Chapter 10: Influences of Financial management

Question 1

Identify the five main influences on financial management.

Answer 1

1. Sources of finance (internal and external)
2. Financial institutions
3. Government (economic policy and legislation)
4. Global market influences
5. Economic conditions

Question 2

Sources of finance – internal and external

Outline factors that influence a business’s choice of finance.

Answer 2

• Purpose of funds (short-term or long-term)
• Business’s level of gearing (debt vs. equity)
• Size of the business (small vs. large)

Question 3

Sources of finance – internal and external

Assess why businesses should match the purpose of funds with the right source of finance.

Answer 3

Choosing the wrong source can create financial instability. For example, using long-term loans for short-term needs increases unnecessary interest costs, while excessive debt can reduce financial flexibility.

Question 4

Sources of finance – internal and external

Explain why banks are less likely to lend to new businesses.

Answer 4

New businesses pose a higher risk due to uncertainty in revenue generation and lack of financial history, making banks reluctant to provide loans without collateral or a proven track record.New businesses face high risk and uncertainty, making banks less willing to lend. Owners must contribute initial funds to establish operations before external investors or lenders consider funding options.

Question 5

Internal sources of finance

Identify the three internal sources of finance.

Answer 5

1. Owners’ equity
2. Retained profits (only one in syllabus)
3. Sale of assets

Question 6

Internal sources of finance

Define retained profits.

Answer 6

Retained profits are net profits that are reinvested into the business instead of being paid out as dividends to shareholders.

• most common source of internal finance, many businesses in Australia retaining as much as 50% of profits for reinvestment.

Question 7

Internal sources of finance

Explain the purpose of retained profits

Answer 7

They allow businesses to fund expansion, invest in new projects, and reduce reliance on external debt, ensuring financial stability.

Question 8

Internal soures of finance

What is owners’ equity?

Answer 8

Owners’ equity is the funds invested into the business by existing owners, either from personal savings or personal loans.

Question 9

Internal sources of finance

What is the purpose of owners’ equity?

Answer 9

It provides initial or additional capital for business growth, often used when external borrowing is not feasible or desirable.

Question 10

Internal Sources of finance

What is the difference between owners’ equity from existing owners and new owners?

Answer 10

Existing owners: Funds invested by current owners from personal savings or loans. These are an internal source of finance.

New owners/shareholders: Funds invested by new stakeholders. These are an external source of finance.

Note: Both types are listed under owners’ equity on the balance sheet, but funds from existing owners are internal, and funds from new owners are external.

Question 11

Internal sources of finance

Define the sale of assets as a source of finance

Answer 11

The sale of assets involves selling surplus or unproductive assets such as land, buildings, or equipment to generate cash.

• Often occurs in a takeover or merger where a business has duplicate assets
• Most of the time cannot be done as assets probably won’t be valuable enough and/or raise enough funds.

Question 12

Internal sources of finance

What is the purpose of selling assets?

Answer 12

It raises funds for investments, expansion, or debt reduction by selling off business assets that are no longer needed.

Question 13

Discuss the advantages and disadvantages of selling assets as a source of finance.

Answer 13

✅ Improves efficiency by making use of unproductive/surplus assets
✅ Raises immediate cash for investment or debt reduction.
✅ Avoids increasing business debt.
❌ Loss of assets may impact future operations.
❌ Limited availability of assets of significant value

Question 14

Internal sources of finance

List some of the things that a business will require funds for throughout its life cycle.

Answer 14

1. Establishing the business
2. Expanding the business
3. Performing regular activities such as upgrading technology, conducting R&D, or responding to downturns in revenue.

Note: Owners usually contribute the majority of funds during establishment, with more options becoming available once the business develops a track record of success and stability.

Question 15

Explain how the sources of finance for a business change as it progresses through its life cycle.

Answer 15

1. During establishment, the business primarily relies on owners’ equity as financial institutions are less inclined to lend.
2. As the business expands, the focus shifts to external sources of finance (e.g., loans, equity investment).
3. Over time, the business accumulates retained profits, which become a more viable source of internal finance.

Note: More finance options become available as the business progresses and develops a stable financial history.

Question 16

Internal sources of finance

Outline one advantage and one disadvantage of owners’ equity as a source of finance.

Answer 16

✅Advantage: No external risk; only loss of the owner’s personal savings. Control remains with the owner when selling owners’ equity.

❌ Disadvantage: Owners may have limited personal savings available for the business’s financial needs.

Question 17

Internal sources of finance

Outline one advantage and one disadvantage of retained profits as a source of finance.

Answer 17

✅Advantage: No risk associated with debt; doesn’t risk personal savings. Retained profits are the business’s earned money, and there is no loss of control.

❌Disadvantage: Results in lower dividend payments to shareholders, potentially reducing their returns.

Question 18

Outline one advantage and one disadvantage of the sale of assets as a source of finance.

Answer 18

✅Advantage:
* Increases efficiency making use of unproductive/surplus assets
* No risk associated with debt; doesn’t risk personal savings.
* Retained profits are the business’s earned money,
* no loss of control.

❌Disadvantage:
* Limited by the availability of assets; most businesses won’t have suitable assets that can raise significant funds.

Question 19

External sources of finance

Identify the two main categories of external sources of finance.

Answer 19

Debt finance: Borrowing funds from external sources, requiring repayment with interest.

Equity finance: Raising capital by selling shares to new owners. (Note: Equity funds from existing owners are considered internal finance.)

Question 20

External sources of finance

Explain why businesses use a combination of debt and equity financing.

Answer 20

Businesses balance debt and equity to fund their tactical and operational plans.

Debt financing allows tax deductions on interest, reducing costs.

A combination of both sources helps achieve strategic objectives while managing risk.

Question 21

External sources of finance - ST

Describe the purpose of short-term finance.

Answer 21

Short-term finance is used to cover temporary cash flow shortages or provide working capital.

It is typically repaid within 12 months and recorded as current liabilities on the balance sheet.

Question 22

External sources of finance - Debt ST

Identify the forms of short-term debt borrowing.

Answer 22

• Bank overdrafts – Allows businesses to overdraw their account up to an agreed limit.
• Commercial bills– Short-term loans (30-180 days) for large amounts, often secured against assets.
• Factoring – Selling accounts receivable at a discount for immediate cash.
• Credit cards – Convenient but high-interest if not repaid within the interest-free period.
• Trade credit – Delayed payment terms (30-90 days) provided by suppliers.

Question 23

External sources of finance - Debt ST

Outline the key features of bank overdrafts.

Answer 23

• Allows a business to overdraw its account up to a limit.
• Interest is charged daily while the balance is negative.
• Provides flexibility for short-term liquidity issues.
• interest rates on OD are typically lower than for other forms of borrowing

All in all, assist businesses with ST cash flow or liquidity problems.

Question 24

External sources of finance - Debt ST

Outline the features of commercial bills.

Answer 24

• Loans issued by institutions other than banks (e.g., merchant or investment banks).
• Typically for amounts over $100,000, making them more suitable for larger businesses.
• Repayment terms range between 30 to 180 days.
• Secured against the assets of the business.
• Interest is paid at the end of the term.

Question 25

# *External sources of finance* - Debt ST Explain what factoring is.

Answer 25

Factoring involves selling accounts receivable (money owed to the business) at a discount to a factoring company.

Question 26

# *External sources of finance* Distinguish between commercial bills and bank overdrafts.

Answer 26

**Commercial** **bills**: Large loans (over $100,000), typically repaid with interest within 30-180 days, often secured against assets. **Bank** **overdrafts**: Flexible, lower interest rates, and help with short-term liquidity issues

Question 27

# *External sources of finance* - Debt ST Explain how factoring can improve a business’s cash flow.

Answer 27

Factoring involves selling accounts receivable (money owed to the business) at a discount to a factoring company. * The business receives immediate cash (usually 90% of the receivables value), instead of waiting 30-60 days for customer payments. * This improves liquidity, as cash inflow increases immediately. * The factoring company takes over debt collection, reducing administrative costs and effort. * Without recourse: The factoring company assumes risk of unpaid debts. * With recourse: The business must repurchase any bad debts.

Question 28

# *External sources of finance* - debt STB Outline the other two types of short term borrowing.

Answer 28

**1. Credit Cards:** * High interest if the balance is not paid off in full within the interest-free period. * Convenient and often provide rewards or benefits for use. * Interest charges can be avoided if debts are repaid on time. * Flexible and widely accepted, but can be risky if not managed carefully. **2. Trade Credit:** * An arrangement with suppliers allowing businesses to use goods/services now and pay for them later (typically within 30-90 days). * Available to businesses that have established trust with suppliers. * Helps businesses w cash flow by deferring payments for stock or inputs until they receive payment from own customers. * Often a low-cost form of STB but relies on strong supplier relationships.

Question 29

# *External sources of finance* - debt LTB Identify the 4 types of debt LTB.

Answer 29

1. **Mortgages** 2. **Debentures** 3. **Unsecured notes** 4. **Leasing** * Operating lease * Financial lease

Question 30

# *External sources of finance* - debt, LTB Define a mortgage

Answer 30

A mortgage is a long-term loan secured against an asset, usually property. The borrower repays the loan with interest over time, and if they default, the lender can seize the asset. *default*: means they fail to meet their financial obligations, such as not making a payment on a loan or mortgage when it's due.

Question 31

# *External sources of finance* - debt, LTB Outline the use of mortgages.

Answer 31

* Used to finance major purchases (e.g., new premises or machinery) * The purchased item acts as security for the loan. * If the borrower defaults, the bank can repossess the asset. * Repayments are made over an agreed period, usually 15-20 years.

Question 32

# *External sources of finance* - debt, LTB Define a debenture

Answer 32

A debenture is a type of fixed-interest loan sold by large businesses to investors in exchange for capital. Investors receive regular interest payments during the debenture’s term (typically bt 12 months and 10 years) and are repaid the principal amount when the debenture expires. Debentures are usually secured against company’s assets, --> debenture holders are among the first to recover their investment if the company becomes insolvent.

Question 33

# *External sources of finance* - debt LTB Explain **debentures** as a source of finance for a business

Answer 33

* Issued by large businesses to raise capital. * Provides investors with fixed interest payments. * Secured against company assets, reducing investor risk. * Ensures priority repayment if the business becomes insolvent.

Question 34

# *External sources of finance* - debt LTB Define an unsecured note.

Answer 34

An unsecured note is a loan issued to a business without any security or collateral. Since it carries higher risk for lenders, it typically has higher interest rates.

Question 35

# *External sources of finance* - debt LTB Explain **unsecured** **notes** as a source of finance for a business:

Answer 35

* Similar to debentures but not secured by assets. * Issued to finance companies and investors. * Higher risk leads to higher interest rates. * Can be a short- or long-term debt (3 months to 3 years).

Question 36

# *External sources of finance* - debt, LTB Define leasing.

Answer 36

Leasing is a financial arrangement where a business rents an asset instead of purchasing it. This allows the business to use the asset while making regular payments to the owner, preserving cash flow.

Question 37

# *External sources of finance* - debt LTB Explain **leasing** as a source of finance for a business:

Answer 37

* Allows businesses to use assets without ownership. * Two types: 1. Operating lease – short-term, asset returned. 2. Financial lease – long-term, leads to ownership. * Reduces upfront costs, improves cash flow. * Fixes repayments, offering financial stability

Question 38

# *External sources of finance* - Equity Ordinary shares Outline equity financing as an external source of finance

Answer 38

📌 Definition: Raising finance through equity means obtaining capital by selling ownership shares in a business, reducing reliance on debt. ✅ Key Features: Less financial risk than debt financing (no interest payments) Dilutes ownership, reducing control and share of profits Commonly used by public companies via share issuance

Question 39

# *External sources of finance* - Equity Ordinary shares Outline ordinary shares as a method of raising equity finance

Answer 39

📌 Definition: Ordinary shares represent part-ownership in a company and are issued to investors in exchange for capital. ✅ Key Features: Shareholders receive dividends (profit distribution) Shareholders gain voting rights at general meetings Provides a long-term source of finance

Question 40

# *External sources of finance* - Equity Ordinary shares Outline **new issues** as a method of raising equity finance

Answer 40

📌 *Definition*: A new issue is the first-time sale of shares on the ASX to raise capital for a public company. ✅ Key Features: Also called primary shares or initial public offerings (IPO) Requires a prospectus (document detailing company info) Distinct from secondary market trades (where shares are resold)

Question 41

# *External sources of finance* - Equity Ordinary shares Outline **rights issues** as a method of raising **equity** finance

Answer 41

📌 Definition: A rights issue offers existing shareholders the opportunity to purchase additional shares at a discount. ✅ Key Features: Helps maintain ownership proportion Offered at a predetermined ratio Raises capital quickly while minimizing dilution for existing shareholders

Question 42

# *External sources of finance* - Equity Ordinary shares Outline Placements as a method of raising equity finance

Answer 42

📌 Definition: Placements involve issuing shares directly to selected outside investors without a public offering. ✅ Key Features: Faster access to capital than a public offering Used to fund expansion, acquisitions, or improve gearing Limited to 15% of total market value to protect existing shareholders

Question 43

# *External sources of finance* - Equity Ordinary shares Outline Share Purchase Plans (SPPs) as a method of raising Equity Finance

Answer 43

📌 Definition: SPPs allow companies to issue up to $30,000 in new shares per shareholder without a prospectus. ✅ Key Features: Issued without brokerage fees Shares offered at a discount to market price Registered with ASIC and helps businesses raise capital quickly

Question 44

# *Financial institutions* Describe how financial markets work and why they are important for businesses.

Answer 44

* Connect buyers (businesses needing funds) and sellers (investors seeking returns). * Facilitate capital raising for business growth and expansion. * Enable businesses to fund daily operations. * Without financial markets, businesses would struggle to access necessary funds.

Question 45

# *Financial institutions* Explain the role of banks as financial institutions.

Answer 45

* **Main** **providers** of finance to businesses * *Examples: Commonwealth, Westpac, NAB, ANZ* * Offer services: overdrafts, credit cards, loans, mortgages * Accept deposits and use funds for business loans * Market share reduced due to financial deregulation

Question 46

# *Financial institutions* Explain the role of investment banks as financial institutions.

Answer 46

* Specialize in services for medium to large businesses * Examples: Macquarie Bank, Barclays, Deutsche Bank * Provide finance, investments, advice on mergers and foreign exchange * Fast-growing sector of the financial system * Products: commercial bills, loans, private equity

Question 47

# *Financial institutions* Explain the role of finance companies as financial institutions.

Answer 47

* Provide loans, lease finance, and factoring * Examples: GE Capital, Latitude Financial Services * Quicker access to funds, less strict criteria * Higher interest rates * Products: loans, credit cards, leasing, factoring

Question 48

# *Financial institutions* Explain the role of superannuation funds as financial institutions.

Answer 48

* Invest members' contributions in shares and loans * Examples: First State Super, CBUS * Long-term funds that invest in long-term securities * Provide stable finance for businesses * Products: equity capital, long-term loans

Question 49

# *Financial institutions* Explain the role of insurance companies as financial institutions.

Answer 49

* Provide coverage for damages or losses in return for premiums * Examples: NRMA, AAMI * Invest premiums in shares and loans * Spread risk and generate returns * Products: equity capital, long-term loans

Question 50

# *Financial institutions* Explain the role of unit trusts as financial institutions.

Answer 50

* Pool funds from multiple investors for diverse investments * Examples: MLC MasterKey, Utilities Trust of Australia * Allow investors to earn larger returns than individual investments * Provide financial products like mortgages and share market funds

Question 51

# *Financial institutions* Explain the role of the Australian Securities Exchange (ASX) as a financial market.

Answer 51

* Market for buying and selling shares * Raises capital for businesses through share issuance * Improves liquidity and long-term stability for companies * Provides a platform for public companies to raise funds * Key role in helping businesses grow and expand

Question 52

# *Financial institutions* Why do insurance companies invest in other businesses?

Answer 52

* To spread their exposure to risk. * To generate returns on funds collected from premiums. * To ensure long-term financial sustainability

Question 53

# *Financial institutions* What type of financial institution provides factoring services to businesses?

Answer 53

**Finance companies.** Offer quicker access to funds than banks. Provide loans, leasing, and factoring services. Typically charge higher interest rates than traditional banks.

Question 54

# *Financial institutions* Which type of financial institution offers services not suitable for small businesses?

Answer 54

* Investment banks. * Specialize in banking services for medium to large businesses. * Provide finance, foreign exchange services, and advice on mergers & takeovers.

Question 55

# *Financial institutions* What is the main source of debt finance for businesses?

Answer 55

**Banks.** Offer overdrafts, credit cards, short- & long-term loans, mortgages. Still the dominant providers of finance, despite financial deregulation increasing competition.

Question 56

# *Financial institutions* Compare and contrast superannuation funds and unit trusts (mutual funds).

Answer 56

**Superannuation Funds:** * Designed for retirement savings. * Invest in shares & long-term loans to businesses. * Large and regulated for long-term stability. **Unit Trusts:** * Pool voluntary investors’ funds for diversified investments. * Not focused on retirement, but general wealth creation. * More flexible, with a variety of investment options. Both: * Pool investor funds to maximize returns. * Invest in shares, securities, and other assets.

Question 57

# *Financial institutions* What happens on the primary market? How does this impact the finance function of a business?

Answer 57

* Companies issue new shares (securities) to raise capital. * Investors purchase shares, becoming part-owners. * Provides businesses with funds for expansion. * Improves liquidity, LT financial stability (solvency). * Acts as a ‘launch pad’ for companies selling shares publicly for the first time through an IPO (Initial Public Offering), also known as a float. * Facilitates the flow of funds from investors (both Australian and international) to businesses. * Encourages economic growth, employment, and wealth creation.

Question 58

# *Influence of government* Outline the influence of government in financial management.

Answer 58

* **Economic policies:** - Monetary policy – affects interest rates and borrowing costs. - Fiscal policy – influences taxation, government spending, and business income. * **Legal regulations:** Corporate laws impact business operations and structure. * **Government agencies: **Monitor and enforce financial laws (e.g., ASIC). * ** Taxation**: Company tax rates affect business profitability and investment decisions.

Question 59

# *Influence of government* Outline the main roles and aims of ASIC.

Answer 59

* **Monitors and enforces** financial sector laws to protect consumers, investors, and creditors. * **Issues licenses** for businesses operating in financial markets. * **Ensures corporate compliance** with laws such as the Corporations Act 2001 (Cth). * ** Investigates breaches **of financial regulations and applies penalties or legal action. * **Promotes transparency** by collecting and publishing company financial information. * **Enhances market confidence** by ensuring fair and well-regulated financial markets.

Question 60

# *Influence of government* Explain the influence of company taxation on financial management.

Answer 60

* **Affects Cash Flow** – Businesses must ensure they have adequate financial resources to meet tax obligations, influencing budgeting and cash flow management. * **Impacts Profitability** – Company tax is deducted before profits are distributed as dividends, reducing net earnings and affecting investment decisions. *** Influences Business Structure** – Businesses may choose to incorporate to benefit from lower company tax rates (25% for small businesses vs. higher personal tax rates). * **Allows Tax Deductions** – Companies can carry forward losses to offset future taxable income, reducing tax liabilities in lean years (e.g., Qantas 2010-2017, FY20-FY22). * **Encourages Investment –** Lower tax rates improve international competitiveness, attracting foreign investors and contributing to economic growth.

Question 61

# *Influence of government* Explain the benefits of a business becoming incorporated in relation to taxation.

Answer 61

**Lower Tax Rates **– Incorporated businesses (companies) benefit from a flat company tax rate (25% for small businesses, 30% for large corporations), which may be lower than personal income tax rates for sole traders and partnerships. **Tax Deductions** – Companies can carry forward losses to offset future taxable income, reducing tax liabilities in years of lower profitability (e.g., Qantas from 2010-2017 and FY20-FY22). **Franking Credits** – Shareholders receive franked dividends, allowing them to claim tax credits for tax already paid by the company, reducing double taxation. **Financial Planning –** Fixed tax rates provide greater predictability for financial management compared to individual tax rates, which increase progressively with income. * **Increased Investment Appeal **– A stable tax structure and the ability to reinvest profits with tax advantages make incorporation more attractive to investors.

Question 62

# *Global Market influences* Explain the global market influences on financial management.

Answer 62

* **Globalisation & Economic Interdependence** – Increased trade and investment flows mean that businesses are affected by international financial markets, exchange rates, and global supply chains. * **Interest Rates & Availability of Funds**– Global financial markets influence the cost and accessibility of borrowing, affecting investment and expansion decisions. * **Economic Crises** – Events like the GFC (2008-09) and COVID-19 pandemic demonstrate how global downturns can reduce demand, disrupt supply chains, and limit business growth. * **Exchange Rate Fluctuations** – A weaker AUD benefits exporters (higher revenue) but increases costs for businesses that rely on imported materials. Conversely, a strong AUD makes exports less competitive but reduces import costs. * **Investor Confidence** – Global events impact stock markets, affecting a company's ability to raise capital through equity or debt financing.

Question 63

# *Global market influences* Define the availability of funds

Answer 63

*** Definition***: Availability of funds refers to how easily businesses can borrow money from domestic and international financial markets.

Question 64

# *GLobal market influences* Outline the influence of global availability of funds on financial management.

Answer 64

*** Definition***: Availability of funds refers to how easily businesses can borrow money from domestic and international financial markets. **Factors Affecting Availability:** * Risk Level – Higher risk leads to stricter lending policies and higher interest rates. * Demand & Supply – High demand for loans or limited supply of funds increases borrowing costs. * Economic Conditions – Global financial crises or inflation impact interest rates and loan accessibility. **Effects on Financial Management:** * During Economic Downturns (e.g., GFC, COVID-19): * Higher interest rates and stricter lending policies make it harder to access funds. * Businesses may raise capital through equity (e.g., Qantas issuing $500M in shares during GFC). * Governments may intervene (e.g., RBA providing low-interest loans). **During Economic Recovery:** * Lower interest rates encourage borrowing and investment. * Governments may reduce intervention (e.g., post-2022 inflationary period). **Business Response:** * Companies may access debt financing early to secure funds before conditions worsen (e.g., Qantas in March 2020).

Question 65

What are interest rates?

Answer 65

Definition: Interest rates represent the cost of borrowing money, expressed as a percentage of the loan amount.

Question 66

Outline the influence of interest rates on financial management.

Answer 66

Definition: Interest rates represent the cost of borrowing money, expressed as a percentage of the loan amount. **Impact on Business Financial Decisions:** Lower Interest Rates: Reduce borrowing costs, making it more attractive to finance expansion, upgrades, and relocation. Encourage investment in growth strategies due to lower repayments. **Higher Interest Rates:** Increase borrowing costs, leading businesses to reconsider expansion or investment. May force businesses to focus on cost-cutting and efficiency. **Risk and Credit Rating Influence:** Businesses with good credit ratings receive lower interest rates. Higher-risk businesses face higher borrowing costs. **Global Borrowing Considerations:** Historically, Australian interest rates have been higher than those in countries like the USA and Japan, making overseas borrowing attractive. Currency Risk: Fluctuations in exchange rates can increase the cost of repaying foreign loans, potentially eliminating any benefits from lower interest rates.