Business

Studies- Finance Study

Notes
Role of Finance-
Strategic Role of Financial Management

 Businesses need to develop a strategic plan as part of a business’s financial

management as it will ensure that the businesses services and grows in the
competitive business world.
 It will allow the business to achieve key goals such as profitability and growth.
 Qantas- the strategic role of Qantas financial management is liquidity,
solvency, profitability, efficiency, growth and return on capital.

Objectives of Financial Management

 The objectives of financial management are-

- Profitability- it is the ability of a business to maximise its profits. Profits
satisfy shareholders of a business in the short term and in the long term
are important for the businesses sustainability.
- Growth- the ability of a business to increase its size in the longer term. It
ensures the business is sustainable into the future. It depends on a
business’s ability to develop and use its asset structure to increase sales,
profits and market share.
- Efficiency- the ability of a business to minimise its costs and manage its
assets so that the 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. If a business cannot meet is financial
obligations in the short term it will not be sustainable in the long term.
- Solvency- is the extent to which the business can meet its financial
commitments in the longer term. It is important to the owners,
shareholders and creditors of a business as it is an indication of the risks
to their investment.
Short Term and Long Term Financial Objectives

 Short term financial objectives- are the tactical (one to two years) and
operational (day-to-day) plans of a business. They are regularly review to
ensure targets are being met and 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 time, usually for more than five years. They
are broad goals- e.g. - to increase profit or market share and require short-
term goals to assist in their achievement.
Business Studies- Finance Study Notes:

Role of Financial Management-

Interdependence with Key Business Functions

 Without finance there would be very little business. Finance flows to each
functional area within a business, which enables it to achieve its goals.
 Qantas- all KBFs at Qantas depend on finance. Qantas spends $275
million+ a year on staff training. Qantas has budgeted $10 billion over the
next 10 years on fleet renewal. Marketing strategies need to be funded.

Human
Resourc
es

Financ
e
Operatio Marketi
ns ng

Influences on Financial Management-

External
Sources of
Finance

Internal
Financial
Sources of
Institutions Influence Finance
s on
Financial
Managem
ent

Global Market Influences of

Influences Government

Sources of Finance- Internal

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Business Studies- Finance Study Notes:
 Int
er
nal

Finance is the funds provided by the owners of the business (finance) or

from the outcomes of business activities (retained earnings).
 Owners’ Equity is the funds contributed by owners or partners to establish
and build the business.
 Retained profits is when the businesses profits are not distributed to
shareholders or owners but are kept in the business as a cheap and
accessible source of finance for future activities.
Influences on Financial Management-
Sources of Finance- External

 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-

 Short term borrowing is provided by financial institutions through bank

overdrafts, commercial bills and bank loans.
 This type of borrowing is used to finance temporary shortages in cash flow or
finance for working capital, it will generally will be repaid within two years.
 A bank overdraft is when the bank allows a business to overdraw its
account to an agreed limit. Bank overdrafts assist business with short term
liquidity problems- e.g. - seasonal decrease in sales. Their cost is lower and as
are interest rates.
 Commercial Bills are a type of bill of exchange (loan) issued by institutions
other than banks and are given for large amounts, usually over $100000 for a
period between 90 and 180 days.
 Factoring is the selling of accounts receivable for a discounted price to a
finance or factoring company. It is a short term source of finance as the
business will receive up to 90% of the amount receivables within 48 hours of
submitting its invoices to the factoring company.
Debt: Long Term Borrowing-

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Business Studies- Finance Study Notes:
 Long term borrowing refers to funds borrowed for periods longer than two
years. It can be secured or unsecured and interest rates are usually variable.
 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.
 Debentures are issued by a company for a fixed rate of interest and for a
fixed period of time.
 An unsecured note is a loan for a set period of time but is not backed by
any collateral or assets- e.g. – house or stock. It presents a high risk to
investors and therefore attracts a higher rate of interest than a secured note.
 Leasing is a long-term source of borrowing for businesses. It involves the
payment of money for the use of equipment that is owned by another party.
Leasing enables an enterprise to borrow funds and use the equipment without
a large debt.

Influences on Financial Management-

Sources of Finance- External
Equity- Ordinary Shares-

 Equity refers to the finance (cash) raised by a company by issuing shares.

 Ordinary shares are the most commonly traded shares, purchase of
ordinary shares by individual’s means they are part-owners of a publically
listed company (e.g. - Westpac) and may receive payments, called dividends.
 The value of a share is determined by a company’s current or future
conditions.
 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).
A share of a company sold for the first time.
- Rights issue- the privilege granted to shareholders to buy new shares in
the same company. You are invited to buy the share.
- Placements- allocation of shares, debentures etc. made directly from the
company to investors.
- Share purchase plan- an offer to existing shareholders in a listed
company the opportunity to purchase more shares in that company
without brokerage fees. The shares can also be offered at a discount to the
current market price. How much money is offered for the share?
Private Equity-

 Private equity is money invested in a private company not listed on the

ASX.
Financial Institutions-

 Banks are the major operators in financial markets and are the most
important source of funds for businesses. They receive savings as deposits
from individuals, businesses and governments and make investments and

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Business Studies- Finance Study Notes:
loans to borrowers. Since the GFC banks have more conservative lending
policies as loan defaults are expensive- they only provide loans to low risk
customers (with a good credit rating).
 Investment banks provide services in both borrowing and lending, mostly to
the business sector. 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.
- Arrange overseas finance.
 Finance and life insurance companies are non-bank financial
intermediates (mediators) that specialise in smaller commercial finance.
These companies are regulated by the Australian Prudential Regulation
Authority.
 Finance companies provide loans to businesses and individuals through
consumer hire-purchase loans, personal loans and secured loans (can sell
assets of a business if they fail to repay the loan) to businesses. They are the
major providers of lease finance to businesses- some specialise in factoring or
cash flow financing.
Influences on Financial Management-
Financial Institutions

 Insurance companies provide loans to businesses through revenues from

insurance premiums, which provide funds for investments. Insurance
companies provide large amounts of equity and loan capital to businesses.
They invest the funds they receive from customers into financial assets (e.g. -
loans to businesses or shares).
 Superannuation Funds provide funds to businesses through investing funds
received from superannuation contributions. Superannuation funds invest in
long-term securities such as company shares, government and company debt
because of the long-term nature of their funds.
 Unit Trusts take funds from lots of small investors and invest them in
specific types of financial assets. Unit trust investments include shares,
mortgages and property and public securities.
 Australian Securities Exchange (ASX) is the primary stock exchange
group in Australia. The ASX offers products and services including shares and
futures. It is a governing body that controls trade sharing within Australia. It
controls, regulates and monitors trading of shares.
Influence of Government
The Australian Securities and Investments Commission (ASIC)-

 The aim of ASIC is to assist in reducing fraud and unfair practices in financial
markets and financial products.
 ASIC ensures that companies comply with the law.
 It collects information about companies and makes it available to the public.
 ASIC is a watchdog.

Company Taxation-

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Business Studies- Finance Study Notes:
 Companies pay company tax on profits- it is levied at a flat rate of 30%.
 It is paid before profits are distributed to shareholders as dividends.
 The government controls tax levels by increasing or decreasing them.
 Australia’s international competitiveness make it a more attractive place to
invest.
 Lowering the tax rate (36% to 30%) means the business will have more
retained profit- allowing them to achieve their business goals- a higher profit
means businesses are more likely to put the money back into their business
to increase its growth.
 Taxing companies allows governments to assist the development of a nation
as it contributes to the building of hospitals, schools etc.

Influences on Financial Management-

Global Market Influences

Availibilit
y of
Funds

Global
Market
Influenc
es
Intere
Econom
ic st
Outlook Rates

Economic Outlook-

 Global Economic Outlook refers specifically to the projected changes to the

level of economic growth throughout the world.
 If the outlook is positive (world economic growth is to increase) then this will
impact on the financial decisions of a business. This may include-
- Increasing demand for products and services.

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Business Studies- Finance Study Notes:
-Decrease the interest rates on fund borrowed internationally form the
financial money market.
 This results mainly from a decrease in the level of risk associated with
repayments- as business sales increase as do profits.
 A poor economic outlook will impact on financial decisions in an opposite way.

Availability of Funds-

 The availability of funds refers to the ease with which a business can
access funds (for borrowing) on the international financial markets.
 There are various conditions and rates that apply and these are primarily
based on-
- Risk
- Demand and supply
- Domestic economic conditions
 The GFC had a major impact on the availability of funds for all companies and
institutions. It caused a sharp increase in interest rates that was a reflection
of the high level of risk in lending.

 This will mean that businesses have more retained profit, allowing them to
achieve more business goals of profitability. Reducing tax allows businesses
to have a higher profit, thus they are more likely to put the money back into
their business to increase its growth.

Influences of Financial Management-

Global Market Influences
Interest Rates-

 Interest rates are the cost of borrowing money.

 The higher the risk of lending to a business, the higher the interest rates.
 The need to maximise profits may lead to business borrowing from an
overseas source to gain the advantage of a lower interest rate.
 However, there is a risk in the exchange rate movements. Currency
fluctuation could see the advantage of cheaper overseas interest rates
quickly eliminated. In the long term ‘cheap’ interest rates may cost more.

 Qantas-global market influences have a big impact on Qantas and its

profitability. Prior to 2009, Qantas benefited from a strong global economy,
increasing demand for its services  record net profit of $970 million (2008).
The GFC caused rapid revenue declines- there was less demand for air travel
 88% fall in net profit (2009). Qantas cut flying capacity and replaced Qantas
with Jetstar on some routes.
Processes of Financial Management-
Planning and Implementing

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 Business Studies- Finance Study Notes:
 Financial planning is essential if a business is to achieve its goals as it
determines how the goals will be achieved.
 It begins with long term or strategic plans. Long term plans include a
business’s planned capital expenditure (what is spent on a business’s non-
current or fixed assets- used to generate revenue) and/or planned
investments.

 The planning cycle-

Establishi Addressin
ng g present
financial financial
controls situation

Determini
Identifyin
ng
g financial
financial
risks
needs

Maintaini
Developin
ng record
g budgets
systems

Processes of Financial Management-

Planning and Implementing

 Long term plans also cover planned sources of finance, spending on research
and development, marketing and product development activities.
 Long term plans cover a period between two and ten years and guide the
development of short term tactical and operating plans.
 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-

 Financial needs refers to how much finance will be needed to achieve the
businesses objectives and when it will be needed.
 They determine where a business is headed and how it will get there.
 Financial information needs to be collected before future plans can be made.
This financial information includes balance sheets, information statements,
cash flow statements, sales and price forecasts, budgets and bank
statements.
 The financial needs of a business are determined by-
- The size of a business

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Business Studies- Finance Study Notes:
- The current stage of the business cycle
- Future plans for growth and development
- Capacity to source finance- debt and/or equity
 A business plan might be used to help seek finance or support for a project as
it sets out financial commitment and proposed usage.
 Financial information is needed to show that the business can generate an
acceptable return for the investment being sought and should include an
analysis of financial performance.
 Financial needs should incorporate all areas of the key business functions,
and be tactical and strategic (short and long term).
Budgets-

 Budgets are a financial forecast of the finance needed to achieve the

objective and when the finance will be needed.
 Budgets plan but also monitor (they enable constant monitoring) and control
(track actual performance against planned performance) objectives.
 They provide information in quantitative terms (facts and figures) about the
requirements to achieve a particular purpose.
 Budgets reflect strategic planning decisions about how resources are used.
They provide financial information for a business’s specific goals and are used
in strategies, tactical and operational planning.
 They can be classified as operating, project or financial budgets.
 Operating budgets relate to the main activities of a business and include
budgets relating to sales, production, raw materials, direct labour, expenses
and cost of goods sold.

Processes of Financial Management-

Planning and Implementing
Budgets-

 Project budgets relate to capital expenditure, and research and

development. Capital expenditure budgets in a business’s strategic plan
include information about the purpose of the asset purchase, life span of the
asset and the revenue that would be generated from the purchase.
 Financial budgets relate to the financial data of a 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 flow. The income statement and balance sheet reflect
the results of operating activities and the cash flow statements shows the
liquidity of a business.
Record Systems-

 Record systems are concerned with the gathering, storing and retrieving of
all the information that relates to strategies designed to achieve the
objectives.

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Business Studies- Finance Study Notes:
 Minimising errors in the recording process, and producing accurate and
reliable financial statements are important aspects of maintaining record
systems.
 The double entry system of accounting is a method of recording all items
twice to see if finances balance and errors can be found quickly.
Financial Risks-

 Financial risk is the risk to a business of being unable to cover its financial
obligations, such as debts that a business incurs through borrowings (both
short term and long term).
 It can be transferred to other businesses specialising in risk (e.g. - insurance
companies).
 Financial risk is about predicting and minimising the risk of the external
environment.
 The risk of bankruptcy is evident if financial risks are not minimised.
 Financial risks include-
- Interest rates increasing
- When borrowings are due to be repaid
- Meeting financial commitments
- Going into more debt
 If the business is financed from borrowings there is a higher risk.
 The higher the risk, the greater the expectation of profits or dividends.

Financial Controls-

 Financial controls are the policies and procedures that ensure that the
plans of a business will be achieved the most efficient way.
 Common causes of financial problems are theft, fraud damage and errors in
record systems.
 Control is important in assets such as accounts receivable, inventory and
cash.
 Common policies and procedures that promote control within a business are
separation of duties, rotation of duties, control of cash, protection of assets
and control of credit procedures.
 Budgets and variance reporting are additional financial controls used in a
business.

Processes of Financial Management-

Debt Finance- Advantages and Disadvantages

Advantages of Debt Disadvantages of Debt

 Funds are usually readily available.
 Increased funds should lead to
increased earnings and profits.
 Tax deduction for interest
payments.
 Increased risk if debt comes from
financial institutions because the
interest, bank charges,
government charges and the
principal have to be repaid.
 Security is required by the
business.

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Business Studies- Finance Study Notes:
 Regular repayments have to be
made.
 Lenders have first claim on any
money if the business ends in
bankruptcy.

Equity Finance- Advantages and Disadvantages

Advantages of Equity Disadvantages of Equity

 Does not have to be repaid unless  Lower profits and return for the
the owner leaves the business. owner.
 Cheaper than other sources of  The expectation that the owner will
finance as there are no interest have return on the investment
payments. (ROI).
 The owners who have contributed
the equity retain control over how
that finance is used.
 Low gearing (uses the resources of
the owner and not external sources
of finance).
 How much level of risk in
borrowing.
 Less risk for the business and
owner.

Process of Financial Management-

Monitoring and Controlling
Cash Flow Statement-

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Business Studies- Finance Study Notes:
 A cash flow statement is a statement that indicates the cash balance position
at the end of an accounting period.
 It shows how much cash came into the business and how much cash was paid
out by the business.
 Monitoring and controlling this is important as the cash cycle can determine
the business solvency.
 Allows businesses to identify cash flow problems which may cause future
liquidity and working capital problems.
 Cash flow forecasts predict the cash position of a business.

Cash Flow Statement-

Processes of Financial Management-

Monitoring and Controlling
Income Statement (Revenue Statement)-

 The income statement shows how much the business sold, how much it cost
to make these sales and how much profit the business made.

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Business Studies- Finance Study Notes:
 It indicates the level of profit or loss) for a business for a particular period.
 The income statement indicates the level of sales, gross profit and net profit
of a business.
 Net profit is the amount of profit made after deducting the expenses from
gross profit it takes into account the cost of goods sold and the level of
expenses (TRUE REALITY).
Income Statement-

Processes of Financial Management-

Monitoring and Controlling
Balance Sheet-

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Business Studies- Finance Study Notes:
 The balance sheet is a statement showing the net worth (total value) of a
business on a particular day (last day of the financial year- 30 th June).
 It indicates the assets and liabilities of a business, which is vital information
for analysis of a business.
 It shows what is owned and what is borrowed.
 Provides information about the profitability and stability of the business.

 Qantas- The financial statements of Qantas summarise its financial

transactions. They are issued to shareholders and are available to the public.
KPMG audits Qantas’ financial statements to ensure they give a true and fair
indication of the company’s finances and comply with accounting standards
and corporate law.
Financial Ratios
Liquidity-

 Liquidity is the extent to which the business can meet its financial
commitments in the short term (<12 months).
 Process of selling a company’s assets a quick as possible to meet short term
debts.
 A business must have sufficient funds to meet debts and unexpected
expenses.
 Ways to improve liquidity-
- Leasing (instead of buying)
- Reduce operations costs
- Collect accounts receivable (factoring)
- Sell non-current assets (e.g.) liquidity)
- Borrow funds
- Retained profits (put back into business- don’t distribute to shareholders)

Processes of Financial Management

Financial Ratios

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Business Studies- Finance Study Notes:
Liquidity-

 A ratio of less than 1:1 indicates insufficient

assets to meet current financial commitments.
 A ratio of 1.5:1 is desirable (need to compare to
industry average).
 If liquidity is too high (e.g. - 3:1) this indicates
that working capital is not being used effectively. Investment maybe an
option.
 Qantas- Qantas’ low rate indicates an inability to meet its short term
debts. However, like most other airlines it operates on a negative working
capital position. Qantas holds little cash reserves and uses the cash received
to pay long term debt, reducing interest costs. Their liquidy ration decreased
in 2014 to 0.66:1 from 0.75:1 in 2013. Singapore Airlines- 1.4:1, Air New
Zealand- 0.98:1.
 Current liquidity strategies employed Qantas include-
- Controlling current assets and liabilities
- Leasing more aircraft, buildings, plant and equipment- frees up cash.
- Considering selling and leasing back terminal buildings.
Gearing-

 Gearing is the proportion of debt (external finance) and the proportion of

equity (internal finance).
 Gearing ratios determine the firm’s solvency- its ability to meet financial
commitments in the longer term.

 Highly geared means that a

company is working harder to repay its debts.
 High debt to equity may discourage shareholders/investors due to the high
risk.
 The more highly geared the business is, the greater the risk for the business
but the greater potential for profit.
 This ratio is an important control aspect for management because the
relationship between debt and equity needs to be balanced carefully.
 There is no optimal level of gearing, it depends on-
- Return on investment
- Cost of debt
- Size & stability if business’s earning capacity
- Liquidity of business’s assets (and ability to quickly meet interest
repayments)
- Purpose of short-term debt
Processes of Financial Management

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Business Studies- Finance Study Notes:
Financial Ratios
Gearing-

 Qantas- Qantas is highly geared due to the capital intensive nature of the
industry. Qantas’ source of funds include a mix of cash, equity, debt and lease
finance. Two equity raisings 2001 and 2002, the decision to lease planes, the
high value of the Australian dollar and improved profitability helped decrease
Qantas’ gearing from 2004-2007. However, a period of low interest rates and
the favourable operating environment and a fleet renewal program caused
Qantas to increase its gearing from 2008.
Profitability-

 Profitability ratios identify if the business is making profits.

 There are three profitability ratios: the gross profit ratio, the net profit ratio
and the return on equity ratio.
 Qantas- Qantas must have a satisfactory level of profit to survive. It is also
important for stakeholders. Profitability in the airline is relatively poor on
average. Qantas’ profitability suffered due to terrorist attacks (2002), SARS
(2004) and the rising cost of fuel (2006). Increasing profitability in 2007 and
2008 was due to the success of Jetstar, the robust economic environment and
cost savings culminated in a net profit of $970 (million??) in 2008. The GFC
and Swine Flu led to an 88% fall in net profit in 2009. Qantas has struggled in
recent years to make profit due to high fuel prices, natural disasters and
weaknesses in the domestic market. Qantas has forecasted a pre-tax
underlying profit between $300 and $350 million this year, due to their cost
cutting program and fall in oil prices.
Gross Profit Ratio-

 The gross profit ratio indicates what percentage of each sales dollar is gross
profit.
 It also helps determine if the sale price of goods and services of a business is
adequate.
 Gross profit is the difference between the sales revenue and the cost of
goods sold (COGS) (the cost of production) what were sold- it is profit before
the expenses (e.g. - salaries) are taken in to account.

 NB- Gross Profit = Sales –

COGS

 The gross profit ratio should be greater than 0.5:1.

 The gross profit ratio indicates what percentage of each sales dollar is gross
profit.
 The gross profit indicates effectiveness of planning policies concerning,
pricing, sales, valuation of stock etc.
 The gross profit ratio can be improved by-
- Efficient operations
- Outsourcing

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Business Studies- Finance Study Notes:
- Economies of scale
- Leasing (long term- disadvantage)
Processes of Financial Management
Financial Ratios
Net Profit Ratio-

 The net profit ratio (return on sales) measures the percentage of each dollar
of sales that is left over to pay tax and returns to lenders (principal and
interest) and owners (dividends and shareholders) for the use of their capital.
 Net profit is the amount of profit after the expenses involved have been
deducted from the gross profit ratio.

 NB: Net Profit = Gross Profit – Expenses

 The net profit ratio assesses a business’s profitability.

 The net profit ratio should be between 10-18%.
 The net profit ratio can be improved by-
- Efficient operations
- Outsourcing
- Economies of scale
- Leasing (long term- disadvantage)

Return on Equity Ratio-

 The return on equity ratio measures the net profit before tax and compares it
to the equity of a business.

 The return on equity ratio will reflect its asset structure (nature of operations)
and financial structure.
 The return on equity ratio is a measure of the owners reward for the risk
involved in keeping the business operating.
 If returns compare favourably, owners might consider expanding the
business. If the return is unfavourable, the owners would consider alternative
options including selling the business.
 The ratio is also an indication to potential shareholders if it they will receive a
return on their investment. A high return on equity, means that people are
more likely to invest in a business.

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Business Studies- Finance Study Notes:
 The return on owner’s equity ratio is calculated using the income statement
and the balance sheet.
Processes of Financial Management
Financial Ratios
Efficiency-

 Efficiency is the ability of the firm to use its resources effectively in ensuring
financial stability and profitability of the business. It relates to the
effectiveness of management in directing and maintaining the goals and
objectives of the firm.
 The more efficient the firm, the greater its profits and financial stability.

Expenses Ratio-

 The expense ratio compares total expenses with sales.

Total expenses
Expense Ratio = Sales
 The ratio indicates the amount of sales that are allocated to individual
expenses such as selling, administration, cost of goods sold and financial
expenses.
 The expense ratio indicates the day-to-day efficiency of the business.
 A business aims to keep expenses at a reasonable level- if the expenses ratio
is too high or low, the management needs to determine why this has
happened.
 Decline in the financial expense ratio maybe a result of lower interest rates or
less debt being used by the firm.
 Qantas- Qantas’s expense ratio increased from 99% in 2013 to 125% in
2014. Qantas has improved efficiently by-
- Introduction of new and more efficient aircraft (new airbus use 25% less
fuel per passenger)
- Introduction of new crew and training bases
- Investment in new IT systems
- Reduced overhead costs due to improved economies of scale
Accounts Receivables Turnover Ratio-

 This ratio shows the effectiveness of a business’s credit policy and how
efficiently they collect their debts (connected to factoring).

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Business Studies- Finance Study Notes:
 The accounts receivable turnover ratio measures the effectiveness of a firm’s
credit policy and how efficiently it collects its debts.
 Changing the credit policy

Processes of Financial Management

Financial Ratios
Accounts Receivable Turnover Ratio-

 It measures how many times the accounts receivable balance is converted

into cash or how quickly debtors pay their accounts.
 The accounts receivable turnover can be improved by-
- Factoring
- Invoicing customers earlier or more often (e.g.- twice a month instead of
once a month)
Comparative Ratio Analysis-

 To make an effective judgement businesses need to compare ratios.

 Comparison and benchmarks are needed.
 Figures over time can indicate directions or trends and make ratio analysis
more meaningful.
 Analysis can also include budget figures so that predicted figures can be
compared against actual figures (usually over short periods).
Limitations of Financial Reports

Limitations of Financial Reports

Normalised Earnings  The process of removing one time influences

from the balance sheets to show the true
earnings of a company.

Capitalising Expenses  Classifying expenses as assets which will

increase profit and the value of the business.
Example- R&D costs are classified investment
in the future of the business  considered an
asset.
Valuing Assets  It is difficult to accurately value assets on the
balance sheet  market value can change
over time due to depreciation and
depreciation. Example- vehicles and
equipment depreciate over time, so their
value on the balance sheet should be
recorded at their market value not at the
original cost.
Timing Issues  Financial reports only cover a specific period
and don’t include income or expenses
occurring outside the time period  these
events may have a large impact on the
profitability of a business.

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Business Studies- Finance Study Notes:
Debt Repayments  Financial reports contain little information
about businesses debt apart from its value.
Other information about debts may be
important to the financial stability of a
business. *doesn’t show what type of debt.
Notes to Financial  Need to be read as they contain additional
Statements information about how the report was
prepared which can affect the figures
recorded. Example- Actual profit maybe
different to ‘normalised profit’ in the income
statement.

Processes of Financial Management

Limitations of Financial Reports-

 Qantas- Limitations of Qantas’ financial reports maybe occur if the

comprehensive notes attached to the reports aren’t read by stakeholders-
helps them understand better and gives more clarity to financial position.
Special circumstances may distort analysis of results- for example natural
disasters (in 2011- cyclone Yasi, Christchurch earthquake, Japan tsunami)
affect Qantas’ profitability. Financial reports don’t give an entire picture of
their debt as it doesn’t disclose when they have to be repaid. It can also be
difficult to value Qantas’ assets because they change over time. Qantas’ long
term assets are depreciated over time but the value of these assets may not
always reflect their true market value.
Ethical Issues of Financial Reports-

 Ethical principles relating to financial reports arise when-

- Current assets not being valued correctly creating a higher value for
working capital.
- High levels of debt create unnecessary risk for the business.
- Unrealistic values are sued for non-current assets.
- Short term cost cutting strategies put at risk long term stability and
growth.
 Another ethical issue involves deliberately manipulating the financial reports
to reduce the amount of tax a business has to pay as low as possible.
 Profits may be shifted to international tax havens such as the Caribbean,
Ireland or Cyprus to reduce tax liability in Australia.
 All public companies in Australia are audited by an independent accounting
firm, ensuring they’re an accurate, true and fair view of the company.
Financial Management Strategies
Cash Flow Management-
Cash Flow Statements-

 Cash flow is the movement of cash in and out of a business over a period of
time.

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Business Studies- Finance Study Notes:
 If more money goes out than in there is a cash flow. Matching cash flow in
and cash flow out is essential.

Receipt of
Payment of
accounts
inventories
recievable

Credit sales
(accounts
recievable)
Cash sales
 Cash flow statements 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.
Financial Management Strategies
Management Strategies-

 Management must implement strategies to ensure that cash is available to

make payments when they are due.
 Management strategies for cash flow include:
- Identifying when the distribution of payments can be and are made.
- Using discounts for early payments.
- Factoring.
Distribution of Payments-

 This involves distributing payments throughout the month, year or other

period so that cash shortfalls do not occur. A cash flow projection can assist in
identifying periods of potential shortfall and surpluses.
Discounts for Early Payment-

 This involves offering creditors a discount for early payments.

 This is most effective when targeted at creditors who owe the largest
amounts of money over the financial year period.
 This is not only beneficial for the creditors who are able to save money and
improve their cash flow but also positively affects the business’s cash flow
status.
Factoring-

 Selling of accounts receivable for a discounted price to a finance or specialist

factoring company. The business saves on costs involved in following up on
unpaid accounts and debts.
Working Capital Management-

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Business Studies- Finance Study Notes:
 Working capital is the funds available for the short term financial
commitments of a business.
 Working capital management involves determining the best balance of
current assets and current liabilities needed to achieve the objectives of the
business.
 Management must achieve a balance between using funds to create profits
and holding sufficient funds to cover payments the more efficient a business
is in organising and using its working capital, the more effective and
profitable it will be.
Control of Current Assets-

 Management of current assets is important for monitoring working capital.

 Excess inventories and lack of control over accounts receivable lead to an
increased level of unused assets, leading to increased costs and liquidity
problems. Insufficient inventories and tight credit control policies may lead to
problems.
 Control of current assets requires management to select the optimal amount
of each current asset held and raising finance required to fund these assets.
 The cost and benefits of holding too much or too little of each asset needs to
be assessed. Working capital must be sufficient to maintain liquidity and
access to credit (overdraft) to meet unforeseen circumstances.

Financial Management Strategies

Control of Current Assets- Cash-

 Cash is critical for business success and the levels of cash receivables and
inventories must be considered carefully.
 Supplies of cash also enable the business to take advantage of investment
opportunities.
 Planning for the timing of cash receipts, cash payments and asset purchases
avoids the situation of cash shortages or excess cash. Cash shortages can
occur due to unforeseen expenses and are a cost to the business.
 Businesses try to keep their cash balances to a minimum and hold marketable
securities as reserves of liquidity. Reserves of cash and marketable securities
guard against sudden shortages or disruptions to cash flow.
Control of Current Assets- Receivables-

 The collection of accounts receivables in important in managing working

capital.
 A business must monitor its accounts receivable and ensuring that their
timing allows the business to maintain adequate cash resources.
 The quicker debtors pay, the better the firm’s cash position.
 Procedures for managing accounts receivable include-
- Checking the credit rating of prospective customers
- Invoicing customers monthly and at the same time each month so debtors
know when to expect accounts
- Following up on accounts that are not paid by the due date
- Stipulating a period (usually 30 days) for the payment of accounts

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Business Studies- Finance Study Notes:
- Putting policies in place for collecting bad debts such as factoring.
 The disadvantage of operating a tight credit control policy is that customers
might choose to buy from other firms. The cots and benefits need to be
weighed up carefully by management.
Control of Current Assets- Inventories-

 Inventories make up a significant amount of current assets and their levels

need to 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.
Insufficient inventory of quick selling items may also lead to loss of customers
and lost sales.
 Inventory is a cost of the business if it remains unsold- holding of too much
stock means unnecessary expenses (e.g. - storage and insurance). The rate of
inventory or stock turnover differs depending on the type of business. E.g. - a
fruit and vegetable merchant has a high turnover.
 Businesses must ensure that inventory turnover is sufficient to generate cash
to pay for purchases and suppliers on time so they will be willing to give
credit in the future.
Control of Current Liabilities-

 Current liabilities are financial commitments that must be paid by a business

in the short term.
 Minimising the costs related to a firms current liabilities is an important part
of the management of working capital.
 This involves in being able to convert current assets into cash to ensure that
the business’s creditors (accounts payable, bank loans or overdrafts) are paid.
Financial Management Strategies
Control of Current Liabilities- Payables-

 A business must monitor its accounts payables and ensure their timing allows
the business to maintain adequate cash resources.
 Holding back accounts payable until their final due date can improve a firm’s
liquidity position as some suppliers allow a period of interest free trade credit
before requiring payment for goods purchased. Businesses should also take
advantage of discounts offered by some creditors, reducing costs and
improving cash flows.
 Accounts must be paid by their due dates to avoid extra charges imposed for
late payment and ensure that trade credit will be extended to the business in
the future.
 Control of accounts payable involves reviewing suppliers and the credit
facilities they provide, for example:
- Discounts
- Interest-free credit periods
- Extended terms for payment
Control of Current Liabilities- Loans-

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Business Studies- Finance Study Notes:
 Short-term loans and bridging finance are important sources of short-term
funding for businesses.
 Management of loans is important as costs for establishment, interest rates
and ongoing charges must be investigated and monitored to minimise costs.
 Short term loans are a more expensive form of borrowing for a business and
their use should be minimised.
 Control of loans involves investigating alternative sources of funds from
different banks and financial institutions. Positive, ongoing relationships with
financial institutions ensure that the most appropriate short-term loan is sued
to meet the short-term financial commitments of the business.
Control of Current Liabilities-Overdrafts-

 Bank overdrafts are a convenient and cheap form of short-term borrowing for
a business.
 Banks require that regular payments be made on overdrafts and may charge
account-keeping fees, establishment fees and interest. Interest payable for a
bank overdraft is usually less than a loan.
 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 bank overdrafts and monitor budgets on a daily or weekly
basis so that cash suppliers can be controlled.

Financial Management Strategies

Strategies for Managing Working Capital-

 Businesses use a number of strategies to manage working capital which is

required to fund the day-to-day operations of a business. These include
strategies include-
- Leasing
- Sale and lease back
Leasing-

 Leasing is the hiring of an asset from another person or company who has
purchased the asset and retains its ownership.
 Leasing frees up cash that can be used elsewhere in a business so the level of
working capital. It is an attractive strategy for some businesses as it is an
expense and is tax deductible. Firms can increase their number of assets
through leasing and this means that revenue and profit can be increased.
Sales and Lease Back-

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Business Studies- Finance Study Notes:
 Sale and lease back is the selling of an owned asset to a lessor and leasing
the asset back through fixed payments for a specified number of years.
 Sale and lease back increases a business’s liquidity because the cash that is
obtained from the sale is used as working capital.
 Financial management needs to be dynamic and relevant to both internal and
external factors that will affect the overall success of a business. External
factors (e.g. GFC) impact a business profitability in all economies. The ability
of a business to effectively implement appropriate financial strategies will
determine long-term success and growth.
Profitability Management-

 Profitability management involves the control of both the business’s costs

and its revenue. Accurate and up-to-date financial data and reports are
essential tools for effective profitability management.
Profitability Management- Cost Controls-

 Business decisions are influenced by costs. The costs associated with a

decision need to be examined carefully before implemented.
 Qantas- recent strategies employed by Qantas to control costs include-
- Cutting flying capacity by halting growth and cutting back services
- Replacing Qantas with Jetstar on some international routes
- Cancelling orders for new planes
- Restructuring management/redundancies (5000 job losses planned over
the next 3 years, 2200 actioned in 2014)
- Freezing executive pay
- Fuel conservation
 Qantas has cut costs by over $5 billion in the last 10 years, reducing its
overall cost base by between 20-25%. They have targeted a further $2
billion in costs savings by 2017.

Financial Management Strategies

Profitability Management- Cost Controls-
Fixed and Variable Costs-

 Businesses management need to have an understanding of

what their costs are.
 Fixed costs are not dependent on the level of operating activity
in a business and are paid regardless of what happens in the
business (e.g. - salaries, insurance and rent).
 Variable costs change proportionately with the level of
operating activity in a business.
 Monitoring levels of both fixed and variable costs is important
in a business. Comparisons of costs with budgets, standards and previous
periods ensure that costs are minimised and profits maximised.
Cost Centres-

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Business Studies- Finance Study Notes:
 A business’s costs and expenses must be accounted for, and management
needs to be able to identify their source and amounts.
 Cost centres are particular areas, departments or sections of a business to
which costs can be directly attributed.
 A cost centre in retail store or service business would be called a service cost
centre. A cost centre in manufacturing would be called a production cost
centre.
 Cost centres have direct and indirect costs. Direct costs can be allocated to a
particular product, activity, department or region. Indirect costs are shared by
more than one product, activity, department or region.
Expense Minimisation-

 Profits can be weakened if the expenses of a business are high as they

consume valuable resources within a business. Guidelines and policies should
be established to minimise expenses where possible. Saving can be
substantial if wastage and unnecessary spending is eliminating.
Profitability Management- Revenue Controls-

 Revenue is the income earned from the main activity of a business. In

determining an acceptable level of revenue business must have clear ideas
and policies, particularly about its marketing objectives including the sales
objectives, sales mix or pricing policy.
 Qantas-Total revenues in 2013 fell by 3.5% from falling domestic and
international sales. Recent strategies employed by Qantas to control revenue
include-
- Setting clear sales objectives and setting up a sales reporting system that
reports sales figures regularly and breaks them down into business
segments.
- Discounting of airfares to maintain loads in a shrinking market.
- Fuel surcharges in response to the rapid increase of the price of fuel.
- Increasing revenue from other services such as travel, catering and freight
to protect it from peaks and troughs of Qantas’ core airline business.

Financial Management Strategies

Profitability Management- Revenue Controls-
Marketing Objectives-

 Sales objectives must be pitched at a level of sales that will cover costs (fixed
and variable) resulting in a profit.
 A cost-volume-profit analysis can determine the level of revenue sufficient for
a business to cover its fixed and variable costs to break even, and predict the
effect on profit of changes in the level of activity, prices or costs.
Marketing Objectives-

 Changes to the sales mix can affect revenue. Businesses should control this
by maintaining a clear focus on the important customer base which revenue
depends on BEFORE diversifying or extending product ranges or ceasing

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Business Studies- Finance Study Notes:
production on particular lines. Research should be undertaken to identify the
potential effects of sales-mix changes before decisions are made.
 Pricing policy affects revenue and working capital. Pricing decisions should be
closely monitored and controlled. Overpricing may fail to attract buyers while
under-pricing may bring higher sales but may result in cash short falls and
low profits.
 Factors that influence pricing include-
- Costs associated with producing the goods or services
- Prices charged by competitors
- Short and long term goals
- Image or level of quality that people associate with the goods or services
- Government policies
Global Financial Management-
Exchange Rates-

 An exchange rate is the price of one currency in terms of another currency.

 When transactions are conducted globally, this means that a business has to
buy or sell foreign currencies. The value of foreign currencies can change,
introducing additional risk for a business.
 If the value of the Australian dollar rises relative to a foreign currency, this is
described as an appreciation, if it falls this is depreciations.
 An appreciating dollar means that is cheaper in AUD to purchase from
overseas, but foreign purchases find it expensive to buy from Australia.
 A depreciating dollar means it is more expensive in AUD to purchase from
overseas, but foreign purchases find it cheaper to buy from Australia.
 Qantas- Qantas generates about 38% of its revenue in other
countriesfinancially exposed to changes in exchange rates (also purchases
aircraft in foreign currency). Appreciation- increase in the value of $AUD
reduces the price Qantas pays for fuel, lease and loan payments and
overseas capital expenditure. Australians are more likely to travel overseas
but overseas tourists are less likely to travel to Australia. Depreciation-
decrease in the value of $AUD increases the price Qantas pays for fuel, lease
and loan payments and overseas capital expenditure. Australians are less
likely to travel overseas but overseas tourists are more likely to travel to
Australia.
Financial Management
Global Financial Management-
Interest Rates-

 Expanding overseas involves raising finance in

global markets.
 Global interest rates can be lower than
Australia’s borrowing in a foreign currency can
introduce exchange rate risk into the business.

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Business Studies- Finance Study Notes:
 An appreciating exchange rate reduces the AUD cost of financing a foreign
currency. A depreciating rate will increase the AUD cost of financing in a
foreign currency.
 Qantas-Qantas is exposed to movements in interest rates both in Australia
and overseas. An increase interest rates increase the interest payments
Qantas pays.
Methods of International Payment-

 An issue in global business is ensuring that payments and goods are received,
it becomes more difficult and expensive to initiate legal action between
different authorities.
 A way to address this problem is to get a third party (e.g. - a bank) to
guarantee payment of a transaction.
 Methods of international payment include- payment in advance, letter of
credit, clean payment, bill of exchange.
Payment in Advance-

 Payment in advance involves an exporter receiving payment before the goods

are shipped.
 This method has no risk for exporters, risk lies with the importers.

Letter of Credit-

 A letter of credit is a commitment by the importers bank to pay the exporter

when the documents proving shipment of goods are presented.
Bills of Exchange-

 A bill of exchange is similar to a cheque that is a written order to pay the

exporter a specific amount of money on demand or at a later date.
 There are two main types-
- Document against payment- the exporter sends a bill of exchange and
sends it to the importers bank along with documents that will allow the
importer to collect the goods. The importers bank only hands over the
documents once the payment is made.
- Documents against acceptance- the exporter sends a bill of exchange and
sends it the importers bank with documents that will allow the importer to
collect the goods. The importers bank hands over the documents once the
importer accepts that it will pay.
Clean Payment-

 Clean payment mean the importer is trusted to pay for the goods once they
receive them.

Financial Management
Global Financial Management-
Bills of Exchange-

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Business Studies- Finance Study Notes:
 A bill of exchange is a document drawn up by the exporter demanding
payment from the importer at a specified time.
Hedging-

 There are two types of hedging-

- Natural hedging which doesn’t involve using financial instruments. Natural
hedges involve using one part of the business to hedge the risk of another
part of a business.
- Financial instrument hedging which involves the use of derivatives to
reduce the risk of changes in asset prices.
 Qantas- Qantas has a successful hedging program outperforming many of
its competitors. Qantas has hedged about 94% of its fuel needs for 2015.
Most of these hedges are in the form of options  they aren’t totally locked in
and can take advantage of falls in fuel prices. Qantas also denominates some
borrowings in net surplus currencies to provide a natural hedge.
Derivatives-

 Derivatives are financial contracts whose value depends on an underlying

asset (their value is ‘derived’ from this asset).
 The main types of derivatives that are used by businesses include-
- Forwards which are an agreement to buy or sell an asset at some future
date a specific price.
- Options- agreements that give the purchaser the right, but not the
obligation to buy or sell an asset at some time in the future at a specific
price.
- Swaps which are agreements to swap the rights of specific financial assets
with an agreement to swap them back in the future.
 Qantas- Qantas uses derivatives like forward cover and options to hedge
future fuel purchase, interest and capital expenditure payments. Qantas
earns revenue in many currencies and incurs costs especially fuel,
maintenance and leasing in other currencies.

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