role of financial management

The planning and monitoring of a business’s financial resources to meet financial objectives.
★ strategic role of financial management
Developing a strategic plan as a part of a business’s financial management will ensure that a business
survives and grows in the competitive business world.
The strategic role of financial management includes:
- Setting financial objectives and ensuring the business is able to achieve these goals
- Sourcing finance
- Preparing budgets and forecasting future finances
- Preparing financial statements
- Maintaining sufficient cash flow
- Distributing funds to other parts of the business

★ objectives of financial management

– profitability, growth, efficiency, liquidity, solvency
Profitability means the excess of revenue or income over expenses or costs. Profits satisfy owners
and shareholders in the short term but are also important for the long term sustainability of a firm. To
ensure that profit is maximised, a business must carefully monitor its revenue and pricing policies,
costs and expenses, inventory levels and levels of assets.
Growth is the ability of a business to increase its size in the longer term. Growth of a business
depends on its ability to develop and use its asset structure to increase sales, profits and market share.
Efficiency is the ability of a business to minimise its costs and manage its assets so that maximum
profit is achieved with the lowest possible level of assets.
Liquidity is the extent to which a business can meet its financial commitments in the short term(less
than 12 months). A business must have sufficient cash flow to meet its financial obligations or be able
to convert current assets into cash quickly.
Solvency is the extent to which the business can meet its financial commitments in the longer
term(more than 12 months). Solvency is particularly important to the owners, shareholders, and
creditors of a business because it is an indication of the risks to their investments. Solvency indicates
whether the business will be able to repay amounts that have been borrowed for investments in
capital. A good indicator to measure solvency is to use gearing(proportion of debt to equity) which
measures the percentage of assets of the business that are funded by external sources. This way it
measures the business’s reliance on outside finance.

– short-term and long-term

● Short term financial objectives are the tactical (1-2 years) and operational (day to
day) plans of a business. These would be reviewed regularly to see if targets are being
met and if resources are being used to the best advantage to achieve the objectives.
● Long term financial objectives are the strategic plans of a business. They are
determined for a set period of time, generally more than 5 years. They tend to be
broad goals such as increasing profit or market share, and each will require a series of
short term goals to assist in its achievement. The business would review their
progress annually to determine if changes need to be implemented.

★ interdependence with other key business functions

Interdependence refers to the mutual dependence that the key functions have on one another. The key
functions work best when they overlap and employees work towards a common goal.
The marketing, operations and human resources departments rely on financial managers to allocate
them adequate funds(budgets) i.e. the operations department requires funds to purchase inputs and
carry out their transformation processes, the marketing department requires funds to undertake various
forms of promotion and the human resources department requires funds in order to pay staff.
The finance department also relies on the other three key business functions. The finance department
relies on operations to produce the products, on marketing to promote the products and on human
resources to manage staff.

influences on financial management

★ internal sources of finance – retained profits
The most common source of internal finance is retained profits in which all profits are not distributed,
but are kept within the business as a cheap and accessible source of finance for future activities.

★ external sources of finance

External finance is the funds provided by sources outside the business, including banks, other
financial institutions, government suppliers or financial intermediaries.
– debt – short-term borrowing (overdraft, commercial bills, factoring), long-term
borrowing (mortgage, debentures, unsecured notes, leasing)
Debt finance refers to the short-term and long-term borrowing from external sources of the business

Short-term borrowing is used to finance temporary shortages in cash flow or finance for working
capital, it generally refers to those funds that will be paid back within 12 months.
Overdraft
A bank allows a business or individual to overdraw their account up to an agreed limit and for a
specified time, to help overcome a temporary cash shortfall. Overdrafts assist businesses with short-
term liquidity problems.
Commercial Bills
Primarily short-term loans issued by financial institutions, for larger amounts (usually over $100,000)
for a period of generally between 30 - 180 days. The borrower receives the sums immediately and
promises to repay the money with interest at a future time.

Businesses that have extra money choose to invest in other businesses and make more money rather
than gaining lower interest from banks
Banks are intermediaries between businesses, facilitating transaction
Factoring
Enables a business to raise funds immediately by selling accounts receivable at a discount to a firm
that specialises in collecting accounts receivable (a finance or factoring business). Factoring involves
greater risk than overdraft or commercial bills because of the likelihood of unpaid debts. Takes
around 48 hours.- 10% fee

Long-term borrowing relates to funds borrowed for periods longer than 12 months and is usually used
to purchase major assets such as buildings and equipment.
Mortgage
A mortgage is a loan secured by the property of the borrower (business). The property that is
mortgaged cannot be sold or used as security for further borrowing until the mortgage is repaid.
Mortgage loans are used to finance property purchases, such as new premises, a factory or office.
They are repaid with interest, usually through regular repayments, over an agreed period of time.
Debentures
Debentures are issued by a company for a fixed rate of interest and for a fixed period of time.
Companies provide them as a way to raise funds from investors, as opposed to financial institutions.
A debenture is a promise made by a company to repay money that has been lent to the business. An
investor lends money to a company and in return, the company issues a debenture with a promise to
make regular interest payments for a defined term and then repay the loan at a particular date in the
future.

Unsecured Notes
An unsecured note is a loan from investors for a set period of time. Unsecured notes are not secured
against the business’s assets and therefore present the most risk to the investors in the note (the
lender). For this reason, it attracts a higher rate of interest than a secured note. Companies sell
unsecured notes to generate money for their initiatives, such as share repurchases and acquisitions.
Leasing
Leasing involves the payment of money for the use of equipment that is owned by another party.
- Operating leases are assets leased for short periods, usually shorter than the life of the asset.
The owner carries out maintenance on the asset.
- Under the conditions of a financial lease, the lessor purchases the asset on behalf of the
lessee. Financial leases are usually for the life of the asset. Lease repayments are fixed for the
economic life of the asset

– equity – ordinary shares (new issues, rights issues, placements, share purchase plans),
private equity
Equity as an external source of funds refers to the finance raised by a company through inviting new
owners.
Ordinary shares
The purchase of ordinary shares by individuals means that they have become part-owners of a
publicly listed company. This means they get voting rights according to the number of shares that they
have as well as payments called dividends.
The following terms refer to variations in the type or issue of ordinary shares:
● New issue - a security that has been issued and sold for the first time on a public
market, sometimes referred to as primary shares or new offerings.When a business
issues an IPO(initial public offering), they are required to provide a prospectus, which
is a document that contains relevant details about the company so investors can make
informed decisions.
● Rights issue - the privilege granted to shareholders to buy new shares in the same
company.
● Placements - allotment of shares made directly from the company to investors. I.e.
additional shares are offered at a discount to their current trading price to special
institutions or investors, in order to persuade investors to invest.
● Share purchase plans - an offer to existing shareholders in a listed company to
purchase more shares in that company without any brokerage fees. SPP’s allow
companies to issue new shares to current shareholders without issuing a prospectus
and they can only issue a maximum of $15,000 in new shares to each shareholder.
Private equity
Private equity is the money invested in a (private) company not listed on the Australian Securities
Exchange (ASX). The aim of the private company is to raise capital to finance future
expansion/investment of the business.

★ financial institutions – banks, investment banks, finance companies, superannuation funds,

life insurance companies, unit trusts and the Australian Securities Exchange
Financial institutions collect funds and invest them in financial assets. They provide financial services
and focus on dealing with financial transactions such as investments, loans and deposits. Finance is
available from a variety of institutions such as banks, investment banks, finance companies,
superannuation funds, life insurance companies, unit trusts and the Australian Securities Exchange.

Banks
Banks are the major operators in financial markets and are the most important source of funds for a
business. Banks receive savings as deposits from individuals, businesses and governments, and, in
turn, make investments and loans to borrowers.
Investment Banks
Investment banks provide services in both borrowing and lending, primarily to the business sector.
They provide a wide variety of different types of loans for businesses and can therefore customise
loans to suit the business’s specific needs. Investment banks sometimes impose conditions when
providing loans, for example, they may require some equity. Investment banks:
● Trade in money, securities and financial futures
● Arrange long-term finance for company expansion
● Provide working capital
● Arrange project finance
● Advise clients on foreign exchange cover
● Advise on mergers and takeovers
● Provide portfolio investment management services
● Underwrite corporate and semi-government issues of securities
● Operate unit trusts including cash management trusts, property trusts, and equity trusts
● Arrange overseas finance
Finance companies
Finance companies are non-bank financial intermediaries that specialise in smaller commercial
finance. They provide mainly short-term and medium-term loans to businesses through consumer
hire-purchase loans, personal loans and secured loans. They are also the major providers of lease
finance to businesses. Some finance companies specialise in factoring or cash flow factoring.
Finance companies raise money through share issues (debentures). Debentures are for a fixed term
and carry a fixed rate of interest. Lenders have the security of priority over the firm’s assets in the
event of liquidation, meaning the finance company is entitled to sell the assets of the business to
recover the initial loan if the business fails. Finance companies can provide businesses with quick
access to funds, although the interest rate will usually be higher.
Life insurance companies
Life insurance companies are also non-bank financial intermediaries who provide cover and a lump
sum payment in the event of death. Policy holders pay regular premiums and the insurer guarantees to
pay the designated beneficiary a sum of money upon death of the insured person or under other
circumstances specified in the contract. Life insurance companies provide both equity and loans to the
corporate sector through receipts of insurance premiums, which provide funds for the investment. The
funds received in premiums, called reserves, are invested in financial assets.
Superannuations funds
Superannuation is a scheme set up by the federal government, which requires all employers to make a
financial contribution to a fund that will provide benefits to an employee when they retire.
Superannuation funds invest the money received from superannuation contributions to many things,
such as company shares, property and managed funds. They do this so that their member will earn
investment returns on the money.
Unit trusts
Unit trusts (also known as mutual funds) take funds from a large number of small investors and invest
them in specific types of financial assets. Unit trusts invest in any mixture of cash, Australian or
international shares , fixed interest securities or property.

Australian Securities Exchange

The Australian Securities Exchange (ASX) is the primary stock exchange group in Australia.
Importantly for businesses, the ASX acts as a primary market. This primary market enables a
company to raise new capital through the issue of shares and through the receipt of proceeds from the
sale of securities. The ASX also operates as a secondary market. The secondary market is where pre-
owned or second-hand securities, such as shares, are traded between investors who may be
individuals, businesses, governments or financial institutions. Transactions in this market do not
increase the total amount of financial assets — the secondary market increases the liquidity of
financial assets and, therefore, influences the primary market for securities.
Secondary market is when a shareholder sells their security from the primary market to another
shareholder - speculative markets/investment
★ influence of government – Australian Securities and Investments Commission, company
taxation
The government influences a business’s financial management decision making with economic
policies such as those relating to the monetary and fiscal policy, legislation and the various roles of
government bodies or departments who are responsible for monitoring and administration. The
following outlines the importance of 2 governmental influences on financial management for
businesses.
The Australian Securities and Investments Commission (ASIC)
ASIC is an independent statutory commission accountable to the Commonwealth parliament. It
enforces and administers the Corporations Act 2001 and protects consumers in the areas of
investments, life and general insurance, superannuation and banking in Australia.
The aim of ASIC is to assist in reducing fraud and unfair practices in financial markets and financial
products. ASIC ensures that companies adhere to the law, collects information about companies and
makes it available to the public. This includes the financial information that companies must disclose
in their annual reports. ASIC have been given a wide range of powers to enforce the Corporations
Act. If a business breaches the law, ASIC will investigate the matter and determine an appropriate
remedy, including imprisonment and monetary penalties. Failure to comply with the Corporations Act
also generates negative publicity for the business.
Company Taxation
All Australian businesses that have been incorporated (private and public) are required to pay
company tax on profits. This tax is levied at a flat rate of 30% of net profit, with the tax being reduced
to 27.5% for small businesses. The Australian government have undertaken this process of reform of
the federal tax system in order to improve Australia’s international competitiveness and make
Australia an attractive place to invest, thereby driving long-term economic growth, i.e. more jobs and
higher wages for Australians.
 ★ global market influences – economic outlook, availability of funds, interest rates
Economic outlook
The global economic outlook refers specifically to the projected changes to the level of economic
growth throughout the world. If the outlook is positive, then this will have an impact on the financial
decisions of the business This may include:
● Increasing demand for products and services
● A decrease in the interest rates on funds borrowed internationally from the financial money
markets.
A poor economic outlook will have an impact on financial decisions of a business in the opposite way
to those mentioned previously.

Some factors that will have an impact on the global economy include:
● An increase in manufacturing and trade
● Increasing consumer confidence
● Increased investment spending
● Uncertainty surrounding the economic policies of the US administration and their global
ramifications
● Uncertainty resulting from the Brexit referendum resulting in the UK withdrawing from the
European Union
● Expected slowing in the growth in the Chinese economy
● Increase in commodity and oil prices
● Financial risks from high and rising credit growth and house price increases

Availability of funds
Availability of funds refers to the ease with which a business can access funds (for borrowing) on the
international financial markets.

Interest rates
Interest rates are the cost of borrowing money.The higher the level of risk involved in lending to a
business, the higher the interest rates
processes of financial management
★ planning and implementing – financial needs, budgets, record systems, financial risks,
financial controls

Financial needs
To determine the direction of a business, it is important to know what its needs are. Important
financial information needs to be collected before future plans are made, this includes, balance sheets,
income statements, cash flow statements, sales and price forecasts, etc.
The financial needs of a business will be determined by:
● Size
● Current phase of the business cycle
● Future plans for growth and development
● Capacity to source finance - debt and/or equity
● Management skills for assessing financial needs and planning

A business plan is used when seeking finance or support for a project from a bank or other financial
institutions/investors as they need a guarantee that their financial contributions will be successful. A
business plan sets out the finance required, the proposed sources of finance and a range of financial
statements. Financial information is needed to show that the business can generate an acceptable
return for the investment being sought and should, therefore, include an analysis of financial
performance (income statement, cash flow statement, balance sheet and financial ratio analysis
reports).

Budgets
Budgets provide information in quantitative terms (facts and figures) about requirements to achieve a
particular purpose. Budgets can be drawn up to show:
● Cash required for planned outlays for a particular period
● The cost of capital expenditure and associated expenses against earning capacity
● Estimated use and cost of raw materials or inventory
● Number and cost of labour hours required for production

Budgets reflect the strategic planning decisions about how resources are to be used. They provide
financial information for a business’s specific goals and are used in strategic, tactical and operational
planning.
Budgets enable constant monitoring of objectives and provide a basis for administrative control,
direction of sales effort, production planning and control of stocks, for example
Budgets are used in both the planning and controlling aspects of a business. As a control measure,
planned performance can be measured against actual performance and corrective action taken as
needed.
Budgets are often prepared to predict a range of activities relating to short-term and longer term plans
and activities. Budgets can be classified as operating, project or financial budgets.

Operating budgets relate to the main activities of a business and may include budgets relating to
sales, production, raw materials, direct labour, expenses and cost of goods sold. Information from
operating budgets is used in preparing budgeted financial statements.
Project budgets relate to capital expenditure and research and development. Capital expenditure
budgets in a business’s strategic plan including information about the purpose of the asset purchased,
its lifespan and the revenue that would be generated from the purchase. Information from project
budgets is included in the budgeted financial statements.
Financial budgets relate to the financial data of the business. The predictions of the operating and
project budgets are included in the budgeted financial statements. Financial budgets include the
budgeted income statement, balance sheet and cash flows. The income statement and balance sheet
reflect the results of operating activities and the cash flow statement shows the liquidity of the
business.

Record systems
Record systems are the mechanisms employed by a business to ensure that data are recorded and the
information provided by record systems is accurate, reliable, efficient and accessible.

Financial risks
Financial risk is the risk to a business of being unable to cover its financial obligations, such as the
debts incurred through borrowings.
If the business is financed from borrowings, there is higher risk. The higher the risk, the greater the
expectation of profit or dividends.
To minimise financial risk, businesses must consider the amount of profit that will be generated. The
profit must be sufficient enough to cover the costs of debts as well as increasing profits to justify the
amount of risk taken by the owners/shareholders.
Consideration must also be given to the liquidity of a business’s assets to repay short-term debts.
Financial controls
Financial controls are the policies and procedures that ensure that the plans of a business will be
achieved in the most efficient way.
The policies and procedures of a business are designed to ensure they are followed by management
and employees. Some common policies and procedures that promote control within a business are:
● Clear authorisation and responsibility for tasks in the business
● Separation of duties
● Rotation of duties
● Control of cash
● Protection of assets
● Control of credit procedures
Budgets and variance reporting are financial controls used in business.

– debt and equity financing – advantages and disadvantages of each

Debt finance relates to the short-term and long-term borrowing from external sources.
Equity finance relates to the internal sources of finance in the business.
 – matching the terms and source of finance to business purpose
The terms of finance must be suitable for the purpose for which the funds are required (e.g.
short term finance cannot fund long term assets). Finance managers should match the length
or term of the loan to the economic lifetime of the asset the finance is being used to purchase
(short term finance for short term assets and long term finance for long term assets).

★ monitoring and controlling – cash flow statement, income statement, balance sheet financial
ratios
The process of monitoring and controlling is essential as inconsistent methods of review and systems
of control will have an immediate impact on the viability of the business and requires management to
monitor the internal and external factors that will impact financially on business operations.
The main financial controls used for monitoring include:
1. Cash flow statements
2. Income statements
3. Balance sheets
These statements indicate how effectively finance is being used and whether the business has
sufficient funds to meet unforeseen circumstances.

Cash flow statement

A cash flow statement is one of the key financial reports as it provides the link between the income
statement and balance sheet through giving important information regarding the firm’s ability to pay
its debts on time.
The cash flow statement indicates the movement of cash receipts and cash payments resulting from
transactions over time. It can also identify trends and can be a useful predictor of change.

A cash flow statement can show whether a firm can:

● Generate a favourable cash flow (inflows exceed outflows)
●
● Pay its financial commitments
● Have sufficient funds for future expansion or change
● Obtain finance from external sources when needed
● Pay drawings to owners or dividend to shareholders
In preparing a cash flow statement, the activities of a business are generally divided into 3 different
categories - operating, investing and financing activities.
Operating activities are the cash inflows and outflows relating to the main activity of the business -
the provision of goods and service.
Investing activities are the cash inflows and outflows relating to the purchase and sale of non-current
assets and investments, used to generate income for the business.
Financing activities are the cash inflows and outflows relating to the borrowing activities of the
business, including either debt(loans) or equity(shares, contribution from owners)

Income statement
The income statement is a summary of the income earned and the expenses incurred over a period of
trading.
The income statement shows:
● Operating income earned from the main function of the business, such as sales of inventories,
services and non-operating revenue earned from other operations, such as, interest, rent and
commission/
 ● Operating expenses such as purchase of inventories, payment for services and other expenses
incurred in the main operation of the business, such as advertising, rent, telephone and
insurance.
Steps to make an income statement
1. Record the income made
2. Record the cost of goods sold
3. Income - COGS = gross profit
4. Gross profit - expenses = net profit

Types of expenses

By examining previous income statements, managers can compare and analyse trends before making
financial decisions. They can see whether expenses and profit are increasing, decreasing or staying the
same and in which areas there has been significant changes.

Balance sheet
A balance sheet represents a business’s assets and liabilities at a particular point in time and
represents the net worth (equity) of the business.

Assets: items of value owned by the business. Current assets can be turned into cash within 12 months
while non-current assets are not expected to be turned into cash within 12 months.
Liabilities: represent what is owed by the business. Current liabilities are expected to be paid within
12 months while non-current liabilities are expected to be paid after 12 months.
Owners Equity: the funds contributed by the owner/s and represents the net worth of the business.

The balance sheet can indicate:

● If the business has enough assets to cover debts
● If the assets are being used to maximise profit
● The owners are making a good return on their investment
● Level of inventories
● How the year’s figures compare with the previous year

The accounting equation

 – liquidity – current ratio (current assets ÷ current liabilities)
Liquidity is the extent to which a business can meet its financial commitments in the short term,
which usually refers to a period of less than 12 months. Current assets and current liabilities
determine the liquidity or short-term financial stability of the business. The firm must ensure that it
has enough current assets to turn into cash quickly, but not so much that the resources are not being
used for producing revenue.

Measures a business’s ability to pay back their current liabilities with their current assets. The higher
the ratio, the more capable the business is to meet their short-term obligations. The ratio 2:1 indicates
a sound financial position for a firm in general.

Strategies to improve liquidity

- Factoring
- Selling non-essential non-current assets
- Injecting more equity into the business

– gearing(solvency) – debt to equity ratio (total liabilities ÷ total equity)

Solvency is the extent to which the business can meet its long term financial commitments (more than
12 months). Potential investors/creditors are interested in gearing ratios, as they show whether they
will be paid or receive a good return on their investment.
Gearing is the proportion of debt(external finance) and the proportion of equity (internal finance) that
is used to finance the activities of the business.
The more highly geared the business is, the higher the risk but the greater potential for profit.

The debt to equity ratio shows the extent to which the firm relies on debt or outside sources to finance
the business. A ratio greater than 1 means that the business has less equity than debt. A ratio between
0 to 1 means that the business has more equity than debt. The higher the ratio, the less solvent the
business is.

Strategies to improve solvency

Decrease debt
- Sell non-essential assets to pay off debts
- Re-negotiate loans to spread their payments over a longer period
- Lease assets opposed to purchasing them
Increase equity
- Retaining more profits
- Injecting more equity funding by either selling more shares or inviting new owners
 – 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 its resources
to maximise profits. Profitability depends on a business’s revenue and their ability to increase selling
prices to cover purchase costs and other expenses. Generating profit is a business’s most important
financial objective.

Gross profit ratio

Gross profit is the difference between the sales revenue and the cost of goods sold.
The gross profit ratio gives the percentage of sales revenue that results in gross profit.

The gross profit ratio shows change from one accounting period to another and indicates the
effectiveness of planning policies concerning prices, sales, discounts, the valuation of stock and so on.
If the ratio is low, alternative suppliers may need to be sourced and competitors investigated.

Net profit ratio

Net profit represents the profit or return to the owners, which is revenue less expenses.

The net profit ratio shows the amount of sales revenue that results in net profit. In order to improve
these ratios, businesses need to focus on strategies to reduce costs and increase revenue.

Return on equity ratio

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. If returns are favourable, owners may
consider expansion or diversification, if they are not favourable, owners would consider alternative
options, including selling the business.

– efficiency – expense ratio (total expenses ÷ sales), accounts receivable turnover

ratio (sales ÷ accounts receivable)
Efficiency refers to the ability of a business to use its resources effectively in ensuring financial
stability and profitability of the business.
The expense ratio compares total expense with sales. The ratio indicates the amount of sales that are
allocated to individual expenses, such as selling, administration, cost of goods sold and financial
expenses. Management uses this ratio to determine where the highest expenses are from and why the
ratio has either increased or decreased.

Accounts receivable turnover ratio measures the effectiveness of a firm’s credit policy and how
efficiently it collects its debts. It measures how many times the accounts receivable balance is
converted into cash or how quickly debtors pay their accounts. By dividing the ratio into 365,
businesses can determine the average length of time it takes to convert the balance into cash.
Strategies to improve accounts receivable turnover
- Charging interest on overdue payments
- Offering discounts for early payments
- Being selective when granting credit
Given as times/year, convert to days.
Not good to have days too low, as employees need to collect receivables too frequently, too
unrealistic

– comparative ratio analysis – over different time periods, against standards, with
similar businesses
For analysis to be meaningful, comparisons and benchmarks are needed. Judgements are then made
by comparing a firm’s analysis against other figures.
Businesses could compare ratios with their results from previous years, with similar businesses and
against common industry standards.

★ limitations of financial reports – normalised earnings, capitalising expenses, valuing assets,

timing issues, debt repayments, notes to the financial statements
Caution must be taken when analysing financial reports as they may not be an accurate assessment of
a business’s financial position. Businesses attempt to make their financial report look good in order to
appeal to potential investors. Misleading information impacts on business decisions and puts the
business at risk. The following issues must be considered when analysing financial reports:

Normalised earnings Normalised earnings are earnings that have been adjusted to better reflect
the core operation of a business. This makes it easier to compare
profitability figures for a business from one year to the next.
Normalised earnings remove unusual/one-off items that affect profit.
The limitation is that businesses DO NOT normalise their earnings.
Capitalising expenses This refers to an accounting method where a business records an expense
as an asset. This means that the expenditure will appear in the balance
sheet rather than the income statement. This understates expenses and
overstates assets and profits. E.g. capitalising expenses include research
and development, and development expenditure.
Valuing assets The process of estimating the value of assets when recording them on a
balance sheet. When an asset is recorded on a balance sheet, its value is
sometimes written as its historical cost, meaning that assets are listed at the
value at which they were purchased. This is inaccurate as the asset may
 have gained value or depreciated.
Some assets are difficult to value, such as intangible assets(goodwill,
patents, trademarks). If financial managers decide to include these assets
on the balance sheet, there may be a temptation to overvalue these assets,
making the business seem more financially stable.
Timing issues Limitations may arise due to timing issues. Under the matching principle,
when an accountant records revenue, they should also record at the same
time any expenses that were directly related to that revenue. When the
principle is followed, the revenue earned will match the costs that were
incurred to earn that revenue, resulting in a more accurate representation of
financial position.
Debt repayments Debt repayments refer to either money owed to the business or by the
business. Financial reports are limited as they do not have the capacity to
to disclose specific information about debt repayments. The recording of
debt repayments on financial reports can be used to distort the ‘reality’ of
the business’s status and this may be undertaken to provide a more
favourable overview of the business at that point in time.
Notes to the financial Notes to the financial statement report the details and additional
statements information that are left out of the main reporting documents, such as the
balance sheet, income statement and cash flow statement. They contain
information that may be useful to stakeholders to help them make sense of
these financial statements, to explain them and contain further detail about
how the figures in the financial statement were calculated and the
procedures used to develop them.

★ ethical issues related to financial reports

Financial managers and accountants have an ethical and legal obligation to ensure financial records
are accurate. In relation to financial management, directors have a duty to:
- Act in good faith
- Exercise power for proper purpose
- Exercise discretion reasonably and properly
- Avoid conflicts of interest

Ethical issues related to financial reports include audited accounts, record keeping, GST obligations
and reporting practices.
Audited accounts
The audit is an independent check of the accuracy of financial records and accounting procedures.
Owners, shareholders and potential investors rely on the independent check of the auditor before
making any decisions. There are 3 types of audits:
1. Internal audits - conducted internally by employees to check accounting procedures and the
accuracy of financial records. Can ensure that data is accurate to avoid penalties from ASIC.
2. Management audits - These are conducted to review the firm’s strategic plan and to determine
if changes should be made.
3. External audits - These are a requirement of the Corporations Act (2001). The firm's financial
reports are investigated by independent and specialised audit accountants to guarantee their
authenticity. The auditor issues a statement indicating that the firm's records and financial
reports are accurate and comply with Australian auditing standards.
Internal and external audits assist in guarding against unnecessary waste, inefficient use of resources,
misuse of funds, fraud and theft.

Record keeping
All accounting processes depend on how accurately and honestly data is recorded in financial reports.
Source documents must be kept for every transaction, even with cash. There is a temptation to receive
payment in the form of cash so it is not recorded as business revenue and thus lowers company
taxation rates. However, the ATO issues heavy penalties for tax evasion, harming the reputation of the
business.
Ledgers, if the balance sheet doesn't balance, you can take a look at this.

Reporting practices
Financial reports are necessary for taxation purposes and other shareholders are entitled to access
these reports. Dishonesty in financial values in reports proves counterproductive as penalties may be
issued, it may be difficult to receive funding and it may be difficult to sell the business to potential
buyers.

Triple bottom line - financial, social, environment

financial management strategies
★ cash flow management
Cash flow is the movement of cash in and out of a business over a period of time. Matching cash
inflows and cash outflows is essential.

– cash flow statements

The statement of cash flow indicates the movement of cash receipts and cash payments resulting from
transactions over a period of time. It can also identify trends and can be a useful predictor of change.

– distribution of payments, discounts for early payment, factoring

Management must implement strategies to ensure that cash is available to make payments when they
are due, these include:
Distribution of payment
Involves distributing payments throughout the month, year or other period so that large expenses do
not occur at the same time and cash shortfalls do not occur, this means that there is more equal cash
outflow each month.
Discounts for early payment
Offering debtors a discount for early payment. This is beneficial for the debtors who are able to save
money and therefore improve cash flow and it also positively affects the business’s cash flow status.
Factoring
The selling of accounts receivable for a discounted price to a finance or specialist factoring company.
The business saves on the costs involved in following up unpaid accounts and debt collection.

★ working capital management

Working capital is the term used in business to describe the funds available for the short-term
financial commitments of a business. Net working capital is the difference between current assets and
current liabilities. It represents those funds that are needed for day-to-day operations of a business to
produce profits and provide cash for short term liquidity.
 The working capital cycle
Refers to the length of time it takes a business to convert its net current assets and current liabilities
into cash, i.e. time taken from when a business purchases inventory to when they receive the cash
once it’s sold.
Working capital management involves determining the best mix of current assets and current
liabilities needed to achieve the objectives of the business. Management must achieve a balance
between using funds to make profits and holding sufficient funds to cover payments.
Net Working Capital = Current Assets - Current Liabilities

– control of current assets – cash, receivables, inventories

Cash
Cash ensures that the business can pay its debts, repay loans and pay accounts in the short term, and
that the business survives in the long term. Supplies of cash also enable management to take
advantage of investment opportunities, such as the short-term money market.
Planning for the timing of cash receipts, cash payments and asset purchases avoids the situation of
cash shortages or excess cash
Businesses try to keep cash balances at a minimum and hold marketable securities as reserves for
liquidity, which guard against sudden shortages or disruptions to cash flow.

Reserves can take adv of business opportunities, avoids shortfalls overdrafts can fix this, forecasting
and budgeting

Receivables
The collection of receivables is important in the management of working capital. Consequently, a
business must monitor its accounts receivable and ensure that their timing allows the business to
maintain adequate cash resources. Procedures for managing accounts receivable include:
- Checking the credit rating of prospective customers
- Sending customers’ accounts monthly at the same time so that debtors know when to expect
accounts
- Following up on accounts that are not paid by the due date
- Stipulating a reasonable period, usually 30 days, for the payment of accounts
- Putting policies in place for collecting bad debts, such as using a debt collection agency
 - Late fees
However, the disadvantage of having a tight credit control policy is the possibility that customers may
choose to buy from other firms.

Inventories
Inventories make up a significant amount of current assets, and their levels must be carefully
monitored so that excess or insufficient levels of stock do not occur. Too much inventory or slow-
moving inventory will lead to cash shortages, while insufficient inventories of best-selling items will
lead to a loss in customers and sales.
Inventory is a cost to a business if it remains unsold (insurance and storage costs)
Businesses must ensure that inventory turnover is sufficient to generate cash to pay for purchases and
pay suppliers on time so that they will be willing to give credit in the future.

Inventory control - use bar coding to control and track inventory.

JIT, LIFO, FIFO, LILO

– control of current liabilities – payables, loans, overdrafts

Payables
A business must monitor its payables and ensure that their timing allows the business to maintain
adequate cash resources. Control of accounts payable involves periodic reviews of suppliers and the
credit facilities they provide, including:
- Discounts
- Interest-free credit periods
- Extended terms for payments, sometimes offered by established suppliers without interest or
other penalty
Alternative financing plans should be investigated with suppliers, such as consignment finance.
Consignment financing is when goods are supplied for a particular period of time and payment is
generally not required until goods are sold. Goods supplied may also be returned if they are not sold
in the designated period.

Loans
Businesses may need to borrow funds in the short term for a number of purposes. Management of
loans is important as costs for establishment, interest rates and ongoing charges must be investigated
and monitored to minimise charges. Control of loans involves investigating alternative sources from
different banks and financial institutions. Positive, ongoing relationships with financial institutions
ensures that the most appropriate short-term loan is used to meet the short-term financial
commitment.
Looking at the matching principle.

Overdraft
Banks require that regular payments be made on overdrafts and may charge account-keeping fees,
establishment fees and interest. Bank charges need to be carefully monitored, as charges vary
depending on the type of overdraft established. Businesses should have a policy for using and
managing overdrafts and monitor budgets on a daily or weekly basis so that cash supplies can be
controlled.

– strategies – leasing, sale and lease back

Businesses use a number of strategies to manage working capital, which is required to fund the day-
to-day operations of a business.
Leasing
Leasing involves the payment of money for the use of equipment that is owned by another party. A
lease is a contract between the lessor and the lessee that lets the lessee rent an asset for a period of
time in exchange for periodic payments. Advantages of leasing include:
- Cash outflows are spread over several years opposed to the one-off large initial outflow if the
business purchased the asset. This helps improve working capital.
- Allows the business to make use of good quality assets, which may have been unattainable to
purchase outright
- Lease payments are considered operating expenses and are therefore tax deductible
- Allows businesses the flexibility to upgrade to new and better assets without having to make a
large cash outlay
- Reduces the risk of technological obsolescence since the leased asset can be upgraded
- Reduces the risk of unpredictable costs associated with the repairs and maintenance of
equipment, depending on the terms of the agreement
- Lease payments help with cash flow forecasting and budgeting as payments are fixed over a
specified period.

Sale and lease back

Sale and lease back refers to the process of selling an asset to the lessor and then leasing the asset
back through fixed payments over a period of time. The biggest advantage of sale and lease back is
that it helps improve a business’ liquidity since it receives a large cash injection from the sale of the
asset, which can then be used as working capital if the business is experiencing a cash shortfall. The
business still continues to benefit from the use of the asset.

★ profitability management
Profitability management involves the control of both the business’s costs and revenue.

– cost controls – fixed and variable, cost centres, expense minimisation

Fixed and variable costs
Fixed costs are not dependent on the level of operating activity and must be paid regardless of what
happens(e.g. Salaries, depreciation, insurance, lease).
Variable costs are those that vary in direct relationship to the levels of operating activity or production
in a business.
Monitoring the levels of fixed and variable costs is important in a business. Changes in the volume of
activity need to be managed in terms of the associated changes in costs. Comparisons of costs with
budgets, standards and previous periods ensure that costs are minimised and profit is maximised.
Can talk about break-even in test
Cost centres
Cost centres are particular areas, departments or sections of a business to which costs can be directly
attributed to. The use of cost centres enables management to utilise resources more efficiently as it
gives them a better understanding of how those resources are being used.
The main function of a cost centre is to track expenses. Monitoring expenses through the use of cost
centres allows for greater control of total costs. Cost centres include the IT department, human
resources department, accounting department and maintenance staff.

Expense minimisation
Guidelines and policies can be established to encourage staff members to minimise expenses where
possible. Savings can be substantial if people take critical looks at cost and eliminate waste and
unnecessary spending.
Can talk about
- Supplier rationalisation
- Economies of scale
- Bulk buying

– revenue controls – marketing objectives

In determining an acceptable level of revenue with a view of maximising profits, a business must have
clear ideas and policies, particularly about its marketing objectives including the sales objectives,
sales mix or pricing policy.

Marketing objectives
Marketing strategies and objectives should lead to an increase in sales and hence an increase in
revenue. A cost-volume-profit analysis can determine the level of revenue sufficient for a business to
cover its fixed and variable costs to break even, and predict the effect on profit of changes in the level
of activity, prices or costs.
Changes to the sale mix affect revenue. Businesses should control this by maintaining a clear focus on
the important consumer base on which most of the revenue depends before diversifying or extending
product ranges or ceasing production on particular lines.
Pricing policy affects revenue and, therefore affects working capital, thus pricing decisions should be
closely monitored and controlled. Overpricing could fail to attract buyers while underpricing may
bring higher sales but may still result in cash shortfalls and low profits.

Factors that influence pricing include:

- The costs associated with producing the goods or services
- Prices charged by competition
- Short and long term goals
- The image or level of quality associated with the product
- Government policies

★ global financial management

– exchange rates
As countries have their own currencies, when transactions are conducted on a global scale, one
currency must be converted into another. This transaction is performed through the foreign exchange
market, which determines the price of one currency relative to another.
The foreign exchange rate is the ratio of one currency to another; it tells how much a unit of one
currency is worth in terms of another (e.g. AUD$1 = US$0.70).
Effects of currency fluctuations
Exchange rates fluctuate over time due to variations in supply and demand. The impact of currency
fluctuation is twofold:
 1. A currency appreciation raises the value of the Australian dollar in terms of foreign
currencies, meaning that each unit of foreign currencies buys fewer Australian dollars and one
Australian dollar buys more foreign currency. Therefore, an appreciation makes our exports
more expensive and imports cheaper. The result of the appreciation therefore, reduces the
international competitiveness of Australian exporting businesses.
2. A currency depreciation lowers the price of Australian dollars in terms of foreign currencies,
therefore, each unit of foreign currency buys more Australian dollars. The result is that our
exports become cheaper and imports are more expensive. A depreciation therefore, improves
the international competitiveness of Australian exporting businesses.

– interest rates
A global business has the option of borrowing money from financial institutions in Australia, or they
can borrow money from financial markets overseas. Though, the real risk here is exchange rate
movements. Any adverse currency fluctuation could see the advantage of cheaper overseas interest
rates quickly eliminated and could eventually cost more. Thus, this will have a major impact on a
business’s profitability if they have borrowed money from finance markets overseas.

– methods of international payment – payment in advance, letter of credit, clean payment, bill
of exchange
As the importer and exporter are unable to trust each other in the transaction of goods, a method of
payment using a third party(normally a bank) that both parties trust, is required.
Payment in advance
The payment in advance method allows the exporter to receive payment and then arrange for the
goods to be sent. This method exposes the exporter to virtually no risk, however many importers will
not agree to the terms as it has high risk as there is no guarantee that they will receive what they
ordered.

Letter of credit
In order to ensure that payment will be received, sometimes exporters will require the importer to
have a letter of credit confirmed by a secure bank. A letter of credit is a document that a buyer can
request from their bank that guarantees the payment of goods will be transferred to the seller. In order
for the payment to occur, the seller must provide necessary documentation proving the shipment of
goods.
If the buyer is unable to make the purchase, the bank will then be required to pay, thus, the bank will
only issue the letter of credit if they know the buyer will pay.
Clean payment
A clean payment method occurs when the exporter ships the goods directly to the importer before
payment is received. The goods are shipped with invoices requesting payment at a certain time after
delivery, usually 30, 60 or 90 days, this is known as the credit term. This method is used when the
exporter is confident that the importer will pay in time.

Bill of exchange
A bill of exchange is a document drawn up by the exporter demanding payment from the importer at a
specified time.
There are two types of bills of exchange:
1. Document (bill) against payment
The importer can only collect the goods after paying for them. The exporter draws up a bill of
exchange with their Australian bank and sends it to the importer’s bank along with a set of documents
that will allow the importer to collect the goods. The importer’s bank hands over the documents only
after the payment is made and transfers the funds to the exporter’s bank.
2. Document (bill) against acceptance
The importer may collect the goods before paying for them. The same process applies as with
documents against payment, except the importer must sign only acceptance of the goods and the terms
of the bill of exchange to receive the documents that allow him or her to pay for the goods at a later
date.

– hedging
When two parties agree to exchange currency and finalise a deal immediately, the transaction is
referred to as a spot exchange. The spot exchange rate is the value of one currency in another currency
on a particular date. However, currency fluctuations change constantly disadvantaging businesses,
though it is possible for businesses to minimise the risk of currency fluctuations. This process is
known as hedging. Hedging refers to the process of minimising the risk of currency fluctuations to
help reduce the level of uncertainty involved with international financial transactions.
Natural hedging
A range of natural hedges that may be adopted by businesses include:
- Establishing offshore subsidiaries
- Arranging for import payments and export receipts denominated in the same foreign
currency; therefore, any losses from a movement in the exchange rate will be offset by gains
from the other.
- Implementing marketing strategies that attempt to reduce the price sensitivity of the exported
products.
- Insisting on both import and export contracts denominated in Australian dollars, effectively
transferring the risk to the buyer (importer).
Financial instrument hedging
There are a growing number of financial products available, called derivatives, that can be used to
minimise or spread the risk of exchange rate fluctuations.

– derivatives
To minimise the financial risks involved with exporting, financial institutions are continually
developing new types of products, collectively referred to as derivatives, which are financial
instruments that may be used to lessen the exporting risks associated with currency fluctuations.
Derivatives work similar to fixed interest rates on a loan, which allows people to lock in an interest
rate on their loan to protect themselves against future interest rate rises, however, they won’t be able
to benefit from falling interest rates if they occur.
Derivatives, if used unwisely, can be as dangerous as the risks against which they are supposed to
protect.
The three main derivatives available for exporters include:
Forward exchange contracts
A forward exchange contract is a contract to exchange one currency for another currency at an agreed
exchange rate on a future date, usually after a period of 30, 90, or 180 days.
Options contract
An option gives the buyer (option holder) the right, but not the obligation, to buy or sell foreign
currency at some time in the future. Option holders are protected from unfavourable exchange rate
fluctuations, yet maintain the opportunity for gain should exchange rate movements be favourable.
Swap contract
A currency swap is an agreement to exchange currency in the spot market with an agreement to
reverse the transaction in the future. It involves a spot sale of one currency together with a forward
repurchase of the currency at a specified date in the future.
Businesses also use currency swaps when they need to raise finance in a currency issued by a country
in which they are not well known and are, therefore, forced to pay a higher interest rate than would be
available to a better known borrower or local business.
The main advantage of a swap contract is that it allows the business to alter its exposure to exchange
fluctuations without discarding the original transaction.

Not being tested on

Global, gearing
Limitations of financial reports
Case study question is on 1 dot point
Need to know about APRA on basic terms, how it regulates

Economies of scales - Reduction in costs as outputs increase → efficiency

Variable costs is essentially cogs
Expense minimisation is only reducing financial, selling, operating and administration expenses