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Financial Management
Study for HSC business
| Term | Definition |
|---|---|
| Objectives of Financial Management | Liquidity, profitability, efficiency, growth, solvency |
| Liquidity | the extent to which a business can meet its financial commitments in the short term. |
| Profitability | the excess of revenue or income over expenses or costs |
| Efficiency | 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 |
| Growth | the ability of the business to increase its size in the longer term |
| Solvency | the extent to which the business can meet its financial commitments in the longer term |
| Strategic Plans | Short-term plans, long-term plans |
| Short-term financial objectives | Short-term financial objectives are the tactical (one to two years) and operational (day-to-day) plans of a business |
| Long-term financial objectives | Long-term financial objectives are the strategic plans of a business. They are determined for a set period of time, generally more than five years. |
| Internal Sources of Finance | Retained profits. |
| Retained profits | The most common form of internal finance is retained earnings or profits in which all profits are not distributed, but are kept in the business as a cheap and accessible source of finance for future activities. |
| External Sources of Finance | Debt (short + long-term borrowing), equity (Ordinary shares, private equity) |
| Short-term borrowing | Is used to finance temporary shortages in cash flow or finance for working capital. Refers to those funds that will be repaid 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. |
| Commercial Bills | are primary short-term loans issued by financial institutions, for larger amounts (usually over $100,000) for a period of generally between 30 to 180 days. |
| 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). |
| Long-term borrowing | Relates to funds borrowed for periods longer than 12 months. Is usually used to purchase major assets such as buildings and equipment, and the assets often serve as security on the loan. |
| Mortgage | is a loan secured by the property of the borrower (business). Mortgage loans are used to finance property purchases, such as new premises, a factory or office. |
| 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. Are secured against the companies assets. |
| Unsecured notes | 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). |
| Leasing | is usually 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. |
| Ordinary shares | Are the most commonly traded shares in Australia. The purchase of ordinary shares by individuals means they have become part-owners of a publicly listed company. |
| New issues | a new issue refers to a security that has been issued and sold for the first time on a public market |
| Rights issues | a rights issue is an invitation to existing shareholders to purchase additional new shares in the same company. |
| Placements | a placement involves creating new shares in return for capital and issuing them to selected investors at a discount to the market price of the company’s shares. |
| Share purchase plans | Share purchase plans refer to an offer to existing shareholders in a listed company to purchase newly issued shares in that company without brokerage fees. The shares are usually offered at a discount to the current market price. |
| Planning and implementing | Finance needs, budgets, record systems, financial risks and financial controls |
| Finance needs | determined by: size of business, current phase of business cycle, future plans, capacity to source finance, management skills for assessing financial needs and planning |
| Budgets | a budget is a financial document used to estimate future revenue and expenses over a period of time. Provides an accurate picture of income and expenses and should be used to drive important business decisions |
| Record systems | The mechanisms employed by a business to ensure that data are recorded and the information provided is accurate, reliable, efficient and accessible |
| Financial risks | Every business is subject to a degree of financial risk and not all financial risks are able to be controlled |
| Financial controls | Procedures, policies and means by which a business monitors and controls the allocation and usage of its resources. The policies and procedures of a business are designed to ensure they are followed by management employees |
| Advantages of Debt and Equity Finance | doesn't have to be repaid unless owner leaves business, cheaper than other sources of finance as there are no interest payments, less risk for the business and the owner, the owners who have contributed the equity retain control over how finance is used |
| Disadvantages of Debt and Equity Finance | Security is required by the business, regular repayments have to be made, lenders have first claim on any money if the business ends in bankruptcy, debt can be expensive |
| Matching the terms and source of finance to business purpose | This means that short-term finance should be used to purchase short-term assets and long-term finance should be used for long-term assets. |
| Monitoring and controlling | Cashflow statement, income statement, balance sheet |
| Cashflow statement | A cash flow statement is a financial statement that indicates the movement of cash receipts and cash payments resulting from transactions over a period of time. Gives information regarding a firm's ability to pay debt on time. Points to difficulties. |
| Income statement | Outlines the level of revenue, costs of goods sold and operating expenses, and calculates whether a business has made profit or loss over a period of time. Shows how much money comes into the business and go out. |
| Balance sheet | A balance sheet represents a business’s assets and liabilities at a particular point in time, expressed in money terms, and represents the net worth of the business. A = L + OE. |
| Financial Ratios | Liquidity, gearing, profitability, efficiency |
| Liquidity – current ratio | (current assets ÷ current liabilities) |
| Gearing – debt to equity ratio | (total liabilities ÷ total equity) |
| Profitability – gross profit ratio | (gross profit ÷ sales) |
| Profitability - net profit ratio | (net profit ÷ sales) |
| Profitability - return on equity ratio | (net profit ÷ total equity) |
| Efficiency – expense ratio | (total expenses ÷ sales) |
| Efficiency - Accounts receivable turnover ratio | (sales ÷ accounts receivable) |
| Cash flow Management Strategies | Distribution of payments, discounts for early payment, factoring |
| Distribution of payments | An important strategy 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. |
| Discounts for early payment | Another cash flow management strategy is to offer debtors a discount for early payment. An early payment discount occurs when a business offers customers a percentage reduction on the total invoice value when it’s settled before the payment deadline |
| Factoring | Factoring is the selling of accounts receivable for a discounted price to a finance or specialist factoring company |
| Capital management | Involves determining the best mix of current assets and current liabilities needed to achieve the objectives of the business. Must achieve a balance between using funds to create profits and holding sufficient funds to cover payments. |
| Strategies for managing working capital | Leasing, sale and lease-back |
| Leasing | The payment of money for the use of equipment that is owned by another party |
| Sale and lease-back | The process of selling an owned asset to a lessor and then leasing the asset back through fixed payments for a specified period of time. It helps improve a business’s liquidity |
Created by:
ChristianDonato
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