Business Studies - Financial Planning and Management Study Notes Financial Planning and Management Study Notes: The

Role of Financial Planning: The strategic role of financial management: Organisational objectives provide a greater detail about the organisations mission Organisation objectives brea! do"n the business operations into achievable outcomes that can be measured and evaluated Strategic Plans: #ncompass a long term vie" of "here the organisation is going$ ho" it "ill get there and a monitoring process to !eep trac! of progress along the "ay Objectives of Financial Management: %i&uidity: 'efers to the ease "ith "hich an asset can be converted cash More importantly it is the ease of a business to meet its short term liabilities Profitability: (s the ability of a business to ma!e a financial return from business activities #fficiency: is generating ma)imum returns for the minimum costs *ro"th: is the increase in the si+e and value of a business over time 'eturn on capital: ,apital is the amount of funds that is invested in a business to create "ealth These funds are referred to as o"ners e&uity The Planning Cycle: The planning cycle is an integral part of the business plan This cycle is ongoing and includes:
-ddressing the present financial position

.etermining financial elements of the business plan .eveloping budgets ,ash flo"s Financial reports
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(nterpretation of financial reports

Maintaining record systems Planning financial controls Minimising financial ris!s and losses

-ddressing the preset financial position: - situational analysis of the current financial position is the basis for effective financial planning .ata driven identification of current financial issues and trends "ill assist the development of appropriate budgets$ analyses$ strategies and controls in the planning cycle .etermining financial elements: The business plan sets out goals and future direction 0vision4 of the business$ including "here the business e)pects to be at the end of a particular time period The financial elements of the plan "ill identify the amount of finance needed$ the sources of finance available and the methods of reporting financial data to support the strategies developed to achieve the vision$ goals and objectives of the business plan .eveloping 5udgets: - budget is a plan predicting revenue 0from sales and investments4 and e)penses of a business for a future time period 5udgets identify anticipated sources of revenue and e)penses and are derived from the overall strategic business plan There are various types of budgets$ including:
The operating budget$ "hich relates to the day to day operation of the business and includes sales$ labour costs and administrative e)penses

Financial budgets$ "hich include the balance sheet$ cash flo" and revenue 0profit and loss statements4 statements

,ash Flo"s: ,ash flo" is the difference bet"een cash inflo"s and cash outflo"s For a business to survive it is necessary to have more cash going in than is going out - cash flo" budget helps a business to predict the cash inflo" and cash outflo"s over specified periods of time ,lose monitoring of the cash flo" position is important so that the business can meet its short term financial commitments Financial 'eports: (nclude statements of financial performance 0'evenue statement4$ statement if financial position 05alance sheet4 These standard reports communicate financial information about the business to sta!eholders$ including o"ners$ shareholders$ employees and government regulatory authorities

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(nterpretation of financial reports: Financial reports re&uire interpretation for the position and performance of a business to be fully understood Financial managers and accountants use the ratio analysis to assist their interpretation of this financial data Maintaining record systems: -re the processes and practices that a business uses to store data such as sales$ e)penses$ assets$ liabilities and customer$ supplier and product information Planning Financial ,ontrols: (s a tool that provides feedbac! on the financial performance of the business Financial controls include budgets$ cash flo" statements$ profit and loss statements and balance sheets Minimising financial ris!s and losses: (s the chance that a financial decision "ill result in a financial loss The main type of financial ris! is that the business "ill not have enough cash flo" to meet its financial commitments .ebt financing also raises the financial ris! of a business Financial Markets relevant to business financial needs: The financial mar!et provides businesses access to a "ide range of financial products This allo"s a business to use the participants e)pertise and to customise the type and use to match the business purpose and structure The t"o main types of financial mar!ets are the:
,apital mar!et

Short term money mar!et

The capital mar!et deals "ith financial securities that help raise long term funds for business This mar!et includes the debt mar!et and the e&uity mar!et The debt mar!et involves the borro"ing and repayments of funds such as mortgages and bonds The e&uity mar!et involves buying and selling of company shares The money mar!et involves the borro"ing and lending of money in the short term This is a highly li&uid form of finance Participants in the money mar!et in debt products that have a maturity date of t"elve months or less Major participants in financial mar!ets: (nclude financial intermediaries$ "hich accept deposits from lenders and ma!e loans to borro"ers Such intermediaries are vital in the provision of e)ternal funding for the establishment$ gro"th and operations of businesses The participants in the financial mar!ets include:
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5an!s

Financial and insurance companies Merchant ban!s Superannuation7 mutual funds ,ompanies *overnment 0'5-4

The role of the -S8 as a primary mar!et: The -S8 has many roles including:
-ssisting companies to raise initial capital finance through the issue of shares$ "hereby those buying the shares become part o"ners in the business

Providing a mar!et for e)isting company shares to be traded bet"een buyers and sellers

Overseas mar!et influences and Trends: - number of overseas influences have affected the -ustralian financial mar!ets including:
9S credit crisis in the subprime mar!et (n 122:$ 9S commercial and investment ban!s "ere affected by the inability of borro"ers to repay their debts

The main domestic mar!et influences are:

Financial deregulation: The regulation of restriction in the -ustralian financial mar!et began in 3;<6 "ith the floating of the -ustralian dollar This deregulation led to an increase in the number of overseas financial institutions$ such as 75arclay 5an! and =S5,$ coming to -ustralia

(nterest 'ates: The '5- sets the cash rate in response to the current economic conditions in -ustralia -n increase in interest rates "ill cause business revenue to decrease as a result of the increase in home loan e)penditure on the common -ustralian consumer ,ompulsory Superannuation: The -ustralian government re&uires employers to contribute an additional ; per cent of an employees salary to a superannuation fund assessable at retirement

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Management of Funds: 5usinesses need to use a mi) of both debt and e&uity finance to achieve their financial objectives Sources of funds: (nternal sources: O"ners #&uity? is the funds contributed by o"ners to establish and build the business 'etained profits: The most common source of internal finance is retained earnings or profits in "hich all profits are not distributed$ but are !ept in the business as a cheap accessible source of finance for future activities #)ternal sources: #)ternal finance is the funds provided by sources outside the business including ban!s$ other financial intermediaries$ government$ suppliers or financial institutions Short term borro"ing: includes overdraft and ban! bills Overdraft is "hen the ban! allo"s a business to dra" che&ues a certain previously settled amount 5an!s bills are short term loans of about ;2? 3<2 days it involves the business getting the money immediately promising that it "ill pay the money bac! at the maturity of the period %ong term borro"ing: Mortgage: a mortgage is a long term loan that is secured by the property of the borro"er The usual length of the loan is 3@ years .ebentures: are issued by a company for a fi)ed rate of interest and for a fi)ed period of time .ebentures are usually not secured to specific property %easing: is a long term source of borro"ing for a business (t involves the payment of money for the use of e&uipment that is o"ned by another party %easing enables an enterprise to borro" funds and use the e&uipment "ithout large capital outlay re&uired Operating %eases: are leases for short periods$ usually shorter than the life of the asset Financial %eases: 9nder the conditions of a financial lease$ the lessor purchases the asset on behalf of the lessee Financial leases are usually for the life of the asset Some advantages of leasing as a source of finance are as follo"s:

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The costs of establishing leases may be lo"er than other methods of financing

(t permits 322 percent financing of assets %ease payments are a ta) deduction

Factoring: (s "here the factor purchases an account receivable from the business for nearly a full percentage of the price (t allo"s the business to gain the money o"ed to them &uic!ly Trade ,redit: (s "here a creditor allo"s the business e)tra time on the repayment of the funds Comparing Debt and equity Finance: Debt
%enders =ave prior claim in the event of li&uidation .ebt must be repaid by periodic repayments

Equity Shareholders have a residual claim on assets #&uity has no maturity date .ividents are not ta) deductible Shareholders re&uire a higher rate of return due to ris! .ividend payments are not fi)ed and may be reduced through lac! of funds #&uity holders have voting rights

(nterest payments are ta) deductable %enders usually re&uire a lo"er rate of return (nterest payments are fi)ed

.ebt providers have no voting rights

*earing7 %everage: (s the proportion of debt 0e)ternal finance4 and the proportion of e&uity that is used to finance the businesses activities *earing7 leverage is an important consideration for businesses as the more highly geared the business 0using debt rather than e&uity4$ the greater the ris! for the business Using Financial Information: Types of financial Ratios: -nalysis: is an important part of the accounting process (t involves "or!ing the financial information into significant and acceptable forms that ma!e it more meaningful and highlighting relationships bet"een aspects of an organi+ation The main types of analysis are vertical$ hori+ontal and trend analysis

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Bertical analysis compares figures "ithin one financial yearC for e)ample e)pressing gross profit as a percentage of sales and comparing debt to e&uity

=ori+ontal analysis compares figures from different financial yearsC for e)ample$ comparing 122: and 122<

Trend analysis compares figures for periods of three to five years (nterpretation: is ma!ing judgements and decisions using the data gathered from analysis %i&uidly: (s the e)tent to "hich the business can meet its current liabilities or short term debt (t is the relationship bet"een current assets and current liabilities and indicates the li&uidity position of the business Solvency: refers to the long term stability of the business Solvency indicates "hether the business can meet its total financial commitments as they fall due Profitability: is the ability to ma!e a financial return from business activities #ffiency: means the amount of return that a business can produce for minimum costs #fficiency ratios provide the basis for assessing ho" efficiently the business is using its assets and spending to create sales and profits 0'atios and other information on table belo"4

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Ratio type Financial ratio

%i&uidity ,urrent ratio

Formula

Reasons for the use of this ratio

Suggested ratio level

The ratio gives an indication The generally preferred of ho" "ell a business can ratio level is 1:3 This meet its current assets means that for every D1 of current assets there is D3 of current liability This means that the business is able to meet its short?term debts comfortably

Solvency

*earing ratio

*earing is the relationship bet"een the level of debt of the business and the level of o"nersE e&uity (f a business is highly geared it faces the possibility of not being able to repay its debt and becoming insolvent

The preferred ratio depends on the specific circumstances but for small business A2F is an acceptable level: for every A2 cents of liabilities there is D3 of o"nersE e&uity The higher the F the greater the financial ris! %arge companies may operate at over 322F The suggested ratio level depends on the type of industry

Profitability

*ross profit ratio

This ratio measures "hat percentage of each dollar of sales is gross profit (t indicates the mar! up on the goods that are sold by the business

Net profit ratio

'eturn on o"nersE e&uity

- gross profit figure of 62 F indicates that The ratio measures "hat every dollar of sales percentage of each dollar contributes 62 c of of sales is net profit (t gross profit to the ta!es into account the business Falling operating e)penses figures or a lo" figure compared to similar This is one of the most businesses "ould be important indicators as it a concern sho"s ho" much the o"nerEs investment and - high or at least ris! in the business is increasing F is earning preferred but it depends on the industry The higher the return the better 9sually over 12 F is a good return

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#fficiency

#)pense ratio

This sho"s the relationship bet"een sales and the e)penses that the business has made in ma!ing those sales T"o steps to calculation: This ratio sho"s ho" long it ta!es for the business to receive cash for its credit sales from the debtors

-ccounts receivable turnover ratio

This depends on the specific circumstances and strtegies that the business may be underta!ing =o"ever$ increasing e)penses over time "ill need closer revie" The standard time to repay credit is bet"een fourteen and thirsty days (f the accounts receivable rate is more than ten days above the standard payment time$ then the business should be concerned

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,omparative ratio analysis: There are three main benchmar!s of "hich a business can compare its financial results to: 34 Past results G historical analysis 14 (ndustry -verage? are you above or belo" industry average for return on O#$ NP$ e)pense ratio$ current ratio and gearing 64 5enchmar! to a standard such as ban! interest rates #g$ return on O# should be above :F "hich is "hat could be earned if the money "ere in the ban! %imitations of financial reports: ,aution needs to be e)ercised in reading the information Misleading information impacts on business decision ma!ing and outs the business at ris! The first consideration that must be made is the effects of an e)ternal shoc!$ if there is a recession then a profit ratio compared to the profit of a time "hen there "as no recession is unreasonable So it must be understood that "hen e)ternal shoc!s are ta!en into account the figures "ould loo! less serious =istorical costs: -s time goes on prices change$ for e)ample if a business is on a property valued 12 years ago then there "ould be a large difference "hen the property is re valued Balue of intangibles: This can include licences$ patents$ trademar!s$ brand names$ intellectual property and good "ill These do not have a value on the balance sheet but can be "orth millions for e)ample the ,oca ,ola name "ould be "orth millions Strategies to Manage:

Working Capital: The first consideration is cash$ "hich should be minimised so an overdraft could be use to manage The second is receivables or accounts rec Factoring is used to speed up the relievable time The final is inventory and a H(T inventory control system "ill minimise holdings of inventory Profitability: ,ont control and #)pense minimisation

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