Finance

Processes of financial management

Slide structure:

► Syllabus heading
► Definitions
► Content
► Case Studies
► HSC Questions/activities
Introduction:

Processes means what the business does daily.

Use these to explain HOW each business function does it’s

job.

This section is very descriptive and not analytical. It can be

rote learned.
Financial management is responsible for the financial planning of the
business.

Financial managers:

► implement reports to determine financial needs of each department

► set budgets

► instigate record systems

► determine financial risks

► use various financial controls.

• Planning and implementing

Financial planning determines how a business’s goals will be

achieved.

Planning processes involve:

► the setting of goals and objectives
► determining the strategies to achieve those goals and objectives
► identifying and evaluating alternative courses of action and
► choosing the best alternative for the business.
- Financial needs
Understanding what external financial requirements are
needed to ensure business attainment of goals. These needs
are determined by the current situation of the business (cash
requirements, liquidity issues, debt, expenses, declining
revenue, swift growth).

Financial needs of a business will be determined by:

-the size of the business
-the current phase of the business
-future plans for growth and development
-capacity to source finance-debt and/or equity
-management skills for assessing financial needs and
planning.
- Budgets

A budget is a financial plan for revenue and expenditure that

guides decision-making in pursuit of business strategic
objectives. It sets out in quantitative terms what the business
will outlay in pursuit of future business activity (expansion,
new product design, rewards program (anything)...

A budget can include:

► Cash required for planned outlays for capital equipment
► Estimated use and cost of raw material inputs
Estimated running costs of firm vs forecasted revenue
(profit guidance)
► Number and cost of labour hours required
- Record systems

Are the mechanisms employed by a business to ensure that

data is recorded and the information provided by records
systems is accurate, reliable, efficient and accessible.

Record systems should be maintained and errors minimised.

- Financial risks

Financial risk refers to the possibility that the business will not be able to
meets its financial objectives. All business activity involves risk.

Financial risks specifically relate to:

► The level of debt and type of debt used in pursuit of revenue and profits
► Changing financial circumstances such as interest rates or availability of
funds
► Possibility of key supplier becoming insolvent
► International firms must monitor exchange rates

The likelihood of various scenarios should be analysed and an appropriate

future pathway determine to mitigate (minimise) financial risks as much as
possible.
- Financial controls

Policies and procedures within the firm to ensure business

goals are attained.
- debt and equity financing – advantages and
disadvantages of each

Advantages debt finance

Advantages
► Interest payments are tax deductible business expenses.
► Can be relatively simple to acquire.
► Loan terms can be negotiated to meet the businesses
specific needs.
► Debt can be easy to plan as they normally schedule
regular. payments of interest and often principal.
► Will not decrease your ownership in the business and the
 Disadvantages debt finance

Disadvantages
► Debt can be expensive.
► Repayments begin immediately and must be met regardless of the
business cash flow.
► Collateral is often needed to secure a loan.
► In some cases, personal guarantees may be needed.
► You may require a good credit history for borrowing.
► It is up to the owner of the business to clearly establish the value of
the business and their ability to repay the loan.
► If bankruptcy or insolvency occurs debt providers have priority before
equity providers
 Advantages equity finance

Advantages
► Does not have to be paid back.
► No repayments, therefore the firm has more cash flow.
► Cash flow generated (especially from additional share
issues) can be used for further investment and expansion.
► Does not incur interest charges.
► Investors are prepared to wait for some time to get a
return on. their investment.
 Disadvantages equity finance

Disadvantages
► You are exchanging ownership of your business.
► A proportion of the profits go to the additional new
owners.
► Does not provide a tax deduction for the business.
► New investors often expect improved growth and
performance of the business and therefore a better return
on their investment.
Comparison of debt and equity finance
Debt
Lenders have prior claim in the event
of liquidation
Debt must be repaid by periodic
repayments
Interest payments are tax deductible
Lenders usually require a lower rate of
return
Interest payments are fixed
Debt providers have no voting rights
Equity
Shareholders have a residual claim on
assets
Equity has no maturity date
Dividends are not tax deductible
Shareholders require higher return due
to higher risk
Dividend payments are not fixed and
may be reduced through lack of funds
Equity holders have voting rights
- Matching the terms and source 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:

-the terms, flexibility and availability of finance
-the cost of each source of finance
-the structure of the business
-The level of control
Complete sheet: Matching terms and source of finance.
Complete the following table (assume it’s for a SME):

Situation Long term Appropriate Justification

or Short source of
term finance

Purchase capital Long term

equipment

Purchase stock Short term

Pay accounts Short term

payable / debtors

Replace a motor Long term

vehicle
• Monitoring and controlling- cash flow
statement, income statement and balance sheet

Monitoring & controlling is essential for maintaining business

viability, and affects all aspects of business operations-
especially financial management.

The main financial controls used for monitoring include:

►cash flow statements
►income statements
►balance sheets
 What did we expect?
What actually happened?
Where did we go wrong?
3 MAIN MONITORING TOOLS: Fix it.
1. The CASH FLOW STATEMENT Over a period of
Measures inflows and outflows of cash. time
e.g. 1 year
“Will we have enough money?”

2. The INCOME STATEMENT

Over a period of
Categorises spending. time
e.g. 1 year
“Did we make a profit?”

3. The BALANCE SHEET

AT A POINT in time
Shows the business’s worth.
June 30th, 2016
“This is how we financed our assets”
Cash flow statement

WHY USE ONE?

1. PLANNING for months where
outflows > inflows
►- Might need to save from previous months
►- Might need to get extra finance (e.g. overdraft)

2. ADJUSTING the numbers where

expectations > actual results
►- Maybe the predictions were too optimistic
►- Maybe there’s an area of spending that comes up as a problem
Refer to HSC questions booklet

2014 paper:

a)Calculate the opening cash balance for March. 1 mark

b)In which month did the business start with a negative cash
balance? 1 mark Refer to table in booklet.
 You need to memorise three equations:

Sales – COGS = Gross Profit

Opening stock + purchases – closing stock = COGS

Gross Profit – Expenses = Net Profit

It can be used to answer the following questions:

►Is income high enough to cover expenses?

►Is the mark-up on purchases sufficient?
►Is the business making a good profit?
►Are the expenses in proportion to the revenue
they are earning?
►Is inventory turnover appropriate for the business?
Refer to HSC questions booklet

2014 paper:
Which of the following would be found on an income
statement?

a)Accounts payable
b)Gross profit
c)Intangibles
d)Net assets
We need to memorise one equation – THE ACCOUNTING
EQUATION:

Assets = Liabilities + Total (“Owner’s”) Equity

Or, you can rearrange it…

Assets – Liabilities = Total Equity

 Money borrowed from
outside the business
Everything the Was
business owns… paid for or
by: Money invested in the
business (including
leftover profits)

2
9
 pa i d this year
Cash Will be rdraft
e cash) e.g. ove
CURRENT
so o n b
(or will ventory
e.g. in

CURRENT LIABILITIES (CL)

ASSETS (CA) e pa i d this year
Won’t b ortgage
e.g. m
NON-CURRENT
year
LIABILITIES (NCL)
’ t be s old this
Won tory
e.g. fac d
i ta l ” ) investe
(“cap
Money ained profits
NON-CURRENT + ret

ASSETS (NCA) TOTAL

EQUITY (E)
3
0
 We went through past papers and found the following in each category…
Bank overdraft
Cash CURRENT
Accounts payable
“Notes payable”
CURRENT
Accounts receivable
Inventory LIABILITIES (CL)
Creditors
“Provisions”
ASSETS (CA)
Bills of Exchange
Trade Debtors
Other Debtors Mortgage
Term Loan
NON-CURRENT
“Long-term debt”
Secured Loans
LIABILITIES (NCL)
Unsecured Loans
“Provisions” (again)
Land and Buildings
Machines and Equipment
“Plant”
NON-CURRENT
Furniture Retained Earnings/Profits
Vehicles
ASSETS (NCA)
Fixtures
TOTAL Reserves
Share Capital
Investment
Intangibles
EQUITY (E)
“Contributed Capital”
LESS “DRAWINGS” (YOU SUBTRACT THESE!!!)

Knowing these is often part of the question – you must learn these. Most are easy!
3
1
 Current vs non-current

► The difference between current and non- current assets is

that current assets can be turned into cash within 12
months and non- current assets cannot be turned into cash
within 12 months.
► The difference between current and non- current
liabilities is that current liabilities must be paid within 12
months and non- current liabilities must be met some time
after the next 12 months.
Liquidity is the extent to which the business can meet its financial
obligations in the short term. This means, a business must have
enough resources to pay its debt and cover unexpected expense.
 LIQUIDITY Formula Write answer What it means… Compare it to… Ways to improve…
as…
2:1!!! AKA:
‘Working Capital
Management’
Shouldn't be too
Measures the ability of the high or too low
Improve your ‘receivables’
business to pay its debts
AS THEY FALL DUE.
(less than 1.5:1 is policy (be more strict in
dangerous). collecting money owing to the
business from customers)
2:1 means that for every
dollar of current liabilities, E.g. 0.5:1 means Reduce the amount of
Current Ratio Current Assets the business has TWO the business is not inventory/stock the business
(“Working Current Liabilities A ratio dollars to pay that debt. liquid and won’t holds (use JIT inventory
management)
Capital”) be able to pay its
short-term debts. Sell non-current assets (and
lease them instead, e.g.
5:1 means the property).
assets of the Reduce current liabilities
business are not (move towards equity funding,
being employed e.g. using retained profits).
effectively.
Pay ‘accounts payable’ (e.g.
bills) at the last possible date.
 5:1 Business resources are not being used efficiently (owners should
reinvest excess cash into the business, e.g. upgrade systems)

2:1 IDEAL RANGE

1.5:1
Business may be in danger of not paying short-term debts
1:1 Business has only one dollar to pay each dollar of short-term debt
Business is not liquid – they cannot pay their bills on
time!

Current Ratio
How to answer ratio questions

Refer to following slides.

► Using the Liquidity Ratio as an example- lets make sense of the numbers and
what you need to understand for the exam.
Look at balance sheet-
if they don’t own the
plant/equipment this is
not an appropriate
suggestion
2012 Paper:

a) Calculate the current ratio (current assets ÷ current liabilities) of this

business. Show all working. 2 marks
2014 paper:
Question 19-20:
19. Which of the following statements is true about liquidity for Kerry’s
Warehouse in 2014?

a)It is better than industry average and has improved since 2013.
b)It is better than industry average and has worsened since 2013.
c)It is worse than industry average and has improved since 2013.
d)It is worse than industry average and has worsened since 2013.

.
- Gearing- Debt to Equity ratio
(total Liabilities ÷ total equity)
► Gearing measures the relationship between debt and equity.
► 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.
 SOLVENCY/GEARING Formula Write answer as… What it means… Compare it to… Ways to improve…

Ability of the
business to pay its
debts IN THE Small business: Reduce debts
LONG TERM. (or selling luxury (obviously).
items)
How much debt is 50% or less.
the business in Increase input
Debt-to-Equity Ratio Total Liabilities compared to how Large business: of equity (e.g.
A percentage much equity has (or selling essential
Total Equity sell more shares
been invested into items) or invite new
the business. 100% or less.
owners in a
Higher than 100% If it is REALLY low, private
= Highly geared! the business might company).
not be taking
advantage of its
ability to borrow
money (to expand).
 The business is highly geared. They have a lot of liabilities and little
equity. They should reduce debts, or increase equity (e.g. sell shares in
the business to get investors’ money).

100%
Large Businesses (or businesses selling essential products, like bread)
can still be safe in this range.

50%
Small Businesses (or businesses selling luxury products) should be in
this range.
At a very low level like this, the business can feel safe to get a loan to expand the business.

Debt-to-Equity Ratio
2014 paper:
Question 19-20:
20. Which of the following statements is true about gearing for Kerry’s
Warehouse in 2014?

a)It is better than industry average and has improved since 2013.
b)It is better than industry average and has worsened since 2013.
c)It is better than industry average and has improved since 2013.
d)It is worse than industry average and has worsened since 2013
2015 Paper

b) Discuss the gearing of Andrew’s Discount Tyres. 5 marks

 2012 Paper:

b) Calculate the debt to equity ratio (total liabilities ÷ total equity) of this
business. Show all working. 2 marks

c) Why is it important for a business to control its debt to equity ratio? 4

marks
- Profitability- gross profit ratio
(gross profit ÷ sales); net profit ratio (net profit ÷
sales); return on equity ratio (net profit ÷ total equity)

► Profitability is the earning performance of the business and indicates its

capacity to use resources to maximise profit.
► The income statement is used to measure the profitability or earning capacity
of the business. Figures from this statement are used to calculate the gross
profit and net profit ratios.
► The return on equity ratio shows how effective the funds contributed by the
owners have been in generating profit, and hence a return on their
investment.
PROFITABILITY Formula Write answer as… What it means… Compare it to… Ways to improve…

COST CONTROLS:
This is the MARK-UP! Higher figures are 1. Reduce fixed and variable
better, but you have to costs (remember though -
SALES – COGS compare it to ONLY costs DIRECTLY
involved in production - e.g.
previous years and obtain MATERIALS at lower
This is the percentage of other businesses in prices - BUT DON’T
each dollar that is gross the same industry. SACRIFICE TOO MUCH
profit (the selling price QUALITY)
Gross Profit Gross Profit minus the cost of making VERY HIGH figures 2. Use COST CENTRES
Ratio Sales A percentage or buying the good might mean that the (make individual areas of the
originally). business is charging business responsible for
keeping the COGS down).
prices that are
DOES NOT include becoming REVENUE CONTROL:
expenses! uncompetitive.
Set and achieve marketing
objectives (SELL MORE!)
 If the gross profit ratio is too high, the prices that the business is
charging might be uncompetitive.

This is where Apple is (about 40%). They get fairly cheap parts and
charge enormous markups (price on top of how much it cost to make
Other the product, e.g. iPhone) compared to other manufacturers.
businesses
and/or
industry
average

The business is making very little on each product sold. Their COGS
(cost of raw materials) may be too high. They could lower costs (e.g.
buying cheaper materials), raise prices or try to increase sales.

Gross Profit Ratio

PROFITABILITY Formula Write answer as… What it means… Compare it to… Ways to improve…
MINIMISE EXPENSES (3 TYPES):

1. Administrative expenses (rent,

printing, etc)

2. Selling expenses (esp. advertising)

Different from the GPR Previous years. 3. Financial expenses (e.g.
because it takes into consolidate high interest loans into
account EXPENSES. Industry average. lower interest loan)
Net Profit Net Profit Use COST CENTRES (make
Ratio Sales A percentage GP - Expenses Retail: 13-20%.
individual areas of the business
responsible for keeping THEIR OWN
Falling figures are expenses down).
bad.
REVENUE CONTROL:

Set and achieve marketing

objectives (SELL MORE!)
 If you’re up here, like Apple at 27%, it means that when you sell a
product, then subtract ALL the costs and expenses for making it, and
you’re STILL making a fortune!

Other
businesses The average for the retail industry is about 13-20%
and/or
industry
average

The business is struggling with costs and expenses. They may need to
lower their expenses (cheaper labour, substitute capital for labour, etc)

Net Profit Ratio

 PROFITABILITY Formula Write answer as… What it means… Compare it to… Ways to improve…

The % return has to be

better than OTHER
INVESTMENTS the
owner could have used
his/her money for (e.g.
BASICALLY JUST USE ANY
bank interest rates, OF THE METHODS TO
government bonds, IMPROVE THE GPR
How much the property). AND/OR THE NPR
Return on Equity Net Profit owner’s investment Reduce COGS AND/OR
Ratio Total Equity A percentage in the business is Keep in mind interest expenses.
earning. rates and inflation, which
affect returns. Effective marketing.
Min:10% (20% better) Improve efficiency.

Can be compared to a previous

period of the company, another
business or the industry
average.
Good sharemarket
investment
You want your business to be as good, or hopefully a better investment
Good property than all the SAFER investments people could put their money into (at
investment least 10%-20%)
Government Bonds

Bank “super saver” If I were a millionaire, would I risk losing all of my money by investing
high interest rate
in your business? Why would I? I could get just as much of a return on
Regular bank my investment by putting my money in a bank! And it’s safer!
account interest
rate
ck…
yo u get ba
much
How

Return on Equity Ratio busin

ess
the
st m ent in
ve
our in
As a % of y
16. What is the net profit ratio (net profit ÷ sales) for 2014?

a)10%
b)20%
c)25%
d)47%
17. Which of the following describes the changes in gross and expense
ratio from 2014 to 2015?
- Efficiency- expense ratio (total expenses ÷ sales),
accounts receivable turnover ratio (sales ÷ accounts
receivable)

► Efficiency is the ability of the business to use its resources effectively to

ensure financial stability and profitability. It relates specifically to
management’s ability to achieve its goals and objectives.
► The two main ways to calculate efficiency include the expense ratio and the
accounts receivable turnover ratio.
 EFFICIENCY Formula Write answer as… What it means… Compare it to… Ways to improve…

Expenses Knowing the source of the

Sales expenses THEN trying to
lower them where possible.

NOTE: You could be Percentage of sales Previous years. Lots of ways of lowering
asked to calculate a taken/absorbed by expenses (depending on what
expenses. Be careful: TYPE of expenses they are).
specific TYPE of expenses
Expenses Ratio ratio, e.g. financial, selling Increasing figures BE CAREFUL:
or administrative expenses. Managers can use over time might just Indiscriminate (“random”)
Just do the same formula, A percentage this to find out be something like the cost-cutting is dangerous
exactly where the business spending (you might be cutting back in
but it would be the wrong area).
highest expenses are more on marketing!
Selling Expenses coming from.
Sales

Or

Financial Expenses
Sales
 The business should cut
expenses (selling
expenses, admin.
Going down Going up
expenses, financial
over time is over time is
expenses).
good bad

BUT, be careful of random

(“indiscriminate”) cost-
cutting! You might cut the
wrong thing (e.g. take ads off
tv because they’re expensive
– but then nobody buys your

Expenses Ratio product!!!)

2013 paper:
What does the expense ratio measure?

a)Efficiency
b)Growth
c)Profitability
d)Solvency
 EFFICIENCY Formula Write answer as… What it means… Compare it to… Ways to improve…

2 WAYS!!! Higher is better. It

means the business is
The syllabus way: collecting payments Charge extra for late
faster. payment.
Sales
Accounts Receivable Measures how 10 would mean that the Offer discount for early
This is stupid, though, because it really only tells you how
efficient the average account payment.
much you’re owed out of how many TOTAL sales you made. business is in receivable is collected
So a corner shop would look amazing because they don’t sell collecting its in 36.5 days (ok). Monitor the business’s
a lot on credit. accounts more effectively.
Accounts accounts 5 would means that it
Receivable But a multi-billion construction company would look terrible A number receivable (money usually takes 73 days to Be careful granting credit.
because they are owed a lot - but it’s perfectly normal and (TIMES PER YEAR)
Turnover Ratio they’re probably getting paid on time!!
owed to the collect your money
Change policies relating to
business) from someone who doubtful debts. (factoring
Correct way:
owes you (bad). could be used.
Credit Sales
Measures
Accounts Receivable Can be compared to a Allowing customers to use
effectiveness of the previous period of the
credit cards is safer
This measures only the sales that the business made ON
CREDIT compared to how much is still owed.
business’s credit company, another (you’ll get that money), but
So a corner shop might only sell $1000 on credit during the
policy. business or the industry there are still costs to the
year but if they’re still owed $500 of that, it’s bad! average. business for using credit
card facilities.
But the multi-billion dollar construction company might
provide $5 billion on credit but only $100 million is still
owing. That’s good!
 REMEMBER: This depends on what your credit policy is. If you
give customers 30 days to pay, compare it to this.
365 If you give them 90 days to pay, compare it to 4 times per year instead.
5
times per year
(on average it takes The business is having trouble collecting money from people.
73 days to collect
your money)
365
10 The business should start looking at ways of getting the money owed
times per year
(on average it takes to it (e.g. charging extra for late payments, offering discounts for early
36.5 days to collect payments)
your money)
365
15
times per year Customers are paying on time.
(on average it takes
24 days to collect
your money)

Accounts Receivable
Turnover Ratio
2013 paper:
Which of the following would improve the financial position of a business?

a)Lower current ratio and lower accounts receivable turnover ratio

b)Higher current ratio and lower accounts receivable turnover ratio
c)Lower current ratio and higher accounts receivable turnover ratio
d)Higher current ratio and higher accounts receivable turnover 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.

This cam be done:

► Over different time periods
► Against standards
► With similar businesses
Once you have CALCULATED the ratios for a business,
you can COMPARE them…
5:1
With Same
business Agains
SIMILAR t
O OVER TIME O COMMON STANDARDS
BUSINESSES R R

IDEAL RANGE 2:1

1.5:1

1:1
• Limitations of financial reports

► Normalised earnings
► Capitalising expenses
► Valuing assets
► Timing issues
► Debt repayments
► Notes to the financial statements
• Limitations of financial reports

There are limitations to financial reports. They can be misinterpreted and can be
misleading, both of which will impact on the decision making of management and
potentially put the business at risk.
- Normalised earnings
If a business had some luck JUST THIS YEAR and made much more than they
NORMALLY would, the business should probably
take those earnings away so that it doesn’t give investors the idea that the
business is ALWAYS going to make that much money.

This will NORMALISE the business’s earnings

(to show what the business would NORMALLY MAKE, rather than just that one lucky year)

This might give a better idea of the business’s ACTUAL strength.

Why is it a LIMITATION of financial reports?

How this ‘normalising’ is done really comes down to the OPINION of the
business’s financial managers (which means that some businesses might say “No,
we plan to ALWAYS make this much money!”).
- Capitalising expenses
Why is it a LIMITATION of financial reports?
Sometimes (naughty) accountants will put an expense into the ‘asset’ category when
it SHOULD BE in the ‘expense’ category.

Example: Research and Development

This is called ‘capitalising expenses’

(saying that an expense is actually an asset – BUT IT’S NOT – IT’S A LIE!)

WHY WOULD THEY DO THIS?

Because it makes THIS YEAR’S PROFIT SEEM BIGGER.
(but it’s NOT!)

WHY IS IT WRONG?
Because NEXT YEAR’S profit won’t be so good
(and investors have really been lied to).
- 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.

For example, how can McDonalds value their goodwill?

When it comes to long-term assets, such as machinery, businesses have to

estimate the how much value they lose every year. This is known as
‘depreciation’.
- Valuing assets

Why is it a LIMITATION of financial reports?

The ‘depreciation rate’ is an ESTIMATE which can be:

1. Wrong by accident

2. Wrong on purpose

(to lie to investors about how much the business is really worth)

To add to this problem…

Some assets are almost IMPOSSIBLE to value, and are sometimes not recorded in
the financial reports at all.

This refers to ‘intangible’ assets

e.g. Goodwill
- 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.

For example, if a business sells swim wear, a yearly cash flow statement may not show
that they struggled with their cash flow in the winter months, as it only covers a full one
year period.

Why is it a LIMITATION of financial reports?

Shifty accountant:
► “It’s the end of the financial year (June 30th), and revenues were not very good,
so we’ll just add some of the revenue from July into the previous financial
year.

► Also, I don’t want that cost showing up on the reports from this financial year,
so I’ll just say we bought it in July so it ends up on next year’s financial
- Debt repayments
The BALANCE SHEET only says how much the business’s debts are –

NOT WHEN THEY’RE DUE!

Why is it a LIMITATION of financial reports?

An investor might see a $50 000 debt and think “Oh, that’s ok, this business can
handle it” – but if it’s due a week later, MAYBE IT CAN’T!
- Notes to the financial statement

Notes to the financial statements report the details and additional information
that are left out of the main reporting documents, such as the balance sheet and
income 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.
Refer to HSC questions booklet

2013 paper:
Auditors have discovered that the value of legal fees paid has been included in
the asset value of a new warehouse purchased by a business.
What limitation of financial reports does this show?

a)Capitalised expenses
b)Debt repayments
c)Normalised earnings
d)Timing issues
 2015 Paper

a) Explain ONE possible limitation of this financial report. 3 marks

• Ethical issues related to financial
reports
Businesses have an ethical and legal responsibility to provide accurate financial
records.
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.

Businesses have an ethical and legal obligation to comply with GST reporting
requirements. Accurate financial reports are necessary for taxation purposes as
well as for other stakeholders.
An audit is an independent check of the accuracy of financial and accounting
procedures and are an important part of the control function of the business.
There are three main types of audits including:
►internal audits: conducted by the business’s employees
►management audits: conducted to review the business’s strategic plan
►external audits: conducted by independent and specialised audit accountants.
These types of audits are a requirement of the Corporations Act 2001 (Cwlth).
Practice questions:
What are assets that are easily turned into cash within the trading period
termed?
a) Liquid assets
b) Capital goods
c) Non-current assets
d) Goodwill
Company X makes a net profit of $50,000. The proprietors make drawings of
$20,000. The remainder stays in the business. What is this called?
a) Gross profit
b) Net tax
c) Liabilities
d) Retained profit
Consider a current ratio of 1:1. Explain the financial concerns over such a ratio (2
marks)
Consider a current ratio of 6:1. Explain the financial concerns over such a ratio (2
marks)
1. What is the problem with a high level of gearing and
how do you overcome it?

2. Why is a low level of gearing considered to be a

possible issue for a business?

3. Under what economic conditions is a low level of

gearing advisable? What alternatives are there for a
business to fund expansion which does NOT involve
increasing their level of gearing?
Scenario: Big profit to Snuggle.... but
Snuggle Pty Ltd has decided not to issue a dividend to its
shareholders this year. The money will be used to finance a
new venture.

1.Outline one internal source of funds for Snuggle Pty Ltd

(2 mark)

2.Outline the advantages of debt and equity financing for

Snuggle (4 marks)
The following annual data is for a shop that sells PC games
and software.
•Budgeted figure for expected results

Year 1 2 3 4 5*
Sales 4000 4800 5200 5300 7500
COGS 3000 4000 4800 5000 6000
Expenses 500 520 520 550 800
Net Profit 500 280 (120) (250) 700

1.Is the expected results for Year 5 realistic? Why or why

not?
2.Why were Years 3 and 4 unprofitable?
In order to calculate the gross profit of a business what data
is needed in addition to sales revenue?
a)assets
b)opening stock and closing stock
c)cost of goods sold
d)liabilities
Konrad wishes to purchase a donut shop. Which financial
statement provides the best indication of profitability?
a)the Balance sheet
b)the cash flow statement
c)the Income statement
d)the accounting equation
What is the liquidity of a business a measure of?
a)The profitability of the business
b)The relationship between debt and equity
c)The difference between assets and liabilities
d)The ability of a business to meet its short term debts