Extensive Notes on Topic 3 – Finance

Resource Description

Role of Financial Management 

 

Strategic Role of Financial Management

• Financial management refers to the planning, organizing & controlling of financial or monetary resources 
• The long-term, or strategic, role of financial management is to ensure the business continues to operate, grow and provide substantial profits to the owners.
• Financial managers need strong accounting knowledge/skills to interpret & analyze financial data. 

 

Objectives of Financial Management  

Profitability	Ability to make a financial return from business activities To ensure profit is maximized, business must carefully monitor its revenue and pricing policies, costs and expenses, inventory levels and levels of assets Measured using net profit from income statement.  Long term profit is vital to business survival; growth & investors return on capital.
Growth	Increase in size and value of a business over time. Could be achieved by increasing value of assets, increasing market share, taking over a competitor, opening more branches/offices in Australia or overseas.  Businesses must monitor levels of growth & manage cash flow effectively to ensure it is sustainable.
Efficiency	Generating maximum returns for minimum costs.  Involves increasing the amount of output with same number of inputs, or achieving the same amount of profit with a smaller amount of assets.     Efficiency may be calculated using an expense ratio & also through their ability to collect accounts receivable ($ owed to them)
Liquidity	The ease with which an asset can be converted into cash. It refers to the extent to which a business can meet its short-term debt (current liabilities). Essential to maintain current assets (e.g. cash in bank, accounts receivable) greater than current liabilities (less than 12 months e.g. short term loan, bank overdraft)  Must have sufficient cash flow to meet its financial obligations or be able to quickly concert an asset into cash in in order to pay a liability e.g. selling inventory.
Solvency	Ability of business to pay both short-term & long-term liabilities as they fall due. Indicates if the business has long term financial stability  Gearing: shows how much debt finance business has acquired to fund its operations compared to use of equity finance. Most businesses use a mixture of both.  There must not be too much cash or too little cash to pay liabilities.

 

Short-Term and Long-Term Objectives 

• Long term objectives (strategic, generally 5yrs+) are broader goals achieved through short term objectives (tactical plans, 1-2yrs) which are reviewed more regularly. 
• The overall long-term objective of financial management is to increase owner’s wealth; this is dependent on profitability in the short-term resulting from increased operating efficiency. 

 

Interdependence with Other Key Business Functions

Operations

• Finance is required for inputs, machinery, land etc. to create value whilst receiving a return on investments
• Operations manages stock & outsourcing whilst finance monitors the cost of it 

 

Marketing

• Generates sales which assists with the short-term financial goal of managing cash flow
• Finance establishes budgets and forecasts marketing must follow

 

Human Resources

• Finance provides funds for wages/salaries & HR strategies such as training/development

 

Influences on Financial Management 

 

Sources of Finance 

Internal Sources of Finance 

Internal funds are obtained from within the business:

1. Owners equity

Funds contributed by owners/partners to establish and build the business, can be raised in other ways such as taking on another partner, issuing private shares or selling unproductive assets.  

 

1. Retained profits = PART OF OWNERS EQUITY

Earnings that instead of being distributed to shareholders in dividends, are kept in the business as a cheap and accessible source of finance. On average in Australia 50% of business profits are retained and reinvested. 

 

External Sources of Finance

 

1. Short-term borrowing 

Short term-debt would be repayable within 12 months. O, C, F

 

Bank overdraft

• Allows business to overdraw their account up to an agreed limit & for a specified time to help overcome temporary cash shortfall.
• Gives flexibility to borrow money at short notice through cheque account & assists with short term liquidity issues.
• Interest (variable) is paid on the daily outstanding balance of the account.

 

Commercial bills

• Written instruction to repay a specified amount of money on a specific date in the future. 
• Bank does not provide the funds; it is borrowed from non-bank institutions. However, the bank guarantees its customer will repay the borrowed money. 
• Business receives the money immediately & must pay principal + interest back at a future date. 
• Typically for amounts exceeding $100 000 and for a period of 3-6 months

 

Factoring

• Cash sale of a business’s accounts receivable at a discount to a factoring company 
• Factoring company will pay business the value of the accounts receivable minus a commission or fee. 
• Business receives up to 90% of amount of receivables within 48hrs of submitting its invoices to the factoring company which will take over management & collection of the unpaid accounts under terms agreed with the business.
• Method of improving liquidity at the expense of some of the businesses working capital in the short term.

 

1. Long-term borrowing 

Loans with a term of repayment longer than 12 months. Can be secured or unsecured. Used to finance real estate, plant (factory/office) and equipment. M, D, U, L, T

 

Mortgage

• Used to fund property purchases e.g. land, factory site, offices 
• Property asset becomes the security for the repayment of the loan (bank can sell)
• Regular repayments + interest over an agreed period of time 

 

Debentures

• Secured loans made by a company to a business for a fixed rate of interest & period of time 
• Lender becomes debenture holder and has the security of the business’s assets 
• Used by large established companies to buy buildings, equipment.

Unsecured notes (bonds)

• Issued by finance companies to gain funds
• Loan for a set period of time that is not secured by any assets 
• Interest higher than that of a debenture as it presents higher risk to the investor 

Leasing

• Businesses lease non-current assets e.g. company car, delivery vehicles, equipment, office or factory space.
• Reduces cost of acquiring the asset as business rents it rather than paying the full value. 
• Firm will be obligated to pay the other business rent.