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Role of Financial Management

Strategic role of Financial Management

Strategic financial management is the process of setting objectives throughout

the business and deciding what resources are needed to achieve these
objectives.
The finance part comes through the specific decisions as to how the resources
will be financed.
Financial management has a strategic role because it takes place in a changing
environment and plans need to be flexible and ready to change.
Strategic financial planning sets out the broad series of steps that need to be
taken to achieve the business strategic objectives.
Examples of changing business environments:
o Taxation and other laws
o Technology
o Economy
o Financial Innovations
Within this changing environment the foals of the business need to be reached.
o Liquidity
o Solvency
o Profitability
o Growth
o Efficiency

Objectives of Financial Management

Liquidity
A business is liquid when it can pay its debts as they fall due.
The relationship between current assets and current liabilities.
A business must have sufficient cash flow to meet its financial obligations or to
be able to convert current assets into cash quickly; for example by selling
inventory.
Controls over the flow of cash into and out of the business ensure that it has
supplies of cash when needed.
Cash shortfalls and excess cash must be avoided as both involve loss of
profitability for a business.
Also known as current ratio, liquidity ratio and working capital ratio

Profitability
Profitability is about the size of profit relative to the size of the business
operations.
Profitability is the ability of a business to maximise its profits.
Profits satisfy owners or shareholders in the short term but are also important
for the longer-term sustainability of a firm.
High profitability:
o Improves confidence in the business by all stakeholders
o Makes it easier to attract new capital (growth)

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o Owners are satisfied with the return

To improve profitability:
o Increase revenues, this means either sell more or sell at a higher price or
both.
o Decrease expenses, this means improving efficiency.

Efficiency
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.
A business that is reducing costs is improving efficiency.
Achieving efficiency requires a firm to have control measures in place to monitor
assets.
A business that aims for efficiency must monitor the levels of inventories and
cash and the collection of receivables.
Improving productivity will:
o Reduce costs
o Increase outputs from the same amount of inputs
o Keep output constant with reduced inputs

Growth
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.
Growth is an important financial objective of management as it ensures that the
business is sustainable into the future.
It improves potential profits and investor returns and makes a takeover of a
business that much harder.

Solvency
Solvency is the extent to which the business can meet its financial commitments
in the longer term.
Solvency is important to the owners, shareholders and creditors of a business
because it is an indication of the risk to their investment.
Solvency indicates whether a business will be able to repay amounts that have
been borrowed for investments in capital, such as equipment and machinery.
Also known as gearing, debt to equity ratio.
The higher the gearing (the higher the debt), the riskier the business.

Short-Term and Long-Term
Financial objectives of a business are based on the goals of its strategic plan,
which can be translated into both the short and long term.
Short-term financial objectives:
o The tactical (one to two years) and operational (day to day) plans of a
business.
o 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.

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o For example, if management has a goal to achieve a 15 per cent increase

in profit for the next 10 years, the tactical plans might involve purchasing
additional machinery, updating old equipment with new technologies,
expanding into new markets and providing new services.
Long- term financial objectives:
o The strategic plans of a business.
o They are determined for a set period of time, generally more than five
years.
o They tend to be broad goals such as increasing profit or market share,
and each will require a series of short-term foals to assist in its
achievement.
o The business would review their progress annually to determine if
changes need to be implemented.

Interdependence with other key business functions

To best explain this section we need to use an example, but you can just morph this
flow chart to fit a case study in the exam.

1. Strategic goal to increase profit by 25% in 2 years
2. Each KBF comes up with a plan and budget to help achieve this goal.
3. Marketing to introduce a new product $4m
4. After getting the marketing plan:
a. Operations plan to extend the factory (to allow the new product to be
made) $1.5m
b. Human Resources decides to employ an additional 15 workers to man the
new product line $750 000 per annum
5. Finance gets the above 3 plans and determines how to finance the $6.25m. After
assessing the current financial position of the firm, the finance manager determines
the business cannot finance the $6.25m. The most the business can finance is $3m
debt and $1.25 equity.
6. The finance manager will go back to the other 3KBF managers and they will each
nee to network their plans within the new budget.
7. Interdependence

Influences on Financial Management

Internal Sources of Finance
Retained Profits
When a business makes a profit, it must decide how to use it to benefit the
business/owner.
Profits if retained within the business can be used to retire debt or to purchase
new equipment or assets.
Either way the retained profits will increase the owners equity and it will
improve the debt to equity ratio.

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Sale of Assets
A business may own assets it no longer needs or assts that could be better used
if turned into cash (liquidated).
One source of equity is to sell non-current assts and use the cash for the project
(or part there of).
The asset would need to be considered redundant (not needed) for this option to
be available.

New Capital Injection by the Owner/s
Especially in small businesses the owners funds could be considered coming
from within the business.

External sources of Finance

Debt Short Term Borrowing

Overdraft
An overdraft is when a bank allows a business to withdraw more than it has in
its account.
Overdrafts are used to overcome cashflow shortages.
An overdraft is a short-term loan often repaid within a few days, interest is
charged daily.
Overdrafts are relatively expensive.
If an overdraft was needed/used every month it would be a sign there is a
problem and something would need to be changed (marketing, sales or
expenses)

Commercial Bills
A bill is a guarantee by a bank to pay an amount.
It could be for a short period of time.
Interest is cheaper than an overdraft.
Commercial bills are quite flexible.

Factoring
Is the selling of accounts receivable or debtors.
If a business uses a factor then when it sends an invoice to a credit customer, it
sends a copy to the factoring institution usually a bank.
The factoring institution will immediately deposit an amount (usually 90-95% of
the invoice) into the business account. When the credit customer pays the full
amount of the invoice the bank receives its money back (90-95%) plus (5-10%)
extra which is the banks income.

Debt Long Term Borrowing
Mortgage
A mortgage is a very long-term loan secured by real property, such as land or
buildings.
Because the loan is secured the interest rate is relatively low.
If the borrow defaults on the loan, the bank (mortgage holder) will sell the land
and building to recoup its money.

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Debentures
Only available to public companies.
A company can borrow large sums of money by selling debentures to
members of the public and institutions like superannuation funds.
A debenture is a loan to a company for a set period of time, for instance 2 3 or 5
years.
They pay an attractive market rate of interest and they are secure by an asset of
the company selling them.

Unsecured Notes
These are the same as debentures except
o There is no asset backing them, they are unsecured.
o Because they are unsecured the interest rate they pay is higher.

Leasing
Rather then having one large outlay for a purchase either debt or equity-
business can lease equipment, land or buildings.
Leasing involves small regular payments for the use of an asset.
Leasing is often used to assist cash flow management.

Equity
Ordinary Shares
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 and may receive payments called dividends.
Value is determined by a companys current or future performance.

New Issues/New Shares
A security that has been issued and sold for the first time on a public market.
New shares are sold on the primary market.
The company sells the new shares and the money from the sale is then available
for use.
The purchasers of the new shares are now owners of the business and are
entitled to a share of the profits (dividends) and to vote at the companys AGM.
After a share is purchased for the first time from which the company gets the
money no subsequent sale involves the company receiving money. The owner
of the shares gets the money I they sell. The company only records the sale and
the details of the new owner.

Rights Issue
The privilege granted to shareholders to buy the right to buy new shares in the
same company.

Placements
Allotment of shares, debentures and so on made directly from the company to
investors.

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Share Purchase Plan
An offer to existing shareholders in a listed company the opportunity to purchase
mores shares in that company without brokerage fees.

Private Equity
Private equity is the money invested in a (private) company not listed on the
Australian Securities Exchange.
The aim of the private company (like the publicly listed companies who sell
ordinary share) is to raise capital to finance future expansion/investment of the
business.

Financial Institutions

Banks
Banks are the largest form of financial institution in Australia.
Most important source of funds for businesses.
Banks receive savings as deposits from individuals, businesses and governments,
and, in turn, make investments and loans to borrowers.
Most of the funds provided through financial markets come from banks that
operate on their own behalf or on behalf of other corporations.
Banks perform an increasingly wide range of roles rather than specialising in one
area, and have subsidiaries in superannuation and mutual, and other funds.
Banks are supervised by the reserve bank of Australia.

Investment Banks
Investment banks make up one of the fastest growing sectors in the Australian
financial system, providing services in both borrowing and lending, primarily to
the business sector.
Investment Banks:
o Trade in money, securities and financial futures
o Arrange long-term finance for company expansion
o Provide working Capital
o Arrange project finance
o Advise clients on foreign exchange cover
o Operate untie trusts including cash management trusts, property trusts
and equity trusts.
o Arrange overseas finance.

Finance and Life Insurance Companies
Are non-bank financial intermediaries that specialise in smaller commercial
finance.
Finance companies act primarily as intermediaries in financial markets. They
provide loans to businesses and individuals through consumer high-purchase
loans, personal loans and secured loans to businesses.
Finance companies are also the major providers of lease finance to businesses
and some specialise in factoring or cashflow financing.
Finance companies raise capital through share issues (debentures)

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Insurance companies provide loans to the corporate sector through receipts of

insurance premiums, which provide funds for investments. They provide large
amounts of both equity and loan capital to businesses.
Insurance can be general insurance (covering property or accident) or life
insurance. The funds received in premiums, called reserves, are invested in
financial assets. The premiums paid by investors provide for compensation or for
savings for future needs.

Superannuation Funds
Have grown rapidly in Australia over the past 20 years due to tax incentives and
compulsory superannuation introduced by the government.
These organisations provide funds to the corporate sector through investment of
funds received from superannuation contribution.
Superannuation funds are able to invest in long-term securities as company
shares, government and company debt because of the long-term nature of their
funds.

Unit Trusts
Also knows as mutual funds.
Take funds from a large number of small investors and invest them in specific
types of financial assets.
Unit trusts investments include the short-term money market (cash management
trusts), shares, mortgages and property, and public securities.
Usually connected to a management firm that manages a diversified investment
portfolio for its investors.

Australian Securities Exchange
The Australian securities exchange (ASX) is the primary stock exchange group in
Australia.
The ASX functions as a market operator, clearing house and payments system
facilitator.
It oversees compliance with its operating rules and promotes standards of
corporate governance among Australias listed companies.

Products and Services include:
o Shares
o Real estate investment funds
o Listed investment Companies
o Interest rate Securities
The ASX acts as a primary market. This primary market enables a company to
raise new capital through the issue of new 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.

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Influence on Government

The government influences a business 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 Australian Securities and Investments Commission (ASIC)
The ASIC is an independent statutory commission accountable to the
commonwealth parliament.
It enforces and administers the corporations Act and protects consumers in the
areas of investments, life and general insurance, superannuation and banking
(except lending) in Australia.
The aim of the ASIC is to assist in reducing fraud and unfair practices in financial
markets and financial products.
The 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.

Company Taxation
Companies and corporations in Australia pay company tax on profits. This tax is
levied at a flat rate of 30%; unlike personal income taxes, which use a
progressive scale.
Company tax is paid for before profits and distributed to shareholders as
dividends.
The Australian government has undertaken a process of reform of the federal tax
system that will improve Australias international competiveness. This will mean
more jobs and higher wages for working Australians, as the reform will affect
long-term economic growth.

Global Market Influences

Global 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 (economic growth is to increase) then this will impact on
the financial decisions of a business. This may include:
o Increasing demand for products and services and therefore a business
would need to increase production to meet demand.
o Decrease the interest rates on funds borrowed internationally from the
financial money market.
A poor economic outlook will impact on financial decisions of a business in the
opposite way to the above examples.

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.

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The international financial markets are made up of a range of institutions,

companies and governments that are prepared to lend money to individuals,
companies or governments who made need to raise capital.
There are various conditions and rates that apply and these will be based
primarily on:
o Risk
o Demand and Supply
o Domestic economic conditions

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.
Overseas interest rates can be lower than in Australia it is possible for
Australian businesses to borrow from countries with lower interest rates. The
problem here is fluctuating exchange rates.
If the exchange rate moves unfavourably for the Australian borrow, they may
end up paying back a lot more than they originally calculated.
Australian exporters love:
o A weak Australian dollar
o A strong global economy
Australian importers love:
o A strong Australian dollar
o A global economy in which prices are low.

Processes of Financial Management

Planning and Implementing

Financial Needs
How much finance is needed for the plan of the business?
Will it be debt or equity and how much of each?
To determine where a business is headed and how it will get there, it is
important to know what its needs are.
Important financial information needs to be collected before future plans can be
made.
This financial information includes balance sheets, income statements, cash flow
statements, sales and price forecasts, budgets, bank statements, weekly reports
from departments, break-even analysis, reports from financial ratio analysis and
interpretation.
The financial needs of a business will be determined by:
o The size of the business
o The current phase of the business cycle
o Future plans for growth and development
o Capacity to source finance debt and/or equity
o Management skills for assessing financial needs and planning.

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Budgets
A forecast of anything can be a budget.
Budgets are predictions made based upon past experiences.
Budgets are used in both the planning and the control aspects of a business.
Budgets provide information in quantitative terms (that is, as facts and figures)
about requirements to achieve a particular purpose.
Budgets can be drawn up to show:
o Cash required for planned outlays for a particular period
o The cost of capital expenditure and associated expenses against earning
capacity.
o Estimated use and cost of raw materials or inventory.
o 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 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, control of
stocks, price setting, financial requirements, control of expenses and of
production cost.
Factors that need to be considered in creating a budget are:
o Review of past figures and trends, and estimates gathered from relevant
departments in the business.
o Potential market or market share, and trends and seasonal fluctuations in
the market.
o Proposed expansion or discontinuation of projects.
o Proposals to alter price or quality of products
o Current orders and plant capacity
o Considerations from the external environment for example, financial
trends from the external environment, availability of materials and
labour.
Common budgets include:
o Income and Sales
o Expenses
Budgets can be made for:
o Sick days
o Customer complaints
o New customers
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.
Project budgets relate to capital expenditure, and research and development.
Financial budgets relate to the financial data of a business.

Record Systems

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Record systems are the mechanisms employed by a business to ensure that data
is recorded and the information provided by the record systems is accurate,
reliable, efficient and accessible.
In order to more accurately monitor budgets and the progress of the plan,
businesses need a record/accounts/finance system.
From the smallest one-person business to the largest public company,
accounting software such as MYOB and QUICKEN are used to store and retrieve
information.
Balance sheets, revenue statements and cash flow statements are produced
always comparing planned vs. actual.
Minimising errors in the recording process, and producing accurate and reliable
financial statements are important aspects of maintaining record systems.

Financial Risks
Financial risk is the risk to a business of being unable to cover its financial
obligations, such as the debts that a business incurs through borrowings, both
short and long-term.
The financial risk is that businesses wont be able to pay its bills as they fall due.
Debt incurs interest, the more debt the more interest must be paid.
The more debt the higher the financial risk to a business.
In assessing financial risk for a business, consideration must be given to:
o The amount of the businesses borrowings
o When borrowings are due to be repaid.
o Interest rates
o The required level of current assets needed to finance operations.
To minimise financial risk, businesses must consider the amount of profit that
will be generated. The profit must be sufficient to cover the cost of debt as well
as increasing profits to justify the amount of risk taken by owners and
shareholders.
Note: This is why the debt to equity ratio and solvency is so important. Too much
debt = too much financial risk = high business failure.

Financial Controls
Budgets, regular data and comparing planned vs. actual are how businesses
control and monitor their financial (and all) plans.
Financial problems and losses prevent a business from achieving its goals. Some
examples include:
o Theft and fraud
o Damage or loss of assets
o Errors in record systems
Financial controls ensure that the plans that have been determined will lead to
the achievement of the businesss goals in the most efficient way.
The policies and procedures of a business are designed to ensure that
management and employees follow them. Control is particularly important in
assets such as accounts receivable, inventory and cash.
Some common policies and procedures that promote control within a business
are:

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o
o
o
o
o
o

Clear authorisation and responsibility for tasks in the business

Separation of duties
Rotation of duties
Control of cash, such as the use of cash registers and cash banked daily
Protection of assets, such as buildings being locked at night
Control of credit customers, such as following up on overdue accounts

Debt and Equity Financing
The amount of debt that is appropriate for a business depends upon how
accurate the cash flow forecast/budget can be.
Businesses that can more accurately predict their income and expenses cash flow
can increase debt (to a point) safely.














Advantages

Debt
Funds are usually readily available.
Increased funds should lead to
increased earnings and profits.
Debt attracts an interest liability
and interest is tax deductible.
Debt does not dilute ownership

Disadvantages

Increased risk if debt comes from

financial institutions because the

interest, bank charges, government
charges and principal all have to be
repaid.
Security is required by the

Equity
Does not have to be repaid
unless the owner leaves the
business.
Cheaper than other sources of
finance as there are no interest
payments.
The owners who have
contributed the equity retain
control over how that finance is
used (have a say)
Low gearing (use resources of
the owner and not external
sources of finance)
Less risk for the business and
the owner.
Lower profits and lower returns
for the owner.
The expectation that the owner
will have about the return on
investment (ROI)
Perpetual claim on the assets
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business.
Regular repayments have to be
paid.
Lenders have first claim on any
money if the business ends in
bankruptcy.

Comparison of Debt and Equity Finance
Debt
Lenders have prior claim in the event of
liquidation
Debt must be repaid by periodic repayments
Interest payments are tax deductible
Lenders usually require a lower rate of
return
Interest payments are fixed

and income of the business.

Unlike debt, equity has no
maturity date.
Equity has no tax deductible.

Equity
Shareholders have a residual claim on assets
Equity has no maturity rate
Dividends are not tax deductible
Shareholders require higher return due to
higher risk
Dividend payments are not fixed and may be
reduced through lack of funds
Equity holders have voting rights

Debt providers have no voting rights

Matching the Terms and Source of Finance to Business Purpose
Choices of how to finance will be influenced by:
o The terms of finance must be suitable for the structure of the business
and the purpose for which funds are required.
o The cost of each source of funding.
o The structure of the business.
o Costs including set up costs and interest rates.
o Flexibility of the source of finance.
o The availability of funds.
o The level of control maintained by the business.








Monitoring and Controlling
When a business has a plan in place it needs to be monitored and controlled. In the
financial sense, the balance sheet, cash flow and revenue statements need to be
monitored carefully when it is evident that actual performance is varying too much

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from planned performance then changes to the plan need to be implemented.
Changes could be:
Marketing
Expenses and Budgets
Even the goal could be changed
Personnel (Staff)

Cash Flow Statement
A cash flow statement is one of the key financial reports that are part of effective
financial planning.
It provides the link between the income statement and balance sheet, as it gives
important information regarding a firms ability to pays its debts on time.
The cash flow statement indicates the movement of cash receipts and cash
payments resulting from transactions over a period of time.
Potential shareholders check that a business has had positive cash flows over a
number of years. A fluctuating pattern of cash flows might point to difficulties in
the business.
Cash flows can be a better predictor of a business status than profitability. A
statement of cash flows can show whether a firm can:
o Generate a favourable cash glow (inflows exceed outflows)
o Pay its financial commitments as they fall due
o Have sufficient funds for future expansion or change
o Obtain finance from external sources when needed
o Pay drawings to owners or dividends to shareholders.
In preparing a cash flow statement, the activities of a business are generally
divided into three categories operating, investing and financing activities.
Operating activities are the cash inflows and outflows relating to the main
activity of the business. Income from sales makes up the main operating inflow
plus dividends and interest received. Outflows consist of payments to suppliers,
employees and other expenses such as rent etc.
Investing activities are the cash inflows and outflows relating to the purchase and
sale of non-current assets and investments.
Financing activities are the cash inflows and outflows relating to the borrowing
activities of the business.
The cash flow statement, income statement and balance sheet are used to show
how effectively finance is being used in a business.

Income Statement
The income statement shows the operating efficiency that is, income earned
and expenses incurred over the accounting period.
Income is the earnings from the main objectives of the business.
Expenses are recurring amounts that are paid out while the business earns its
revenue.
The income statement shows:
o Operating income earned from the main function of the business, such as
sale of stock and non-operating revenue earned from other operations,
such as interest rent and commission.

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o Operating expenses such as, the purchase of stock and other expenses
incurred in the main operation of the business, such as advertising and
rent.
By examining figures from previous income statements, managers can make
comparisons and analyse trends before making important financial decisions.
They can see whether expenses are increasing, decreasing or remaining the same
and why profits are increasing or decreasing.

Balance Sheet
A balance sheet represents a business assets and liabilities at a particular point
in time and represents the net worth (equity) of the business.
The balance sheet shows the level of current and non-current assets, current and
non-current liabilities, including investments and owners equity.
The balance sheet shows the financial stability of the business and analysis of the
balance sheet can indicate whether:
o The business has enough assets to cover its debts
o The interest and money borrowed can be paid
o The assets of the business are being used to maximise profits
o The owners of the business are making a good return on their
investment.
o The years figures compare with the previous year.

Financial Ratios
Comparative Ratio Analysis
Comparing a business analysis against other figures, percentages and ratios
allows for judgements to be made. This is known as comparative ratio analysis
and is important for businesses.
Comparisons can be made in a number of ways.
Ratio analysis taken for a business over a number of years can be compared with
similar businesses and again common industry standards or benchmarks.
Figures from at least the previous two years can indicate directions or trends and
make ration analysis more meaningful.
Comparisons can be made over different time periods, against standards, or with
similar businesses.
Analysis can also include budget figures so that predicted figures can be
compared against actual figures.
Comparison with other businesses and benchmarking are common. However,
care must be taken to ensure that the same things are compared. Also, each
business has differences, and finding comparable firms may be difficult.




Limitations of Financial Reports
Normalised Earnings

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This is the process of removing one time or unusual influences from the balance
sheet to show the true earnings of a company. An example of this would be the
removal of a land sale, which would achieve a large capital gain.

Capitalising Expenses
This is the process of adding a capital expense to the balance sheet that is
regarded as an asset (in that it will add to the value of the company and is
therefore recorded on the balance sheet) rather that an expense (in this
situation, it would be recorded on the income statement).
Examples of capitalising expenses include:
o Research and Development
o Development Expenditure

Valuing Assets
This is the process of estimating the market value of assets or liabilities. The
valuations can be used in a variety of contexts for a business, including
investment analysis, mergers and acquisitions and financial reporting.
Two main methods used for valuing assets include:
o Discounted cash flow method. This method estimates the value of an
asset based on its expected future cash flows, which are discounted to
the present (i.e. the present value)
o Guideline company method. This method determines the value of a
business by observing the prices of similar companies (guideline
companies) that are sold in the market.

Timing Issues
Financial reports cover activities over a period of time, usually one year. Therefore,
the businesss financial position may not be a true representation if the business has
experienced seasonal fluctuations.

Debt Repayments
Financial reports can be limited because they do not have the capacity to
disclose specific information about debt repayments such as:
o How long the business has had or has been recovering the debt
o The capacity of the business or its debtor to repay the amounts owed
o The adequacy of provisions and methods the business has for the
recovery of debt.
o What provision does the business have in place for doubtful debts and
how is this evident in the financial reports
o Have debt repayments been held over until another accounting period
therefore giving a false impression of the situation
The recording of debt repayments on financial reports can be used to distort the
reality of the businesss status and this may be undertaken to provide a more
favorable overview of the business at that point in time.

Notes to the Financial Statements
Notes to the financial statements report the details and additional information

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that are left out of the main reporting documents, such as the balance sheet and
income statement.
These notes contain important information such as the accounting methods used
for recording and reporting transactions that can affect the bottom-line return
expected from an investment in a company.

Ethical issues related to Financial Reports

If debt funds are used extensively to finance activities in a business, although
debt funds may be used to increase profits, there is added risk for shareholders.
The impact of debt funds on risks to shareholders is an ethical issue that must be
considered.
In preparing budgets, the expenditures and revenues are estimated. The
common practice in business is overestimating expenditures and understanding
revenues to allow for unexpected and uncertain events is an ethical issue for a
business.
Ethical considerations are closely related to legal aspects of financial
management. Legislation is in place to guard against unethical business activity
but there is often a time lag between the recognition of a problem and its
implementation through law.

Audited Accounts
An audit: is an independent check of the accuracy of financial records and
accounting procedures.
Potential users of information include financial institutions, owners and
shareholders and potential investors who rely on this information before making
a decision about the business.
Audits are an important part of the control function and are generally used to
examine the financial affairs of a business.
There are three types of Audits:
o Internal Audits
o Management Audits
o External Audits
Internal and external audits assist in guarding against unnecessary waste,
inefficient use of resources, misuse of funds, fraud and theft.
External auditors are used to provide an annual audit of accounting practice and
procedures.

Record Keeping
All accounting processes depend on how accurately and honestly data is
recorded.
Source documents must be created for every transaction, even those in which
cash has changed hands.



Goods and Services Tax (GST) Obligations
Businesses have an ethical and legal obligation to comply with the GST reporting

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requirements.

Reporting Practices
Not only are accurate financial reports necessary for taxation purposes, but
other stakeholders are entitled to access to a business financial information
Shareholders in a private company are legally entitled to receive financial reports
annually, even if the company is a small business and the shareholders are family
members.

Financial Management Strategies

Cash Flow Management

Cash flow is the movement of cash in and out of a business over a period of time.
If more money goes out than comes in, or if money must be paid out before cash
payments have been received, there is a cash glow problem.
Inflows include:
o Sales
o Accounts Receivable
o Commissions
o Sale of Assets
o Interest on investments
o Dividends
Outflows include:
o Payments to suppliers
o Interest on loans
o Operating expenses
o Purchase of Assets
o Loan Repayments

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.

Management Strategies
A business may have temporary shortfalls of cash. Many businesses use bank
overdrafts to cover these shortages.
Shortfalls of cash over longer periods are of greater concern for a business as
insolvency or bankruptcy may result.

Distribution of Payments
An important strategy involves distributing payments throughout the month,
year or other period so that cash shortfalls do not occur.

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A cash flow projection can assist in identifying periods of potential shortfalls and
surpluses.

Discounts for Early Payment
Another cash flow management strategy is offering creditors a discount for early
payments.
This strategy is most effective when targeted at those creditors who owe the
largest amounts over the financial year period.
This is not only beneficial for the creditors who are able to save money and
therefore improve their cash flow, but it also positively affects the business cash
flow status.


Factoring
Factoring is 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 on unpaid accounts and
debt collection.
Factoring is growing in popularity as a strategy to improve working capital.

Working Capital Management

Short-term liquidity is important for businesses. It means a business can take

advantage of profit opportunities when they arise, as well as meet short-term
financial obligations.
A business must have sufficient liquidity so that cash is available or current assts
can be converted to cash to pay debts.
A lack of short-term liquidity could result in the sale of non-current assets to
raise cash. In the long-term this can lead to reduced profitability for owners and
shareholders.
Working capital management involves determining the best mix of current assets
and current liabilities needed to achieve the objectives of the business.

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 in turn to increased costs and liquidity
problems.
Excess cash is a cost if left idle and unused.
Control of current assets requires management to select the optimal amount of
each current asset held, as well as raising the finance required to fund those
assets.
The costs and benefits of holding too much or too little of each asset must be
assessed.
Working capital must be sufficient to maintain liquidity and access to credit
(overdraft) to meet unexpected and unforeseen circumstances.

Cash

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Cash is critical for business success, and careful consideration must be given to
the levels of cash receivables and inventories that are held by a business.
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.
Cash shortages can, however, occur due to unforeseen expenses and they are a
cost to the business.

Accounts Receivable
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.
The quicker the debtors pay, the better the business cash position.
Procedures for managing accounts receivable include:
o Checking the credit rating of prospective customers
o Seeking customers statements monthly and at the same time each month
so that debtors know when to expect accounts
o Following up on accounts that are not paid by the due date
o Stipulating a reasonable period for the payment of accounts
o Putting policies in place for collecting bad debts, such as using a debt
collection agency.
The disadvantage of operating a tight credit control policy is the possibility that
customers might choose to buy from other firms. Management must weigh up
the costs and benefits carefully.

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.
Insufficient inventory of quick-selling items may also lead to loss of customers,
and hence lost sales.
Inventory is a cost to the business if it remains unsold.
Businesses must ensure that inventory turnover is sufficient to generate cash to
pay for purchases and to pay suppliers o time so that they will be willing to give
credit in the future.

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

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Accounts Payable
A business must monitor its payables and ensure that their timing allows the
business to maintain adequate cash resources.
The holding back of accounts payable until their final due date can be a cheap
means to improve a firms liquidity position, as some suppliers allow a period of
interest-free trade credit before requiring payment for goods purchased.
It may also be possible to take advantage of discounts offered by some creditors.
This reduces costs and assists with cash flow.
Accounts must, however, be paid by their due dates to avoid any extra charges
imposed for late payment and to ensure that trade credit will be extended to the
business in the future.


Control of accounts payable involves periodic reviews of suppliers and the credit
facilities they provide, for example:
o Discounts
o Interest free credit periods
o Extended terms for payments, sometimes offered by established
suppliers without interest or other penalties.

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 costs.
Short-term loans are generally an 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 used to meet the short-term financial
commitments of the business.
Overdrafts
Bank overdrafts are a convenient and relatively cheap form of short-term
borrowing for a business. They enable a business to overcome temporary cash
shortages.
Features of overdrafts differ between banks, but generally involve an
arrangement with the bank that the business account can be overdrawn to a
certain amount.
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 that for a loan.
Bank charges do, however, 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 supplies can be

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controlled.
Strategies
Leasing
Leasing is the hiring of an asset from another person or company who has
purchased the asset and retains ownership of it.
Leasing frees up cash that can be used elsewhere in a business, so the level of
working capital is improved.
It is an attractive strategy for some businesses as it is an expense and is tax
deductible.
Firms can also increase their number of assets through leasing and this means
that revenue, and therefore profits, can be increased.
Regular and fixed payments made for the lease can be planned to match the
business cash flow.
While most loans require a deposit so that a firm can borrow only 90 to 95 per
cent of the purchase price of the asset, leasing allows 100 per cent financing.

Sale and Lease-Back
Sale and lease-back is the selling of an owned asset to a lesser and leasing the
asset back through fixed payments for a specified number of years.
Sale and lease-back increases a business liquidity because the cash that is
obtained from the sale is then used as working capital.

Profitability Management

Profitability management involves the control of both the businesss costs and its
revenue.
Accurate and up-to-date financial data and reports are essential tools for
effective profitability management.

Cost Controls
Most business decisions are influenced by costs.
The costs associated with a decision need to be carefully examined before it is
implemented.

Fixed and Variable Costs
Before a business can control its costs, management must have a clear
understanding of what those costs are.
Fixed costs are not dependent on the level of operating activity in a business.
Fixed costs do not change when the level of activity changes they must be
paid regardless of what happens in the business.
Examples of fixed costs are salaries, depreciation, insurance and lease.
Variable costs are those that change proportionately with the level of operating
activity in a business. For example, materials and labour used in the production
of a particular item are variable costs, because they are often readily identifiable
in a business and can be directly attributable to a particular product.
Monitoring the levels of both 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.

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Comparisons of costs with budgets, standards and previous periods ensure that
costs are minimised and profits maximised.

Cost Centers
A business costs and expenses must be accounted for, and management needs
to be able to identify their source and amounts.
A number of costs can be directly attributable to a particular department or
section of a business, and these are termed cost centers.
Cost centers have direct and indirect costs.
Direct costs are those that can be allocated to a particular product, activity,
department or region.
Indirect costs are those that 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 encourage staff to minimise
expenses where possible.
Savings can be substantial if people take a critical look at costs and eliminate
waste and unnecessary spending.

Revenue Controls
Revenue is the income earned from the main activity of a business.
For most businesses, revenue comes from sales or, in the case of a service
business, from fees for professional services or commission.
In determining an acceptable level of revenue with a view to maximizing 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
Sales objectives must be pitched at a level of sales that will cover costs, both
fixed and variable, and result 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.
Pricing policy affects revenue and, therefore, affects working capital.
Pricing decisions should be closely monitored and controlled. Overpricing could
fail to attract buyers, while under pricing may bring higher sales but may still
result in cash shortfalls and low profits.
Factors that influence pricing include:
o The costs associated with producing the goods or service
o Prices charged by the competition
o Short and long term goals of the business
o The image or level of quality that people associate with the goods or
services
o Government policies.

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