Role

 of  Financial  Management  

 
Strategic  Role  of  Financial  Management  
Developing  a  strategic  plan  as  part  of  a  business’s  financial  management  will  ensure  that  the  business  
survives  and  grows  in  the  competitive  business  world.  
 
Businesses  exist  for  a  number  of  purposes  that  are  translated  into  goals.  For  example,  a  business’s  
goals  may  include:  
 
• To  increase  the  dividends  to  shareholders  
• To  maintain  an  environmentally  friendly  business  
• To  be  a  market  leader  within  five  years.  
 
The  main  purpose  or  goal  for  a  business  is  usually  to  maximise  profits.  
 
Strategic  Plan  
Strategic  plans  encompass  a  long-­‐term  view  of  where  the  business  is  going,  how  it  will  get  there  and  a  
monitoring  process  to  keep  track  of  progress  along  the  way.  The  strategies  that  a  business  uses  to  
achieve  its  goals  are  incorporated  into  a  strategic  plan.  
 
Managing  Financial  Resources    
Financial  resources  are  those  resources  of    
a  business  that  have  a  monetary  or  money    
value.  Financial  management  is  the    
planning  and  monitoring  of  a  business’s    
financial  resources  to  enable  the  business    
to  achieve  its  financial  goals.    
   
The  mismanagement  of  financial    
resources  can  lead  to  problems  such  as:    
   
• Insufficient  cash  to  pay  suppliers    
• Inadequate  capital  for  expansion    
• Too  many  assets  that  are  non-­‐  
productive    
• Delays  in  accounts  being  paid    
• Possible  business  failure    
 
• Overstocking  of  materials  
 
 
 
Strategies  for  monitoring  the  financial  
 
resources  include:  
   
 
• Monitoring  an  business’s  cash  
 
flows  
 
• Paying  its  debts  
 
• Developing  financial  control    
techniques    
• Auditing  of  financial  accounts    
• Continuing  to  make  profits  for  its    
owners  and  shareholders    
 
 
Objectives  of  Financial  Management  
For  a  business  to  achieve  its  long-­‐term  goals  it  must  have  a  number  of  short-­‐term,  specific  objectives.  
The  objectives  of  financial  management  are  to  maximise  the  business’s:  

ProQitability   Growth   EfQiciency   Liquidity   Solvency  

Profitability:  Profitability  is  the  ability  of  a  business  to  maximise  its  profits.  
 
Growth:  Growth  is  the  ability  of  the  business  to  increase  its  size  in  the  longer  term.  
 
Efficiency:  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.  
 
Liquidity:  Liquidity  is  the  ability  of  a  business  to  pay  its  debs  as  they  fall  due.  A  business  must  have  
sufficient  cash  flow  to  meet  its  financial  obligations  or  be  able  to  convert  current  assets  into  cash  
quickly.  
 
Solvency:  Solvency  is  the  extent  to  which  the  business  can  meet  its  financial  commitments  in  the  
longer  term.  Solvency  indicates  whether  a  business  will  be  able  to  repay  amounts  that  have  ben  
borrowed  for  investments  in  capital.  
 

Short-­‐Term  and  Long-­‐Term  Financial  Objectives  

Short  Term  Financial  Objectives:  Tactical  (one  to  two  years)  and  operational  (day-­‐to-­‐day)  plans  
of  a  business.  These  would  be  reviewed  regularly  to  see  if  targets  are  being  met  and  if  resources  
are  being  used  to  the  best  advantage  to  achieve  the  objectives.  
 
Long  Term  Financial  Objectives:  Determined  for  a  set  period  of  time,  they  tend  to  be  broad  goals  
such  as  increasing  profit  or  market  share,  and  each  will  require  a  series  of  short-­‐term  goals  to  
assist  in  its  achievement.  
 
 
Interdependence  with  Other  Key  Business  Functions  
Without  finance,  there  would  be  very  little  business.  Finance  (funding)  flows  to  each  functional  area  
within  a  business,  which  enables  it  to  achieve  its  goals.  Funds  are  needed  for  marketing  so  that  they  
can  develop  new  plans  for  promoting,  operations  needs  funding  for  the  development  of  the  product,  
and  human  resources  needs  funding  so  that  new  employees  with  necessary  skills  can  be  recruited  and  
selected,  and  trained/retrained.  
   
Definitions  
 
Capital   Owners  contribute  financial  resources  to  a  business  when  it  is  
established  and  throughout  the  business  lifetime.  This  is  called  capital.  
Drawings   The  withdrawal  of  profits  by  the  owner  is  recorded  as  drawings  under  
equity  in  the  balance  sheet.  
Accounts  Receivable   Money  owed  by  customers  (individuals  or  corporations)  to  another  
entity  in  exchange  for  goods  or  services  that  have  been  delivered  or  used,  
but  not  yet  paid  for.  
Current  Assets   Current  assets  are  cash  and  other  assets  that  are  expected  to  be  used,  
sold  or  converted  into  cash  within  12  months.  These  include  cash  in  the  
bank,  accounts  receivable,  inventory  and  prepaid  expenses.  
Current  Liabilities   Current  liabilities  are  debts  that  are  due  to  be  paid  within  12  months.  
These  include  accounts  payable,  bank  overdrafts,  short-­‐term  loans,  
interest  payable  on  loans  and  salaries  payable.  
Non-­‐Current  Assets   Non-­‐current  assets  are  assets  that  include  amounts  expected  to  be  
recovered  more  than  12  months  after  the  reporting  period.  Non-­‐current  
assets  is  not  to  be  converted  to  cash  within  12  months  of  the  balance  
sheet  date,  and  is  not  expected  to  be  consumed  or  sold  within  the  normal  
operating  cycle  of  a  firm  (in  contrast  to  current  assets).  Examples  
include:  property,  plant,  equipment,  investment  property,  and  intangible  
assets  such  as  goodwill.  
Non-­‐Current  Liabilities   Non-­‐current  liabilities  are  a  business’s  long-­‐term  financial  obligations  
(debts)  that  are  not  due  within  the  present  accounting  year.  Examples  of  
noncurrent  liabilities  include  long-­‐term  borrowing,  bonds  payable  and  
long-­‐term  lease  obligations.  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Influences  on  Financial  Management  
 
Sources  of  Finance  –  Internal  and  External  
A  business  cannot  establish  itself  and  thrive  without  funds  to  enable  it  to  pursue  its  activities.  In  the  
establishment  of  a  business,  owners  and/or  shareholders  usually  contribute  funds.  When  a  business  is  
considering  growth  and  development  in  later  years,  a  number  of  options  can  be  considered  regarding  
sources  of  funds  and  how  those  sources  will  be  used.  Sources  of  funds  may  be  internal  or  external.  

Internal  Sources  
Internal  finance  comes  either  from  the  business’s  owners  (equity  or  capital)  or  from  the  outcomes  of  
business  activities  (retained  profits).  
 
 
Owner’s  Equity:  Owner’s  equity  is  the  funds  contributed  by  owners  or  partners  to  establish  and  build  
the  business.  
 
Retained  Profits:  Retained  profits  are  the  most  common  source  of  internal  finance  –  all  profits  are  not  
distributed,  but  are  kept  in  the  business  as  a  cheap  and  accessible  source  of  finance  for  future  
activities.  
External  Sources  
External  finance  refers  to  the  funds  provided  by  sources  outside  the  business,  including  banks,  other  
financial  institutions,  government,  suppliers  or  financial  intermediaries.  Finance  provided  from  
external  sources  through  creditors  or  lenders  is  known  as  debt  finance.  
 
The  increased  funds  for  the  business  should  mean  increases  in  earnings  and  hence  profits.  Regular  
repayments  on  the  borrowings  must  be  made  so  firms  have  to  generate  sufficient  earnings  to  make  
the  payments.  
 
DEBT:  Short-­‐Term  Borrowing
Short-­‐term  borrowing  is  used  to  finance  temporary  shortages  in  cash  flow  or  finance  for  working  capital  

Bank  Overdraft:     Commercial  Bills:   Factoring:    

A  bank  allows  a  business  to   Commercial  bills  are  a  type  of  bill   Factoring  enables  a  business  to  
overdraw  its  account  to  an   exchange  issued  by  institutions   raise  funds  immediately  by  
agreed  limit  –  assists   other  than  banks,  and  are  given   selling  accounts  receivable  at  a  
businesses  with  short-­‐term   for  larger  amounts,  usually  over   discount  to  a  firm  that  
liquidity  problems  (e.g.   $100,000.  The  borrower  receives   specialises  in  collecting  
seasonal  decrease  in  sales).   the  money  immediately  and   accounts  receivable.  A  factoring  
  promises  to  pay  the  sum  of   company  may  offer  its  services  
Q Costs  are  minimal,  and   money  and  interest  at  a  future   with  or  without  recourse.  
interest  rates  are  lower   time.   Q Without  recourse’  means  
than  other  forms  of     that  the  business  transfers  
borrowing.   responsibility  for  non-­‐
  collection  to  the  factoring  
company.  
Q With  recourse’  means  that  
bad  debts  will  still  be  the  
responsibility  of  the  
business.  
 
DEBT:  Long-­‐Term  Borrowing  
 
  Long-­‐term  borrowing  is  used  to  finance  real  estate,  plant  (factory/office)  and  equipment  
 

Mortgage:     Debentures:   Unsecured  Notes:     Leasing:    

A  mortgage  is  a  loan   Debentures  are  issued   An  unsecured  note  is  a   Leasing  involves  the  
secured  by  the   by  a  company  for  a   loan  for  a  set  period  of   payment  of  money  for  
property  of  the   fixed  rate  of  interest   time  but  is  not  backed   the  use  of  equipment  
borrower  (business).   and  for  a  fixed  time  -­‐   by  any  collateral  or   that  is  owned  by  
Mortgage  loans  are   companies  that   assets,  and  therefore   another  party.  Leasing  
used  to  finance   borrow  offer  security   presents  the  most  risk   enables  an  enterprise  
property  purchases,   to  the  lender  usually   to  the  investors  in  the   to  borrow  funds  and  
such  as  new  premises,   over  the  company’s   note  (the  lender).   use  the  equipment  
a  factory  or  office.   assets.  On  maturity,     without  the  large  
  the  company  repays   capital  outlay  
the  amount  of  the   required.  
debenture  by  buying    
back  the  debenture.  
 
 
Types  of  Leases    
Operating  Leases:  Operating  leases  are  assets  leased  for  short  periods,    
usually  shorter  than  the  life  of  the  asset.    
   
Financial  Leases:  Financial  leases  are  usually  for  the  life  of  the  asset  –  the    
lessor  purchases  the  asset  on  behalf  of  the  lessee.  Plant,  vehicles,    
equipment,  furniture  and  fittings  are  leased  as  financial  leases.  Some  of  the    
advantages  of  leasing  as  a  source  of  finance  include:    
   
Ø The  costs  of  establishing  leases  may  be  lower  than  other  methods  of    
financing    
Ø If  some  assets  are  leased  a  business  may  be  in  a  better  position  to    
borrow  funds    
Ø It  provides  long-­‐term  financing  without  reducing  control  of  ownership    
Ø It  permits  100  per  cent  financing  of  assets    
Ø Repayments  of  the  lease  are  fixed  for  a  period  so  cash  flow  can  be    
monitored  easily    
Ø Lease  payments  are  a  tax  deduction    
Ø Payment  usually  includes  maintenance,  insurance  and  finance  costs.    
   
   
 
 
 
EQUITY  

Equity  refers  to  the  finance  (cash)  raised  by  a  company  by  issuing  shares  to  the  public  for  purchase  
through  the  Australian  Securities  Exchange  (ASX).  Equity  as  a  source  of  external  finance  includes:  
 
Ø Ordinary  shares  (new  issue,  rights  issue,  placements,  share  purchase  plan)  
Ø Private  equity.  
 
 
EQUITY:  Ordinary  Shares  
 
The  purchase  of  ordinary  shares  by  individuals’  means  they  have  become  part-­‐owners  of  a  publicly  
listed  company  and  may  receive  payments  called  dividends.  
 
The  following  terms  refer  to  variations  in  the  type  or  issue  of  ordinary  shares:  
 
Ø New  issue  —  a  security  that  has  been  issued  and  sold  for  the  first  time  on  a  public  market;  
sometimes  referred  to  as  primary  shares  or  new  offerings  
 
Ø Rights  issue  —  the  privilege  granted  to  shareholders  to  buy  new  shares  in  the  same  
company  
 
Ø Placements  —  allotment  of  shares,  debentures,  and  so  on  made  directly  from  the  company  
to  investors  
 
Ø Share  purchase  plan  —  an  offer  to  existing  shareholders  in  a  listed  company  the  
opportunity  to  purchase  more  shares  in  that  company  without  brokerage  fees.  The  shares  
can  also  be  offered  at  a  discount  to  the  current  market  price.  
 
 
EQUITY:  Private  Equity  
 
Private  equity  is  the  money  invested  in  a  (private)  company  not  listed  on  the  Australian  Securities  
Exchange  (ASX).  The  aim  of  the  private  company  is  to  raise  capital  to  finance  future  
expansion/investment  of  the  business.  
 
 
Financial  Institutions  
 
 
 
 
Banks  
 
 
 
  Investment  
ASX   Banks  
 
 
 
 
 
Financial  
  Institutions  
  Finance  and  
  Companies   Life  Insurance  
  Companies  

 
 
 
 
  Unit  Trusts  
Superannuation  
  Funds  

 
 
 Australian  Securities  Exchange  (ASX)  
The  ASX  functions  as  a  market  operator,  clearing  house  and  payments  system  facilitator.  It  oversees  compliance  with  
its  operating  rules  and  promotes  standards  of  corporate  governance  among  Australia’s  listed  companies.  The  ASX  
offers  products  and  services  including:  
>Shares  
>Futures  
>Exchange  traded  options  
>Exchange  traded  funds  
>Real  estate  investment  trusts  
>Listed  investment  companies  
>Interest  rate  securities  
This  primary  market  enables  a  company  to  raise  new  capital  through  the  issue  of  shares  and  through  the  receipt  of  
proceeds  from  the  sale  of  securities.  The  ASX  also  operates  as  a  secondary  market.  The  secondary  market  is  where  
pre-­‐owned  or  second-­‐hand  securities,  such  as  shares,  are  traded  between  investors  who  may  be  individuals,  
businesses,  governments  or  Qinancial  institutions.  

Investment  Banks  
Banks  
Investment  banks  make  up  one  of  the  fastest  growing  sectors  in  the  
Australian  Qinancial  system  –  providing  services  in  borrowing  and  lending.   >Banks  receive  savings  as  deposits  
Investment  banks:   from  individuals,  businesses  and  
governments,  and,  in  turn,  make  
 
investments  and  loans  to  
>Trade  in  money,  securities  and  Qinancial  futures   borrowers.  
>Arrange  long-­‐term  Qinance  for  company  expansion    
>Provide  working  capital   >Most  of  the  funds  provided  
>Arrange  project  Qinance   through  Qinancial  markets  come  
from  banks  that  operate  on  their  
>Advise  clients  on  foreign  exchange  cover   own  behalf  or  on  behalf  of  other  
>Advise  on  mergers  and  takeovers   corporations.  
>Provide  portfolio  investment  management  services    
>Underwrite  corporate  and  semi-­‐government  issues  of  securities   >Since  the  2008-­‐09  GFC,  banks  
have  become  more  cautious  –  they  
>Operate  unit  trusts  including  cash  management  trusts,  property  trusts  
can  only  provide  loans  that  have  an  
and  equity  trusts  
acceptable  level  of  risk.  
>Arrange  overseas  Qinance  

Finance  and  Life  Insurance  Companies  

>Finance  companies  act  primarily  as  
intermediaries  in  Qinancial  markets.  They  
provide  loans  to  businesses  and  individuals  
Superannuation  Funds   Unit  Trusts   through  consumer  hire-­‐purchase  loans,  
personal  loans  and  secured  loans  to  
Superannuation  funds  provide   Unit  trusts  (also  known  as   businesses  
funds  to  the  corporate  sector   mutual  funds)  take  funds  from  a    
through  investment  of  funds   large  number  of  small  investors   >Finance  companies  raise  capital  through  
received  from  superannuation   and  invest  them  in  speciQic  types   share  issues  (debentures)  
contributions.  Superannuation   of  Qinancial  assets.  Unit  trusts    
funds  are  able  to  invest  in  long-­‐ investments  include  the  short-­‐ >The  Qinance  company  is  entitled  to  sell  the  
term  securities  as  company   term  money  market  (cash   assets  of  the  business  to  recover  the  initial  
loan  if  the  business  fails  
shares,  government  and   management  trusts),  shares,    
company  debt  because  of  the   mortgages  and  property,  and  
>Insurance  companies  provide  loans  to  the  
long-­‐term  nature  of  their  funds.   public  securities.   corporate  sector  through  receipts  of  
insurance  premiums,  which  provide  funds  
for  investment.  They  provide  large  amounts  
of  both  equity  and  loan  capital  to  
  businesses  
Influence  of  Government  
The  government  influences  a  business’s  financial  management  decision  making  with  economic  
policies  such  as  those  relating  to  the  monetary  and  fiscal  policy,  legislation  and  the  various  roles  of  
government  bodies  or  departments  who  are  responsible  for  monitoring  and  administration.  
 
  The  Australian  Securities  and   Company  Taxation  
  Investments  Commission  (ASIC)    
    Companies  and  corporations  in  
  It  enforces  and  administers  the   Australia  pay  company  tax  on  profits.  
  Corporations  Act  and  protects   This  tax  is  levied  at  a  flat  rate  of  30  per  
  consumers  in  the  areas  of  investments,   cent;  unlike  personal  income  taxes,  
  life  and  general  insurance,   which  use  a  progressive  scale.  
  superannuation  and  banking  (except   Company  tax  is  paid  before  profits  are  
  lending)  in  Australia.  The  aim  of  ASIC   distributed  to  shareholders  as  
  is  to  assist  in  reducing  fraud  and  unfair   dividends.  
  practices  in  financial  markets  and  
  financial  products.  
   
   
 
Global  Market  Influences  
Globalisation  has  created  more  interdependence  between  economies  and  their  business  (and  finance)  
sectors,  which  relies  on  trade  for  expansion  and  increased  profits.  Global  market  influences  
increasingly  affect  business  financial  decisions,  and  this  is  specifically  evident  in  the  availability  of  
funds  for  loans  and  the  interest  rates  charged  for  these  loans.  
 
Global  Economic  Outlook  
The  global  economic  outlook  refers  specifically  to  the  projected  changes  to  the  level  of  economic  
growth  throughout  the  world.  For  example,  positive  outlook  could  include:  
Ø Increasing  demand  for  products  and  services  
Ø Decrease  the  interest  rates  on  funds  borrowed  internationally  from  the  financial  money  
market  
 
Availability  of  Funds  
The  availability  of  funds  refers  to  the  ease  with  which  a  business  can  access  funds  (for  borrowing)  on  
the  international  financial  markets.  There  are  various  conditions  and  rates  that  apply  and  these  will  
be  based  primarily  on:  
Ø Risk  
Ø Demand  and  supply  
Ø Domestic  economic  conditions  
 
Interest  Rates  
The  higher  the  level  of  risk  involved  in  lending  to  a  business,  the  higher  the  interest  rates.  
 
 
 
 
 
 
 
 
Processes  of  Financial  Management  
 
Planning  and  Implementing  
Ø Financial  planning  determines  how  a  business’s  goals  will  be  achieved.  
 
1. Determining  Financial  Needs  
To  determine  where  a  business  is  headed  and  how  it  will  get  there,  it  is  important  to  know  what  its  
needs  are.  The  financial  needs  of  a  business  will  be  determined  by:  

Management  skills  
The  current  phase   Future  plans  for   Capacity  to  source   for  assessing  
The  size  of  the  business   of  the  business   growth  and   Qinance  -­‐  debs  
Qinancial  needs  
cycle   development   and/or  equity  
and  planning  

Financial  information  is  needed  to  show  that  the  business  can  generate  an  acceptable  return  for  the  
investment  being  sought  and  should,  therefore,  include  an  analysis  of  financial  performance,  income  
statement,  cash  flow  statement,  balance  sheet  and  financial  ratio  analysis  reports.  
 
2. Developing  Budgets  
Budgets  provide  the  facts  and  figures  for  future  planning  and  decision-­‐making,  and  enable  constant  
monitoring  of  progress  and  problem  areas.  They  signal  where  things  are  not  going  according  to  plan  
so  that  adjustments  can  be  made,  and  show  where  achievement  towards  objectives  has  occurred.    
 
Budgets  can  be  drawn  up  to  show:  
Q Cash  required  for  planned  outlays  for  a  particular  period  
Q The  cost  of  capital  expenditure  and  associated  expenses  against  earning  capacity  
Q Estimated  use  and  cost  of  raw  materials  or  inventory  
Q Number  and  cost  of  labour  hours  required  for  production  
 
3. Maintaining  Record  Systems  
Record  systems  are  the  mechanisms  employed  by  a  business  to  ensure  that  data  are  recorded  and  the  
information  provided  by  record  systems  is  accurate,  reliable,  efficient  and  accessible.  By  recording  all  
items  twice,  the  entries  can  be  seen  to  balance,  and  checks  to  find  errors  can  be  carried  out  quickly.  
 
4. Identifying  Financial  Risks  
The  amount  of  the   Financial  risk  is  the  risk  to  a  business  of  
business's  
being  unable  to  cover  its  financial  
borrowings  
obligations,  such  as  the  debts  that  a  
business  incurs  through  borrowings,  both  
short  term  and  longer  term.  If  the  business  
When  borrowings   is  unable  to  meet  its  financial  obligations,  
are  due  to  be  repaid   bankruptcy  will  occur.  
When  assessing  
Qinancial  risk,    
consideration  must   To  minimise  the  risk,  the  profit  must  be  
be  given  to:   sufficient  to  cover  the  cost  of  debt  as  well  as  
Interest  rates   increasing  profits  to  justify  the  amount  of  
risk  taken  by  owners  and  shareholders.  If  a  
business  has  short-­‐term  debt,  it  must  have  
The  required  level  of   liquid  assets  so  that  debts  including  interest  
current  assets   payments  can  be  covered.  
needed  to  Qinance    
operations    
 
 
 
 5. Establishing  Financial  Controls  
The  most  common  causes  of  financial  problems  and  losses  are:  
Q Theft  
Q Fraud  
Q Damage  or  loss  of  assets  
Q Errors  in  record  systems  
 
Financial  controls  include  policies  and  procedure  to  ensure  that  a  business’  plans  are  successfully  
achieved  in  the  most  efficient  way:  
Q Clear  authorisation  and  responsibility  for  tasks  in  the  business  
Q Separation  of  duties  
Q Rotation  of  duties  
Q Control  of  cash  
Q Protection  of  assets  
Q Control  of  credit  procedures  
 
Debt  and  Equity  Financing  
Equity  and  debt  financing  are  both  a  liability  to  a  business  as  it  is  money  owed  to  external  sources.  
Businesses  must  carefully  consider  whether  to  use  debt  or  equity  finance  and  how  much  of  each  is  
needed.  
 
 
 
 
 
 
 
 
 
 
  
 
Matching  the  Terms  and  Sources  of  Finance  to  Business  Purpose  
When  a  business  identifies  and  plans  to  meet  its  financial  objectives,  it  is  necessary  to  match  the  terms  
of  finance  with  its  purpose.  This  requires  a  business  to  consider:  
Q The  terms,  flexibility  and  availability  of  finance  
Q The  cost  of  each  source  of  funding  
Q The  structure  of  the  business  
 
 
 
 
 
Monitoring  and  Controlling  
Monitoring  and  controlling  is  essential  for  maintaining  business  viability,  and  affects  all  aspects  of  
business  operations  –  especially  financial  management.  

Main  Financial  
Controls  Used  
For  Monitoring  

Cash  Flow   Income  

Balance  Sheets  
Statements   Statements  
The  general  purpose  of  financial  reports  is  to  communicate  relevant,  reliable  and  understandable  
information  about  the  business  that  can  be  used  by  managers  and  other  stakeholders  to  make  
decisions.  
 
Cash  Flow  Statements  
The  cash  flow  statement  (CFS)  indicates  the  movement  of  cash  receipts  and  cash  payments  
resulting  from  transactions  over  a  period  of  time.  
 
 
Users  of  CFS  include:  
Q Creditors  
Q Lenders  
Q Owners  
Q Shareholders  
 
A  statement  of  cash  flows  shows  whether  a  firm  can:  
1) Generate  a  favourable  cash  flow  (inflows  exceed  outflows)  
2) Pay  its  financial  commitments  as  they  fall  due  –  e.g.  interest  on  borrowings,  repayment  of  
borrowings,  accounts  payable  
3) Have  sufficient  funds  for  future  expansion  or  change  
4) Obtain  finance  from  external  sources  when  needed  
5) Pay  drawings  to  owners  and  dividends  to  shareholders  
 
On  a  cash  flow  statement,  the  activities  of  a  business  is  divided  into  three  categories:  
1) Operating  Activities:  refers  to  operating  activities.    
Inflows:  income  from  sales,  dividends  and  interest  received  
Outflows:  payment  to  suppliers,  employees  and  other  expenses  
 
2) Investing  Activities:  refers  to  the  cash  inflows  and  outflows  of  purchase  and  sale  of  non-­‐
current  assets  and  investments.  
E.g.  selling  of  old  motor  vehicle,  purchasing  new  plant  and  equipment  or  purchasing  
property.  
 
3) Financing  Activities:  refers  to  the  cash  inflows  and  outflows  relating  to  the  borrowing  
activities  of  the  business.  
Inflows:  equity,  debt  
Outflows:  repayments  of  debt  or  cash  drawing  of  the  owner  or  payment  of  dividends  
 
  
Income  Statements  (Statements  of  Financial  Performance  or  Revenue  Statement)  
The  income  statement  shows  the  operating  efficiency  –  that  is,  income  earned  and  expenses  
incurred  over  the  accounting  period  with  the  resultant  profit  or  loss.  
 
 
The  revenue  statement  includes:  
Q Income  and  expenses  over  an  
accounting  period  
Q Selling,  administrative  and  financial  
expenses  
Q Cost  of  goods  sold  
Q Net  profits  
 
The  income  statement  shows:  
1) Operating  income  –  sales  of  
inventories,  services,  interests,  rent  and  
commissions  
2) Operating  expenses  –  purchase  of  
inventories,  payment  for  services,  
advertising,  rent,  insurance,  bills  
 
Before  examining  figures  from  previous  
income  statements,  managers  can  make  
comparisons  and  analyse  trends  before  making  
important  financial  decisions.  
 
  
Balance  Sheets  (Statements  of  Financial  Position)  
A  balance  sheet  represents  a  business’s  assets  and  liabilities  at  a  particular  point  in  time  and  
represents  the  net  worth  (equity)  of  the  business.  It  shows  the  financial  stability  of  the  business.  
 
 
J Assets:  what  is  owned  
J Liabilities:  what  is  owed  
J Owner’s  Equity:  what  is  owed  by  the  business  to  the  owner  
 
Analysis  of  the  balance  sheet  can  indicate  whether:  
• The  business  has  enough  assets  to  cover  its  debts  
• The  interest  and  money  borrowed  can  be  paid  
• The  assets  of  the  business  are  being  used  to  maximise  profits  
• The  owners  of  the  business  are  making  a  good  return  on  their  investment  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Balance  Sheet  –  The  Accounting  Equation  and  Relationships  
Q The  proprietor  (owner)  of  a  business  and  the  business  itself  are  distinct.  
Q The  balance  sheet  shows  the  outcome  of  the  accounting  process.  The  accounting  equation  can  
be  represented  in  different  ways  but,  because  it  is  an  equation,  it  must  always  be  equal.  
 
Assets  =  Liability  +  Equity  
 
Owners’  equity  =  Assets  –  Liabilities  
 
Liabilities  =  Assets  –  Owners’  equity  
 
 
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
A  balance  sheet  showing  Assets  =  Liabilities  +  Owners’  equity  
 
The  revenue  statement  and  balance  sheet  are  produced  to  show  the  effects  of  revenue  earned  and  
expenses  incurred  on  owners’  equity.  The  accounting  equation  could  more  accurately  be  expressed  as:  

Assets  =  Liabilities    +  Capital  +  Revenue  –  Expenses  

 
Or  
 
Assets  =  Liabilities  +  Capital  +  Profit  (Revenue-­‐Expenses)  
 
 
  
Current  Assets   Current  Assets  are  the  key  assets  that  your  business  uses  up  during  a  12-­‐
month  period  and  will  likely  not  be  there  the  next  year.  Current  asset  
accounts  include  the  following:  cash  in  checking,  saving,  cash  on  hand,  
account  receivable  (an  account  that  records  what  your  customer  owes  to  the  
business),  inventory  and  prepaid  insurance.  
Non-­‐Current  Assets   Non-­‐current  assets  are  assets  that  include  amounts  expected  to  be  recovered  
more  than  12  months  after  the  reporting  period.  Non-­‐current  assets  is  not  to  
be  converted  to  cash  within  12  months  of  the  balance  sheet  date,  and  is  not  
expected  to  be  consumed  or  sold  within  the  normal  operating  cycle  of  a  firm  
(in  contrast  to  current  assets).  Examples  include:  property,  plant,  equipment,  
investment  property,  and  intangible  assets  such  as  goodwill.  
Current  Liabilities   Current  liabilities  include  all  debts  of  the  business  that  are  to  be  settled  within  
the  financial  year  or  the  operating  cycle  of  a  firm.  Example:  short-­‐term  debt,  
account  payable.  
Non-­‐Current  Liabilities   Non-­‐current  liabilities  are  a  business’s  long-­‐term  financial  obligations  (debts)  
that  are  not  due  within  the  present  accounting  year.  Examples  of  noncurrent  
liabilities  include  long-­‐term  borrowing,  bonds  payable  and  long-­‐term  lease  
obligations.  
Intangible  Assets   The  intangible  assets  of  a  business  may  include  patents,  trademarks,  brands  
and  goodwill.  Intangibles  that  are  purchased  are  easily  included  in  a  balance  
sheet,  whereas  intangibles  that  are  developed  by  a  business  are  very  difficult  
to  value  accurately.  
 
 
Financial  Ratios  
The  financial  statements  of  a  business  must  be  analysed  to  gain  a  thorough  understanding  of  the  
activities  of  a  business.  The  analysis  involves  comparing  similar  figures  contained  in  the  financial  
statements  and  balance  sheets.  The  main  types  of  analysis  include:  
Q Vertical:  within  one  year  
Q Horizontal:  between  different  years  
Q Trend:  over  a  period  of  3-­‐5  years  
 
The  analysis  of  financial  statements  is  usually  aimed  at  the  areas  of  financial  stability  (liquidity  and  
gearing),  profitability  and  efficiency.  
 
 
 
 
  Comparative  
Ratio   Liquidity  
  Analysis  
 
 
 
  EfQiciency   Gearing  
 
 
 
ProQitability  
 
 
  
Liquidity  Ratios  
 
 
 
This  ratio  is  a  rough  measure  of     This  ratio  shows  us  the  
how  easily  a  business  can  meet     relationship  between  current  
its  current  liabilities     assets  and  current  liabilities  and  
(commitments)  by  using  its     provides  a  guide  to  the  liquidity  
available  cash  or  assets  that  can     situation.    
be  quickly  converted  into  cash.      
The  ratio  indicates  the  ability  o     Information  for  this  ratio  is  
meet  short-­‐term  debt.     obtained  from  the  Balance  Sheet.  
  The  ratio  is  also  called  the  Working  
  Capital  of  a  business.  
 
 

 
 
 
 
 
 
 
  Current  Ratio  is:  
   
  𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐴𝑠𝑠𝑒𝑡𝑠
   
 
𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
 
  These  come  from  the  
  Balance  Sheet  
   
 
 
 
 
 
 
 
 
  Strategies  to  improve  this  result:  
  If  the  current  ratio  is  too  low  a  
The  suggested  level  for  this  ratio     manager  would  be  advised  to  reduce  
should  be  a  ratio  of  2:1  (i.e.     current  liabilities  such  as  overdrafts  by  
current  assets  twice  that  of     equity  funding  such  as  retained  profits.  
current  liabilities).  This  is  often     Non-­‐current  assets  could  be  sold  to  
considered  a  safe  figure.     increase  current  assets.  Factoring  and  
Businesses  dealing  mainly  in  cash     leasing  would  also  free  up  current  
could  have  a  lower  figure  e.g.     assets.  Factoring  and  sale  of  inventory  
1.5:1.  If  the  figure  is  quite  high     (stock)  would  make  some  current  
e.g.  5:1  it  would  indicate  that  the     assets  more  available  (and  liquid).  
assets  of  the  firm  are  not  being     Emergency  short  term  measures  
employed  efficiently.     would  include  an  overdraft  and  using  
more  credit  facilities.  
  
Gearing  Ratios  (Solvency)  
 
 
 
 
As  this  ratio  increases  from  80%  to    
120%  there  would  be  greater  reliance     This  ratio  shows  us  –  The  relationship  
on  debt  funding  instead  of  equity     between  the  total  liabilities  (debt)  and  
funding.  This  could  be  of  concern  if  the     the  level  of  equity  put  in  by  the  owners.  
business  was  not  able  to  sustain  the     The  ratio  measures  the  level  of  debt  in  
cost  of  servicing  this  increasing  debt.     comparison  to  money  invested  by  
  owners/shareholders.  
 
 
 
 
 
 
 
 
 
 
 
 
 
  Debt  to  Equity  Ratio  is:  
   
  𝑇𝑜𝑡𝑎𝑙  𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
   
 
𝑂𝑤𝑛𝑒𝑟𝑠 ! 𝐸𝑞𝑢𝑖𝑡𝑦
   
  These  come  from  the  
  Balance  Sheet  
   
 
 
 

The  suggested  level  for  this  ratio  should    

be?    
   
Strategies  to  improve  this  result  
It  is  difficult  to  generalise.  Many  small    
include:  
businesses  like  to  operate  on  a  figure  of    
 
50%,  which  means  that  the  level  of  debt    
If  a  business  wished  to  lower  the  
is  half  the  level  of  funds  provided  by  the    
ratio  it  would  need  to  lower  debt  
owner.  Many  large  established  business    
and  increase  the  input  of  equity  
operate  on  figures  above  100%.      
funds.  Any  of  a  range  of  measures  
   
that  reduce  or  eliminate  the  
A  figure  that  is  quite  low  might  indicate    
immediate  debts  of  the  business  
that  a  business  is  not  taking  full    
will  help.  
advantage  of  its  capacity  to  use    
borrowed  fund  to  expand  its  operations.  
  
Profitability  Ratios  (Gross  Profit  Ratio)  
Q Profitability  is  the  earning  performance  of  the  business  and  indicates  its  capacity  to  use  its  
resources  to  maximise  profits.  
Q Profitability  depends  on  the  revenue  earned  by  a  business  and  the  ability  of  the  business  to  
increase  selling  prices  to  cover  purchase  costs  and  other  expenses  incurred  in  earning  income.  
 
 
High  Gross  Profit  figures  are  preferred,    
  This  ratio  shows  us  –  The  percentage  of  
but  the  ratio  will  vary  greatly  from  
  each  dollar  of  sales  that  is  gross  profit  
business  to  business.  Falling  figures  from  
  (Sales  minus  COGS).  It  indicates  the  mark-­‐
previous  years  and  low  figures  compared  
  up  or  contribution  margins.  Businesses  
to  other  businesses  would  indicate  a  
  often  calculate  this  ratio  for  the  various  
problem  as  Gross  Profit  is  needed  to  cover  
  departments  of  the  business.  Non-­‐retail  
costs  and  provide  a  return.  A  very  high  
  businesses  may  have  difficulty  calculating  
figure  might  indicate  that  prices  are  
  this  ratio.  
becoming  temperature.  
   
 
 
 
 
 
 
 
 
  Gross  profit  represents  
  Gross  Profit  Ratio  is:   the  amount  of  sales  
    that  is  available  to  
  𝐺𝑟𝑜𝑠𝑠  𝑃𝑟𝑜𝑓𝑖𝑡 meet  expenses  
    resulting  in  net  profit.  
 
𝑆𝑎𝑙𝑒𝑠 A  fall  in  the  rate  of  
  gross  profit  may  mean  
  These  come  from  the  
  a  fall  in  the  amount  of  
Revenue  Statement   net  profit.  
   
   
 
 
 
 
 
 
 
The  suggested  level  for  this  ratio  
  Strategies  to  improve  this  result  
should  be  –  
  include  –  
 
   
It  is  difficult  to  suggest  a  prescribed  
  A  low  or  declining  ratio  situation  could  
level  as  the  figure  would  vary  between  
  call  for  the  need  to  raise  prices  and  or  
industries  and  businesses.  
  obtain  stock  at  lower  prices.  These  
 
  measures  are  not  always  possible  or  
A  mark-­‐up  of  100%  gives  a  Gross  
  they  could  result  in  falling  sales  due  to  
Profit  Ratio  of  50%.  This  figure  is  only  
  high  prices  and  poorer  quality  goods.  
important  when  compared  to  previous  
  Increasing  the  level  of  sales  can  
years  and  other  similar  businesses.  A  
  compensate  for  lower  profit  margins.  
falling  figure  may  not  be  a  concern  if  it  
results  in  a  much  higher  level  of  sales.  
  
Profitability  Ratios  (Net  Profit  Ratio)  
 
 
 
  This  ratio  shows  us  –  
A  low  or  declining  Net  Profit  figure  could    
be  of  concern  as  it  shows  that  the  amount    
 
of  each  sale  going  to  the  owner  is  low  or   This  differs  from  the  Gross  Profit  Ratio  as  
 
falling.  The  Net  Profit  Ratio  is  related  to   it  takes  into  account  Expenses.  This  ratio  
 
and  affected  by  the  Gross  Profit  Ratio.   measures  the  percentage  of  each  dollar  of  
  sales  to  pay  tax  and  provide  a  financial  
Rising  levels  of  expenses  would  also  be  a    
major  factor  causing  a  fall  in  this  figure   return  to  the  owners.  This  ratio  gives  an  
 
indication  of  the  level  of  and  trends  in  
  Expenses.  
 
 
 
 
 
 
 
 
 
 
  Net  profit  represents  
  Net  Profit  Ratio  is:   the  profit  or  return  
    to  the  owners.  The  
  𝑁𝑒𝑡  𝑃𝑟𝑜𝑓𝑖𝑡 net  profit  ratio  
    shows  the  amount  of  
  𝑆𝑎𝑙𝑒𝑠 sales  revenue  that  
    results  in  net  profit.  
  These  come  from  the   A  firm  would  be  
  Revenue  Statement   aiming  at  a  high  net  
    profit  ratio.    
   
 
 
 
 
 
 
 
 
 
The  suggested  level  for  this  ratio  should  be  –      
  Strategies  to  improve  this  result:  
   
Generally  the  higher  the  figure  the  better,    
although  this  would  need  to  be  considered   Measures  to  increase  the  Gross  Profit  
  Ratio  will  also  increase  the  Net  Profit  
with  the  volume  of  sales  and  the  type  of    
industry.   Ratio.  The  main  strategies  to  increase  
  the  Net  Profit  Ratio  relate  to  measures  
   
In  many  retail  industries  a  figure  of  13-­‐20%  is   to  reduce  Expenses.  Increase  the  
  volume  of  sales  and  level  of  output  will  
considered  good,  but  it  is  difficult  to    
generalise.     compensate  for  a  low  or  falling  Net  
  Profit  Ratio.  
 
A  falling  figure  is  generally  a  cause  of  concern.  
  
Profitability  Ratios  (Return  on  Owner’s  Equity)  
 
 
  This  ratio  shows  us  –  
Low  rates  of  return  and  declining      
rates  of  return  indicate  that  the     The  reward  the  owners  receive  for  
owners’  assets  are  not  generating       using  and  risking  their  funds  
adequate  income.  For  owners  this     (Equity).  This  is  probably  the  most  
is  critical.  Share  prices  would     important  information  for  the  
certainly  decline  and  it  would  be     owners.  The  owners  will  be  
difficult  to  raise  funds  for     particularly  concerned  about  the  
expansion.     return  they  receive  on  the  money  
  they  have  invested  rather  than  the  
  return  on  the  total  assets  of  the  
  business.  
 
 
 
 
 
 
 
 
   
 
Return  on  Owner’s  Equity  is:  
 
   
  𝑁𝑒𝑡  𝑃𝑟𝑜𝑓𝑖𝑡
   
𝑇𝑜𝑡𝑎𝑙  𝐸𝑞𝑢𝑖𝑡𝑦
   
  These  come  from  the  
  Revenue  Statement  and  
  Balance  Sheet  
   
 
 
 
 
 
 

The  suggested  level  for  this  ratio     Strategies  to  improve  this  result  
should  be  –       include  –  
     
A  high  level  would  be  desirable.  The     Strategies  to  improve  the  returns  
figure  varies  depending  on  the     on  investment  include  reducing  
industry  and  the  general  economic     expenses  and  improving  efficiency,  
conditions  and  an  overall  trend  is  the     changing  the  sale  mix  to  increase  
best  indicator.  Business  owners     sales,  adjusting  pricing  to  increase  
would  be  unhappy  with  numbers     sales  and  more  effective  marketing.  
below  10%  as  higher  returns  could      
be  achieved  with  little  risk  in  areas     Higher  returns  can  be  achieved  by  
such  as  property  and  financial     exiting  from  areas  of  poor  returns  
institutions.  Figure  above  20%   and  re-­‐investing  in  areas  with  
would  be  considered  excellent.   higher  growth  potential.  
  
Efficiency  Ratios  
Efficiency  is  the  ability  of  the  firm  to  use  its  resources  effectively  in  ensuring  financial  stability  and  
profitability  of  the  business.  The  more  efficient  the  firm,  the  greater  its  profits  and  financial  stability.  
 
Expense  Ratio  
The  expense  ratio  compares  total  expenses  with  sales.  The  ratio  indicates  the  amount  of  sales  that  are  
allocated  to  individual  expenses,  such  as  selling,  administration,  cost  of  goods  sold  and  financial  
expenses.  The  expense  ratio  indicates  the  day-­‐to-­‐day  efficiency  of  the  business.  A  business  aims  to  
keep  expenses  at  a  reasonable  level.  For  example,  if  the  selling  expense  ratio  has  increased,  it  may  be  
that  advertising  costs  have  not  generated  the  expected  increase  in  sales.  Alternatively,  a  decline  in  the  
financial  expense  ratio  may  be  a  result  of  lower  interest  rates  or  less  debt  being  used  by  the  firm.  

 
Accounts  Receivable  Turnover  Ratio  
Accounts  receivable  turnover  ratio  measures  the  effectiveness  of  a  firm’s  credit  policy  and  how  
efficiently  it  collects  its  debts.  It  measures  how  many  times  the  accounts  receivable  balance  is  
converted  into  cash  or  how  quickly  debtors  pay  their  accounts.    
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 SUMMARY  OF  RATIOS  
Analysis  of  
which  
What  does  analysis  of  this  
aspect  of   Interpretations  of  ratio  
Ratio   Formula   ratio  show  about  a  
the   results  
business?  
financial  
statement  
Current   Liquidity   Shows  the  short-­‐term   It  is  generally  accepted  that  
ratio   financial  stability  of  a   a  ratio  of  2:1  indicates  a  
 
business  (i.e.  its  ability  to   sound  financial  position  (i.e.  
meet  its  short-­‐term  financial   a  firm  should  have  double  
commitments)   the  amount  of  assets  to  
cover  its  liabilities).  
Debt  to   Gearing   Shows  the  extent  to  which  the   The  higher  the  ratio,  the  less  
equity   (Solvency)   firm  is  relying  on  debt  or   solvent  the  firm  (i.e.  the  
ratio     outside  sources  to  finance  the   higher  the  ratio  of  debt  to  
business   equity,  the  higher  the  
business  risk).  
Gross   Profitability   Shows  the  changes  from  one   The  higher  the  ratio  the  
profit  ratio   accounting  period  to  another   better.  
 
and  indicates  the    
effectiveness  of  planning   If  the  ratio  is  low,  alternative  
policies  concerning  pricing,   suppliers  may  need  to  be  
sales,  discounts,  the  valuation   sourced  and  competitors  
of  stock  etc.   investigated.  
Net  profit   Profitability   Net  profit  ratio  represents  the   A  firm  will  be  aiming  for  a  
ratio   profit  or  return  to  the  owners.   high  net  profit  ratio.  
 
A  low  net  profit  ratio  
  indicates  that  expenses  
should  be  examined  to  look  
for  possibility  of  reductions.  
Return  on   Profitability   Shows  how  effective  the   The  higher  the  ratio  or  
equity   funds  contributed  by  the   percentage,  the  better  the  
ratio     owners  have  been  in   return  for  the  owner.  
generating  profit  and  so  the  
return  on  investment  (ROI)  
Expense   Efficiency   Each  of  the  categories  of   Expense  ratios  indicate  day-­‐
ratio   expenses  is  compared  with   to-­‐day  efficiency  of  the  
  sales.  The  ratio  indicates  the   business.  Expense  ratios  
amount  of  sales  that  are   need  to  be  kept  at  a  
allocated  to  individual   reasonable  level,  and  
expenses  such  as  selling,   management  must  monitor  
administration,  COGS  and   each  type  of  expense  in  
financial  expenses.   relation  to  sales.  
 
Higher  expense  ratios  may  
be  the  result  of  poor  
management.  
Accounts   Efficiency   Measures  the  effectiveness  of   High  turnover  ratios  indicate  
receivable   a  firm’s  credit  policy  and  how   the  business  has  efficient  
turnover     efficiently  it  collects  its  debt.   debt  collection.  
ratio  
 
 
 
 
 
Comparative  Ratio  Analysis  
Figures,  percentages  and  ratios  do  not  provide  a  complete  picture  for  analysis.  For  analysis  to  be  
meaningful,  comparisons  and  benchmarks  are  needed.  Judgements  are  then  made  by  comparing  a  
firm’s  analysis  against  other  figures,  percentages  and  ratios.  This  is  known  as  comparative  ratio  
analysis  and  is  important  for  firms.  
o Ratio  analysis  taken  for  a  firm  over  a  number  of  years  can  be  compared  with  similar  businesses  
and  against  common  industry  standards  or  benchmarks.  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
An  example  of  profitability  trends  over  a  number  of  years  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Limitations  of  Financial  Reports  
Misleading  information  impacts  on  business  decision  -­‐making  and  puts  the  business  at  risk.  The  table  
highlights  the  issues  which  must  be  considered  when  analysing  financial  information.  
Normalised This is the process of removing one time or unusual influences from the balance
earnings sheet to show the true earnings of a company. An example of this would be the
removal of a land sale, which would achieve a large capital gain.
Capitalising This is the process of adding a capital expense to the balance sheet that is regarded
expenses as an asset (in that it will add to the value of the company and is therefore recorded
on the balance sheet) rather that an expense (in this situation, it would be recorded
on the income statement).

Examples of capitalising expenses include:

• research and development
• development expenditure
Valuing assets This is the process of estimating the market value of assets or liabilities. The
valuations can be used in a variety of contexts for a business, including investment
analysis, mergers and acquisitions and financial reporting.

Two main methods used for valuing assets include:

1. Discounted cash flow method. This method estimates the value of an asset based
on its expected future cash flows, which are discounted to the present (i.e.
the present value).
2. Guideline company method. This method determines the value of a firm by
observing the prices of similar companies (guideline companies) that sold in
the market.
Timing issues Financial reports cover activities over a period of time, usually one year. Therefore,
the business’s financial position may not be a true representation if the business has
experienced seasonal fluctuations.
Debt Financial reports can be limited because they do not have the capapcity to disclose
repayments specific information about debt repayments such as:

• How long the business has had or has been recovering the debt
• The capacity of the business or its debtor to repay the amount/s owed (What if a
debtor is close to bankruptcy and will not be able to repay a debt?)
• The adequacy of provisions and methods the business has for the recovery of
debt. (Larger businesses have the ability to outsource debt recovery by hiring
an agent to undertake this process but smaller business may not have the
resources to do the same as it is costly and time consuming.)
• What provision does the business have in place for doubtful debts and how is this
evident in the financial reports?
• Have debt repayments been held over until another accounting period therefore
giving a false impression of the situation?
The recording of debt repayments on financial reports can be used to distort the
‘reality’ of the business’s status and this may be undertaken to provide a more
favourable overview of the business at that point in time.
Notes to the Notes to the financial statements report the details and additional information that
financial are left out of the main reporting documents, such as the balance sheet and income
statement statement. These notes contain important information such as the accounting
methodologies used for recording and reporting transactions that can affect the
bottom-line return expected from an investment in a company.
 
 
Ethical  Issues  Related  To  Financial  Reports  
Q Businesses  have  an  ethical  and  legal  responsibility  to  provide  accurate  financial  records.  
Q Laws  relating  to  corporations  regulate  the  conduct  of  directors  and  the  requirement  for  
disclosure  of  all  information  to  be  accurate.  This  is  very  important  to  lenders  and  shareholders  
of  companies  who  make  decisions  about  investment  based  on  the  information  provided  by  the  
business.  
 
Audited  Accounts  
An  audit  is  an  independent  check  of  the  accuracy  of  financial  and  accounting  procedures  and  is  an  
important  part  of  the  control  function  of  the  business.  There  are  three  main  types  of  audits  including:  
 
1) Internal  Audits:  conducted  by  the  business’s  employees  
2) Management  Audits:  conducted  to  review  the  business’s  strategic  plan  
3) External  Audits:  conducted  by  independent  and  specialised  audit  accountants.  These  types  of  
audits  are  a  requirement  of  the  Corporations  Act  2001  (Cwlth)  
 
Record  Keeping  
All  accounting  processes  depend  on  how  accurately  and  honestly  data  is  recorded  in  financial  reports.  
 
Goods  and  Services  Tax  (GST)  Obligations  
Business  have  an  ethical  and  legal  obligation  to  comply  with  GST  reporting  equipment  
 
Recording  Processes  
Accurate  financial  reports  are  necessary  for  taxation  purposes  as  well  as  for  other  stakeholders.  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial  Management  Strategies  

Working  
Cash  Flow  
Capital  
Management  
Management  

Global  
ProQitability  
Financial  
Management  
management  

 
Cash  Flow  Management  
Cash  flow  is  the  movement  of  cash  in  and  out  of  a  business  over  a  period  of  time.  By  keeping  records  
of  cash  flow,  you  know  how  much  cash  you  have  in  your  wallet  or  in  the  bank  at  a  given  time.  
 
 
 
 
 
 
THE  CYCLICAL  FLOW  OF  FUNDS.  EFFICIENT  
MANAGEMENT  OF  CASH  FLOW  IS  CRUCIAL  
TO  A  BUSINESS’S  SUCCESS  
 
 
 
 
 
 
 
Cash  Flow  Statements:  
A  cash  flow  statement  provides  important  information  regarding  a  firm’s  ability  to  pay  its  debts  on  
time.  It  can  also  assist  in  identifying  periods  of  potential  shortfalls  and  surpluses.  
 
Management  Strategies:  
Management  must  implement  strategies  to  ensure  that  cash  is  available  to  make  payments  when  
they  are  due.  Management  strategies  for  cash  flow  include:  
o Identifying  when  the  distribution  of  payments  can  be  and  are  made  
o Offering  discounts  to  creditors  for  early  payments  to  positively  affect  cash  flow  status  
o Factoring  
 
Working  Capital  Management  

Working  capital  management  is  determining  the  best  mix  of  current  assets  and  current  liabilities  
needed  to  achieve  the  business’s  objectives.  
 
 
Working  capital  is  the  term  used  in  businesses  to  describe  the  funds  available  for  the  short-­‐term  
financial  commitments  of  a  business.  Net  working  capital  is  the  difference  between  current  assets  
and  current  liabilities.  
 
The  working  capital  cycle:  
 
 
 
 
 
 
 
 
 
 
   
 
 
 
 
 
 
 
Management  must  achieve  a  balance  between  using  funds  to  create  profits  and  holding  sufficient  
funds  to  cover  payments.  The  more  efficient  a  business  is  in  organising  and  using  its  working  capital,  
the  more  effective  and  profitable  it  will  be.  
 
 
 
The  requirements  for  working  capital  vary  for  
each  business.  
 
(A) A  food  outlet  requires  a  relatively  low  
level  of  working  capital  as  its  cash  flow  cycle  
is  short.  
 
(B) A  snowboard  manufacturer  requires  a  
higher  level  of  working  capital  as  the  cash  
flow  cycle  –  between  paying  for  raw  materials  
and  receiving  payment  for  finished  goods  sold  
–  is  longer.  
 
 
 
 
 
 
 
The  current  (working  capital)  ratio  shows  if  current  assets  can  cover  current  liabilities  –  that  is,  a  
business  can  determine  whether  it  can  pay  its  immediate  debts.  
 
Control  of  Current  Assets  
Control  of  current  assets  refers  to  the  management  process  that  determines  the  optimal  amount  
of  each  current  asset  held.  This  includes:  
 
o Cash:  money  in  the  hands  of  the  company  and  ensures  the  business  can  repay  its  debts,  
loans  and  and  accounts  in  the  short  term  
 
o Receivables:  the  sums  of  money  due  to  a  business  from  customers  to  whom  it  has  
supplied  goods  and  services  
 
o Inventories:  refers  to  the  stock  a  business  holds.  A  business  must  manage  its  inventory  in  
order  to  remain  solvent.  

Control  of  Current  Liabilities  

The  current  liabilities  of  a  business  refer  to  the  financial  commitments  that  must  be  paid  by  a  
business  in  the  short  term.  A  business  must  monitor  and  manage  current  liabilities  such  as:  
 
o Payables:  sums  of  money  owed  by  the  business  to  other  businesses  from  whom  it  has  
purchased  goods  and  services.  
 
o Loans:  sums  of  money  that  are  borrowed  from  financial  institutions  for  the  purpose  of  
funding  such  things  as  the  purchases  of  property  and  equipment.  These  loans  can  either  
be  short  or  long  term  in  duration.  
 
o Overdrafts:  a  relatively  cheap  and  convenient  form  of  short-­‐term  borrowing.  The  main  
purpose  is  to  allow  a  business  to  cover  temporary  cash  shortages.  

 
Strategies  
The  main  strategies  for  working  capital  management  include:  
 
o Leasing:  the  hiring  of  an  asset  from  another  person  or  company  who  has  purchased  the  asset  
and  retains  ownership  of  it.  
 
o Sales  and  Lease-­‐Back:  the  selling  of  an  owned  asset  to  a  lessor  and  leasing  the  asset  back  
through  fixed  payments  for  a  specified  number  of  years.  
 
 
 
 
 
 
 
 
 
 
 
 
 
Profitability  Management  

Profitability  management  involves  the  control  of  both  the  business’s  cost  and  its  revenue.  Accurate  
and  up-­‐to-­‐date  financial  data  and  reports  are  essential  tools  for  effective  profitability  management.  
 
Cost  Controls  
Most  business  decisions  are  influenced  by  costs.  The  costs  associated  with  a  decision  need  to  be  
carefully  examined  before  it  is  implemented.  
 
Fixed  and  Variable  Costs  
• Fixed  costs  are  not  dependent  on  the  level  of  operating  activity  in  a  business.  Fixed  costs  do  
not  change  when  the  level  of  activity  changes  –  they  must  be  paid  regardless  of  what  happens  
in  the  business.  E.g.  salaries,  insurance  and  lease.  
 
• Variable  costs  are  those  that  change  proportionately  with  the  level  of  operating  activity  in  a  
business.  E.g.  materials  and  labour  used  in  the  production  of  a  particular  item  are  variable  
costs,  because  they  are  often  readily  identifiable  in  a  business  and  can  be  directly  attributable  
to  a  particular  product.  
 
 
 
 
 
 
 
 
 
 
Cost  Centres  
A  business’s  costs  and  expenses  must  be  accounted  for,  and  management  needs  to  be  able  to  identify  
their  source  and  amounts.  A  number  of  costs  can  be  directly  attributable  to  a  particular  department  or  
section  of  a  business,  and  these  are  termed  cost  centres.  
o E.g.  a  cost  centre  in  manufacturing  would  be  called  a  production  cost  centre.  
 
Cost  centres  have  direct  and  indirect  costs.  
o Direct  costs  can  be  allocated  to  a  particular  product,  activity,  department  or  region  
o Indirect  costs  are  shared  by  more  than  one  product,  activity,  department  or  region.    
 
Expense  Minimisation  
Profits  can  be  weakened  if  the  expenses  of  a  business  are  high,  as  they  consume  valuable  resources  
within  a  business.  Guidelines  and  policies  should  be  established  to  encourage  staff  to  minimise  
expenses  where  possible.  
 
Revenue  Controls  
In  determining  an  acceptable  level  of  revenue  with  a  view  to  maximising  profits,  a  business  must  have  
clear  ideas  and  policies,  particularly  about  its  marketing  objectives.  
 
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.  A  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.  
 
Global  Financial  Management  

Global  financial  management  refers  to  the  strategies  implemented  by  business  to  deal  with  the  
export  component  of  business  activities.  

 
Exchange  Rate/Currency  Fluctuations  
Q Currency  fluctuations  create  risks  for  global  business.  Depreciation  and  appreciations  will  
impact  on  both  import  and  export  levels  and  the  payments  made  to  overseas  businesses  or  
financial  intermediaries.  
 
 Interest  Rates  
Q Domestic  and  international  businesses  will  source  funds  internationally  and  will  therefore  
need  to  consider  the  interest  rates  offered  on  borrowings.  The  repayment  of  this  debt  must  
also  allow  for  fluctuations  in  currency.  
 
Interest  Rates  
The  main  methods  of  international  payment  include:  
Q Payment  in  advance  —  allows  the  exporter  to  receive  the  payment  and  then  arrange  for  the  
goods  to  be  sent.  
Q Letter  of  credit  —  a  commitment  by  the  importer’s  bank,  which  promises  to  pay  the  exporter  
a  specified  amount  when  the  documents  proving  shipment  of  the  goods  are  presented.  
Q Clean  payment  —  occurs  when  the  payment  is  sent  to,  but  not  received  by,  the  exporter  
before  the  goods  are  transported.  
Q Bill  of  exchange  —  a  document  drawn  up  by  the  exporter  demanding  payment  from  the  
importer  at  a  specified  time.  
 
 
 
 

 
 
 
 
 
Hedging  
Hedging  is  the  process  of  minimising  the  risk  of  currency  fluctuations.  Hedging  helps  reduce  the  level  
of  uncertainty  involved  with  international  financial  transactions.  
 
Natural  Hedging:  
A  business  may  adopt  a  number  of  strategies  to  eliminate  or  minimise  the  risk  of  foreign  exchange:  
Q Establishing  offshore  subsidiaries  
Q Arranging  for  import  payments  and  export  receipts  denominated  in  the  same  foreign  currency  
Q Implement  marketing  strategies  that  reduce  the  price  sensitivity  of  the  exported  products  
Q Insisting  on  both  import  and  export  contracts  denominated  in  Australian  dollars  
 
Derivatives  
Derivatives  are  simple  financial  instruments  that  may  be  used  to  lessen  the  exporting  risks  associated  
with  currency  fluctuations.  
 
The  three  main  derivatives  available  for  exporters  include:  
 
Q Forward  exchange  contracts:  contract  to  exchange  one  currency  for  another  currency  at  an  
agreed  exchange  rate  on  a  future  date.  
 
Q Options  contract:  An  option  gives  the  buyer  the  right  to  buy  or  sell  foreign  currency  at  some  
time  in  the  future  –  protected  from  unfavourable  exchange  rate  fluctuations.  
 
Q Swap  contract:  A  currency  swap  is  an  agreement  to  exchange  currency  in  the  spot  market  
with  an  agreement  to  reverse  the  transaction  in  the  future.