HSC TOPIC 2: FINANCIAL PLANNING AND MANAGEMENT

The role of financial planning -Financial planning is mainly concerned with: (1) Evaluating the size of projects + activities (2) Financial decisions (3) Evaluation of the Bs overall financial resources Strategic role of financial planning -it is the process of setting objectives throughout the B + deciding what resources will be needed to achieve these objectives -usually has a longer time frame, approx. 3.5 years into the future -it is involved with setting objectives for other departments in B -takes place in a changing environment, internally and externally e.g. GFC -changes = potential to create opportunities /threats for a B, e.g. taxation, tech + financial innovation Objectives of financial management Liquidity Terms Liquidity Current Assets Current Liabilities Debtors Creditors Accounts Payable Accounts Receivable Definition the ability of the B to pay its short term debts as they fall due assets that earn revenue for a B in the short term; < 12 months money owed to an external B/person that will be repaid in the short term; < 12 months the B/ individuals that owe money to the B (aka accounts receivable) Bs, financial institutions + individuals to which a B owes money (aka accounts payable) Money a B owes to its supplies (aka creditors) Represents money owed to the B in the short term. This money is owed to the B by customers who are yet to pay for G/S they have received (aka debtors)

-Factors influencing liquidity objective: Industry Amount of cash tied up in debts and inventory (accounts payable) Ease of non-current assets into $ (e.g. land/building, plant/equipment/ fixtures/fittings + motor vehicles) Efficiency of collecting customer debts (accounts receivable) -debtors = expected to pay their accounts in a short period of time Accounts receivable = relatively liquid asset -NC assets are the least liquid = it takes time to advertise + negotiate the sale of them to convert them to $ -financial managers check liquidity = useful indicator for Bs to know how quickly they can convert an asset into $ -keeping the B in a financially stable position in the short term by keeping it liquid = (CA>CL) -a B that liabilities on time may find: its electricity, telephone or water services are cut off, suppliers wont wish to trade with it, bad credit ratings, may have to long term debt = raise $ = less financial stable position -however a B with high liquidity is not always more successful than one with lower liquidity -too much $ = criticised for being overly cautiously = ineffective finance - $ could be used in the B/investment rather that earning little interest in the bank

Profitability Def. Profitability: the ability of an organisation to maximise its profit -most Bs will seek to profit as it = most recognisable financial objective

Net Profit = gross profit - expenses

Def. Gross profit: the revenue remaining after paying COGS sold (e.g. wholesale cost + freight) -gross profit figure does not take into account any other expense apart from the cost of buying the inputs that are made into the goods for sale Def. Net profit: the final amount of revenue remaining after all expenses have been paid -financial manager = can work out if B is making enough profit from its investment in assets by calculating + analysing the gross profit ratio + net profit ratio -EBIT (Earnings Before Interest Tax) is a more precise measure of profitability than net profit because it measures profit made directly from the operations of the B Efficiency Def. Efficiency: the ability of a firm to use its resources effectively in ensuring the financial stability and profitability of the B -related to profitability because a B will be able to profit when it cost -service based B = expenses due to wages + services of staff (manufacturers = raw materials + machinery) -efficiency can be calculated using an expense ratio -can also be gained when the B achieves the same level of profit from having a smaller amount of resources -another measure = Bs ability to collect accounts receivable (AR) -AR turnover ratio = average time it takes customers to pay their invoices average time = more efficient Growth -a B that grows = more output = more sales = revenue and profit in the long term -growth = important financial objective of management = ensures that the B is sustainable in the future -usually involves additional funds -A growth strategy tries to increase the size or level of a businesss operations by increasing: *Sales revenue *Production capacity *Market share Return on Capital Def. Return on capital: the amount of profit returned to owners or shareholders of their capital contribution Def. Capital: money invested by the owners of a B when they contribute finance when B is established -return on capital is calculated as a % of the owners original investment -a B would be judged a success if the return > safe alternatives such as investing in a savings account or property

The Planning Cycle-the planning cycle refers to the continuous series of financial activities that take place as a B plan to move from one point to another over time.

1. ASSESING THE PRESENT FINANCIAL POSITION 2. DETERMINING THE FINANCIAL ELEMENTS OF THE BUSINESS PLAN

to know where the B is heading in the future+ how it will get there= important to know current position = a key aspect of cycle involves the analysis of : (1) $ from sales +credit customers pay in their account (2) $ paid to suppliers + other creditors (3) evaluation of profitability B plan = a detailed study of a B's activities highlighting where the B has has been, where it is at + where it would like to go in the future. plan also includes an action program = achieve desired results e.g. profitability , mkt share, employee's welfare, R+D and quality/service etc. implementing these may = financial implications

3. DEVELOPMENT BUDGETS

devlopment managers receive objectives from top management = usually involve sales + profit objectives budgets = formal statements of the financial resources set aside for carrying out specific activities in a given period of time functional/divisional managers prepare budgets = what their section will need for the B goal + what resources they need to carry out these activities
$ that flows in + out of B = key function of financial planning important to consider cash flows that change over time e.g. seasonal, peak periods of the year, credit periods and purchases etc. standardised records + reports summarise the financial activities of a B during a particular period = wide range of uses for mangers = for meeting requirments of regulators, needs of creditors + owners as well as monitoring the performance of the B creditors = who evaluate the B's ability to pay debts to them on time owners = assesing the B's financial condition + decisions on shares indicates performance of the B = assess the effectiveness of plans standardised + provide general purpose info people interpreting the reports needs knowldge on how to read/compile/extraxt info from the standard + principles that determine how the accounts will be represented = (GAAP) generally accepeted accounting principles managers need infor from 2 sources: extrenal (threats + opportunities) and internal (how well their plans work) MIS (management information system)=organises lots of data info sytems = easier to ensure records needed for cycle is maintained these are tools = enable managers to compare the actual financial performance of their B with the planned performance e.g. budgets managers generally have 3 objectives= liquididty, profitbaility + growth managers need to balance b/w these 3 by monitoring + controlling e.g. financial controls (controls = measure + compare current to planned) financial riks = not being able to repay a debt as it falls due failure may = insolvency + poetential failure of the B techniques to risk = hedging(transferring risk to another B) + derivatives

4. PLANNING CASH FLOWS

5. PREPARING FINANCIAL REPORTS

6. INTERPRETING FINANCIAL REPORTS

7. MAINTAINING RECORD SYSTEMS 8. PLANNING FINANCIAL CONTROLS 9. MINIMISING FINANCIAL RISK AND LOSS

Financial markets relevant to business financial needs -financial institutions + markets are important to B operations, for when a B grows it may require finance to develop their B (e.g. purchasing: new staff, technology, buildings etc.) Participant Description -Major operators in financial market (largest form of financial institution) -most large banks also offer specialist B services Source of funds *online banking, detailed statements, credit cards *services e.g. EFTPOS +BPay *deposit accounts from individuals *home mortgages *bank overdrafts *B insurance + superannuation *bank bills *int. Trade finance *risk management *economic outlook reports *secured loans (require an asset = security for the loan) *unsecured loans ( asset for security + advertised to B) *commercial bills *leasing finance *debentures *source of income for retirement *can be invested in long term securities *use ppls savings and invest it in property & equities

Banks

Merchant Banks

-deal with Bs only -can provide advice + arrange finance a B may need and B loans will be customised to the specific need of the B -banks continuously develop new financial products + become more competitive -specialise in smaller commercial finance -provide diff types of secured + unsecured loans to B

Finance and Insurance Companies

Superannuation funds/ mutual funds

Companies

Government (RBA)

- fed govt policy + law= all employees must have a small part of their Y invested in superannuation -purpose: provide an investment once working stops = need for the aged pension provided by fed govt -over time the superannuation with returns + instalments -current superannuation rate = min. 9% -those that have very good profitability can lend surplus cash to other Bs as a loan -borrow money to fund their operations -dealing in foreign exchange + commodities with overseas suppliers -fed govt participates = influence the Aus economy (i.e. monetary policy) -the RBA is Australias central bank + acts as banker + financial agent for the fed govt -through RBA, fed govt will (1) buy + sell govt securities + loans and (2) adjust int. rates to stabilise the economy

*short-term loan *equity loan

*low interest rate loans *grants to some Bs

Role of the Australian Stock Exchange as a primary market - ASX comprises the largest primary and secondary markets for companies and individuals wishing to list and exchange financial assets in the economy. -its role has due to deregulation, developing technology + in the amount of shares + debt securities traded -as a primary market it enables a company to raise new capital through the issue of shares and through the receipt of proceeds from the sale of securities -provides 3 principle markets, for trading: Equities: trading of shares Debt securities: bonds Derivatives: dealing in the future (contract to sell in future at current price) Overseas and domestic market influences and trends in financial markets and their implication for business financial needs Overseas: *foreign exchange rate e.g. $Aus against $US *world events e.g. 2004 oil shortage *accounting regulations affecting foreign operations *tax regulations on foreign operations *Political risks e.g. terrorism *Differences in interest rates b/w countries e.g. in domestic int. rates = borrowing + inflow of $ from o/s *Foreign government intervention Domestic: *changes in govt. policy e.g. 1980 deregulation of the Australian financial sector by fed govt = o/s banks were allowed to operate in Aus + restrictions on int. rates were removed *changes in inflation rate *competing demands for funds *employment patterns *level of economic growth *changes in interest rates e.g. through the RBA the govt directs interest rates Bs need finance in all stages of their life cycle: -to fund Bs establishment costs -to fund the ongoing fixed + variable costs of B operation -to fund Bs expansion + growth Management of Funds Sources of funds -sources of funds need to be managed efficiently = to promote B liquidity, solvency + profitability Internal -internal sources of B finance = funds contributed by owners/shareholders into the B = equity (1)Owners Equity Def. owners equity: the owners financial claim on the assets of a B, to fund or establish the B. -an owner can invest his or her own money

-or issue shares privately or publicly -privately: selling shares to the internal employees of a B -publicly: apply to have the B listed on the stock exchange and sell shares to the public -when a B goes through incorporation + become a company = able to raise finance from selling shares -diff no. of shares: *ordinary shares = basic form of capital *preference shares = receive dividends before ordinary stakeholders Advantage: do not have to pay at a predetermined date + less risky than debt finance Disadvantage: the more owners = ownership is diluted = original owners have less control of the B + more complex than debt to organise (2)Retained Profits Def. Retained profit: net profit that is reinvested into the B External

SHORT TRERM

-bank bills -overdrafts -trade credit

LONG TERM

-mortgage lonas -debentures

OTHER

-leasing -factoring -venture capital -grant

Debt finance- any money that has been borrowed Short term borrowing (used to pay short term expenses + purchase of current assets) Bank overdraft -gives B flexibility to borrow money from the bank at a short notice -it is a relatively small amount of money in a short period of time -high interest rates Advantage: current taxation laws allow interest paid to be claimed as a tax deduction Disadvantage: they carry a financial risk because the B must repay the interest regardless of the level of profits that the loan could generate Bank bill -bank bill or commercial bill is a written order for a loan amount that is guaranteed by the Bs bank -the money is borrowed from other companies/individuals that have surplus funds -Bs + govts that need funds in the short term = act as intermediaries by selling these bills -large amounts of money paid in a short period time = B investigated if it is able to repay its borrowings Trade Credit -a type of loan from a supplier = payment to the supplier is delayed -the length of the loan is determined by the creditors who set the invoice

-a supplier made find it difficult to monitor + control amounts owed + will only give trade credit to reliable customers with a good credit rating Long term borrowing (used to purchase long term or non-current assets) -often takes >a year to repay -these borrowings are usually used for purchase of assets OR a takeover bid Mortgage loans -a secured loan where a borrower (mortgagor) gives a change over property to the lender (mortgagee) in return for a loan -typical mortgage loans for a B are for the purchases of commercial premises e.g. office, warehouses + showrooms Debenture loans -a loan from the general public to a B -usually done by large established Bs -usually sets out a prospectus to the public to provide necessary info for an informed decision -must appoint a trustee to act on the lenders behalf to ensure all conditions are met -a secured loan (could include a floating charge = all assets that have not been mortgaged) -the company issuing the debenture agrees to repay the loan in a specific period of time along with an agreed interest at given intervals -debentures are usually for large amounts of $ because there are costs involved e.g. ads Other sources of funds Leasing -Bs lease non-current assets = cost of acquiring these assets (as the B does not have to outlay the full value of the asset in one transaction) -when a B leases an asset = agreeing to an ongoing, regular payment that allows it to use an asset that is owned by another B Factoring -a source of short term finance (it can be used to improve cash flow, using the capital invoices as a B security) -it is the cash sales of a Bs accounts receivable to a factoring company -factoring company = takes over management + collection of the unpaid accounts *under terms agreed with the B *will pay up to 90% of the value of the accounts receivable for a fee *debtors pay directly to the B *will then return the remaining 10% of the paid debts to the B = receives the full value of what it is entitled to -factoring = a method of improving a Bs liquidity at the expense of some of its working capital in the short term Venture capital -an entrepreneur/finance company/superannuation fund can provide finance to a B in exchange for part ownership -venture capitalist = minimal say in the daily management of the B -if entrepreneur determines that the risk is worthwhile (B plan) = provide capital for the B to grow + break even Grant -financial gifts provided by the govt to assist B to establish or expand = benefit the economy

Financial Considerations -MATCHING PRINCIPLE: if the source and terms of finance match the economic life of the resource/ asset then the cost of the asset can be met from the earnings -BS CAPITAL STRUCTURE: is determined by the mix of long term debt + equity it uses to finance its assets -Costs, including set-up costs and interest rates must also consider fluctuations in cost due to market and economic conditions. -Size and stability of business earning capacity. -Flexibility, so that businesses can pay off at certain time or increase/renew their borrowing. -Availability of finance and ease of access to finance -Level of control if the lender requires security over an asset and other conditions of lending are imposed, a businesss ability to consider future financing possibilities is reduced. Other benefits (e.g. tax benefits) Comparison of Debt and Equity Financing -Bs use a mixture of debt + equity financing + make a decision on which type to use depending on the Bs purpose + structure -if the source + terms of the finance match the economic life of the resource/asset = the cost of the finance can be met from the earnings of the resource/ asset -a Bs capital structure is determined by the mix of long term debt and equity it uses to finance its assets Debt finance Equity finance

Costs - repay with interest (disadvantages) - repayments are timed - there is a level of control by lenders - easy to obtain -first claim on the assets + income of the tax - tax deductable - cheaper than equity = higher profitability

- shareholders have residual claim on assets - divide profits through paymnt of dividends, - not tax deductable - interest not paid, hence equity cheaper - increased revenue & profits - market value = share prices - no change in ownership (funding is internal) -no maturity time on equity finance - fluctuating share prices - mgt decisions on profitability influence the bizs public image -diluted control = ppl giving funds to the B will have a say in how the B runs (influences management)

Benefits

Risks

- may not be able to make payments when they fall due - changes in interest rates - may create cash flow problems -no voice in the management of the B -there is a maturity time on the debt

Gearing/Leverage Def. Gearing: measures the relationship between equity & debt in funding a bs operations

-The level of gearing is calculated through the use of the debt-to-equity ratio -The higher the level of debt compared to the equity finance, the higher the gearing, hence the greater the risk for the biz (but a higher risk also = greater potential). -In balancing the gearing of a biz, profits must be sufficient to cover interest payments. Neither debt nor equity is good or bad, both have their merits; however a right combination of the two is important! Using Financial Information The Accounting Framework -different stakeholders have different uses for financial info about a B -they must work to extract the required info that allows them to make informed decisions -the accounting framework (Australian Accounting Standards) = a set of guidelines established by the AASB (Australian Accounting Standards Board) in the 1980s/1990s to provide a framework within which accounting procedures were to be carried out Def. revenue statement: a summary of the income + expenses of a B over a set period of time. Def. Balance sheet: a document that provides info on a Bs assets and liabilities and owners equity at a particular point in time, expressed in money terms, and represents the net worth of the B. Def. accounting equation: the equation forms the basis of the accounting process and shows the relationship b/w assets, liabilities and owners equity. Types of Financial Ratios -financial ratios are used to help financial managers analyse financial data -analysis is then used to assist managers in the business Basic Formulas

A = L + OE (Assets = liabilities + owners equity) COGS = opening stock + purchases closing stock Gross Profit = sales revenue - cost of goods sold Net Profit = gross profit - expenses Net Profit / Net Loss = sales revenue - COGS Working Capital = current assets current liabilities

Aspect of the financial statement: Liquidity (the ability of the B to pay its short term debts as they fall due)

Current Ratio = current assets/current liabilities

Ratio: -Current / Working Capital Ratio It shows: -the short term stability of the B + ability to meet short term financial commitments Interpretation of results: -should be > 2 -a low ratio would indicate imminent liquidity problems = CA cannot cover CL -a high ratio is often said to suggest that cash is being poorly utilised -must consider the makeup of CA e.g. a high level of stock + a high level of debtors = cash convertibility = a lower liquidity ratio than the ratio suggests Strategies: -an injection of owners equity into the B = improve the cash balance of the B -the sale of non-current assets + leasing back of assets = cash available -transfer of current liabilities into a more long term debt Aspect of the financial statement: Solvency improve CA position

Solvency Ratio = total debts / owners equity

Ratio: -solvency/gearing/ debt to equity ratio It shows: -measures the level of external borrowings as compared to the level of internal funding to finance the B Interpretation of results: -generally accepted ratio is 1.5: 1 or 60% - ratio = debt used = level of risk = interest to pay + vulnerable to repayment demands = solvent - ratio = debt used = level of risk = havent fully utilised funds + is able to pay its debts = solvent Strategies: - debt by selling assets - equity by selling more shares (= improve shareholder capital) etc.

Aspect of the financial statement: Profitability Ratio (1): -Gross Profit Ratio

GPR = gross profit x 100 sales 1

It shows: -the changes from one accounting period to another + the effectiveness of financial management Interpretation of results: -the higher the ratio the better -a 50% GPR means mark up is 100% Strategies: -source cheaper supplies to COGS - mark ups/ margins -leave the industry + seek opportunities in other industries -buy in bulk -improve stock control (J.I.T) Ratio (2): -Net Profit Ratio

NPR = net profit x 100 sales 1

It shows: -represents the profit or return to the owners Interpretation of results: -the NPR is a much better indication of overall profitability than GPR as it factors in the expenses -the higher the better -an NPR > than 18% = considered a high return -low NPRs indicate that costs are high = cost reduction strategies need to be implemented Strategies: - sales = intro a new/diff marketing campaign OR of variety of products sold to concentrate on 1 product - expenses = costs by intro new labour saving tech, outsourcing, leasing

Aspect of the financial statement: Profitability continued Ratio (3): -Return on Owners Equity ratio

ROE = net profit x 100 capital 1

It shows: -how much the owners/shareholders investment is earning and is influenced by the level of borrowings Interpretation of results: -most indicative profitability ratio -the higher the percentage the better -the ROE ratio is influenced by the economic cycle Strategies: -net profit Aspect of the financial statement: Efficiency -if B can improve the way something is done = gained efficiencies i.e. output from a given set of inputs Ratio (1): -Expense Ratio

Expense Ratio = expenses x 100 sales 1

Expense Ratio = GPR-NPR

It shows: -what costs need to be minimised +which expenses seem unusually high Interpretation of results: -indicate day to day efficiency of the B -need to be kept at a reasonable level + must monitor in relation to sales otherwise =affect the efficiency of the B -higher expenses ratio may be the result of poor management Strategies: -management must control expenses = them to efficiency i.e. BUDGETS - sales but with proportionally less expenses

Aspect of the financial statement: Efficiency continued -if B can improve the way something is done = gained efficiencies i.e. output from a given set of inputs Ratio (2): -Accounts Receivable

Accounts Receivable Turnover Ratio= credit sales average accounts receivable

It shows: -measures how often debtors are collected throughout the year Interpretation of results: -the lower the better -generally Bs seeks to turnover 30 days or less -if figure is appalling it could be due to poor credit record of customers / poor accounting of the B Strategies: *credit collection policy *add interest * Blackman them/banned *discount for early payment *add interest after 30 days *put bad payers on cash only basis *council rates *reduce the period of pay *go to court

Comparative Ratio Analysis Over time -comparing current years results to those of previous years -evaluates Bs performance -will allow managers to identify trends in profit, costs and financial stability With similar businesses -business benchmark -enables the Bs to see how/where it can improve by reviewing the Bs plan + planning new strategies Against common standards -industry averages -shows what is the expected performance for all Bs in a particular industry Limitations of financial statements - Managers must be aware of the limitations of financial reports & the tools associated with them, when making decisions based on the reports.

Historical costs: In financial reports, historical cost accounting states that values are to be recorded at the cost incurred at the time of purchase. However, assets may depreciate/ appreciate in cost value over time hence real value may not be reflected. -inflations, obsolescence, amortisation (depreciation of intangible assets) Value of intangibles: -items that are of value to a B but does not physically exist -the value of intangibles is difficult to determine, and can never be exact - includes patents, copyrights, brands and trademarks, employees, established customers, reputation and image. Effective Working Capital (liquidity) Management Working capital: - current assets that are used for the day-to-day operation of a biz. -working capital management= determining the best mix of current assets & current liabilities needed to achieve biz goals, ensuring that there is always enough cash at hand to pay short-term bills as they fall due - It is a means of internal control, not used to compare with other businesses. The working capital ratio

Working Capital = current assets current liabilities Working Capital Ratio = current assets / current liabilities
It is important to have enough working capital to maintain liquidity. If the working capital is: Positive: B is better able to pay its short-term debts as they fall due. Risk is minimised, and excess cash is idle (could be reinvested into the biz) Negative: increases risk of not being able to pay short-term debts as they fall due. Insufficient working capital means there are cash shortages or liquidity problems and the situation forces businesses to increase their debt, find new sources of finance or sell off non-current assets which eventually lead to loss of profitability Control of current assets cash, receivables, inventories -Controlling current assets is important for monitoring working capital -ensuring that there is enough cash + current assets to pay expenses and current liabilities Cash -most liquid current asset -A B needs cash for predictable & unpredictable costs e.g. investment opportunities, debts -controlling cash requires preparation of a cash budget -can cash by sale lease back -A cash budget: is a detailed plan of inflows & outflows of cash over a specified period -estimates the size + timing of cash flows (anticipate periods of cash shortage and surplus) -Excess cash is a cost if left idle & unused

Receivables -Customers dont always pay their accounts on time, hence a B must develop policies to control receivables Procedures for managing accounts receivable include: Establishing a credit policy outlines length of credit period & amt of credit to be given - A credit policy also acts as a guide to staff on what to do if customer debt is not paid on time - Tight credit policies can also dissuade customers, influencing their choice to buy from another B Factoring: involves the sale of accounts receivable payment to a 3rd party, for a discounted price. This improves working capital because cash is paid immediately. Inventories -B may experience having too much cash invested in raw materials, work in progress and finished goods Inventory: any stored resource. Inventory must be controlled to ensure stock is kept to a minimum, so costs are kept low. -Insufficient inventory may lead to loss of customers, therefore loss of sales. - Inventory can be controlled with an: Inventory policy: ensures regular stock takes of inventories JIT inventory system: inventory bought JIT to be used; no storage. This method helps reduce stock from becoming obsolete/ damaged. Computerised inventory management system using bar codes to identify stock movements Control of current liabilities payables, loans, overdrafts Controlling current liabilities is important for monitoring working capital. Payables -Accounts payable is a major source of unsecured short-term financing & needs to b carefully controlled. -They need to be paid on time to protect credit rating. Most Bs control accounts payable by stretching accounts payable paying creditors as late as possible without damaging credit ratings. Loans -Bs need to borrow funds. Short-term loans are generally expensive and should be minimised. Control of loans involves ensuring that: Repayments are made on time B is not taking out excessive loans Capital budgeting: assessing what return can be gained from borrowing $, and risks involved Alternative sources of funds: from different financial institutions, minimises credit risk Overdrafts -The control of overdrafts is concerned with minimising costs -Overdrafts should only be used when necessary, and should not be relied upon as a constant source of funds (since interests must be paid to the bank) -to control overdrafts, a B can invest surplus cash, transferring these funds when needed. Strategies for managing working capital

Leasing -An agreement in which the owner of an asset allows another party to use in return for periodic payments. -includes no upfront fees, conserving working capital. Factoring -Allows for immediate cash from credit sales -When a B sells an asset to a financier, who then leases the asset back to the B under a long-term agreement. This conserves working capital by reducing amt of working capital tied up in expensive assets Sale and lease back 1. The selling of an asset to a leaser. 2. Leasing the asset back through fixed payments for a specified number of years. -Increases working capital as cash obtained from the sale can be used to fund its operations. Effective financial planning Effective financial planning ensures that the biz achieves its goals while avoiding insolvency Effective cash flow management Effective cash flow mgt requires the preparation of cash flow statements. -Cash flow the movement of cash in and out of a business over a period of time. -Statements: indicates the movement of cash receipts and cash payments resulting from transactions. -Gives information regarding a firms ability to pay its debts on time and indicates: Whether financial payments can be made as they fall due. Whether there are sufficient funds for future expansion or change. If finance can be obtained from external sources when needed. If there are enough funds to pay dividends to shareholders. -financial manager can draw up a budget to anticipate how much cash the B needs to pay its expenses Cash flow statements (Liquidity) -Cash flow statements show the movement of cash receipts & payments -Cash in a B represents a reservoir of liquidity that is increased by inflows & decreased by outflows. Cash flow statements group cash flows into: *Operating flows: sales revenue & operating expenses related to the Bs main activity (selling product/ service, e.g. sales revenue, payments to suppliers, rent, advertising) *Investment flows: purchase & sales of non-current assets (e.g. sell/purchase machinery, buildings) *Financing flows: inflows & outflows associated with borrowing, debt & equity, of the biz Management strategies Two key strategies to manage cash flows are: Distribution of payments: matching payments (outflows) to income (inflows); distributing payments throughout the year to avoid cash shortfalls. Discounts for early payments: % reduction from purchase price if paid within specific time, encouraging regular inflows of cash.

Effective profitability management

Profitability mgt is another important part of effective fin.ial planning. Profit = Revenue Expenses Effective profitability mgt is concerned with the control of costs & revenue. The objective of good profitability mgt is to max revenue with min costs. Cost control A biz must control its costs, but before that, mgt must have clear understanding of what costs are. There are 2 types of costs, which identify & account for expenses: Fixed costs: dont change, not dependent on level of biz activity; they must be paid regularly (e.g. salaries, rent). Can be reduced by, e.g. cheaper warehousing. Variable costs: change proportionally with level of biz activity (e.g. materials, bills- electricity). Can be reduced by, e.g. reducing workforce, adopting JIT technologies. Variable costs can be controlled by establishing cost centres: a section within a biz which managers (of that section) are held responsible for all costs associated with that sections function. Expense minimization, through expense budgets, is another important factor in cost control. Revenue controls Revenue controls are concerned with maximizing revenues. This involves establishing: Sales objectives: set out in a revenue budget to determine how best to achieve sales & analyse figures to forecast future sales. Sales mix: review each products profit-margin contribution to concentrate marketing effort on the right products Pricing policy: balance profitability and market share (e.g. overpricing could fail to attract customers, whilst under pricing may increase sales but bring lower profits). Effective cash flow management Operating flows Directly associated with making and selling products or services. Inflows from main operations, and outflows to suppliers, employees and insurance/ rent/ advertising. Investment flows Associated with purchase and sale of long term assets.

Financing flows Associated with debt and equity financing transactions. Include borrowing inflows and cash outflows relating to repayments of debt or dividend payments. Management strategies Distribution of payments

Cash flow projection can assist in identifying periods of potential shortfalls and surpluses. Timing of purchases and investments; should be matched to time when cash is available. Discounts for early payments Cash discount a percentage deduction from the purchase price if the buyer pays within a specified time shorter than the credit period. Encourages earlier payment, and improves cash flows.

Effective profitability management Fixed and variable costs Fixed costs unaffected by the level of operating activity in a business; must be paid regardless of profits. Variable costs incurred in proportion to the output of a particular good or service. Strategies to reduce variable costs: Reducing workforce, increase productivity by multi-skilling employees. JIT inventory system. Substitute variable for more fixed costs. Cost centres Particular units (departments or sections) of a business to which costs can be directly attributed. Expense minimisation Downsizing, reducing fixed expenses in times of strong competition or recession. Expense budget. Revenue control Revenue: money received from operating, financial and investment activities. Sales objectives Set out in revenue budget, they are a forecast of future sales. Level of expected sales must cover costs, both fixed and variable, and result in a profit. Cost-volume-profit analysis determines level of revenue sufficient to cover costs to break even. Sales mix Mix of products a business offers to sale. Controlled by analysing the contribution margin for each product. Pricing policy Factors: costs associated with producing the product, competition prices, short-term and long-term goals, and government policies. Determining the price for each product that will maintain or improve market share, at the same time meeting profitability objectives.