Chapter 8 management processes

8.5 financial management

Page 231-249
A thorough understanding of _________________ and________________ is essential for business
managers.

Accounting is ______________________________________________________________________
_________________________________________________________________________________

Finance is _________________________________________________________________________

Management of business finance is a crucial aspect of business success. Management of finance

starts with ___________________ — where will the funding come from? Once a business has
secured funding, it then needs to ensure that it is applied appropriately.

All financial managers would be aware of the need to manage the _________ _________ of the
business. The management of cash flow involves anticipating ____________ _______________ and
ensuring that enough of the _______________ earned comes in the form of cash.

A further challenge is to ensure that there is enough __________ ____________ in the event of
unexpected challenges. Some money for ___________________ needs to be put aside.
Contingencies are _________________________________________________________________.
For a business to be well managed, it needs to have saved money for such events because they can
place the business under unexpected financial pressure.

A business that is well managed will have a __________________________________, which means

that lenders will be prepared to lend the business money because they know that it is safe for them
to do so. The credit rating is determined by _______________ ______________ that assess the
capacity of the business, both to repay debt and manage finances responsibly. If a business has a
good credit rating, lenders will readily provide _____________. The business can use ____________
to its advantage. Thus, if it wants to expand operations, update technology or open offices
overseas, it probably will be able to get the money to do so.

Accounting – Introduction and scope

Accounting is a managerial and administrative tool that involves the recording of financial
transactions, so that a _________ ______________of what has happened to the money coming in

1
and going out can be traced over time. Every financial transaction, from the ordering of stock to the
sale of an old stock item, is recorded.

The statements are set out in a standard format so that they are easy to read and understand. A
well-trained manager can use these statements to get a very accurate picture of the financial status
of the business.

Complete the 3 main accounting financial statements in the table below:

Name of statement Content of the statement

A business has responsibility both to its internal and external _____________________. Accounting
provides information that is valuable to managers, employees, owners and shareholders (if it is a
company), suppliers, lenders, customers, government (including regulators), competitors and the
general public.

Accounting is useful, as it provides information in statements about each of the following as it

relates to the business:

 _____________________________________
 _____________________________________
 ______________________________________________
 ______________________
 _____________________________________
 ___________________________________________________________________________
_______________________________

Finance – Introduction and scope

Finance refers to how a business _______________ its activities — for instance, where it gets the
money to trade, why it chooses to use certain lenders — as well as the costs, risks, terms and
benefits of different types of borrowings.
2
Businesses, even very small ones, generally _________________ money at some time — usually
when they first set up. It is vital for a business to be able to manage its borrowing and to use
appropriate types of borrowing.

Businesses (sole traders and partnerships) borrow short or long term loans (debt) from financial
institutions. These loans can have fixed or variable interest rates and can be secured against a
businesses assets.

Companies (private and public) can either source finance through debt (like sole
traders/partnerships) OR equity by selling shares and part ownership of the company.

Questions: p.235 – Q.1, 2, 3, 5 and 7

Financial Statements
Summarise the 3 financial statements below:

Cash Flow Statement: ___________________________________

______________________________________________________
______________________________________________________

Income Statement: _____________________________________

_________________________________________________________________________________
_________________________________________________________________________________

Balance Sheet:
_________________________________________________________________________________
_________________________________________________________________________________

1. Cash Flow Statement

Cash flow statements are vital for the business to assess whether
money _______________ can match money _______________.
The term ‘______________’ is often used to describe whether a
business has a good or adequate ________________.

A business is said to be _____________ if it has the cash available

to meet payments as they are due. Generally a business would
prefer its sales to be in _____________ for precisely this reason
— it has a need for cash to meet its own payments.

Why do businesses allow credit sales when they prefer cash?

_______________________________
_________________________________________________________________________________
_________________________________________________________________________________

3
Using figure 8.31 complete the following:

Cash inflows include: _______________________________________________________________

Cash outflows include: ______________________________________________________________

A study of the cash flow statement (see figure 8.32) of a manufacturer shows that this business
made a cash ______________ for two of its first three months of trading for the year the report
was made. You can see that the business made a small surplus in January and a large surplus in
February. However, in March, this business experienced a cash ______________. It should be clear
now why such statements are necessary. A business can track its _____________ and ___________
over a period of time. It can then use these statements to determine why the inflows and outflows
are taking the pattern they are.

For example, in January, sales to manufacturer A were down on the usual $2.5 million average. This
may have been due to the normal business lull in January. The surplus for February is quite high and
an astute manager would have ensured that a portion of this surplus was put aside in case it was
needed in future months. As it turned out, the materials costs for March were very high and sales
to manufacturer C continued to fall.

Cash Flow Statements for larger businesses

While the cash flow statements previously shown are very detailed, they are more suited to small
to medium sized businesses. The format of cash flow statements used by large businesses and
4
public companies is shown in figure 8.33. It can be seen that cash is categorised into operating,
investing and financing activities for larger businesses.

Activity: Label the inflows and outflows on the cash flow statement below.

Strategies to improve cash flow (HSC course):

When there are more outflows than inflows, there is a cash deficit. Businesses can implement
strategies to ensure they have good liquidity (enough cash to make payments as they fall due).

1. Discounts for early payments: Offering creditors a discount for early payments to receive
inflows sooner.
2. Distribution of payments: Distributing payments owed throughout the month/year, so that
large expenses do not occur at the same time and shortfalls do not occur.

Complete the following content questions in your book: p.239 Q.1, 2, 3 & 5

5
Question 1:

Juanita owns a craft shop. During July the business sold $8200 of craft goods and received $200 in
bank interest. She paid her sales assistant a monthly wage of $1350. During this month, the
business spent $2800 on craft equipment, $350 on rent, $750 on insurance and $150 on electricity.

(a) Construct a cash flow statement for the month of July for Juanita’s business.

(b) Calculate the business’s closing cash balance for July if the opening cash balance was $3500.

Question 2: Complete the cash flow statement below for Cooper & Zacs café

Month Jan Feb March April May

Opening 10,000
balance
Cash Inflows 30,000 35,000 45,000 25,000 35,000

Cash Outflows 20,000 50,000 15,000 40,000 25,000

Closing
balance

a) Which month does Cooper and Zac experience a negative cash flow?

b) What will the cash flow statement show Cooper and Zac?

c) What can Cooper and Zac do to manage their cash flow more effectively?

Question 3: Complete the following cash flow statement.

6
 Month Jan Feb March April May June July
Opening 0
balance
Cash Inflows 1,000 1,000 1,000 1,200 1,600 2,400 3,600

Cash Outflows 700 2,500 60 1,300 800 1,100 1,500

Closing balance

a) What is the opening cash balance for March?

b) What is the closing cash balance in July?

Question 4: Below is the Cash Flow statement for McCoy’s Music Shop in February 2020.

$ $
Opening Cash Balance 33,000
Cash receipts (inflows) 6,000
Cash payments (outflows) 12,000
Closing cash balance ?

a) Calculate the closing balance for February and suggest ONE factor resulting in the change
from the opening balance.

b) Describe TWO strategies McCoy’s can use to help maintain a satisfactory cash balance.

Question 5: Dorctor R.U. O’Kay operates a surgery. His cash flow for April was as follows:

7
 April 1, Cash Balance 600
Purchases of needles 120
Petrol 200
Wages 6,000
Accounts Receivable* 1,500
Payment Received 1,000
Received rebate from 8,000
Medicare
Rent 1,000
Phone 100
*Accounts receivables are payments that are owed to the business, however, have not be paid in
cash yet.

a) Reorganise the following into a cash flow statement.

b) The cash balance at the end of April was __________________________________

c) What strategies can the doctor implement to improve the cash flow? (Hint: Accounts
Receivables)

Question 6:

Charmaine’s Flag Store operates as a sole trader. Flags were manufactured in Korea and
8
 imported by Charmaine. They were of various sporting teams and nationalities, and were sold at
sporting arenas and direct to the public. The following financial data was obtained.

Month Opening Balance Cash Inflows Cash Outflows Closing Balance

January 0 0 0
February 2000 4000
March 5000 3000
April 3500 2600
May 3400 2700
June 3100 2500
July 3000 4000

a) Describe the cash flow of this business over the 6 month period between February and July.

b) What month did Charmaine obtain the best financial return? ________________________

c) What month did Charmaine obtain the worst financial return? _______________________

d) Outline possible reasons for there being a cyclical flow of cash in this business.

Question 7: Calculate Ben and Lucy’s cash flow to identify the months in which they have a cash
flow problem.

2.
Income Statements
9
(AKA: Revenue Statement & Profit and Loss Statement)

Profit = Revenue (Sales) – Expenses

P=R–E

Figure 8.34 is a simple

income statement that
enables you to see the
general format. There are several important features to note.

First, the statement must have a heading that states the _________________________ over which
the business was operating for the purposes of the statement. Usually this is __________________,
but it may be half yearly, quarterly, or even every month or six weeks.

Second, there are only five main categories of items:

1. ________________________________
2. ______________________________________________
3. ________________________________
4. ________________________________
5. ________________________________

Third, the income earned (or revenue) is always stated at the _________ of the report. If the
business had absolutely no expenses then this would be the profit figure. This is not realistic. In
truth, the business would have had costs that arose from selling. So, we then deduct the
________________ that occurred while the income was being earned. This is done in three steps:

1. _________________________________________________________
2. ___________________________________________________________________________
3. ___________________________________________________________________________
_______________________________________________________

Net Sales

Net sales are the amount of ___________________ a business has

earned from sales when the effects of sales returns are deducted.

Gross Profit and Cost of Goods Sold (COGS)

10
The gross profit calculation is important as, essentially, it tells the business how much its
___________________ is on the cost price of the goods it has sold.

This varies somewhat from business to business but is generally between

______________________. If the mark-up was enormous (say 800 or 1000 per cent), then it would
attract other businesses to compete in the market.

The cost of goods sold is an expense to the business. However, it is not grouped with other
expenses. This is because the mark-up (or ‘contribution margin’) on the cost of goods sold
determines the level of overall income. In a ______________________________ business, there is
no stock and therefore no mark-up. Therefore, income and gross profit are the same. Cost of goods
sold only affects businesses that on-sell items they have purchased.

The calculation of COGS is shown below:

Here is an example showing how COGS is calculated:

Other Expenses

Expenses must always be subtracted from ______________ to work

out ______________________.

Although not always shown, it is very useful to separate the expenses

by type because this helps users of the financial information to target
problem areas quickly. In this part of the statement, all the expenses
that do not form part of the cost of goods are listed.

The expenses are broken down specifically into three types. These are
shown in figure 8.35.

11
Net Profit and Expenses

Calculating the net profit is the final step in the income statement.

When compiling the income statement, the manager should be mindful of several things — the
proportion of gross and net profit to sales and also the level of expenses that accrue to selling,
administration and finance. These can be calculated using the following ratios (HSC course):

Gross Profit Ratio: Measures the mark up of COGS (Generally 40-60%)

Net Profit Ratio: Measures the ‘bottom-line’ profits in proportion to sales (Generally 12-15%)

Expense Ratio: Measures the efficiency of expenses in proportion to sales

12
Below is an example of an income statement. Highlight Sales, COGS, Gross Profit, Expenses and Net
Profit.

1. Calculate the Gross Profit for U Win Pty Ltd (Gross Profit = Sales – COGS)

2. Add up the total expenses (Selling expenses + Administration expenses + Financial expenses)

3. Calculate the Net Profit for U Win Pty Ltd (Net Profit = Gross Profit – Expenses)

4. Calculate the Gross Profit Ratio (GP/Sales x 100)

5. Calculate the Net Profit Ratio (NP/Sales x 100)

Complete the following questions in your book – p.244 – Q.1-6

13
Income Statement Questions
Question 1: (Show all working)

a) Calculate the Gross Profit. (Sales –

COGS)

b) Calculate total expenses.

c) Calculate the Net Profit. (GP – expenses)

d) Calculate the Gross Profit Ratio. How does it compare to the industry average? What
implications does this have on Brady’s Hardware? (3 marks)

e) Calculate the Net Profit Ratio. How does it compare to the industry average? What
implications does this have on Brady’s Hardware? (3 marks)

f) Calculate and comment on the expense ratio. (2 marks)

14
Question 2: Using the following Income Statement, answer the questions below showing ALL
working.

a) Record the Sales. (1 mark)

b) Calculate COGS (Opening stock + purchases – closing stock) (1 mark)

c) Calculate Gross Profit (Sales – COGS) (1 mark)

d) Calculate total expenses. (1 mark)

e) Calculate Net Profit (GP – expenses) (1 mark)

f) Calculate and comment on the gross profit ratio (GP/Sales x 100) (2 marks)

g) Calculate and comment on the net profit ratio (NP/Sales x 100) (2 marks)

Question 3: Complete an Income Statement for Cornock’s Carpentry for the period ending 30 June
2021 and in doing so calculate the gross profit and net profit. (5 marks)
15
Opening Stock 50,000
Sales 200,000
Rent 20,000
Advertising 25,000
Insurance 8,000
Cartage/Freight 10,000
Purchases 60,000
Closing Stock 10,000
Bad Debts 2,000

Income Statement for Cornock’s Carpentry for period ending 30/6/21

a) Calculate COGS (Opening stock + purchases – closing stock) (1 mark)

b) Calculate Gross Profit (Sales – COGS) (1 mark)

c) Calculate Net Profit (GP – expenses) (1 mark)

d) Calculate and comment on the gross profit ratio (GP/Sales x 100) (2 marks)

16
 e) Calculate and comment on the net profit ratio (NP/Sales x 100) (2 marks)

f) Calculate and comment on the expense ratio (Expenses/Sales x 100) (2 marks)

Question 4: Create an income statement using the following information.

Sunny and Patrik’s Go-Cart Manufacturers Pty Ltd had revenue totalling $550,000 during the
financial year of 2019-20. They had purchases for the year totalling $100,000, with stock at the
beginning of the year being $250,000 and stock at the close of the year amounting to $150,000.
Sunny and Patrik had to pay their employees $120,000, had petrol expenses of $40,000, electricity
bills amounting to $35,000 and insurance at $8,000.

a) Calculate COGS. (1 mark)

17
 b) Calculate Gross Profit (1 mark)

c) Calculate Net Profit (1 mark)

d) In the following year, Sunny and Patrik hope to increase their net profits. Outline TWO
strategies they can use to achieve this goal. (4 marks)

e) During 2020-21, Sunny and Patrik are able to decrease their expenses to $180,000. Calculate
the new Net Profit. (2 marks)

Question 5: Use the information below to construct an income statement (statement of financial
performance) for Sathya’s Skatehouse:

18
 Revenue from cash sales 500 000 Insurance 2 000
Closing stock 20 000 Revenue from credit sales 50 000
Purchases for the period 50 000 Opening stock 100 000
Telephone 15 000 Depreciation 4 000
Salesperson’s wages 80 000 Rent 20 000
Rates 3 500 Electricity 2 100
Advertising costs 10 000 Water 3 500
Interest costs 2 500 Lease costs (machinery) 5 500

Calculate the GP Ratio, NP Ratio and Expense Ratio and comment on the financial position Saytha’s
Steakhouse. (6 marks)

3. Balance Sheet
19
The balance sheet, sometimes called the statement of financial position, is used to help owners
keep a watch on their _____________ and __________ levels, compare their overall financial
position with that of previous periods, and assist with the process of financial decision making.

A typical balance sheet is shown in figure 8.38.

There are several things to note about the balance sheet. First, its heading denotes that it is a
____________ of the business’s financial position as ______________________________________.
Second, if a line is drawn between the two columns of figures, the ____________ of items on the
left-hand side ‘_______________’ is equal to, or balances, the sum of items on the right-hand side
(__________________ and ______________________). This format for a balance sheet is called
the ‘T-format’ because we can draw a line down the middle and separate the report into two halves
by using the letter T.

Balance Sheet Items

You will notice that the balance sheet is divided into two parts as shown in figure 8.38. On the
________________________ side are recorded the __________________ — the things the
business ___________. On the _____________________ side are recorded the _____________ and
_________________________ — the things the business _____________.

Assets

Assets can be divided into several different types: _______________

________________________________________________________
20
Current assets are _________________________________________
________________________________________________________

Non-current assets are _____________________________________

________________________________________________________.

Examples of Current Assets Examples of Non-Current Assets

Liabilities

The business will divide the liabilities into current and non-
current items.

Current liabilities are ___________________________________

____________________________________________________

Non-current liabilities are _______________________________

Examples of Current Liabilities Examples of Non-Current Liabilities

Owners Equity

The owners give a business money for it to acquire resources and

begin operating. This money is called _______________________
(capital).
21
As the business operates, it should start to earn an income to cover its costs and then later earn a
____________. The business can hold or retain these profits to target money for a particular
project or it may put money into ‘reserves’ for distribution later.

The business could also choose to repay the owners who ______________ their money in the
business at the outset. Over time, a successful business will have its owner’s equity amount
________________ in value.

Owner’s equity is considered to be a liability from the point of view of the business, because it is a
type of debt the business carries. However, unlike liabilities, owner’s equity is a debt owed to
__________________ because of the risk they took in investing in the business.

Complete the following questions in your book – p. 247 – Q.4,5,6 & 8

Activity:

The Balance Sheet Equation

The balance sheet is called the balance sheet for a good reason — __________________________
_______________. This means that the sum of items on the left-hand side (___________________)
must total the sum of items on the right-hand side (______________________________________).
This is summarised in the balance sheet equation below.

22
This equation can be rearranged to find ‘Liabilities’ or ‘Owners equity’.

Complete the following questions in your book – p.249 Q1-5

HSC Course (Extension) – Financial Ratios
Figures of the balance sheet can be used to measure a business’
liquidity and solvency.

To measure liquidity, we use the ‘current ratio’, which measures a

business’ ability to pay back their current liabilities with their
23
current assets. The higher the current ratio, the more capable the business is of meeting their
short-term obligations (more liquid). A ratio of 2:1 indicates a sound financial position. That is, a
business should have double the amount of assets to cover its liabilities.

Gearing ratios determine the businesses solvency. Gearing is

the proportion of debt (external finance) and the proportion of
equity (internal finance) that is used to finance the activities of a
business. The ‘debt to equity ratio’ is used to measure this.

A safe debt : equity ratio is 1:1. That means for every $1 of debt, there is $1 of equity.

 A ratio greater than 1 means the business has more debt than equity, posing more risk to
the business. It is highly geared and less solvent. There is however, potential for increased
profit.
 A ratio less than 1 means the business has more equity than debt, meaning it is safe.
However, there is less opportunity for profit. It is low geared and highly solvent.

Balance Sheet Questions

Question 1: It is always a good idea to sort out all items before you complete a balance sheet.

Classify each of the following as assets, liabilities or owner’s equity.

a) Accounts Receivable (Debtors) _____________________________

b) Capital contributed by owner _____________________________
c) Bank loan _____________________________
d) Stock _____________________________
e) Prepaid expenses _____________________________
f) Cash at bank _____________________________
g) Fixtures and Fittings _____________________________

Determine whether the items are categorised into current assets, non-current assets, current
liabilities, non-current liabilities or owners equity.

a) Car ____________________________
b) Accounts Receivable ____________________________
c) Owner’s Capital ____________________________
24
 d) Bank overdraft ____________________________
e) Cash ____________________________
f) Mortgage ____________________________
g) Drawings by the owner ____________________________
h) Accounts Payable ____________________________
i) Inventory ____________________________
j) Profit reinvested by the owner ____________________________

Question 2: Create a balance sheet using the following information

Inventory 30,000 Cash 10,000 Accounts receivable 15,000

Debentures 25,000 Accounts payable 25,000 Capital 8,000
Retained Profits 35,000 Equipment 35,000 Loan 22,000
Furniture 25,000

Assets Liabilities
Current Assets Current Liabilities

Non-current Assets Non-current Liabilities

Owners Equity

Total Assets Total Equity & Owners Equity

Question 3: Complete a balance sheet for the following. Dom the Dentist gave you the following
figures as at 30 March 2021.

Stock 20,000 Cash 1,000 Accounts receivable 5,000

Car 30,000 Accounts payable 2,000 Income (profit) 10,000
Owners Capital 19,000 Mortgage 40,000 Furniture & Fixtures 15,000

25
Question 4: Complete a Balance Sheet for Darcy’s Daycare as at 1 April 2021 and in doing so
calculate owners equity.

Stock 35,000 Cash 10,000 Accounts receivable 20,000

Car 50,000 Accounts payable 8,000 Owners Capital 40,000
Overdraft 5,000 Mortgage 67,000 Drawings by the owner 5,000

Question 5: What is the value of the total owners equity for Fire Up Pty Ltd?

a) $148,000
b) $178,100
c) $518,300
d) $386,100

Balance Sheet for Fire Up Pty Ltd

30 June 2020

26
Question 6: Use the balance sheet below to answer the following questions.

Assets Liabilities
Current Assets Current Liabilities
Cash 4,725 Accounts payable 10,000
Accounts receivable 3,000 Overdraft 6,000
Stock 12,000
Non-current Liabilities
Non-current Assets Mortgage 150,000
Buildings 215,000 Secured loans 100,000
Vehicles 50,000
Equipment 20,000 Owners Equity

a) Calculate the value of total assets, total liabilities and owners equity. (3 marks)

b) Calculate and comment upon the current ratio for this firm. (Current Assets : Current
Liabilities).
27
 c) Calculate and comment upon the gearing ratio for this firm. (Debt : Equity)

Question 7: Use the following information to construct a balance sheet for Foot Freaks Reflexology
on the grid that is provided for you.

Creditors 4,000 Cash 20,000 Property 80,000

Inventory 6,000 Debtors 8,000 Overdraft 6,000
Mortgage 40,000 Equipment 30,000 Owners equity 94,000

Assets Liabilities
Current Assets Current Liabilities

Non-current Assets Non-current Liabilities

Owners Equity

Total Assets Total Equity & Owners Equity

Check that your balance sheet is correct before completing the following questions.

1. The current ratio for Foot Freaks Reflexology is

a) 1 : 3.4 c) $24,000
b) 3.4 : 1 d) 0.2 : 1

2. The debt to equity ratio of this firm is

28
 a) 0.53 : 1 c) Highly geared
b) Roughly 50% d) 0.27 : 1

3. This firm is:

a) Liquid and solvent c) Profitable

b) Highly geared d) Insolvent

4. Total assets for Foot Freaks Reflexology is equal to

a) $64,000 c) $110,000
b) $34,000 d) $144,000

Extension Question: Construct an income statement and balance sheet in correct format using the
following information. (12 marks)

29