Finance HSC Business Notes

– Year 12 Finance Business Notes - 2020
Finance HSC Business Notes

Role of Financial Management
Strategic Role of financial Management
Financial Management
 Financial management is concerned with planning, monitoring and controlling the

allocation of the business finances
 Done in order to link the goals of the business with the resources
Strategic Role of Financial Management is:
 Achieving the objectives of the business and making funds available

Strategic Plans
 Highly important
 Give businesses long term vision and direction and it monitors the progress
 Strategic plans may cover 10 years in advance
 The strategic the business would like to undertake to achieve their goals are outlined in the
strategic plan
It Includes:
 Setting financial objectives and ensuring the business is able to achieve these goals
 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

 Businesses all have goals that they want to achieve e.g. to increase profit
 Goals are then turned into ‘business objectives’
 Objectives give a business direction
 Goals although can be short term and long term most businesses will have more long-term
goals
Profitability (Long-term):
 Ability of a business to maximise its revenue

 Profits make the business owner happy in the short term but also important for long term
business viability
 To ensure that profit is maximised a business must carefully monitor all avenues such as
pricing policies and inventory levels etc.
Growth (Long-term):
 The ability for the business to grow long-term
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 Growth depends on the business’ ability to expand and use its asserts to maximise sales,
profits and market share
 Businesses need to grow otherwise they will hit a state of decline (Business life cycle)
 Business have to maintain suitability
Efficiency (Short-Term):
 Ability of a business to reduce costs and manage its asserts so that maximum profits are
achieved
 To achieve efficiency a business must have ‘control’ measure in place
 Business must monitory inventory levels, cash flow and the collections of receivables (money
owed to the business by external sources)
Liquidity (Short-term):
 Liquidity is the ability of a business to pay their debts as they fall due in the short term
 A business must have a decent cash flow to meet their debts OR
 The ability to convert their current assets into cash quickly e.g. selling stock
 Ideally for every dollar of debt a business should have two dollars for assets this is not always
the case
 A business should have sufficient cash or cash flows and excess idle cash must be avoided as
both involves loss of profitability for a business
Solvency (Long-term):
 Solvency is the extent to which a business can meet its financial obligations in the long term
(greater than 12 months
 Solvency also indicates whether a business will be able to repay money that has been
borrowed from lenders such as the bank for investments in capita e.g. equipment
 If a business is highly geared it means they have a high amount of debt
 Gearing is the proportion of debt (external finance) and the proportion of equity (internal
finance) that is used to finance the activities of a business. Gearing ratios determine the firms
solvency, which measures the percentage of the assets of the business which are funded by
external sources.
Short- term and long-term objectives
Short- term Long-Term
 Tactical (1-2 years)  Strategic Plans

 Operational (day to day)  Determined for a set period of time,
 Reviewed regularly usually more than 5 years
 Goals can be broad
This is in order to meet targets  Requires short term goals to occur in
order to benefit in the long-term
 Short-Term and long-term goals often complement each other but also cause conflict because
if you choose to meet short term goals, sometimes you impact long-term goals or vice versa.
o E.g. To gain long-term goal of growth, this means forging short-term goals of
profitability in the short-term due to the costs for research. Etc.
o If a business is investing in marketing, then they may have to forgo profits
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Interdependence with other business functions

 Refers to the mutual dependence that the key functions have on one another
 Key functions work best when they overlap, and employees work towards common goals
 Each function depends on the support of the others to perform to its capacity
 Marketing, operations and human resources departments rely on financial managers to
allocate them adequate funds. I.e. marketing department funds to undertake the various forms
of promotion and human resources department requires funds to employ staff
 Finance department relies on operations to produce products, marketing to help promote
products and human resources to manage staff
 Each these functions allows the business to generate sales to provide income for the finance
department
Influences on Financial Management

Refers to the funds generated from inside the business.
Internal Sources of Finance – Retained Profits, Owners’ Equity

Retained Profits:
 Retaining earnings or profits in which all profits are not distributed, but are kept in the
business as a cheap and accessible source of finance for future activities
 Some businesses keep some of their profit in the form of retained earnings
 Approximately 50cents of profit on average are retained to be reinvested
Owners’ Equity:
 Internal finance is sourced from within the business

 Is not borrowed money
 Money comes from the business owners or from the outcome of business activity
External sources of Finance

 Refers to the sources provided by sources outside the business
o E.g. Banks, other financial institutions, government, suppliers or financial
intermediaries
 Provided through external sources such as creditors, lenders and is also known as debt finance
 Using debt as a finance relies on outside sources rather than the owners to finance the
business
 There is an increased risk as interest has to be paid on top of the money being borrowed
Debt:
 New business owner may lack the equity to successfully establish or ‘kick start’ a business as
set up costs can be high
 Debt finance can provide this funding and it allows the full ownership of the business can be
maintained
 Debt finance offers certain taxation benefits and allows the owner to plan effectively for
regular repayments made each month
 Disadvantages of debt finance include having to pay back the principal amount with interest
 It can be hard to obtain initially as the business may be seen as a risk by the lender and
security for the loan may be required. If you miss a payment, they up the interest.
 New business often experiences cash flow which can make it difficult to repay the debt on
time and may impact on their credit rating
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Short-Term Borrowing (overdraft, commercial bills, factoring):
 Short-term borrowing allows businesses to finance temporary shortages in cash flow or

finance for working capital
 Refers to the funds that will be repaid within 12 months
 Short-term debts are recorded as current liabilities on the balance sheet
Source of Description Cost

Funds
Bank An overdraft allows a bank to allow a Costs for overdrafts are minimal and
Overdraft business or individual to overdraw their interest rates are lower than other
account up to an agreed limit for a specified forms of borrowing. Interest rates are
time, to help overcome a temporary cash usually variable, interest is paid on the
shortfall. It helps assist with short-term daily outstanding balance of the
liquidity problems, e.g. seasonal decrease in account. Banks require agreed limits
sales. to overdraft to be maintained at a high
level and require security. Overdrafts
may be repayable on demand.
Businesses prefer overdrafts to short-
term bank loans because overdrafts
have more flexibility.
Commerci Are short-term loans issued by financial Borrower receives sum immediately
al Bills/ institutions, for larger amounts (usually and has to repay the money with
Bills of over $100 000) for a period of 30 to 180 interest at a future time. Full amount
Exchange days. borrowed doesn’t have to be repaid
until the end of term. Commercial
bills are flexible in relation to interest
that needs to be paid and the
repayment period. These types of
loans are secured against business’s
assets and are generally rolled over
until the borrower has the funds to
repay the loan in full.
Factoring It is the selling of accounts receivable Factoring has greater risks because of
(money people owe you) for a discounted the likelihood of unpaid debts. It is
price to a finance or factoring company. It relatively expensive source of finance
enables a business to raise funds because the business is usually
immediately by selling accounts receivable. responsible for debts that remain
The business will receive up to 90 per cent unpaid, and commission is paid in the
of the amount within 48 hours of debt. In the past, Factoring was used
submitting invoices to the factoring as a last resort but in the last decade,
company. Access to immediate funds allow factoring is seen as legitimate means
businesses to improve in cash flow and of financing activity.
gearing. The business does not have to
worry about the collection of the accounts,
or the costs involved in the process.
Factoring company may offer services with
or without recourse (‘Without recourse’
means that the business transfers
responsibility for non-collection to factory
company. ‘With Recourse’ means that bad
debts will still be the responsibility of the
business)
Long-term borrowing (mortgage, debentures, unsecured notes, leasing):
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 Relates to funds borrowed for periods longer than 12 months

 Long-term borrowing is used to purchase major assets such as buildings and equipment, and
assets often serve as security on the loan
 Long-term borrowing is recorded as non-current liabilities on the balance sheet
Source of Description Cost

Funds
Mortgage A loan secured by the property of They are repaid with interest, usually
the borrower (business). The through regular repayments, over an agreed
property that is mortgaged cannot amount of time.
be sold or used as security for
further borrowing until mortgage is
repaid. Mortgage loans are used to
finance property purchases, such as
new premises, factory or office.
Debentures Are issued by a company for a Companies that borrow offer security to
fixed rate of interest and for a fixed the lender over the company’s assets. On
period of time. Companies provide maturity, the company repays the amount
them ways to raise funds from of debenture by buying back the debenture.
investors, as opposed to financial The amount of profit made by a company
institutions. A debenture means you has no effect on the interest because
have to repay back the money lent debentures have a fixed rate of interest.
from a business. An investor lends Finance companies raise much of their
money to a company in return the funds through the debenture’s issues to the
company issues a debenture and the public.
business has to make regular
payments for a defined term and
then repay the loan at a particular
date in the future.
Unsecured Is a loan from investors for a set Attracts a higher rate of interest than a
Notes period of time. Unsecured notes are secured note. Companies sell unsecured
not secured against the business’s notes to generate money for their
assets and present more risk for initiatives, such as repurchases and
investors in the note (the lender). acquisitions.
Leasing Involves the payment of money for Cost and benefits of financial asset are
the use of equipment that is owned transferred from lessor to the lessee. The
by another party. Assets suitable for lessee uses the equipment for an agreed
leasing includes business cars, plant period of time. A long-term lease cannot be
and machinery, equipment, usually be cancelled.
computers and software. Leasing
enables an enterprise to borrow
funds and use the equipment
without large capital outlay
required.
More Info Leasing:

Two types of leasing:
1. Operating leases are assets for short periods, usually shorter than the life of the asset. The
owner carries out the maintenance of the asset. Operating assets can be cancelled without
penalty.
2. Financial lease allows the lessor to purchase the asset on behalf of the lessee. Financial
leases are usually for the life of the asset. Lease repayments are fixed for economic life of
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the asset (3 to 5 years). Plant, vehicles, equipment, furniture and fittings are leased as
financial leases. Usually penalties for cancellation of financial leases. Leasing assets for
long periods as financial leases is cheaper than as operating leases.
Advantages of Leasing Disadvantages of Leasing

Assist a business with their cash flow. As cash Interest charges may be higher than other forms
outflows or payments related to leasing are of borrowing
spread out over several years. This saves the
burden of one-off significant cash payment.
Costs of establishing leases may be lower
than other methods of financing
Some assets are leased a business may be in a
better position to borrow funds
Provides long-term financing without
reducing control of ownership
Permits 100 per cent financing of assets
Repayments of the lease are fixed for a
period so cash flow can be monitored easily
Lease Payments are a tax deduction
Payment usually includes maintenance,
insurance and finance costs
Equity:
 Refers to the finance raised by a company through inviting new owners

 Funds invested in a business by its owners are called equity
o E.g. issuing shares though the Australian Securities Exchange. This is used as an
alternate debt funding.
Ordinary shares (new issues, right issues, placements, share purchase plans) – Private Equity
Source of Description
Funds
Ordinary Purchase of ordinary shares by individuals means they have become part-owners of a
Shares publicly listed company. That means they get voting rights according to the number of
shares that they have as well as payments called dividends. (Distributed of company’s
profits to shareholders). When shareholders purchase shares in a company, they are
providing a source of finance (equity) for the business. Value of the share is
determined by a company’s current or future performance.
New Issue A security that has been issued and sold for the first time on a public market e.g.
Australian Securities Exchange. Sometimes referred to as primary shares or new
offerings. (Initial public offering (IPO) is when a company issues shares to the public
for the first time). Business is required to issue a prospectus, a document that contains
relevant details about the
Rights Issue Shareholders buy new shares in the same company. It occurs after the IPO provides
existing shareholders with the opportunity to purchase more shares. The current
shareholders have the right to purchase new shares in proportion to the number of
shares they currently own. Shareholders do not have to take up the right issues.
Placements Shares are made directly from the company to investors. This means shares are offered
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at a discount to their current trading price to special institutions or investors. This

discount is intended to persuade specific investors to invest in the company.
Share An offer existing shareholder in a listed company to purchase more shares in that
Purchase company without brokerage fees. Shares can be offered at a discount to the current
Plan market price. A maximum issue of $15 000 in new shares to each shareholder.
Private Money invested in a (private) company not listed on the Australian Securities
Equity Exchange. The aim of the private company (like the publicly listed companies who sell
ordinary shares) is to raise capital to finance future expansion/investment of the
business.
Financial Institutions
 Financial institutions collect funds and invest them in financial assets
 Provide financial services a focus dealing with financial institutions such as investments,
loans and deposits
 Most businesses acquire funds from a bank, finance is also available from a variety of other
institutions, such as investment, banks finance companies, superannuation funds, life
insurance companies, unit trusts and the ASX
Financial Financial Instruments Characteristics

Institution
Banks Banks receive savings such as deposits Most of the funds come from
from individuals, businesses and banks that operate on their own
governments and in turn make behalf or on other corporations.
investments and borrowers. Banks shares have declined as the
financial markets become
deregulated.
Investment Banks Investment banks provide services such Investment banks trade in money,
as both borrowing and lending, securities and financial futures,
primarily to the business sector. Provide arrange long-term finance for
a wide variety of loans and can therefore compulsory expansion, provide
customise loans to suit the business’s working capital, arrange project
specific needs. finance, advise clients on foreign
exchange cover, advise on
mergers and takeovers, provide
portfolio investment management
services, underwrite corporate
and semi-government issues of
securities, operate unit trusts
including cash management
trusts, property trusts and cash
trusts and arrange overseas
finance.
Finance and Life Finance companies provide mainly Finance companies rise money
insurance short-term and medium-term loans to through share issues
companies businesses through customer high- (debentures). As they are a fixed
purchase loans. Some finance term and carry a fixed rate of
companies specialise in factoring or interest. Lenders have security of
cash flow financing. priority over the firm’s assets if
they were to go through
Life insurance companies are non-bank liquidation. Finance companies
financial intermediaries who provide are entitled to sell the assets of
cover and a lump sum payment in event the business to recover the initial
of death. Provide both equity and loans loan if the business fails. Finance
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to the corporate sector companies provide businesses

with quick access to funds,
although interest rates will be
higher.
Policy holders pay regular

premiums and the insurer
guarantees pay the designated
beneficiary a sum of money to
the insured person.
Superannuation Superannuation is a scheme set
Funds up by federal government, which
requires all employers to make
financial contribution to fund that
will provide benefits to an
employee when they retire.
Employers are required by
government make superannuation
contributions. Employers must
pay an amount of 9.5 per cent of
employee’s salary to super fund
account. Superannuation funds
invest the money received from
superannuation contributions and
many things, such as company
shares, property and managed
funds.
Uni Trusts Also known as mutual funds.
They take funds from a range of
small investors and invest them
in specific types of financial assts
such as the short-term money
market, shares etc. Some unit
trusts also invest in gold, silver,
oil and gas. Usually connect to a
larger firm that also may deal
with superannuation and other
investment options. Easier and
quicker way to raise funds.
Australian The ASX is a market where
Securities shares are bought and sold. ASX
Exchange oversees compliance with its
operating rules and promotes
standards of corporate
government. ASX offers shares,
futures, exchange trade options,
warrants, contracts for difference,
exchange traded funds, real estate
investment trusts, listed
investment companies and
interest rate securities. ASX acts
as a primary market. The primary
market enables a company to
raise new capital through the
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issue of shares and through sale

of securities. ASX also operates
as the secondary market were
pre-hand and second-hand shares
are bought.
Influence of Government (Australian Securities and Investments Commission,

Company taxation)
 Government influences a business through the changes in monetary and fiscal policy
legislation
 Through the various role of government bodies or department who are responsible for
monitoring and administration of business
 Australian Prudential Regulation Authority – Is an independent federal body that
businesses adhere to government regulations to maintain appropriate financial information
and provide consumer protection
Australian Securities and Investments Commission
 ASIC is an independent statutory commission accountable to the commonwealth parliament

 It enforces corporations Act 2001 protects consumers in the area of investments, life a general
insurance, superannuation and banking (except lending) in Australia
 Aim of ASIC is to assist in reducing fraud and unfair practices in financial markets and
financial products
 ASIC ensures companies adhere to the law collects information about companies and makes it
available to the public.
 ASIC has been given power because of the corporation’s act. If a business breaches the law
ASIC will investigate the manner and determine the appropriate remedy. They are able pursue
punishment depending on the misconduct.
Company Taxation
 All businesses included private and public company is required to pay company tax on profits
 The tax is levied at 30 per cent of net profit, unlike personal income taxes, which uses a
progressive scale
 Company tax is paid before profits are distributed to shareholders as dividends
 Australian government has undertaken this process of reform of the federal tax system in
order to improve Australia’s international competitiveness and make Australia a good place to
invest resulting in a long-term economic growth
 This means more jobs are paid higher wages for working Australians
Global Market Influences (Economic Outlook, Availability of funds interest rates)
These influences are part of external business environment and may not be significantly controlled by
the business. However, appropriate financial management strategies should be used to minimise
negative impacts.
o Rely on trade globally, rely on factories offshore
o More interdependence between economies
 Higher risks than domestic risks associated with financial markets
Global Economic Outlook
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 Refers to predicted changes to the level of economic growth through the world
 Negative and positive outlooks (economic growth is to increase) will affect the market
 Increasing demand for products and services.
Impact on financial decisions of a business:
o E.g. In Australia it includes businesses need to increase production to meet the
demand and therefore require funds to purchase equipment, employ or train staff, or
expand the size of the business
o A decrease in the interest rates on funds borrowed internationally from the financial
money market. This results from the decrease in the level of risk associated with
repayments. As business sales increase, so do profits (increase demands for fund can
cause interest rates to rise)
Poor economic outlook will have an impact on financial decisions of a business in the opposite way
then mentioned
Availability of funds
 Refers to the ease with which a business can access funds (for borrowing) on the international
financial markets
 Made up of a range of institutions, companies and governments that are prepared to lend
money to individuals, companies or governments who may need to raise capital
Conditions apply based on:
o Risk
o Demand and supply
o Domestic Economic conditions
 THE GFC (2008-2009) had a major impact on the global availability of funds for all
companies and institutions.
o Caused a sharp increase in interest rates that was because of the high-level risk in
lending
Interest Rates
Interest rates are the cost of borrowing money
 High risk level involved in lending to a business

 A business that plans to relocate offshore or expand domestic production facilities to increase
direct exporting will need to raise finance
 Australian interest rates are higher than other countries. E.g. US and Japan
 Australian business can finance from an overseas source to gain an advantage of lower
interest rates. The real risk is the exchange rate movements. In the long term the ‘cheap’
interest rate might end up costing more.
Process of Financial Management

Important part of financial management is establishing effective financial processes to monitor the
financial health of the business and ensure the organisation meets the objectives.
Planning and Implementing
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Figure 1 The Planning Cycle
(Financial Needs, Budgets, Record Systems, Financial Risks & Financial Controls)
 Financial Planning is essential to a business to achieve its goals
 Financial planning determines how a business’s goals will be achieved
Process of Planning:
1. Determining financial needs
2. Developing budgets
3. Maintaining record systems
4. Identifying financial risks
5. Establishing financial controls
Financial Needs
Financial needs of a business will be determined by
o Size of the business
o Current Phase of the business cycle
o Future Plans for growth and development
o Capacity to source finance – Debt and/or equity
o Management skills for assessing financial needs and planning
 A business plan might be used when seeking finance or support
 A plan sets out the finance required, the proposed sources of finance
 Financial information is needed to show that the business can generate an acceptable return
for the investment being sought
Financial information that is needed to assess a business performance is:
o Analysis of financial performance
o Income statement
o Cash flow statement
o Balance Sheet
o Financial Ratio Analysis
Budgets
Budgets provide information in quantitative terms (facts and figures) about requirements to achieve a
particular purpose.
Purpose:
1. Cash required for planned outlays for a particular period
2. The cost of capital expenditure and associated expenses against earning capacity
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3. Estimated use and cost of raw materials or inventory

4. Number and cost of labour hours required for production
 Budgets reflect the strategic planning decisions about how resources are to be used. Provide
financial information for a business’s specific goals and are used in strategic, tactical and
operational.
 Allows a business to be efficient and proactive in terms of financial planning
 It allows constant monitoring of objectives and provides a basis for administrative control,
direction of sales effort, production planning, control of stocks, price setting, financial
requirements, control of expenses and production cost.
Budgets used for:
Planning - Controlling
Budgets used in both strategic planning and control aspects of a business. As a control measure,
planned performance can be measured against actual performance and corrective action taken is
needed.
 Budgets are often prepared to predict range of activities.

 Controlling (Gross profit ratio, Liquidity Ratio, Solvency Ratio) – These will determine the
corrective actions that needs to be taken
Different Types of Budgets
1. Operating Budgets – Sales Production, expense, raw materials, labour hours
2. Project Budgets – Capital Expenditure, Research and development
3. Financial Budgets – Income statement, balance sheet, cash flow statement
a. (Reflects the results of Operating activities (income), Shows the liquidity of the
business (cash flow)
Record Systems
Record Systems are the mechanisms employed by a business to ensure data is recorded and the
information provided by the record systems is accurate, reliable, efficient and accessible.
 Management has to set up a record system that allows them to record all information needed
 Minimising errors in the recording process, and producing accurate and reliable financial
statements are important aspects of maintaining record systems
 Double entry of accounting is an important control aspect
 Recording items twice, the entries can be seen to balance, and checks to find errors can be
carried out quickly
 Makes information more accessible
 May be used by shareholder to look at financial records
Financial Risk
Financial Risk is the risk to a business of being unable to cover financial risks. E.g. debts that a
business has incurred through borrowing money both short term and long term
Risk in Business Operation:
o Unable to meet its financial obligations bankruptcy will result
o If a business financed from borrowings the risk is higher
 To minimise risk, businesses must consider the amount of profit that will be generated
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 Profit must be sufficient to cover costs of debt as well as increasing profits to justify the
amount of risk taken by owners and shareholders
 If a business has a short-term debt, it must have liquid assets so that debts including interest
payments and the repayment of principal loans can be covered
Financial Controls
Financial Controls are the policies and procedures that ensure that the plans of a business will be
achieved in the most efficient way.
 Financial problems and losses prevent a business from achieving goals

 Theft and fraud include over-purchase of stock for personal use, conflict of interest, misuse of
expense accounts, false invoices, theft of inventory or assets and credit-card fraud
 Financial problems can be cause from both management and employees
 Financial controls ensure that plans that have been determined will lead to the achievement of
a business goal
 Budgets are an important tool as they assist a business to estimate a resource requirement for
a specified future period to predict e.g. cash flow statement predicts cash shortages
Financial Control Strategy that will minimise problems:
Theft:
Control of cash, such as the use of cash registers, cash banked daily, no money kept on premises
overnight, payments made by cheque not cash.
Fraud:
Control of credit procedures, such as following up overdue accounts and customer credit checks
Clear authorisation and responsibility for tasks in the business
Damage or loss of assets:
Protection of assets – E.g., buildings are kept locked, a registry of assets is maintained, regular checks
of inventory are carried out and security cameras are installed
Errors in records systems:
Separation of duties – E.g. one person is responsible for ordering and another for receiving
inventories; one person writes the cheques and another signs the cheques.
Clear authorisation and responsibility for tasks in the business
Rotation of duties – E.g. staff are skilled in number of areas can rotate duties
Debt and Equity Financing – Advantages and Disadvantages
Debt finance relates to the short-term and long-term borrowing from external sources by a business.
Equity finance relates to the internal sources of finance in the business.
o Know at least two disadvantages and two advantages
Debt Finance
Advantages of Debt Disadvantages of Debt

Funds are usually readily available and can An increased risk if debt comes from financial
be acquired at short notice. institution because interest, bank charges and
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government charges may increase.

Increased funds should lead to increased Security is required by the business
profits
Interest Payments are tax deductible Regular payments have to be made
Flexible payment periods and types of debt Lenders have first claim on any money if the
are not available business ends in bankruptcy
It will not dilute the current ownership in the Debt can be expensive e.g. interest must be paid
business
Equity Finance
Advantages Disadvantages
Does not have to be repaid unless the owner Lower Profits and lower returns for the owner
leaves the business
Cheaper than other sources of finance as Expectation that the owner will have return on
there are no interest payments the investment
Owners who have contributed the equity Long and expensive process to obtain funds this
retain control over how that finance is used way
Low gearing (use resources of the owner and Ownership is dilute i.e. the current owners will
not external sources of finance) have less control
Less risk for the business and the owner
Debt Finance Vs Equity Finance
 Take into account what the finance is needed for

 Higher amount of debt is the higher level of risk
Debt Equity
Lenders have prior claim in the event of Shareholders have residual claim on assets
liquidation
Debt must be repaid by periodic repayments Equity has no maturity date
Interest payments are tax deductible Dividends are not tax deductible
Lenders usually require a lower rate of Shareholders require higher return due to higher
return risk
Interest payments are fixed Dividend payments are not fixed and may be
reduced through lack of funds
Debt providers have no voting rights Equity holders have voting rights
Matching the Terms and Source of Finance to Business Purpose
 Small businesses must find the source of finance that is most appropriate to fund the activities
arising from these decisions
 Finance must be suitable for the purpose of which the fund is required
 Use of short-term finance to fund long-term assets
o E.g. Causes financial problems because the amount borrowed must be repaid before
long-term assets had time to generate increased cash flow
 Use of long term to fund short-term situations or assets means the business is paying
mortgage long after the situation is resolved or the stock had been sold, and profits will be
reduced
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 Finance mangers should match the length or term of the loan with the economic lifetime of
the asset the finance is being used to purchase
 Short-term finance should be used to purchase short-term assets and long-term finance for
long-term assets
 Availability of finance affected by a business’s credit rating – banks’ willingness increases
with high credit rating
 Structure: Private companies invite shareholders. Companies can raise by issuing funds to
unincorporated business
Monitoring and Control (Cash Flow Statement, Income Statement & Balance Sheet)
Monitoring and control is an essential in all business aspects as inconsistent methods of review and
systems of control will have an immediate impact on the visibility of the business and requires
management to monitor the internal and external factors that will financially impact the business
Cash Flow Statement
Cash flow statement is a financial statement that indicates the movement of cash receipts and cash
payments resulting from transactions over a period of time. Also, how effective finance is being used
for a business. Provides information if that business has sufficient funds to meet certain needs and
unseen circumstances.
Main purpose of Cash Flow Statement:
o Generate a favourable cash flow (inflows exceed the outflows)
o Pay its financial commitments as they fall due. E.g. interest on borrowings,
repayments of borrowings, accounts payable
o Have sufficient funds for future expansion or change
o Obtain finance from external sources when needed
o Pay drawings to owners or dividends to shareholders
Business activities are divided into three categories for cash movements:
Operating Activities:
Are the cash inflows and outflows relating to the main activity of the business that is, the provision of
goods and services. Income from sales (cash and credit) make up the main operating inflows plus
dividends and interest received.
Outflows consist of payments to:
o Suppliers
o Employees
o Other operating expenses (insurance, rent, advertising)
Investing Activities:
The cash inflows and outflows relating to the purchase and sale of non-current assets and the
investments. These assets and investments are used to generate income for the business.
o E.g. Includes the selling of an old motor vehicle, purchasing new plant and equipment
or purchasing property
Financing Activities:
The cash inflows and the outflows relating to borrowing activities of the business. Borrowing inflows
can relate to equity (issue of shares or capital contribution from owner) or debt (loans from financial
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institutions). Cash outflows relate to the payments of debt and cash drawings of the owner or
payments of dividends to shareholders.
Income Statement
Income Statement is a summary of the income earned and the expenses incurred over a period of
trading. It helps users of information see exactly how much money has come into the business as
revenue, how much has gone out as expenditure and how much has been derived as profit.
Statement Shows:
o Operating Income earned from the main function of the business, such as sales of
inventories, services and non-operating revenue earned from other operations, such as
interest, rate and commission
o Operating expenses such as purchase of inventories, payment for services and other
expenses incurred in the main operation of the business, such as advertising, rent,
telephone and insurance
 The difference between the income and expenses is the profit if exceeds income the loss
Balance Sheet
A balance sheet represents a business’s assets and liabilities at a particular point in time, expressed in
money terms, and represents the net worth of the business.
Assets
The items of value owned by the business. Current assets can be turned into cash within 12 months,
whereas non-current assets are not expected to be turned into cash within 12 months
Liabilities
Claims by people other than owners against assets and represent what is owned by the business.
Current liabilities must be repaid within 12 months, whereas non-current liabilities must be met some
time after the next 12 months.
Owner’s Equity
The funds contributed by the owner(s) and represents the net worth of the business
Balance Sheet Analysis can be used to find out:
o The business has enough assets to cover its debts
o The interest and money borrowed can be paid
o The assets of the business are being used to the maximise profits
o The owners of the business are making a good return on their investment
Account Equation – Forms the basis of the accounting process, shows the relationship between
assets, liabilities and owners’ equity
o Assets = Liabilities + Owners’ Equity
o Owners’ Equity = Assets – Liabilities
o Liabilities = Assets – Owners’ Equity
Financial Ratios
Financial Statement summaries the activities of the business over a period of time. These must be
analysed to increase understanding of the implications of those activities.
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Analysis involves working the financial information into significant and acceptable forms that make
it more meaningful and highlighting relationships between different aspects of a business.
In finance knowing how to compare the ratio analyse the information from the industry norm.
Main types of Analysis are:
o Vertical Analysis: Compares figures within one financial year, E.g. expressing gross
profit as a percentage of sales and comparing debt to equity
o Horizontal Analysis: Compares figures from different financial years. E.g.
Comparing 2017 to 2018
o Trend Analysis: Compares figures for periods of 3-5 years
Ratios are main tools used to analyse financial information and you are required to interpret this
information.
Liquidity: Current Ratio (Current Assets ÷ Current Liabilities)
Liquidity is the extent to which a business can meet its financial commitments in the short-term (less
than 12 months)
 Business must have sufficient resources to pay from its debt and enough funds for unexpected
expenses
 The ability of a business to meet its short-term debts
 Holding of outstanding debts means the business has less cash to earn revenue
 Current assets and current liabilities determine the liquidity or short-term financial stability of
a business
Strategies:
 Leasing, Sale and lease back, factoring, cash budget to monitor inflows and outflows, better
credit policies, JIT stock control, inject equity into bs, task on another partner, cheaper
suppliers, negotiate better supplier credit terms, monitor overdraft rates/ consolidate smaller
loans
Current Ratio (Working Capital) (Ratio only)
Current Ratio = Current Assets ÷ Current Liabilities
 Current Ratio measures a business’s ability to pay back their current liabilities with their
current assets
 Higher the current ratio the more capable the business is in meeting their short-term
obligations
 Determines the liquidity of the business and the financial stability of the business
General Ratio: 1:1 – Indicates a sound financial position for a firm. A firm should have double the
amount of current assets to cover current liabilities.
Acceptable Ratio 2:1: Depends on a number of factors. E.g. type of firm, how other firms in the
industry are operating and factors in the external environment
E.g. The firm has $1.54 of current assets to cover $1 of current liabilities (Commenting on the ratio).
They have more in assets therefore they are able to cover their liabilities.
 If you see a ratio too high can indicate the business is using their current assets well
(sufficient use of assets is a good thing)
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Gearing – Debt to Equity Ratio (Total Liabilities ÷ Total Equity)

(Shown as percentage)
Gearing is the proportion debt (external finance) and the proportion of equity (internal finance) that is
used to finance the activities of a business. Gearing ratios determine the firm’s solvency.
Indicate the long-term stability of the business and the degree to which the business relies on debt
finance. (Borrowing)
Solvency - extent to which the business can meet its financial commitments in the longer term (more
than 12 months)
 Potential investors and creditors are interested in gearing ratios, as they show whether the
creditors will be paid or whether investors can expect a good return on their money.
 An industry that carries higher risk but is likely to generate large profits (e.g. Mining) may
have a higher debt to equity ratio that is highly geared
 Debt affects stakeholders and potential investors because high risk involved may discourage
investment
 Factors such as risk, return and degree of control over the enterprise influence the level of
leverage that is appropriate for a business
 Debt and equity must be balanced
A business must consider:
 Return on investment
 Cost of debt
 Size and stability of the business’s earning capacity
 Liquidity of the business’s assets (the greater the cash flow and the more liquid the assets, the
more likely the interest’s charges will be paid)
 Purposes of short-term debt
Debt to Equity Ratio
Debt to Equity Ratio = Total Liabilities ÷ Total Equity
 Debt to Equity ratio shows the extent to which the firm is relying on debt or outside sources
to finance the business
 A ratio greater than 1 means that the business has less equity than debt
 A ratio between 0 and 1 means that the business has more equity than debt
 Higher the ratio, the less solvent the firm. That is, higher the ratio of debt to equity, the higher
risk
 The type of business will determine how highly geared a business can be. E.g. a business that
is less influenced by economic fluctuations can be more highly geared. A shop selling
essential food items will not be affected by economic downturns so it can carry more debt that
sells luxury items.
 General Standard: 1:1 (Lower is better) – Highly geared is using more debt
(Comment on Gearing) - E.g. For every $1.80 of funding, 80 cents come from borrowing (debt) and
$1 comes from owners (equity)
Profitability – Gross Profit Ratio (Gross Profit ÷ Sales) Net Profit Ratio (Net Profit ÷ Sales) Return on
Equity (Net Profit ÷ Total Equity)
Gross Profit = Sales Revenue – Cost of Goods Sold
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Net Profit = Gross Profit – Expenses

COGS = Opening Stock + Purchases – Closing Stock
Profitability is the earning performance of the business and indicates its capacity to use its resources
to maximise profits.
Measures the earnings of the business
The higher the better
Expressed AS PERCENTAGES
Stakeholders interest in profitability:
 Owners and shareholders want to know whether the firm is earning an acceptable return on
their investment
 Creditors want to know whether they will be paid and should offer credit in the future
 Lenders want to know whether the principal on the loan and interest will be repaid and
whether to lend to the firm in the future
 Management uses profitability to decide on the need for adjustments to policies
Determines amount of profit made by a business:
1. Volume of Sales
2. Mark-Up on purchases
3. Level of expenses
Gross Profit Ratio
Gross Profit = Gross Profit ÷ Sales
 Gross Profit shows the changes from one accounting period to another, and indicates the
effectiveness of planning policies concerning pricing, sales, discounts, the valuation of stock.
 A fall in the rate of gross profit means a fall in the amount of net profit
The amount of decrease depends on:
o Price reductions due to specials or sales
o Mark-Downs on out-of-date stock
o Theft of Stock
o Errors in determining prices
o Changes in the mark-up polices
o Changes in the Mix Of sales
Net Profit Ratio

Net Profit = Net Profit ÷ Sales
 The Net Profit shows the amount of sales revenue that results in net profit
 The cost or expenses after gross profit must be low enough to generate a net profit
 The amount of sales must be sufficiently high to cover costs or expenses of the firm and still
result in profit
Return on Equity Ratio
Return on Equity Ratio = Net Profit ÷ Total Equity
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 The Return on Equity Ratio shows how effective the funds contributed by the owners have
been in generating profit, through a return on their investment
 Used to compare the return with alternative investment considerations, e.g. interest earned
through a financial institution
 The ratio indicates how much the owner’s investment in the business is earning
 The higher the better
 If return is unfavourable, they would consider alternative options, e.g. selling the business
Efficiency – Expense Ratio (Total Expenses ÷ Sales) Accounts receivable turnover Ratio (Sales ÷
Accounts Receivable)
Efficiency is the ability of a business to minimise its costs and manage its assets so that
maximum profit is achieved with the lowest possible level of assets.
Expense Ratio (Percentage)
Expense Ratio = Total Expenses ÷ Sales
 A ratio indicates the amount of sales that are allocated to individual expenses, such as selling,
administration, cost of goods sold and financial expenses
 Businesses need to compare their results with their past performance and industry averages
 Lower the percentage the better
 If the percentage is high businesses need to look at a way of monitoring and controlling and
avoiding unnecessary expenses
 General standard is 30 days, however, it is still determined by the credit policy
Accounts Receivable Turnover Ratio
Accounts Receivable Turnover Ratio = Sales ÷ Accounts Receivable
 Accounts Receivable Turnover Ratio Measures the effectiveness of a firm’s credit policy and
how efficiently it collects debt
 By dividing the ratio into 365, businesses can determine the average length of time it takes to
convert the balance into cash. If a firm’s accounts receivable turnover is 84 days but its credit
policy allows 30 days before payment
o Number under 365 determines how many times a business receives accounts
receivable (higher the better if the business receives more accounts receivable)
Comparative Ratio Analysis – Over different periods, Against standards, with similar businesses
 Comparative Ratio Analysis is used to assess the business performance

 Judgements are made by comparing a firm’s financial records and rations over different time
frames against other figures, percentages and ratios e.g. quarterly, 6 months and 12 months
 It is important to look at trends in the financial information over several years
 Figures from 2 years ago can indicate directions or trends and make ratio analysis more useful
 Australian business has mainly used Australian standards but with globalisation, world
standards are commonly used as a benchmark
 Inter-Business Comparisons are useful, and firms may have access to relevant business Stats
from a number of sources
 Comparison with other business and benchmarking. The business will compare against
industry standards. Care must be taken to ensure you are comparing similar attributes
 With similar business – Business will look at financial statements and ratios (if accessible) of
other similar business e.g. coke compares to Pepsi
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 To budget – Compare what you have forecasted against what you achieved
Limitations of Financial Reports

Issue Description
Normalised Earnings that have been adjusted to consider changes in the economic cycle or to
Earnings remove one off or unusual items that will affect profitability. This is done to give a
more accurate depiction of the true earnings of a company. It is easier to compare
profitability figures for a business from one year to the next, and against other
businesses. E.g. removal of land sale, which would achieve large capital gain.
Capitalisin An accounting method where a business records an expense as an asset on the
g Expenses balance sheet rather than as an expense on the income statement. Does not accurately
represent the true financial condition of the business as it understates the expenses
and overstates the profits and assets of the business. As a result, the business can’t
make accurate finance decisions. E.g. Capitalising expenses includes research and
development, development expenditure.
Valuing Process of estimating the value of assets when recording them on a balance sheet.
Assets When an asset is recorded on a balance sheet, its value is written as its historical
cost. Historical cost is an accounting method where assets are listed on a balance
sheet with the value at which they were purchased. Main advantage of using the
historical cost is that the cost can be verified. The disadvantage is that this value may
distort the business’s balance sheet, meaning it will not accurately represent the true
worth of the business’s assets. This is because the original cost of an asset may be
different from its current market value. Non-current assets such as land, typically
increases the value over time. Other non-current assets such as machinery, may lost
value over time. This is known as depreciation. Business must estimate how much
value they lose every year. Financial managers can depreciate assets so that the value
of the assets on the balance sheet presents an accurate view. A limitation when
interpreting financial report is the depreciation rate as an estimate and this may give
false impression about how much the business is worth. Limitation of financial
reports is that some assets are very difficult to value. Intangible assets are items of
value to a business, but do not physical exist, e.g. trademarks. The assets are of value
to the business, but they are not included on a balance sheet because their value is
too difficult to work out because there is no set formula. Financial managers decide
to include these assets on the balance sheet, the business may be overvalued and
make the business seem more financially stable than it is.
Timing Limitations can arise due to timing issues. Under the matching principle, expenses
Issues incurred by a business must be recorded on the income statement for the account
period in which the revenue is earned. When an accountant record revenue, they
should record at the same time any expenses that are directly related to the revenue.
E.g. A real estate agent may have sold a property and they receive 2% commission
for sales, but their employer did not pay them until July. This expense should be
recorded in June. Principle is followed, the revenue earned will match the costs that
incurred to earn that revenue. The matching principle results in the presentation of a
more accurate representation of the financial position of a business.
Debt Gearing Ratio is often used to determine whether businesses are at risk of meeting
Repayment their long-term financial commitment. A business that is highly geared may be
s alarming for some stakeholders. Highly geared business has increased risk, their
potential is greater. E.g. higher levels of debt to fund growth can lead to increased
profits in the future. Financial reports can be limited because they do not have the
capacity to disclose specific information about debt repayments. Such as: how long
the business has business has been recovering from debt or the capacity of the
business or its debtor to repay the amount/s owed. (Either money owed to the
business or by the business). The recording of debt repayments on financial reports
can be used to distort the ‘reality’ of the business and provide a more favourable
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overview of the business at that point in time.

Notes to Notes to the financial statements report the details and additional information that
the are left out of the main reporting documents, such as the balance sheet, income and
Financial cash flow statement. They contain information that may be useful to stakeholders to
Statements understand the financial statements. Notes contain important information such as
accounting methodologies used for recording and reporting transactions that can
affect the bottom-line return expected from an investment company. May also
contain further details about how figure in the financial statements were calculated
and the procedures used to develop them.
Ethical Issues Related to Financial Reports

Ethics is important in financial reporting because:
 Financial Managers and accountants have an ethical and legal obligation to ensure financial
records are accurate
 Financial Management decisions must reflect the objectives of a business and interests of
owners and shareholders
 Ethical considerations are important is in the valuing of assets, including inventories and
accounts receivable. Such valuations influence the level of working capital and, hence, the
short-term financial stability of a business
 Ethical considerations are closely related to legal aspects of financial management
Audited Account
An audit is an independent check of the accuracy of financial records and accounting process. Audits
are important to occur to ensure they are true and accurate.
The three types of audits are:
1. Internal Audits: These are conducted internally by employees to check accounting
procedures and the accuracy of financial records.
2. Management Audits: These are conducted to review the firm’s strategic plan and to
determine if changes should be made. The factors affecting the firm’s strategic plan may
include human resources, production processes and finance
3. External Audits: These are a requirement of the Corporations Act 2001. Firm’s financial
reports are investigated by independent and specialised audit accountants to guarantee
their authenticity.
 Internal and External audits assist in guarding against unnecessary waste, inefficient use of
resources, misuse of funds, fraud and theft. Makes businesses more transparent and allows the
business to be more accurate.
 External auditors are used to provide an annual audit of accounting practice and procedures
Record Keeping
 Accounting processes depend on how accurately and honesty data is recorded in financial
report
 Documents must be created for every transaction, even those in cash
 If cash is received and not recorded it will not show up as business revenue, and will reduce
the business’s profit for the year, resulting in a lower tax
 Reducing tax burden is regularly monitored by the ATO, those found to be evading tax can
receive fines
 Prosecution for tax evasion can harm the reputation of the business, and alienate customers
who wish to deal with honest and ethical businesses
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GST Obligations
 Goods and services (GST) are a tax of 10% on most goods, services and other items sold or
consumed in Australia
 If our BS is registered for GST, you have to collect this extra money from your customers.
You pay this to the Australian Taxation Office (ATO) when it’s due.
 Businesses that meet the A$75,000 registration threshold will need to register for GST,
charges GST on relevant sales and remit the GST to us by lodging returns
Reporting Practices
 Accurate financial reports necessary for taxation purposes

 Shareholders in a private company are legally entitled to receive financial reports annually,
even if the company is a small business and the shareholders are family members
 If a business is selling, any purchaser might want to see financial reports. Understating profit
or overstating value of assets may prove counter-productive when a potential buyer subjects
the reports to close scrutiny
Financial Management Strategies

Effective Strategies can be used to address issues relating to the following headings.
Cash Flow Management

Cash flow is the movement of cash in and out of a business over a period of time.
 If more money goes out than come in, or if money must be paid out before cash payments
have been received there is a cash problem
 Vital that a business manages its cash flow out and ensures enough is coming in
Cash Flow Statements
 Cash flow indicates the movement of cash receipts and cash payments resulting from
transactions over a period of time.
 Shows what goes in and out
 It can also identify trends and can be a useful predictor
Inflows – Sales, Cash Payment for accounts receivable, Commissions received, Sale of assets,
proceeds from issues of shares, interest received (investments/loans etc.), Dividends
Outflows – Payments to suppliers – Raw – Materials/Finished goods, interest on loans, operating
expenses – wages/salaries/raw materials/finished goods, drawings, purchase of assets, loan
repayments
Management Strategies (Distribution of Payments, Discounts for early payment, Factoring)
 Management must implement strategies to ensure that cash is available to make payments
when they are due
o E.g. ATO, Suppliers for accounts payable, employees for wages, owners and
shareholders for profits… Etc.
Overdrafts
 Used to cover temporary shortfalls of cash

 Banks allow the business to overdraw their account to a set limit with the payment of
competitive interest rates.
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 Shortfalls of cash over longer periods are a greater concern for a business as insolvency or
bankruptcy may result
 Take out morre money that what is available
Distribution of Payments
 Distributing payments through the month, year or other period so that large expenses do not
occur at the same time and cash shortfalls do not occur
 Distributing payments throughout the years means there is a more equal cash outflow each
month rather than large outflows in particular months
 Cash flow projection can assist identifying periods of potential shortfalls and surpluses
Discounts for Early Payment
 Offering debtors, a discount for early payments

 This is effective when target at those debtors who owe large amounts over the financial year
period
 Not only beneficial for the debtors who are able to save money and improve cash flow, but it
also positively affects the business’s cash flow status
 A downfall could be you don’t make as much money
Factoring
 Factoring is the selling of accounts for a discounted price to a finance or specialist company
 Business saves on the costs involved in following up on unpaid accounts and debt collection
 Factoring is growing in popularity as a strategy to improve working capital
 Collects payment on those invoices from the business’s customers
 Main reason that companies choose to factor is that they want to receive cash quickly on their
receivables, rather than waiting
 Long wait on customer payments can limit the amount of cash your company has on hand to
meet expenses and achieved financial goals
 Main benefit is quick payment on your invoices
E.g. Your company averages $100,000 receivables each month because your customers will wait
longer than 30 days to pay. Factoring ensures that you received cash on invoices immediately. Your
business can have $80,000 in the ban at month’s end, instead of zero.
Working Capital Management

Liquidity is important as it means:
 A business can take advantage of profit opportunities, pay creditors on time to claim
discounts, pay tax and meet payments on loans and overdrafts
 A business must have sufficient liquidity in order to meet their short-term debt commitments
 They must have sufficient cash at the bank or current assets that can be converted to cash to
pay debts
 The lack of short-term liquidity might mean that the business has to sell some of their non-
current assets including long-term investments such as property raise the cash
 Long term this can lead to less profitability
Working Capital is the funds available for short-term financial commitments of a business.
Net working Capital is the difference between current assets and current liabilities. It represents those
funds that are needed for that are needed for the day-to-day operations of a business to produce profits
and provide cash for short-term liquidity.
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Working Capital Management determines the best mix of current assets and current liabilities needed
to achieve the objectives of the business
The Current (Working Capital) Ratio
(Working Capital) Current Ratio = Current Assets ÷ Current Liabilities
Working Capital = Current Assets – Current Liabilities
 A high current ratio may indicate that the business has invested too much in current assets
that bring in small return
o Profitability may be reduced as the business has chosen to reduce risk of not pay debt
 A low current ratio may mean that the business is more profitable if it is investing its
resources term assets and generating more profits
o Risk that the business may not be able to pay its current liabilities
 A current ratio of 2:1, is generally acceptable, but ratios vary depending on the industry, type
of business, efficiency of the business in being able to convert current assets into cash and the
relation with creditors and banks.
 A business working capital is constantly changing
 This is due to the business selling stock, paying out cash for bills and receiving payments
from customers. Always different from month to month
Control of Current Assets
Control of current assets requires management to select the optimal amount of each current asset held,
as well as raising finance to fund those assets.
Current Use Management Strategies
Asset
Cash Pay Debts Cash Receipts
Repay Loans Cash Payments
Pay Accounts Asset Purchases
Investment Opportunities Cash Flow Budget
Overdraft
Cash Flow Budget
Discount for early payment
Receivables Checking the credit rating of prospective Check Credit rating for
customers customers
Sending customers’ statements monthly and at Send regular reminders for
the same time each month so that the debtors repayments to customers
know when to expect accounts Provide a time period for
Following up accounts that are not paid by the repayment to be made
due date Impose clear policies for debt
Stipulating a reasonable period, usually 30 days, collection
for the payment of accounts
Putting Policies in play for collecting bad debts,
such as using a debt collection agency
Inventories Holding Stock. (Inventory is a cost to the Look at strategies for this:
business if it remains unsold). JIT (Just in time)
LIFO (Last in first out)
Businesses must ensure that inventory turnover FIFO (First in First Out)
is sufficient to generate cash to pay for Inventory Policy (Inventory
purchases and pay suppliers on time so that they levels meet demand and need)
will be willing to give credit in the future. Way to control to industry so
that you don’t have delays in
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Business must prevent build-up of inventories as industry and meeting customer

this could lead to cash shortages. demand
Businesses must limit expenses in storing

inventory whilst having a high turnover in
selling their stock as difficulty in selling
inventory = loss of Profit
Control of Current Liabilities

Current Use Management Strategies
Liability
Payables Business payments must be monitored Discounts are available
carefully to ensure there will be Interest-Free credit Periods
enough $$ left after each payment. Extended terms for payments sometimes
It is best to ensure that there is a offered by established Payments
credit/interest free period for
repayments to be made and take out
loans during discount or low interest
periods.
Holding back payments until their due
to improve liquidity situation.
Loans Loans are commonly taken by business Establishment
for growth, expansion and to cover Interest Rates
unforeseen expenses. Ongoing charges must be investigated and
monitored to minimise cost
Careful monitoring required to ensure that
interest repayments are paid on time and
that a large loan is taken from the best
financial provider.
Young need to investigate alternative loans
to see what works best for you, make sure
interest repayments are made on time.
Overdraft Important for business to not reply too Businesses must also have a good credit
heavily on bank overdrafts as this will rating
gather interest as will and banks can Monitor the charges
often demand immediate repayment Do your research and look for the best
Other fees and costs will also have policy for using and overdraft
been paid Monitor your money
Used to cover short term debt
shortages
Strategies for managing working capital – Leasing, Sale and Lease Back
Businesses use a number of strategies to manage working capital, which is required to fund day-to-
day operations
Leasing
Leasing involves the payment of money for the use of equipment that is owned by another party.
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 Lease is a contract between the lessor (owner of asset) and lets the lessee rent an asset for a
period of time in exchange for periodical payments
 Business avoids having to make a lump sum payment
 Regular payments are often better for business to make better planning and no need for loans
 Able to expand the number of assets to use if they can lease everything
 Reduces the risk of technological obscene
 The business hiring the equipment allows the business to save money as they don’t need to
pay to repair for the equipment
Advantages include:
 Cash outflows related to leasing are spread over several years. This helps improve working
capital
 It allows businesses to make use of good quality assets, which might have been unaffordable
or expensive if they have to purchase them outright
 Lease Payments are considered operating expenses and are therefore tax deductible
 It allows businesses the flexibility to upgrade new and better assets when necessary without
having make large cash outlay purchasing new equipment once an asset becomes outdated
 Reduces the risk of technological oldness since the leased asset can be upgraded
 Depending on the terms of the agreement, it reduces the risk of unpredictable costs associated
with the repairs and maintenance of equipment
 The lease payments help with cash flow forecasting and budgeting as the payments are fixed
for a specified time. Businesses will know at the outset what the payments will be for the
duration of the lease and the repayments won’t fluctuate over time like other forms of
borrowing
Sale and Lease-Back
Sale and Lease back refers to the process of selling an owned asset to a lessor and then leasing the
asset back through fixed payments for a specified period of time
 Lessor retains ownership of the asset as part of the agreement

 Advantage of sale and lease-back is that it helps improve a business’s liquidity since it
enables the business to receive a large cash injection from the sale of the asset, which can be
used as working capital if the business is experiencing as cash shortfall
 Business still continues to benefit from the use of the asset. This strategy shares the same
advantages as leasing
Case Study: SMH Sydney Airport Qantas terminal lease $535m
Profitability Management
Involves the control of both the business’s cost and its revenue.
Cost Controls
Fixed Costs
Fixed costs are those that are not dependent on the level of operating activity in a business. Fixed
costs do not change and remain the same over a long period of time when the level of activity changes
– they must be paid regardless of what happens in the business
o E.g. Salaries, Depreciation, Insurance and lease
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Variables costs are those that vary over time in direct relationship to the levels of operating activity or
production in a business. Such costs include labour costs and costs of energy
o E.g. Materials, Labour, Water Bill, Electricity and Wages
Strategies to Manage:
1. Monitoring the levels of both fixed and variable costs
2. Comparisons of costs with budgets
3. Standards and previous periods ensure that costs are minimised and profits maximised
Cost Centres
Cost Centres are particular areas departments or sections of a business to which costs can be directly
attributed
 Main function of a cost centre is to track expenses

 Monitoring expenses through the use of cost centres allows for greater control of total costs
 Cost centre a specific areas, department or sections of a business where costs can be directly
attributed – e.g. service cost centre, production cost centre, advertising cost centre and IT
department
 Allows for clear budgeting and cost control for each function/department
Impact cost centres have on direct and indirect costs:
o Direct costs the impact is the cost allocated to a particular product and particular
department
o Indirect costs the impact is shared across more than one department. You can track
the expenses to see which department is using the most budget and work on a strategy
to minimise the amount of money being used.
Expense Minimisation
 Profits can be weakened if the expenses of a business are high, as the take up valuable
resources within a business
 Guidelines and Policies should be established to encourage staff to minimise expense where
possible
 Savings can be substantial if people take a critical look at costs and eliminate waste and
unnecessary spending
 Reducing and minimising the level expenses in the business
o E.g. Minimise cost through design and materials used in the making of the good or
service; find locations that are less expensive or are closer to suppliers; minimise
costs in packaging
Revenue Controls
The income earned from the prime function is revenue. This is directly linked to the marketing
objective of the business.
Marketing Objectives
 Sales: Objectives must be pitched at a level of sales that will cover costs, both fixed and
variable, and result in a profit. Cost-Volume Profit analysis can determine the level of
revenue sufficient for a business to cover its fixed and variable costs to break even and predict
the effect on profit of changes in the level of activity, prices or costs.
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 Sales Mix: can affect revenue. Businesses can control this by maintaining a clear focus on the
important customer base on which most of the revenue depends before diversifying or
extending product ranges or ceasing production on particular lines. Research should be
carried out to identify the potential effect of sales-mix changes before decisions are made
 Pricing Policy: Affects revenue and working capital. Pricing decisions should be closely
monitored and controlled. Overpricing could fail to attract buyers, while under-pricing may
bring higher sales but result in cash shortfalls and low profits.
Factors the influence include:
o Costs associated with producing the goods or services (materials, labour, overheads)
o Prices charged by competition
o Short- and long-term goals. E.g. business aims to improve market shay in 5 years,
prices may be reduced
o Image or level of quality that people associate with goods or services
o Government Policies
Global Financial Management

 Financial Risks associated with global expansion are greater than those with domestic
business
 These are largely uncontrollable in that in that the business cannot include these factors
Exchange Rates
Foreign Exchange market determines the price of once currency relative to another.
Foreign Exchange rate is the ration of one currency to another; it tells how much a unit of one
currency is worth in terms of another
Appreciation is an upward movement of the Australian dollar (or any other currency) against another
currency.
 It means that each unit of foreign currency will buy fewer Australian dollars (we have become
more expensive)
 This is not good for our exports as they become expensive and international buyers will go
elsewhere.
 Importing into Australia would be less expensive
Effects of Currency Fluctuations
1. Currency appreciation raises the value of the Australian dollar in foreign currencies. Means
that each unit of foreign currency buys fewer Australian dollars. Appreciation makes our
exports more expensive on international markets for imports will fall. This reduces the
international competitiveness of Australian exporting business
2. Currency depreciation has the opposite impact. Depreciation lowers the price of Australian
dollars in terms of foreign currencies. Each unit of foreign currency buys more Australian
dollars. The result is that our exports become cheaper and the price of imports will rise.
Depreciation improves the international competitiveness of Australian Exporting Businesses
 Currency Fluctuation impact on the profitability of global businesses and affects the
businesses ability to meet their financial objectives
 A depreciation lowers the price of Australian dollars
 Exports more competitive (affordable) however importing into Australia becomes more
expensive
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 Depreciation in terms of Aussies businesses will improve their international competitiveness

Interest Rates
 A real risk is the exchange rate movement

 A business that may want to expand (internationally or domestically) may look to offshore
financial institutions to access funds. This is generally because Aussie interest rates are higher
than other countries such as US interest rates.
o Any adverse currency fluctuation could see the advantage of cheaper overseas interest
rates could see the advantage of cheaper overseas interest rates quickly eliminated
Methods of International Pay
 Banks act in an intermediary role in international transactions as they are trusted by both
parties
 Method chosen depends on the business’s assessment of the importers ability to pay
Method of Payment How it Works
Payment in Advance Allows the exporter to receive payment and then arrange for goods
to be sent. Exposes the exporter to no risk and is often used if the
other party is a subsidiary or when the credit worthiness of the
buyer is uncertain. Importers are exposed to the most risk and it
does not guarantee that they will receive what they ordered.
Letter of Credit A document that buyer can request from their bank that guarantees
the payment of goods will be transferred to the seller. Seller has to
present the bank with the necessary documents proving the
shipment of the goods, specified amount that they have promised
the person. The buyer cannot make the payment the bank will be
required to cover the purchase. Only payment in advance offers
less risk. The letter of credit is bit better for the seller. They bank
will only sell if the buyer has enough money to pay.
Clean Payment The exporter ships the goods directly to the importer before
payment is received. Method only used when the exporter is
confident the importer will pay by the agreed time. They receive an
invoice requesting payment within a certain time – credit term.
Riskiest for exporters. – Buying doesn’t pay until the goods are
received. (Risky for the seller) – (No risk of the buyer). The buyer
sending the product first before they receive the payment can be a
result as a better customer relationship.
Bill Of exchange a - Importer can collect goods after paying for them. Exporter
a) Against Payment draws bills of exchange and sends it to the importers bans that will
b) Against Acceptance allow the importer to collect the goods. Importers bank transfers
funds.
b – the importer may collect the goods before paying for them.
Importer must sign only acceptance of goods and terms of the bill
of exchange to receive documents that will allow them to pay for
goods at a later of death.
Hedging
Hedging is the process of minimising the risk of currency fluctuations to help reduce the level of
uncertainty involved with international financial transactions.
 Hedging is used to reduce currency fluctuations without the use of spot exchange
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Spot exchange rate is the value of one currency in another currency on a particular day’ (may not
always be a good rate). This may involve two parties agree to exchange currency and finalise their
deal.
Strategies that can be adopted to minimise risk of foreign exchange exposure:
Natural Hedging
o Establishing offshore subsidiaries
 An offshore finance subsidiary issues stocks and bonds on behalf of the
parent company. The parent controls interest in the subsidiary company,
meaning it controls half the stock. It is the same currency and its easier to do
business and not worry about the exchange rate. They don’t have to think
about the loss and the gain. E.g. the US currency rate is the most stable. So,
many businesses import in this rate.
 If you buy in a US dollar and sell in the Australian dollar you would lose the
money. If you buy in the Australian dollars and sell it in Australian dollars
it’s a gain.
o Arranging for important payments and exports receipts denominated in the same
foreign currency and any losses from movement in the exchange rate will be offset by
gains from the other
o Implementing marketing strategies that attempt to reduce the price sensitivity of the
exported products
o Insisting on both import and export contracts denominated in Australian dollars. This
effectively transfers the risk to the buyer (importer).
Financial Instrument Hedging
 Apart from natural hedges that are growing in number of financial products available, called
derivatives, that can be used to minimise or spread the risk of exchange rate fluctuations
o More formalised as it involves the contracts
Derivatives
Derivatives are simple financial instruments that may be used to lessen the exporting risks associate
with current fluctuations
Examples Include
Forward Exchange Contract
 Is a contract to exchange one currency for another currency at an agreed exchange rate on a
future date usually after a period of 20,90 or 180 days
 Bank guarantee the exporter within set time, at a fixed rate of exchange for the money
generated from the sale of exported goods
Options Contract
 Gives the buyer (option holder) the right, but not the obligation, to buy or sell foreign
currency at some time in the future
 Option holder are protected from unfavourable exchange rate fluctuations and gives them the
opportunity to gain an exchange rate movement favourable
Swap Contact
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 Is an agreement to exchange currency in the sport market with an agreement to reverse the
transaction in the future
o E.g. Swapping $50 million AU dollars from the US dollars now and agreement to
reverse the swap within three months
 Uses currency swaps when they need to raise finance in a currency issued by a country in
which they are not well known in and is forced to pay higher interest rate
 Allows the business to take advantage of the low interest rates
 Main advantage of a swap contract is that it allows the business to alter its exposure exchange
fluctuations without discarding the original transaction
Case Study Kathmandu – BS Textbook
Cambridge Textbook Case Study – Virgin Australia and Dominos
Case Study: Apple and Qantas
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– Year 12 Finance Business Notes - 2020

Finance HSC Business Notes

Strategic Role of financial Management

 Financial management is concerned with planning, monitoring and controlling the

 Achieving the objectives of the business and making funds available

Objectives of Financial Management

 Ability of a business to maximise its revenue

 The ability for the business to grow long-term

Short- term and long-term objectives

Short- term Long-Term

 Tactical (1-2 years)  Strategic Plans

Interdependence with other business functions

Influences on Financial Management

Internal Sources of Finance – Retained Profits, Owners’ Equity

 Internal finance is sourced from within the business

External sources of Finance

Short-Term Borrowing (overdraft, commercial bills, factoring):

 Short-term borrowing allows businesses to finance temporary shortages in cash flow or

Source of Description Cost

 Relates to funds borrowed for periods longer than 12 months

Source of Description Cost

More Info Leasing:

Advantages of Leasing Disadvantages of Leasing

 Refers to the finance raised by a company through inviting new owners

at a discount to their current trading price to special institutions or investors. This

Financial Financial Instruments Characteristics

to the corporate sector companies provide businesses

Policy holders pay regular

issue of shares and through sale

Influence of Government (Australian Securities and Investments Commission,

 ASIC is an independent statutory commission accountable to the commonwealth parliament

Global Market Influences (Economic Outlook, Availability of funds interest rates)

 High risk level involved in lending to a business

Process of Financial Management

Planning and Implementing

Figure 1 The Planning Cycle

3. Estimated use and cost of raw materials or inventory

 Budgets are often prepared to predict range of activities.

 Financial problems and losses prevent a business from achieving goals

Advantages of Debt Disadvantages of Debt

government charges may increase.

Less risk for the business and the owner

Debt Finance Vs Equity Finance

 Take into account what the finance is needed for

Matching the Terms and Source of Finance to Business Purpose

Gearing – Debt to Equity Ratio (Total Liabilities ÷ Total Equity)

Net Profit = Gross Profit – Expenses

Net Profit Ratio

 Comparative Ratio Analysis is used to assess the business performance

Limitations of Financial Reports

overview of the business at that point in time.

Ethical Issues Related to Financial Reports

 Accurate financial reports necessary for taxation purposes

Financial Management Strategies

Cash Flow Management

 Used to cover temporary shortfalls of cash

 Offering debtors, a discount for early payments

Working Capital Management

Business must prevent build-up of inventories as industry and meeting customer

Businesses must limit expenses in storing

Control of Current Liabilities

 Lessor retains ownership of the asset as part of the agreement

 Main function of a cost centre is to track expenses