Role%of%Financial%Management%

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Strategic%Role%of%Financial%Management%
Developing!a!strategic!plan!as!part!of!a!businesss!financial!management!will!ensure!that!the!business!
survives!and!grows!in!the!competitive!business!world.!
!
Businesses!exist!for!a!number!of!purposes!that!are!translated!into!goals.!For!example,!a!businesss!
goals!may!include:!
!
To!increase!the!dividends!to!shareholders!
To!maintain!an!environmentally!friendly!business!
To!be!a!market!leader!within!five!years.!
!
The!main!purpose!or!goal!for!a!business!is!usually!to!maximise!profits.!
!
Strategic)Plan!
Strategic!plans!encompass!a!longBterm!view!of!where!the!business!is!going,!how!it!will!get!there!and!a!
monitoring!process!to!keep!track!of!progress!along!the!way.!The!strategies!that!a!business!uses!to!
achieve!its!goals!are!incorporated!into!a!strategic!plan.!
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Managing)Financial)Resources) !
Financial!resources!are!those!resources!of! !
a!business!that!have!a!monetary!or!money! !
value.!Financial!management!is!the! !
planning!and!monitoring!of!a!businesss! !
financial!resources!to!enable!the!business! !
to!achieve!its!financial!goals.! !
! !
The!mismanagement!of!financial! !
resources!can!lead!to!problems!such!as:! !
! !
Insufficient!cash!to!pay!suppliers! !
Inadequate!capital!for!expansion! !
Too!many!assets!that!are!nonB !
productive! !
Delays!in!accounts!being!paid! !
Possible!business!failure! !
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Overstocking!of!materials!
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Strategies!for!monitoring!the!financial!
!
resources!include:!
! !
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Monitoring!an!businesss!cash!
!
flows!
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Paying!its!debts!
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Developing!financial!control! !
techniques! !
Auditing!of!financial!accounts! !
Continuing!to!make!profits!for!its! !
owners!and!shareholders! !
!
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Objectives%of%Financial%Management%
For!a!business!to!achieve!its!longBterm!goals!it!must!have!a!number!of!shortBterm,!specific!objectives.!
The!objectives!of!financial!management!are!to!maximise!the!businesss:!

ProQitability! Growth! EfQiciency! Liquidity! Solvency!

Profitability:!Profitability!is!the!ability!of!a!business!to!maximise!its!profits.!
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Growth:)Growth!is!the!ability!of!the!business!to!increase!its!size!in!the!longer!term.!
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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.!
!
Liquidity:!Liquidity!is!the!ability!of!a!business!to!pay!its!debs!as!they!fall!due.!A!business!must!have!
sufficient!cash!flow!to!meet!its!financial!obligations!or!be!able!to!convert!current!assets!into!cash!
quickly.!
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Solvency:!Solvency!is!the!extent!to!which!the!business!can!meet!its!financial!commitments!in!the!
longer!term.!Solvency!indicates!whether!a!business!will!be!able!to!repay!amounts!that!have!ben!
borrowed!for!investments!in!capital.!
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Short?Term)and)Long?Term)Financial)Objectives)
Short)Term)Financial)Objectives:!Tactical!(one!to!two!years)!and!operational!(dayBtoBday)!plans!
of!a!business.!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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Long)Term)Financial)Objectives:!Determined!for!a!set!period!of!time,!they!tend!to!be!broad!goals!
such!as!increasing!profit!or!market!share,!and!each!will!require!a!series!of!shortBterm!goals!to!
assist!in!its!achievement.!
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Interdependence%with%Other%Key%Business%Functions%
Without!finance,!there!would!be!very!little!business.!Finance!(funding)!flows!to!each!functional!area!
within!a!business,!which!enables!it!to!achieve!its!goals.!Funds!are!needed!for!marketing!so!that!they!
can!develop!new!plans!for!promoting,!operations!needs!funding!for!the!development!of!the!product,!
and!human!resources!needs!funding!so!that!new!employees!with!necessary!skills!can!be!recruited!and!
selected,!and!trained/retrained.!
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Capital% Owners!contribute!financial!resources!to!a!business!when!it!is!
established!and!throughout!the!business!lifetime.!This!is!called!capital.!
Drawings% The!withdrawal!of!profits!by!the!owner!is!recorded!as!drawings!under!
equity!in!the!balance!sheet.!
Accounts%Receivable% Money!owed!by!customers!(individuals!or!corporations)!to!another!
entity!in!exchange!for!goods!or!services!that!have!been!delivered!or!used,!
but!not!yet!paid!for.!
Current%Assets% Current!assets!are!cash!and!other!assets!that!are!expected!to!be!used,!
sold!or!converted!into!cash!within!12!months.!These!include!cash!in!the!
bank,!accounts!receivable,!inventory!and!prepaid!expenses.!
Current%Liabilities% Current!liabilities!are!debts!that!are!due!to!be!paid!within!12!months.!
These!include!accounts!payable,!bank!overdrafts,!shortBterm!loans,!
interest!payable!on!loans!and!salaries!payable.!
NonECurrent%Assets% NonBcurrent!assets!are!assets!that!include!amounts!expected!to!be!
recovered!more!than!12!months!after!the!reporting!period.!NonBcurrent!
assets!is!not!to!be!converted!to!cash!within!12!months!of!the!balance!
sheet!date,!and!is!not!expected!to!be!consumed!or!sold!within!the!normal!
operating!cycle!of!a!firm!(in!contrast!to!current!assets).!Examples!
include:!property,!plant,!equipment,!investment!property,!and!intangible!
assets!such!as!goodwill.!
NonECurrent%Liabilities% NonBcurrent!liabilities!are!a!businesss!longBterm!financial!obligations!
(debts)!that!are!not!due!within!the!present!accounting!year.!Examples!of!
noncurrent!liabilities!include!longBterm!borrowing,!bonds!payable!and!
longBterm!lease!obligations.!
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 Influences%on%Financial%Management%
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Sources%of%Finance%%Internal%and%External%
A!business!cannot!establish!itself!and!thrive!without!funds!to!enable!it!to!pursue!its!activities.!In!the!
establishment!of!a!business,!owners!and/or!shareholders!usually!contribute!funds.!When!a!business!is!
considering!growth!and!development!in!later!years,!a!number!of!options!can!be!considered!regarding!
sources!of!funds!and!how!those!sources!will!be!used.!Sources!of!funds!may!be!internal!or!external.!

Internal)Sources)
Internal!finance!comes!either!from!the!businesss!owners!(equity!or!capital)!or!from!the!outcomes!of!
business!activities!(retained!profits).!
!
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Owners)Equity:!Owners!equity!is!the!funds!contributed!by!owners!or!partners!to!establish!and!build!
the!business.!
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Retained)Profits:!Retained!profits!are!the!most!common!source!of!internal!finance!!all!profits!are!not!
distributed,!but!are!kept!in!the!business!as!a!cheap!and!accessible!source!of!finance!for!future!
activities.!
External)Sources)
External!finance!refers!to!the!funds!provided!by!sources!outside!the!business,!including!banks,!other!
financial!institutions,!government,!suppliers!or!financial!intermediaries.!Finance!provided!from!
external!sources!through!creditors!or!lenders!is!known!as!debt%finance.!
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The!increased!funds!for!the!business!should!mean!increases!in!earnings!and!hence!profits.!Regular!
repayments!on!the!borrowings!must!be!made!so!firms!have!to!generate!sufficient!earnings!to!make!
the!payments.!
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DEBT:%ShortETerm%Borrowing
ShortBterm!borrowing!is!used!to!finance!temporary!shortages!in!cash!flow!or!finance!for!working!capital!

Bank)Overdraft:!! Commercial)Bills:) Factoring:!!

A!bank!allows!a!business!to! Commercial!bills!are!a!type!of!bill! Factoring!enables!a!business!to!
overdraw!its!account!to!an! exchange!issued!by!institutions! raise!funds!immediately!by!
agreed!limit!!assists! other!than!banks,!and!are!given! selling!accounts!receivable!at!a!
businesses!with!shortBterm! for!larger!amounts,!usually!over! discount!to!a!firm!that!
liquidity!problems!(e.g.! $100,000.!The!borrower!receives! specialises!in!collecting!
seasonal!decrease!in!sales).! the!money!immediately!and! accounts!receivable.!A!factoring!
! promises!to!pay!the!sum!of! company!may!offer!its!services!
! Costs!are!minimal,!and! money!and!interest!at!a!future! with!or!without!recourse.!
interest!rates!are!lower! time.! ! Without!recourse!means!
than!other!forms!of! ! that!the!business!transfers!
borrowing.! responsibility!for!nonB
! collection!to!the!factoring!
company.!
! With!recourse!means!that!
bad!debts!will!still!be!the!
responsibility!of!the!
business.!
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DEBT:%LongETerm%Borrowing%
%
! LongBterm!borrowing!is!used!to!finance!real!estate,!plant!(factory/office)!and!equipment!
!

Mortgage:!! Debentures:! Unsecured)Notes:!! Leasing:!!

A!mortgage!is!a!loan! Debentures!are!issued! An!unsecured!note!is!a! Leasing!involves!the!
secured!by!the! by!a!company!for!a! loan!for!a!set!period!of! payment!of!money!for!
property!of!the! fixed!rate!of!interest! time!but!is!not!backed! the!use!of!equipment!
borrower!(business).! and!for!a!fixed!time!B! by!any!collateral!or! that!is!owned!by!
Mortgage!loans!are! companies!that! assets,!and!therefore! another!party.!Leasing!
used!to!finance! borrow!offer!security! presents!the!most!risk! enables!an!enterprise!
property!purchases,! to!the!lender!usually! to!the!investors!in!the! to!borrow!funds!and!
such!as!new!premises,! over!the!companys! note!(the!lender).! use!the!equipment!
a!factory!or!office.! assets.!On!maturity,! ! without!the!large!
! the!company!repays! capital!outlay!
the!amount!of!the! required.!
debenture!by!buying! !
back!the!debenture.!
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Types%of%Leases% !
Operating)Leases:!Operating!leases!are!assets!leased!for!short!periods,! !
usually!shorter!than!the!life!of!the!asset.! !
! !
Financial)Leases:!Financial!leases!are!usually!for!the!life!of!the!asset!!the! !
lessor!purchases!the!asset!on!behalf!of!the!lessee.!Plant,!vehicles,! !
equipment,!furniture!and!fittings!are!leased!as!financial!leases.!Some!of!the! !
advantages!of!leasing!as!a!source!of!finance!include:! !
! !
" The!costs!of!establishing!leases!may!be!lower!than!other!methods!of! !
financing! !
" If!some!assets!are!leased!a!business!may!be!in!a!better!position!to! !
borrow!funds! !
" It!provides!longBterm!financing!without!reducing!control!of!ownership! !
" It!permits!100!per!cent!financing!of!assets! !
" Repayments!of!the!lease!are!fixed!for!a!period!so!cash!flow!can!be! !
monitored!easily! !
" Lease!payments!are!a!tax!deduction! !
" Payment!usually!includes!maintenance,!insurance!and!finance!costs.! !
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EQUITY%

Equity!refers!to!the!finance!(cash)!raised!by!a!company!by!issuing!shares!to!the!public!for!purchase!
through!the!Australian!Securities!Exchange!(ASX).!Equity!as!a!source!of!external!finance!includes:!
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" Ordinary!shares!(new!issue,!rights!issue,!placements,!share!purchase!plan)!
" Private!equity.!
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EQUITY:%Ordinary%Shares%
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The!purchase!of!ordinary!shares!by!individuals!means!they!have!become!partBowners!of!a!publicly!
listed!company!and!may!receive!payments!called!dividends.!
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The!following!terms!refer!to!variations!in!the!type!or!issue!of!ordinary!shares:!
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" 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!
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" Rights%issue!!the!privilege!granted!to!shareholders!to!buy!new!shares!in!the!same!
company!
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" 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!more!shares!in!that!company!without!brokerage!fees.!The!shares!
can!also!be!offered!at!a!discount!to!the!current!market!price.!
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EQUITY:%Private%Equity!
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Private!equity!is!the!money!invested!in!a!(private)!company!not!listed!on!the!Australian!Securities!
Exchange!(ASX).!The!aim!of!the!private!company!is!to!raise!capital!to!finance!future!
expansion/investment!of!the!business.!
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Financial%Institutions%
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Banks!
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! Investment!
ASX! Banks!
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Financial!
! Institutions!
! Finance!and!
! Companies! Life!Insurance!
! Companies!

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! Unit!Trusts!
Superannuation!
! Funds!

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 Australian)Securities)Exchange)(ASX)!
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.!The!ASX!
offers!products!and!services!including:!
>Shares!
>Futures!
>Exchange!traded!options!
>Exchange!traded!funds!
>Real!estate!investment!trusts!
>Listed!investment!companies!
>Interest!rate!securities!
This!primary!market!enables!a!company!to!raise!new!capital!through!the!issue!of!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!
preBowned!or!secondBhand!securities,!such!as!shares,!are!traded!between!investors!who!may!be!individuals,!
businesses,!governments!or!Qinancial!institutions.!

Investment)Banks!
Banks)
Investment!banks!make!up!one!of!the!fastest!growing!sectors!in!the!
Australian!Qinancial!system!!providing!services!in!borrowing!and!lending.! >Banks!receive!savings!as!deposits!
Investment!banks:! from!individuals,!businesses!and!
governments,!and,!in!turn,!make!
!
investments!and!loans!to!
>Trade!in!money,!securities!and!Qinancial!futures! borrowers.!
>Arrange!longBterm!Qinance!for!company!expansion! !
>Provide!working!capital! >Most!of!the!funds!provided!
>Arrange!project!Qinance! through!Qinancial!markets!come!
from!banks!that!operate!on!their!
>Advise!clients!on!foreign!exchange!cover! own!behalf!or!on!behalf!of!other!
>Advise!on!mergers!and!takeovers! corporations.!
>Provide!portfolio!investment!management!services! !
>Underwrite!corporate!and!semiBgovernment!issues!of!securities! >Since!the!2008B09!GFC,!banks!
have!become!more!cautious!!they!
>Operate!unit!trusts!including!cash!management!trusts,!property!trusts!
can!only!provide!loans!that!have!an!
and!equity!trusts!
acceptable!level!of!risk.!
>Arrange!overseas!Qinance!

Superannuation)Funds!
Superannuation!funds!provide!
funds!to!the!corporate!sector!
through!investment!of!funds!
received!from!superannuation!
contributions.!Superannuation!
funds!are!able!to!invest!in!longB
term!securities!as!company!
shares,!government!and!
company!debt!because!of!the!
longBterm!nature!of!their!funds.!
! businesses!
Unit)Trusts!
Unit!trusts!(also!known!as!
mutual!funds)!take!funds!from!a!
large!number!of!small!investors!
and!invest!them!in!speciQic!types!
of!Qinancial!assets.!Unit!trusts!
investments!include!the!shortB
term!money!market!(cash!
management!trusts),!shares,!
mortgages!and!property,!and!
public!securities.!
Finance)and)Life)Insurance)Companies!
>Finance!companies!act!primarily!as!
intermediaries!in!Qinancial!markets.!They!
provide!loans!to!businesses!and!individuals!
through!consumer!hireBpurchase!loans,!
personal!loans!and!secured!loans!to!
businesses!
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>Finance!companies!raise!capital!through!
share!issues!(debentures)!
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>The!Qinance!company!is!entitled!to!sell!the!
assets!of!the!business!to!recover!the!initial!
loan!if!the!business!fails!
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>Insurance!companies!provide!loans!to!the!
corporate!sector!through!receipts!of!
insurance!premiums,!which!provide!funds!
for!investment.!They!provide!large!amounts!
of!both!equity!and!loan!capital!to!
Influence%of%Government!
The!government!influences!a!businesss!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.!
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! The%Australian%Securities%and% Company%Taxation%
! Investments%Commission%(ASIC)% %
! % Companies!and!corporations!in!
! It!enforces!and!administers!the! Australia!pay!company!tax!on!profits.!
! Corporations!Act!and!protects! This!tax!is!levied!at!a!flat!rate!of!30!per!
! consumers!in!the!areas!of!investments,! cent;!unlike!personal!income!taxes,!
! life!and!general!insurance,! which!use!a!progressive!scale.!
! superannuation!and!banking!(except! Company!tax!is!paid!before!profits!are!
! lending)!in!Australia.!The!aim!of!ASIC! distributed!to!shareholders!as!
! is!to!assist!in!reducing!fraud!and!unfair! dividends.!
! practices!in!financial!markets!and!
! financial!products.!
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Global%Market%Influences%
Globalisation!has!created!more!interdependence!between!economies!and!their!business!(and!finance)!
sectors,!which!relies!on!trade!for!expansion!and!increased!profits.!Global!market!influences!
increasingly!affect!business!financial!decisions,!and!this!is!specifically!evident!in!the!availability!of!
funds!for!loans!and!the!interest!rates!charged!for!these!loans.!
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Global)Economic)Outlook)
The!global!economic!outlook!refers!specifically!to!the!projected!changes!to!the!level!of!economic!
growth!throughout!the!world.!For!example,!positive!outlook!could!include:!
" Increasing!demand!for!products!and!services!
" Decrease!the!interest!rates!on!funds!borrowed!internationally!from!the!financial!money!
market!
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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!will!
be!based!primarily!on:!
" Risk!
" Demand!and!supply!
" Domestic!economic!conditions!
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Interest)Rates)
The!higher!the!level!of!risk!involved!in!lending!to!a!business,!the!higher!the!interest!rates.!
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Processes%of%Financial%Management%
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Planning%and%Implementing%
" Financial!planning!determines!how!a!businesss!goals!will!be!achieved.!
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1. Determining)Financial)Needs)
To!determine!where!a!business!is!headed!and!how!it!will!get!there,!it!is!important!to!know!what!its!
needs!are.!The!financial!needs!of!a!business!will!be!determined!by:!

Management!skills!
The!current!phase! Future!plans!for! Capacity!to!source! for!assessing!
The!size!of!the!business! of!the!business! growth!and! Qinance!B!debs!
Qinancial!needs!
cycle! development! and/or!equity!
and!planning!

Financial!information!is!needed!to!show!that!the!business!can!generate!an!acceptable!return!for!the!
investment!being!sought!and!should,!therefore,!include!an!analysis!of!financial!performance,!income!
statement,!cash!flow!statement,!balance!sheet!and!financial!ratio!analysis!reports.!
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2. Developing)Budgets)
Budgets!provide!the!facts!and!figures!for!future!planning!and!decisionBmaking,!and!enable!constant!
monitoring!of!progress!and!problem!areas.!They!signal!where!things!are!not!going!according!to!plan!
so!that!adjustments!can!be!made,!and!show!where!achievement!towards!objectives!has!occurred.!!
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Budgets!can!be!drawn!up!to!show:!
! Cash!required!for!planned!outlays!for!a!particular!period!
! The!cost!of!capital!expenditure!and!associated!expenses!against!earning!capacity!
! Estimated!use!and!cost!of!raw!materials!or!inventory!
! Number!and!cost!of!labour!hours!required!for!production!
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3. Maintaining)Record)Systems)
Record!systems!are!the!mechanisms!employed!by!a!business!to!ensure!that!data!are!recorded!and!the!
information!provided!by!record!systems!is!accurate,!reliable,!efficient!and!accessible.!By!recording!all!
items!twice,!the!entries!can!be!seen!to!balance,!and!checks!to!find!errors!can!be!carried!out!quickly.!
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4. Identifying)Financial)Risks)
The!amount!of!the! Financial!risk!is!the!risk!to!a!business!of!
business's!
being!unable!to!cover!its!financial!
borrowings!
obligations,!such!as!the!debts!that!a!
business!incurs!through!borrowings,!both!
short!term!and!longer!term.!If!the!business!
When!borrowings! is!unable!to!meet!its!financial!obligations,!
are!due!to!be!repaid! bankruptcy!will!occur.!
When!assessing!
Qinancial!risk,! !
consideration!must! To!minimise!the!risk,!the!profit!must!be!
be!given!to:! sufficient!to!cover!the!cost!of!debt!as!well!as!
Interest!rates! increasing!profits!to!justify!the!amount!of!
risk!taken!by!owners!and!shareholders.!If!a!
business!has!shortBterm!debt,!it!must!have!
The!required!level!of! liquid!assets!so!that!debts!including!interest!
current!assets! payments!can!be!covered.!
needed!to!Qinance! !
operations! !
!
!
!
 5. Establishing)Financial)Controls)
The!most!common!causes!of!financial!problems!and!losses!are:!
! Theft!
! Fraud!
! Damage!or!loss!of!assets!
! Errors!in!record!systems!
!
Financial!controls!include!policies!and!procedure!to!ensure!that!a!business!plans!are!successfully!
achieved!in!the!most!efficient!way:!
! Clear!authorisation!and!responsibility!for!tasks!in!the!business!
! Separation!of!duties!
! Rotation!of!duties!
! Control!of!cash!
! Protection!of!assets!
! Control!of!credit!procedures!
!
Debt%and%Equity%Financing%
Equity!and!debt!financing!are!both!a!liability!to!a!business!as!it!is!money!owed!to!external!sources.!
Businesses!must!carefully!consider!whether!to!use!debt!or!equity!finance!and!how!much!of!each!is!
needed.!
!
!
!
!
!
!
!
!
!
!
!
%
Matching%the%Terms%and%Sources%of%Finance%to%Business%Purpose%
When!a!business!identifies!and!plans!to!meet!its!financial!objectives,!it!is!necessary!to!match!the!terms!
of!finance!with!its!purpose.!This!requires!a!business!to!consider:!
! The!terms,!flexibility!and!availability!of!finance!
! The!cost!of!each!source!of!funding!
! The!structure!of!the!business!
!
!
!
!
!
Monitoring%and%Controlling%
Monitoring!and!controlling!is!essential!for!maintaining!business!viability,!and!affects!all!aspects!of!
business!operations!!especially!financial!management.!

Main!Financial!
Controls!Used!
For!Monitoring!

Cash!Flow! Income!
Balance!Sheets!
Statements! Statements!
The!general!purpose!of!financial!reports!is!to!communicate!relevant,!reliable!and!understandable!
information!about!the!business!that!can!be!used!by!managers!and!other!stakeholders!to!make!
decisions.!
!
Cash%Flow%Statements%
The!cash!flow!statement!(CFS)!indicates!the!movement!of!cash!receipts!and!cash!payments!
resulting!from!transactions!over!a!period!of!time.!
!
!
Users!of!CFS!include:!
! Creditors!
! Lenders!
! Owners!
! Shareholders!
!
A!statement!of!cash!flows!shows!whether!a!firm!can:!
1) Generate!a!favourable!cash!flow!(inflows!exceed!outflows)!
2) Pay!its!financial!commitments!as!they!fall!due!!e.g.!interest!on!borrowings,!repayment!of!
borrowings,!accounts!payable!
3) Have!sufficient!funds!for!future!expansion!or!change!
4) Obtain!finance!from!external!sources!when!needed!
5) Pay!drawings!to!owners!and!dividends!to!shareholders!
!
On!a!cash!flow!statement,!the!activities!of!a!business!is!divided!into!three!categories:!
1) Operating%Activities:!refers!to!operating!activities.!!
Inflows:!income!from!sales,!dividends!and!interest!received!
Outflows:!payment!to!suppliers,!employees!and!other!expenses!
!
2) Investing%Activities:!refers!to!the!cash!inflows!and!outflows!of!purchase!and!sale!of!nonB
current!assets!and!investments.!
E.g.!selling!of!old!motor!vehicle,!purchasing!new!plant!and!equipment!or!purchasing!
property.!
!
3) Financing%Activities:!refers!to!the!cash!inflows!and!outflows!relating!to!the!borrowing!
activities!of!the!business.!
Inflows:!equity,!debt!
Outflows:!repayments!of!debt!or!cash!drawing!of!the!owner!or!payment!of!dividends!
%
!
Income%Statements%(Statements%of%Financial%Performance%or%Revenue%Statement)%
The!income!statement!shows!the!operating!efficiency!!that!is,!income!earned!and!expenses!
incurred!over!the!accounting!period!with!the!resultant!profit!or!loss.!
!
!
The!revenue!statement!includes:!
! Income!and!expenses!over!an!
accounting!period!
! Selling,!administrative!and!financial!
expenses!
! Cost!of!goods!sold!
! Net!profits!
!
The!income!statement!shows:!
1) Operating%income!!sales!of!
inventories,!services,!interests,!rent!and!
commissions%
2) Operating%expenses!!purchase!of!
inventories,!payment!for!services,!
advertising,!rent,!insurance,!bills%
!
Before!examining!figures!from!previous!
income!statements,!managers!can!make!
comparisons!and!analyse!trends!before!making!
important!financial!decisions.!
!
!
Balance%Sheets%(Statements%of%Financial%Position)%
A!balance!sheet!represents!a!businesss!assets!and!liabilities!at!a!particular!point!in!time!and!
represents!the!net!worth!(equity)!of!the!business.!It!shows!the!financial!stability!of!the!business.!
!
!
# Assets:!what!is!owned!
# Liabilities:!what!is!owed!
# Owners%Equity:!what!is!owed!by!the!business!to!the!owner!
!
Analysis!of!the!balance!sheet!can!indicate!whether:!
The!business!has!enough!assets!to!cover!its!debts!
The!interest!and!money!borrowed!can!be!paid!
The!assets!of!the!business!are!being!used!to!maximise!profits!
The!owners!of!the!business!are!making!a!good!return!on!their!investment!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
Balance)Sheet))The)Accounting)Equation)and)Relationships)
! The!proprietor!(owner)!of!a!business!and!the!business!itself!are!distinct.!
! The!balance!sheet!shows!the!outcome!of!the!accounting!process.!The!accounting!equation!can!
be!represented!in!different!ways!but,!because!it!is!an!equation,!it!must!always!be!equal.!
!
Assets"="Liability"+"Equity"
"
Owners"equity"="Assets""Liabilities"
"
Liabilities"="Assets""Owners"equity"
!
!
! !
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
A"balance"sheet"showing"Assets"="Liabilities"+"Owners"equity"
!
The!revenue!statement!and!balance!sheet!are!produced!to!show!the!effects!of!revenue!earned!and!
expenses!incurred!on!owners!equity.!The!accounting!equation!could!more!accurately!be!expressed!as:!

Assets"="Liabilities""+"Capital"+"Revenue""Expenses"
"
Or"
"
Assets"="Liabilities"+"Capital"+"Profit"(RevenueCExpenses)"
"
!
!
Current'Assets' Current'Assets'are'the'key'assets'that'your'business'uses'up'during'a'126
month'period'and'will'likely'not'be'there'the'next'year.'Current'asset'
accounts'include'the'following:'cash'in'checking,'saving,'cash'on'hand,'
account'receivable'(an'account'that'records'what'your'customer'owes'to'the'
business),'inventory'and'prepaid'insurance.'
Non,Current'Assets' Non6current'assets'are'assets'that'include'amounts'expected'to'be'recovered'
more'than'12'months'after'the'reporting'period.'Non6current'assets'is'not'to'
be'converted'to'cash'within'12'months'of'the'balance'sheet'date,'and'is'not'
expected'to'be'consumed'or'sold'within'the'normal'operating'cycle'of'a'firm'
(in'contrast'to'current'assets).'Examples'include:'property,'plant,'equipment,'
investment'property,'and'intangible'assets'such'as'goodwill.'
Current'Liabilities' Current'liabilities'include'all'debts'of'the'business'that'are'to'be'settled'within'
the'financial'year'or'the'operating'cycle'of'a'firm.'Example:'short6term'debt,'
account'payable.'
Non,Current'Liabilities' Non6current'liabilities'are'a'businesss'long6term'financial'obligations'(debts)'
that'are'not'due'within'the'present'accounting'year.'Examples'of'noncurrent'
liabilities'include'long6term'borrowing,'bonds'payable'and'long6term'lease'
obligations.'
Intangible'Assets' The'intangible'assets'of'a'business'may'include'patents,'trademarks,'brands'
and'goodwill.'Intangibles'that'are'purchased'are'easily'included'in'a'balance'
sheet,'whereas'intangibles'that'are'developed'by'a'business'are'very'difficult'
to'value'accurately.'
!
!
Financial%Ratios%
The!financial!statements!of!a!business!must!be!analysed!to!gain!a!thorough!understanding!of!the!
activities!of!a!business.!The!analysis!involves!comparing!similar!figures!contained!in!the!financial!
statements!and!balance!sheets.!The!main!types!of!analysis!include:!
! Vertical:!within!one!year!
! Horizontal:!between!different!years!
! Trend:!over!a!period!of!3B5!years!
!
The!analysis!of!financial!statements!is!usually!aimed!at!the!areas!of!financial!stability!(liquidity!and!
gearing),!profitability!and!efficiency.!
!
!
!
!
! Comparative!
Ratio! Liquidity!
! Analysis!
!
!
!
! EfQiciency! Gearing!
!
!
!
ProQitability!
!
!
!
Liquidity)Ratios)
This!ratio!is!a!rough!measure!of!
how!easily!a!business!can!meet!
its!current!liabilities!
(commitments)!by!using!its!
available!cash!or!assets!that!can!
be!quickly!converted!into!cash.!
The!ratio!indicates!the!ability!o!
meet!shortBterm!debt.!
!
!
!
!
!
! This!ratio!shows!us!the!
! relationship!between!current!
! assets!and!current!liabilities!and!
! provides!a!guide!to!the!liquidity!
! situation.!!
! !
! Information!for!this!ratio!is!
! obtained!from!the!Balance!Sheet.!
! The!ratio!is!also!called!the!Working"
! Capital!of!a!business.!

!
!
!
!
!
!
!
! Current"Ratio"is:"
! "
! !"##$%&!!""#$"
! !
!
!"##$%&!!"#$"%"&"'(
"
! These!come!from!the!
! Balance!Sheet!
! !
!
!
!
!
!
!
!
!
! Strategies!to!improve!this!result:!
! If!the!current!ratio!is!too!low!a!
The!suggested!level!for!this!ratio! ! manager!would!be!advised!to!reduce!
should!be!a!ratio!of!2:1!(i.e.! ! current!liabilities!such!as!overdrafts!by!
current!assets!twice!that!of! ! equity!funding!such!as!retained!profits.!
current!liabilities).!This!is!often! ! NonBcurrent!assets!could!be!sold!to!
considered!a!safe!figure.! ! increase!current!assets.!Factoring!and!
Businesses!dealing!mainly!in!cash! ! leasing!would!also!free!up!current!
could!have!a!lower!figure!e.g.! ! assets.!Factoring!and!sale!of!inventory!
1.5:1.!If!the!figure!is!quite!high! ! (stock)!would!make!some!current!
e.g.!5:1!it!would!indicate!that!the! ! assets!more!available!(and!liquid).!
assets!of!the!firm!are!not!being! ! Emergency!short!term!measures!
employed!efficiently.! ! would!include!an!overdraft!and!using!
more!credit!facilities.!
 !
Gearing)Ratios)(Solvency))
!
!
!
!
As!this!ratio!increases!from!80%!to! !
120%!there!would!be!greater!reliance! ! This!ratio!shows!us!!The!relationship!
on!debt!funding!instead!of!equity! ! between!the!total!liabilities!(debt)!and!
funding.!This!could!be!of!concern!if!the! ! the!level!of!equity!put!in!by!the!owners.!
business!was!not!able!to!sustain!the! ! The!ratio!measures!the!level!of!debt!in!
cost!of!servicing!this!increasing!debt.! ! comparison!to!money!invested!by!
! owners/shareholders.!
!
!
!
!
!
!
!
!
!
!
!
!
!
! Debt"to"Equity"Ratio"is:"
! "
! !"#$%!!"#$"%"&"'(
! !
!
!"#$%! ! !"#$%&
! "
! These!come!from!the!
! Balance!Sheet!
! !
!
!
!

The!suggested!level!for!this!ratio!should! !
be?! !
! !
Strategies!to!improve!this!result!
It!is!difficult!to!generalise.!Many!small! !
include:!
businesses!like!to!operate!on!a!figure!of! !
!
50%,!which!means!that!the!level!of!debt! !
If!a!business!wished!to!lower!the!
is!half!the!level!of!funds!provided!by!the! !
ratio!it!would!need!to!lower!debt!
owner.!Many!large!established!business! !
and!increase!the!input!of!equity!
operate!on!figures!above!100%.!! !
funds.!Any!of!a!range!of!measures!
! !
that!reduce!or!eliminate!the!
A!figure!that!is!quite!low!might!indicate! !
immediate!debts!of!the!business!
that!a!business!is!not!taking!full! !
will!help.!
advantage!of!its!capacity!to!use! !
borrowed!fund!to!expand!its!operations.!
 !
Profitability)Ratios)(Gross)Profit)Ratio))
! Profitability!is!the!earning!performance!of!the!business!and!indicates!its!capacity!to!use!its!
resources!to!maximise!profits.!
! Profitability!depends!on!the!revenue!earned!by!a!business!and!the!ability!of!the!business!to!
increase!selling!prices!to!cover!purchase!costs!and!other!expenses!incurred!in!earning!income.!
!
!
High!Gross!Profit!figures!are!preferred,! !
! This!ratio!shows!us!!The!percentage!of!
but!the!ratio!will!vary!greatly!from!
! each!dollar!of!sales!that!is!gross!profit!
business!to!business.!Falling!figures!from!
! (Sales!minus!COGS).!It!indicates!the!markB
previous!years!and!low!figures!compared!
! up!or!contribution!margins.!Businesses!
to!other!businesses!would!indicate!a!
! often!calculate!this!ratio!for!the!various!
problem!as!Gross!Profit!is!needed!to!cover!
! departments!of!the!business.!NonBretail!
costs!and!provide!a!return.!A!very!high!
! businesses!may!have!difficulty!calculating!
figure!might!indicate!that!prices!are!
! this!ratio.!
becoming!temperature.!
! !
!
!
!
!
!
!
!
!
! Gross!profit!represents!
! Gross"Profit"Ratio"is:" the!amount!of!sales!
! " that!is!available!to!
! !"#$$!!"#$%& meet!expenses!
! ! resulting!in!net!profit.!
!
!"#$% A!fall!in!the!rate!of!
" gross!profit!may!mean!
! These!come!from!the!
! a!fall!in!the!amount!of!
Revenue!Statement! net!profit.!
! !
! !
!
!
!
!
!
!
!
The!suggested!level!for!this!ratio!
! Strategies!to!improve!this!result!
should!be!!
! include!!
!
! !
It!is!difficult!to!suggest!a!prescribed!
! A!low!or!declining!ratio!situation!could!
level!as!the!figure!would!vary!between!
! call!for!the!need!to!raise!prices!and!or!
industries!and!businesses.!
! obtain!stock!at!lower!prices.!These!
!
! measures!are!not!always!possible!or!
A!markBup!of!100%!gives!a!Gross!
! they!could!result!in!falling!sales!due!to!
Profit!Ratio!of!50%.!This!figure!is!only!
! high!prices!and!poorer!quality!goods.!
important!when!compared!to!previous!
! Increasing!the!level!of!sales!can!
years!and!other!similar!businesses.!A!
! compensate!for!lower!profit!margins.!
falling!figure!may!not!be!a!concern!if!it!
results!in!a!much!higher!level!of!sales.!
!
Profitability)Ratios)(Net)Profit)Ratio))
!
!
!
! This!ratio!shows!us!!
A!low!or!declining!Net!Profit!figure!could! !
be!of!concern!as!it!shows!that!the!amount! !
!
of!each!sale!going!to!the!owner!is!low!or! This!differs!from!the!Gross!Profit!Ratio!as!
!
falling.!The!Net!Profit!Ratio!is!related!to! it!takes!into!account!Expenses.!This!ratio!
!
and!affected!by!the!Gross!Profit!Ratio.! measures!the!percentage!of!each!dollar!of!
! sales!to!pay!tax!and!provide!a!financial!
Rising!levels!of!expenses!would!also!be!a! !
major!factor!causing!a!fall!in!this!figure! return!to!the!owners.!This!ratio!gives!an!
!
indication!of!the!level!of!and!trends!in!
! Expenses.!
!
!
!
!
!
!
!
!
!
!
! Net!profit!represents!
! Net"Profit"Ratio"is:" the!profit!or!return!
! " to!the!owners.!The!
! !"#!!"#$%& net!profit!ratio!
! ! shows!the!amount!of!
! !"#$% sales!revenue!that!
! " results!in!net!profit.!
! These!come!from!the! A!firm!would!be!
! Revenue!Statement! aiming!at!a!high!net!
! ! profit!ratio.!!
! !
!
!
!
!
!
!
!
!
!
The!suggested!level!for!this!ratio!should!be!!! !
! Strategies!to!improve!this!result:!
! !
Generally!the!higher!the!figure!the!better,! !
although!this!would!need!to!be!considered! Measures!to!increase!the!Gross!Profit!
! Ratio!will!also!increase!the!Net!Profit!
with!the!volume!of!sales!and!the!type!of! !
industry.! Ratio.!The!main!strategies!to!increase!
! the!Net!Profit!Ratio!relate!to!measures!
! !
In!many!retail!industries!a!figure!of!13B20%!is! to!reduce!Expenses.!Increase!the!
! volume!of!sales!and!level!of!output!will!
considered!good,!but!it!is!difficult!to! !
generalise.!! compensate!for!a!low!or!falling!Net!
! Profit!Ratio.!
!
A!falling!figure!is!generally!a!cause!of!concern.!
 !
Profitability)Ratios)(Return)on)Owners)Equity))
!
!
! This!ratio!shows!us!!
Low!rates!of!return!and!declining! ! !
rates!of!return!indicate!that!the! ! The!reward!the!owners!receive!for!
owners!assets!are!not!generating! ! ! using!and!risking!their!funds!
adequate!income.!For!owners!this! ! (Equity).!This!is!probably!the!most!
is!critical.!Share!prices!would! ! important!information!for!the!
certainly!decline!and!it!would!be! ! owners.!The!owners!will!be!
difficult!to!raise!funds!for! ! particularly!concerned!about!the!
expansion.! ! return!they!receive!on!the!money!
! they!have!invested!rather!than!the!
! return!on!the!total!assets!of!the!
! business.!
!
!
!
!
!
!
!
!
! !
!
Return"on"Owners"Equity"is:"
!
! "
! !"#!!"#$%&
! !
!"#$%!!"#$%&
! "
! These!come!from!the!
! Revenue!Statement!and!
! Balance!Sheet!
! !
!
!
!
!
!
!

The!suggested!level!for!this!ratio!
should!be!!!
! !
A!high!level!would!be!desirable.!The!
figure!varies!depending!on!the!
industry!and!the!general!economic!
conditions!and!an!overall!trend!is!the!
best!indicator.!Business!owners!
would!be!unhappy!with!numbers!
below!10%!as!higher!returns!could!
be!achieved!with!little!risk!in!areas!
such!as!property!and!financial!
institutions.!Figure!above!20%!
would!be!considered!excellent.!
! Strategies!to!improve!this!result!
! include!!
!
! Strategies!to!improve!the!returns!
! on!investment!include!reducing!
! expenses!and!improving!efficiency,!
! changing!the!sale!mix!to!increase!
! sales,!adjusting!pricing!to!increase!
! sales!and!more!effective!marketing.!
! !
! Higher!returns!can!be!achieved!by!
! exiting!from!areas!of!poor!returns!
and!reBinvesting!in!areas!with!
higher!growth!potential.!
 !
Efficiency)Ratios)
Efficiency!is!the!ability!of!the!firm!to!use!its!resources!effectively!in!ensuring!financial!stability!and!
profitability!of!the!business.!The!more!efficient!the!firm,!the!greater!its!profits!and!financial!stability.!
!
Expense)Ratio)
The!expense!ratio!compares!total!expenses!with!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!dayBtoBday!efficiency!of!the!business.!A!business!aims!to!
keep!expenses!at!a!reasonable!level.!For!example,!if!the!selling!expense!ratio!has!increased,!it!may!be!
that!advertising!costs!have!not!generated!the!expected!increase!in!sales.!Alternatively,!a!decline!in!the!
financial!expense!ratio!may!be!a!result!of!lower!interest!rates!or!less!debt!being!used!by!the!firm.!

!
Accounts)Receivable)Turnover)Ratio)
Accounts!receivable!turnover!ratio!measures!the!effectiveness!of!a!firms!credit!policy!and!how!
efficiently!it!collects!its!debts.!It!measures!how!many!times!the!accounts!receivable!balance!is!
converted!into!cash!or!how!quickly!debtors!pay!their!accounts.!!
!

!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
 SUMMARY%OF%RATIOS%
Analysis%of%
which%
What%does%analysis%of%this%
aspect%of% Interpretations%of%ratio%
Ratio% Formula% ratio%show%about%a%
the% results%
business?%
financial%
statement%
Current! Liquidity! Shows!the!shortBterm! It!is!generally!accepted!that!
ratio! financial!stability!of!a! a!ratio!of!2:1!indicates!a!
!
business!(i.e.!its!ability!to! sound!financial!position!(i.e.!
meet!its!shortBterm!financial! a!firm!should!have!double!
commitments)! the!amount!of!assets!to!
cover!its!liabilities).!
Debt!to! Gearing! Shows!the!extent!to!which!the! The!higher!the!ratio,!the!less!
equity! (Solvency)! firm!is!relying!on!debt!or! solvent!the!firm!(i.e.!the!
ratio! ! outside!sources!to!finance!the! higher!the!ratio!of!debt!to!
business! equity,!the!higher!the!
business!risk).!
Gross! Profitability! Shows!the!changes!from!one! The!higher!the!ratio!the!
profit!ratio! accounting!period!to!another! better.!
!
and!indicates!the! !
effectiveness!of!planning! If!the!ratio!is!low,!alternative!
policies!concerning!pricing,! suppliers!may!need!to!be!
sales,!discounts,!the!valuation! sourced!and!competitors!
of!stock!etc.! investigated.!
Net!profit! Profitability! Net!profit!ratio!represents!the! A!firm!will!be!aiming!for!a!
ratio! profit!or!return!to!the!owners.! high!net!profit!ratio.!
!
A!low!net!profit!ratio!
! indicates!that!expenses!
should!be!examined!to!look!
for!possibility!of!reductions.!
Return!on! Profitability! Shows!how!effective!the! The!higher!the!ratio!or!
equity! funds!contributed!by!the! percentage,!the!better!the!
ratio! ! owners!have!been!in! return!for!the!owner.!
generating!profit!and!so!the!
return!on!investment!(ROI)!
Expense! Efficiency! Each!of!the!categories!of! Expense!ratios!indicate!dayB
ratio! expenses!is!compared!with! toBday!efficiency!of!the!
! sales.!The!ratio!indicates!the! business.!Expense!ratios!
amount!of!sales!that!are! need!to!be!kept!at!a!
allocated!to!individual! reasonable!level,!and!
expenses!such!as!selling,! management!must!monitor!
administration,!COGS!and! each!type!of!expense!in!
financial!expenses.! relation!to!sales.!
!
Higher!expense!ratios!may!
be!the!result!of!poor!
management.!
Accounts! Efficiency! Measures!the!effectiveness!of! High!turnover!ratios!indicate!
receivable! a!firms!credit!policy!and!how! the!business!has!efficient!
turnover! ! efficiently!it!collects!its!debt.! debt!collection.!
ratio!
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Comparative)Ratio)Analysis)
Figures,!percentages!and!ratios!do!not!provide!a!complete!picture!for!analysis.!For!analysis!to!be!
meaningful,!comparisons!and!benchmarks!are!needed.!Judgements!are!then!made!by!comparing!a!
firms!analysis!against!other!figures,!percentages!and!ratios.!This!is!known!as!comparative!ratio!
analysis!and!is!important!for!firms.!
o Ratio!analysis!taken!for!a!firm!over!a!number!of!years!can!be!compared!with!similar!businesses!
and!against!common!industry!standards!or!benchmarks.!
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 Limitations%of%Financial%Reports%
Misleading!information!impacts!on!business!decision!Bmaking!and!puts!the!business!at!risk.!The!table!
highlights!the!issues!which!must!be!considered!when!analysing!financial!information.!
Normalised This is the process of removing one time or unusual influences from the balance
earnings 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 This is the process of adding a capital expense to the balance sheet that is regarded
expenses 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:

research and development
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:

1. 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).
2. Guideline company method. This method determines the value of a firm by
observing the prices of similar companies (guideline companies) that 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 Financial reports can be limited because they do not have the capapcity to disclose
repayments specific information about debt repayments such as:

How long the business has had or has been recovering the debt
The capacity of the business or its debtor to repay the amount/s owed (What if a
debtor is close to bankruptcy and will not be able to repay a debt?)
The adequacy of provisions and methods the business has for the recovery of
debt. (Larger businesses have the ability to outsource debt recovery by hiring
an agent to undertake this process but smaller business may not have the
resources to do the same as it is costly and time consuming.)
What provision does the business have in place for doubtful debts and how is this
evident in the financial reports?
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
favourable overview of the business at that point in time.
Notes to the Notes to the financial statements report the details and additional information that
financial are left out of the main reporting documents, such as the balance sheet and income
statement statement. These notes contain important information such as the accounting
methodologies 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%
! Businesses!have!an!ethical!and!legal!responsibility!to!provide!accurate!financial!records.!
! Laws!relating!to!corporations!regulate!the!conduct!of!directors!and!the!requirement!for!
disclosure!of!all!information!to!be!accurate.!This!is!very!important!to!lenders!and!shareholders!
of!companies!who!make!decisions!about!investment!based!on!the!information!provided!by!the!
business.!
!
Audited)Accounts)
An!audit!is!an!independent!check!of!the!accuracy!of!financial!and!accounting!procedures!and!is!an!
important!part!of!the!control!function!of!the!business.!There!are!three!main!types!of!audits!including:!
!
1) Internal!Audits:!conducted!by!the!businesss!employees!
2) Management!Audits:!conducted!to!review!the!businesss!strategic!plan!
3) External!Audits:!conducted!by!independent!and!specialised!audit!accountants.!These!types!of!
audits!are!a!requirement!of!the!Corporations%Act%2001%(Cwlth)!
!
Record)Keeping)
All!accounting!processes!depend!on!how!accurately!and!honestly!data!is!recorded!in!financial!reports.!
!
Goods)and)Services)Tax)(GST))Obligations)
Business!have!an!ethical!and!legal!obligation!to!comply!with!GST!reporting!equipment!
!
Recording)Processes)
Accurate!financial!reports!are!necessary!for!taxation!purposes!as!well!as!for!other!stakeholders.!
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Financial%Management%Strategies%

Working!
Cash!Flow!
Capital!
Management!
Management!

Global!
ProQitability!
Financial!
Management!
management!

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Cash%Flow%Management%
Cash!flow!is!the!movement!of!cash!in!and!out!of!a!business!over!a!period!of!time.!By!keeping!records!
of!cash!flow,!you!know!how!much!cash!you!have!in!your!wallet!or!in!the!bank!at!a!given!time.!
!
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THE%CYCLICAL%FLOW%OF%FUNDS.%EFFICIENT%
MANAGEMENT%OF%CASH%FLOW%IS%CRUCIAL%
TO%A%BUSINESSS%SUCCESS%
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Cash)Flow)Statements:)
A!cash!flow!statement!provides!important!information!regarding!a!firms!ability!to!pay!its!debts!on!
time.!It!can!also!assist!in!identifying!periods!of!potential!shortfalls!and!surpluses.!
!
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:!
o Identifying!when!the!distribution!of!payments!can!be!and!are!made!
o Offering!discounts!to!creditors!for!early!payments!to!positively!affect!cash!flow!status!
o Factoring!
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Working%Capital%Management%

Working!capital!management!is!determining!the!best!mix!of!current!assets!and!current!liabilities!
needed!to!achieve!the!businesss!objectives.!
!
!
Working%capital!is!the!term!used!in!businesses!to!describe!the!funds!available!for!the!shortBterm!
financial!commitments!of!a!business.!Net%working%capital!is!the!difference!between!current!assets!
and!current!liabilities.!
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The!working!capital!cycle:!
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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.!
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The!requirements!for!working!capital!vary!for!
each!business.!
!
(A) A!food!outlet!requires!a!relatively!low!
level!of!working!capital!as!its!cash!flow!cycle!
is!short.!
!
(B) A!snowboard!manufacturer!requires!a!
higher!level!of!working!capital!as!the!cash!
flow!cycle!!between!paying!for!raw!materials!
and!receiving!payment!for!finished!goods!sold!
!is!longer.!
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The!current%(working%capital)%ratio%shows!if!current!assets!can!cover!current!liabilities!!that!is,!a!
business!can!determine!whether!it!can!pay!its!immediate!debts.%
!
Control)of)Current)Assets)
Control!of!current!assets!refers!to!the!management!process!that!determines!the!optimal!amount!
of!each!current!asset!held.!This!includes:!
!
o Cash:!money!in!the!hands!of!the!company!and!ensures!the!business!can!repay!its!debts,!
loans!and!and!accounts!in!the!short!term!
!
o Receivables:!the!sums!of!money!due!to!a!business!from!customers!to!whom!it!has!
supplied!goods!and!services!
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o Inventories:!refers!to!the!stock!a!business!holds.!A!business!must!manage!its!inventory!in!
order!to!remain!solvent.!

Control)of)Current)Liabilities)
The!current!liabilities!of!a!business!refer!to!the!financial!commitments!that!must!be!paid!by!a!
business!in!the!short!term.!A!business!must!monitor!and!manage!current!liabilities!such!as:!
!
o Payables:!sums!of!money!owed!by!the!business!to!other!businesses!from!whom!it!has!
purchased!goods!and!services.!
!
o Loans:!sums!of!money!that!are!borrowed!from!financial!institutions!for!the!purpose!of!
funding!such!things!as!the!purchases!of!property!and!equipment.!These!loans!can!either!
be!short!or!long!term!in!duration.!
!
o Overdrafts:!a!relatively!cheap!and!convenient!form!of!shortBterm!borrowing.!The!main!
purpose!is!to!allow!a!business!to!cover!temporary!cash!shortages.!

!
Strategies)
The!main!strategies!for!working!capital!management!include:!
!
o Leasing:!the!hiring!of!an!asset!from!another!person!or!company!who!has!purchased!the!asset!
and!retains!ownership!of!it.!
!
o Sales!and!LeaseBBack:!the!selling!of!an!owned!asset!to!a!lessor!and!leasing!the!asset!back!
through!fixed!payments!for!a!specified!number!of!years.!
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Profitability%Management%

Profitability!management!involves!the!control!of!both!the!businesss!cost!and!its!revenue.!Accurate!
and!upBtoBdate!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)
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.!E.g.!salaries,!insurance!and!lease.!
!
Variable%costs!are!those!that!change!proportionately!with!the!level!of!operating!activity!in!a!
business.!E.g.!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.!
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Cost)Centres)
A!businesss!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!centres.!
o E.g.!a!cost!centre!in!manufacturing!would!be!called!a!production!cost!centre.!
!
Cost!centres!have!direct!and!indirect!costs.!
o Direct%costs!can!be!allocated!to!a!particular!product,!activity,!department!or!region!
o 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!encourage!staff!to!minimise!
expenses!where!possible.!
!
Revenue)Controls)
In!determining!an!acceptable!level!of!revenue!with!a!view!to!maximising!profits,!a!business!must!have!
clear!ideas!and!policies,!particularly!about!its!marketing!objectives.!
!
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!costBvolumeBprofit!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.!
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Global%Financial%Management%

Global%financial%management%refers!to!the!strategies!implemented!by!business!to!deal!with!the!
export!component!of!business!activities.!

!
Exchange)Rate/Currency)Fluctuations)
! Currency!fluctuations!create!risks!for!global!business.!Depreciation!and!appreciations!will!
impact!on!both!import!and!export!levels!and!the!payments!made!to!overseas!businesses!or!
financial!intermediaries.!
!
!Interest)Rates)
! Domestic!and!international!businesses!will!source!funds!internationally!and!will!therefore!
need!to!consider!the!interest!rates!offered!on!borrowings.!The!repayment!of!this!debt!must!
also!allow!for!fluctuations!in!currency.!
!
Interest)Rates!
The!main!methods!of!international!payment!include:!
! Payment%in%advance!!allows!the!exporter!to!receive!the!payment!and!then!arrange!for!the!
goods!to!be!sent.!
! Letter%of%credit!!a!commitment!by!the!importers!bank,!which!promises!to!pay!the!exporter!
a!specified!amount!when!the!documents!proving!shipment!of!the!goods!are!presented.!
! Clean%payment!!occurs!when!the!payment!is!sent!to,!but!not!received!by,!the!exporter!
before!the!goods!are!transported.!
! Bill%of%exchange!!a!document!drawn!up!by!the!exporter!demanding!payment!from!the!
importer!at!a!specified!time.!
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Hedging)
Hedging!is!the!process!of!minimising!the!risk!of!currency!fluctuations.!Hedging!helps!reduce!the!level!
of!uncertainty!involved!with!international!financial!transactions.!
!
Natural)Hedging:)
A!business!may!adopt!a!number!of!strategies!to!eliminate!or!minimise!the!risk!of!foreign!exchange:!
! Establishing!offshore!subsidiaries!
! Arranging!for!import!payments!and!export!receipts!denominated!in!the!same!foreign!currency!
! Implement!marketing!strategies!that!reduce!the!price!sensitivity!of!the!exported!products!
! Insisting!on!both!import!and!export!contracts!denominated!in!Australian!dollars!
!
Derivatives)
Derivatives!are!simple!financial!instruments!that!may!be!used!to!lessen!the!exporting!risks!associated!
with!currency!fluctuations.!
!
The!three!main!derivatives!available!for!exporters!include:!
!
! Forward%exchange%contracts:!contract!to!exchange!one!currency!for!another!currency!at!an!
agreed!exchange!rate!on!a!future!date.!
!
! Options%contract:!An!option!gives!the!buyer!the!right!to!buy!or!sell!foreign!currency!at!some!
time!in!the!future!!protected!from!unfavourable!exchange!rate!fluctuations.!
!
! Swap%contract:!A!currency!swap!is!an!agreement!to!exchange!currency!in!the!spot!market!
with!an!agreement!to!reverse!the!transaction!in!the!future.!