (overdraft, commercial bills, factoring), long-term borrowing (mortgage, debentures, unsecured notes, leasing) equity ordinary shares (new issues, rights issues, placements, share purchase plans), private equity Issues in answering the question Directive term use- what does it mean? How means How to, how might, how would, how can and why are and why is? explain show cause and effect Profitability Debt Solvency Sources of funds Cause and effect Financial Objective s Efficiency Equity Growth How? evaluate / make a judgement Know the syllabus Case study material Len Nixon Finance 6
1. What type of finance to use? Sources of finance Internal - Equity External - Debt Debt Current Liabilities (external debt) Short Term means - 1. Type Cost Source Use 2. Type Cost Source Use 3. Type Cost Source Use 4. Type Cost Source Len Nixon Finance 7
Use Long Term (External) Non-Current Liabilities Long term means 1. Type Cost Source Purpose 2. Type Cost Source Purpose 3. Type Cost Source Purpose 4 Type Cost Source Purpose Len Nixon Finance 8
Financial Management issues The use of short and long-term debt will affect: Profitability - Solvency Efficiency Important financial management principle The matching the terms and sources of finance to the purpose Equity internal and external equity Internal Equity relates to an Unincorporated business structures such as Sources of funds External Equity sources relates to Incorporated business entity such as Type Cost Source Purpose 2014 HSC Emu Manufacturer Uniform You have been hired as a consultant to write a report to the management. In your report: recommend a source of finance for the factory expansion Sales are increasing They need to expand. To do this they will have to outsource overseas OR expand their current factory sixe Len Nixon Finance 9
Recommend a source of finance for the factory expansion Suggestions? Advantages and disadvantages of using debt finance Advantages Disadvantages Advantages and disadvantages of using Equity finance Advantages Disadvantages Other Financial institutions Australian Securities Exchange Insurance companies Superannuation Funds Unit trusts Len Nixon Finance 10
The connection between external INFLUENCES on a business s Financial Statements PROCESSES, RATIO and COMPARATIVE ratio analysis, the management s response FINANCIAL STRATEGIES and the financial implications of these strategies. Global Influences External Influences Government Influences S Financial Implications of strategies for Financial objectives Profitability Efficiency Solvency Liquidity Leads to Len Nixon Finance 11
Influences on financial management Global market influences global economic outlook, availability of funds and interest rates. These external influences are out of the direct control of management but can affect a business in the following areas: Growth Liquidity Solvency Profitability Efficiency Global economic outlook Availability of funds Interest rates Case Study For example, assume global demand for building products increases. For Doors R US, being an Australian company, this trend represents an opportunity to sell more of its products overseas. The financial implications for the business are the following: Increased prof Increased growth Increased market share Need to finance operations through debt and equity - Solvency Businesses can access funds from overseas Debt markets Equity markets Because of the removal of many barriers by owing to the removal of regulations, many Australian businesses have been able to raise funds in European and USA debt and equity markets. There are a number of management issues to be considered when undertaking such a strategy. This include: Interest rates Interest rate Exchange rate The bigger pool of funds available The length time of the loan Sec required against the loan This is the cost of borrowing funds. Note that interest rates are an expense and hence will affect financial efficiency of the business together with net profitability. At present, Australian interest rates are lower than many of its trading partners such as Japan and USA. Len Nixon Finance 12
Processes of financial management Limitation of financial reports limitations of financial reports normalised earnings, capitalising expenses, valuing assets, timing issues, debt repayments, notes to the financial statements ethical issues related to financial reports HSC 2013 Auditors have discovered that the value of legal fees paid has been included in the asset value of a new warehouse purchased by a business. What limitation of financial reports does this show? (A) Capitalised expenses (B) Debt repayments (C) Normalised earnings (D) Timing issues How do ethical considerations play a role in the valuing of current assets such as Accounts Receivable Inventories What does Capitalising expenses means? What are the ethical issues related to the issues of debt payment Len Nixon Finance 13
Processes of financial Management Financial Ratios Ratio Formula Calculation Interpretation Direct Links Sales generated = Marketing Advertising = Marketing Cost of Goods Sold = Operations Franchise Fees = Operations Rent = Operations Wages = Human Resources Len Nixon Finance 14
Liquidity Industry Average 0.75:1 Gearing Industry Average 1:1 Profitability Industry Average Gross Profit : 80% Net Profit: 40% Return on Owner s Equity: 58% Efficiency Industry Average 40% Current Assets Current Liabilities Total Debt Total Equity Gross Profit Total Sales Net Profit Total Sales Net Profit Total Equity Total Expenses Total Sales Len Nixon Finance 15
Financial strategies Report 2013 Kingland Office Supplies operates in a large NSW city in a highly competitive market. A paid manager is responsible for the day to day running of the business. The owners are concerned about the low profitability of the business. Investigations by the owners indicate the following problems: customers find the product mix unappealing poor management of cash flow poor accounts receivable turnover compared to similar businesses. The manager has also identified low prices offered by larger competitors as a cause of the low profitability. Write a report recommending financial strategies to improve the performance of the business. providing reasons for financial strategies such as cash flow management, working capital and profitability management to address the issues identified in the hypothetical situation Len Nixon Finance 16
Financial Objective Working capital management Liquidity Problems and Solutions Us e of funds Current Assets Types Calculated CA/CL Liquidity found in Balance Sheet ability to pa y short term debts Current Liabilities Types of short te rm de bt Sourc es Ba nks Fina nce Companies La rge Companies Too much or Too little Storage Transport Insurance Costs Problems Problems Ca sh Stock/ Inventory Solutions Solutions Ca sh Budgets J.I.T Stocktakes Two Bin method. Ba nk Overdraft Ac counts Payable Financial management strategies The use of all these types of finance will be a cost or expense t o the business. Their use will decrease profit s Poor credit policies Clerical problems High Ac ounts Receivable Turnover Age ac counts Problems Ac counts Receivable Solutions Problems with the current assets will have and effect on the business's cashflow cycle Fa ctoring Cash only Discounts Credit restrictions Credit Ca rd Bank Bill Financial Management Curr ent Ass ets = Current Liabilit ie Len Nixon Finance 17
Terms, Definitions, Problems and Financial manage ment issues related to Profitability Sales reve nue Revenue inflow Influenc ed by Sales obj ectives Pricing policy Profit Outflow Cost control Expenses Profit may increase or decrease owing to sales. This is the outc ome of good or poor mark eting de cisions Pric e Determined by Marketing Issues and strategies Marketing research Market Segmentation Ta rg et Market 4 P strategies Promotion Calculations Gross Profit Margin Net Profit Margin Re turn on Equity Liquidity issues Too much Not enough Stock Good and poor management centres on the purc has e of stock Problems Cost of goods sold Ope ning Inventory + Purchases less e nding stock Solutions and Costs Ra tes of interest (borrowed funds) Storage Ordering Transport Se lling Marketing arising from Outlays to ge nerate revenue and profit Fina ncial Bad Debts (A/C Receivable Expenses directly affect the EFFICIENCY of a Business Strategies and Solutions Administration Huma n Re source s Cost control More efficient management of marketing Employment relations and operations Management Place Product J. I. T Stocktakes Two Bin Method Fixe d Costs Variable Costs Len Nixon Finance 18 These transactions are to be found in a business's Profit and Loss Statement Known as a Statement of Financial Performance Cost centres
Cash flow Management Cash flow the problem The example below represents a summary of a cash in and cash out for a clothing store and the cyclical flow of funds Jan Feb Mar April May 2000 4000-1000 -5000 Cash In 2000 0 22000 1600 0 1600 0 1700 0 Cash Out Surplus / shortag e 1800 0 + 2000 19000 2100 0 +400-0 1000 2000 1700 0 0-5000 -5000 Management Strategies to overcome potential cash flow problems Strategies to manage cash flow Factoring ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------ Discounts for early payment ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- ------------------------- Distribution of payments ---------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------ Receipt of cash from credit sales Other Strategies ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- ------------------------- Outflow of cash for stock purchased Credit sales Accounts Receivable Len Nixon Finance 19