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Business Studies > Finance > Flashcards

Finance Flashcards

1
Q

Financial management

A

Monitoring and controlling of a business’s financial resources to meet its financial objectives

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2
Q

Objectives of financial management

A
  • Profitability
  • Growth
  • Efficiency
  • Liquidity
  • Solvency
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3
Q

Profitability

A

Maximising the difference between revenue and costs

  • Revenue: generated through sales. Total revenue = Sales price x Quantity of sales
  • Costs: comprised of fixed and variable costs. Total costs = Fixed costs + Variable costs
  • Gross Profit = Sales revenue - Cost of goods sold
  • Net Profit = GP - other business expenses
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4
Q

Growth

A

Expansion of a business’s operations over time with a view to increase sales revenue and profitability

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5
Q

Efficiency

A

Product production at the lowest cost to maximise output from a given resource level
- Can be measured in expense ratio and accounts receivable turnover ratio (how long a business takes to collect its debts)

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6
Q

Liquidity

A

Ability to meet short-term financial commitments or be able to convert current assets into cash quickly
- Determined by current ratio

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7
Q

Solvency

A

Ability to meet long-term financial obligations

- Determined by gearing ratio

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8
Q

Interdependence

A

Operations
- Finance pays for materials and resources used for production
- Operations looks to continually reduce costs and increase efficiency
Marketing
- Finance funds market research and makes marketing budgets
- Marketing boosts revenue
HR
- Finance funds training and development programs as well as wages and monetary rewards
- HR acquires the right staff for finance

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9
Q

Sources of finance

A

Ways business can perform business activities like paying suppliers and buying equipment

  • All firms carry some cost - correlation between risk and reward
  • Long-term sources for long-term commitments, short-term sources for short-term commitments
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10
Q

Internal sources of finance

A

Finance from inside the business

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11
Q

Retained profits

A

Undistributed profits which can be used for future activities
- In Australia, businesses keep around 50% of profits

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12
Q

Owners’ equity

A

Funds provided by owners into business
+ Cheapest way of raising funds - debt levels do not rise and costs incurred from external funding are avoided
+ Does not have to be repaid unless owner leaves the business
– Retained profits are restricted by profit levels
– Lower dividends

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13
Q

External sources of finance

A

Obtained from individuals and institutions outside the business, such as banks, NBFIs and shareholders
- Includes both debt and equity

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14
Q

External equity

A

Form of financing that gives external parties a share of the business in return for funds
+ Does not increase debt levels
+ Does not require interest payments
– Ownership structure may change
– Investors will expect dividends and a rise in share value
– Can dilute shareholders, reducing dividends

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15
Q

Ordinary shares

A

Investors pay funds to a company to become part-owners in return for an ownership share, voting rights and, potentially, dividends

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16
Q

New issues

A

Shares issued and sold for the first time publicly, sometimes called primary shares

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17
Q

Rights issues

A

The privilege granted to shareholders to buy new shares in the same company

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18
Q

Placements

A

Allotment of shares, debentures made directly from the company to investors

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19
Q

Share purchase plans

A

An offer to existing shareholders to opportunity to purchase shares at a discount (max $30,000)

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20
Q

Private equity

A

Form of equity involving giving large external financiers a proportion of ownership in return for a funds injection
- Can be from a private equity or venture capital firm (like Dorilton Capital)

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21
Q

Overdraft

A

Loan from the bank allowing an overdrawn account up to an agreed limit for a specified time
- Used to overcome temporary shortfalls in cash

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22
Q

Commercial bills

A

Loans issued by NBFIs for large amounts (>$180000) for a period between 1 to 6 months

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23
Q

Factoring (source)

A

Selling accounts receivable for a discounted price to a finance or factoring company, obtaining up to 90% of the value of their accounts receivable within 48 hours of invoice submission
- Help cash flow issues

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24
Q

Mortgage

A

Secured loan by the borrower’s property

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25
Q

Debentures

A

Loans issued by a company secured by the company’s assets, repaid on maturity by being bought back

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26
Q

Unsecured notes

A

Debenture without security

  • Higher risk
  • Higher interest rates
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27
Q

Leasing (source)

A

Business (lessee) leases assets from a lessor rather than buying them

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28
Q

Banks

A

Main finance provider to businesses and consumers, offering many products (such as overdrafts and mortgages)

  • Money deposited into the banks as investment are used as loans for businesses
  • Interest is charged at a rate for the cost of borrowing
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29
Q

Investment banks

A

Specialise in business banking, offering a variety of loan types (such as overdrafts and mortgages)

  • May require conditions to borrower
  • Can provide advice on mergers and acquisitions, foreign exchange cover and operate unit trusts
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30
Q

Finance companies

A

Non-bank institutions which do not take public deposits (NBFIs)

  • Quick access to short and medium-term finance (like commercial bills, factoring, unsecured notes)
  • Have high interest rates
  • Regulated by Australian Prudential Regulation Authority
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31
Q

Life insurance companies

A

NBFIs who raise funds through life insurance policies

- Through selling policies, they receive premiums which provide investment funds

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32
Q

Superannuation funds

A

Financial contribution that individuals make for retirement use
- Can be used for long-term securities (e.g. company shares and long-term loans)

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33
Q

Unit trusts

A

Take funds from a large number of small investors and the appointed trustee invests in a plethora of investments

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34
Q

ASX

A

Market in which Australian shares are bought and sold
- Acts as a primary market for companies to issue new shares as well as a secondary market for the trading of pre-owned shares
+ Access to large amounts of money
+ Does not add to debt levels
– Costs money to list
– Can be expensive to fulfil ASX requirements

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35
Q

ASIC

A

Enforce and administer the Corporations Act 2001
- Consumer protection in relation to investment, insurance and banking (excluding lending)
- Aims to reduce fraud and unfair practices in relation to financial markets and products
- Financial information oversight in relation to annual report disclosure
Impact:
- Legislation influences financial decisions
- Businesses must ensure they comply with legal obligations or they could be remedied by ASIC as well as
receiving negative publicity
- Legislation differs between legal structures, impacting choice

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36
Q

Company taxation

A

Taxation of net profits at a flat rate of 30% for companies with >$50 million in revenue and 25% for companies with <$50 million in revenue (2021–22 figures, Treasury Laws Amendment [Enterprise Tax Plan] Act 2017)
- Diverted Profit Tax was introduced in 2017 as a 40% tax rate to prevent tax avoidance for businesses who:
- Earn >$1 billion in revenue
- Result in less than 80% of tax being paid overseas that should have been paid in Australia
- Are reasonably viewed as trying to secure a tax reduction
Impact:
- Can affect financial decisions based on what is better taxation-wise
- Regulations require sound financial management so businesses will require adequate financial resources
for when taxes are due

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37
Q

Global economic outlook

A

Projected changes to the level of economic growth worldwide
- Directly affects Australia’s export demand; positive outlook increases demand for Australian products and
vice-versa

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38
Q

Availability of funds

A

Ease with which a business can access borrowing funds on the international markets

  • Risk, supply and demand and domestic economic conditions all influence availability
  • Will impact whether businesses can access the necessary funds for expansion
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39
Q

Interest rates (influence)

A

Cost of borrowing money

- A change in global interest and/or exchange rates can change repayment amounts, impacting profits

40
Q

Financial needs

A

Determining these will ensure that the business can meet its short-term liabilities and long-term goals
- Financial statements and budgets can help determine these

41
Q

Budgets

A

Forecast of expected future results
- Set in line with business goals and objectives
+ Motivates management and staff
+ Sets timelines
+ Great comparative tool
– Time and costs associated with budget creation
– Potential conflict if budgets are not met
–Forecasting inaccuracies
Operating budgets: used to forecast income and expenditure in terms of day-to-day activities (such as labour, production, material, sales and expenses)
Financial budgets: used to forecast financial data and for creating budget cash flow statements, income statements and balance sheets
- Can help financial expansion and decide if expansion is possible

42
Q

Record systems

A

All data must be recorded accurately to comply with tax laws and make informed decisions
- Includes invoices, payments, taxes and wages

43
Q

Financial risks

A

Any risk that can financially threaten the business, internally or externally

44
Q

Financial controls

A

Must be in place to ensure the business is meeting its financial obligations. Includes:

  • Reconciling accounts
  • Measuring actual performance against budgets
  • Performing credit checks on new customers
  • Using specialised finance staff
45
Q

Pros and cons of debt finance

A

+ Ownership structure does not change
+ Interest is tax deductable
+ Flexible and readily available
+ Increased funds should increase earnings and profits
– Interest can be expensive and must be repaid regularly
– Security usually required
– Impacts gearing levels
– Increased risk if from financial institutions

46
Q

Pros and cons of equity finance

A 
\+ Doesn't require repayment unless owner leaves
\+ No interest; cheaper
\+ Contributors control use of finance
\+ Low gearing
\+ Less risk for business and owner
– Lower profits and returns
– Owner will have expectations on the Return On Investment
– Long, expensive obtaining process
– Ownership is diluted; loss of control
47
Q

Balance sheet

A

Summary of all assets, liabilities and equity

48
Q

Accounting equation

A

Assets = Liability + Owners’ Equity

49
Q

Income statement

A

Summary of income and expenditure

  • COGS = Opening stock + purchases - closing stock
  • Gross profit = Sales revenue - COGS
  • Net profit = Gross profit - expenses
50
Q

Cash flow statement

A

Summary of cash inflows and outflows over a specific time period
- Operating activities: Relating to the core function of the business
- Examples include sales revenue and interest earned (inflows) along with supplier and wage payments
(outflows)
- Investing activities: Activities such as land sale (inflow) and purchase (outflow)
- Financing activities: Activities such as money incoming from share issues (inflow) along with loan
repayments and dividends (outflows)

51
Q

Current ratio

A

Current assets/current liabilities

  • Measures liquidity - for every dollar the business has in current liabilities, it has $x in current assets
  • Results under 1:1 suggest a negative working capital position and poor liquidity
  • 2:1 is preferred
52
Q

Debt-to-equity ratio

A

Total liabilities/Owners’ equity (x100%)

  • Measures solvency/gearing - for every $1 of OE, the firm has $x of debt
  • Lower ratio indicates higher solvency
  • <100% is preferred, though variant by industry
53
Q

Gross profit ratio

A

Gross profit/sales (x100%)

  • Measures profitability - how much each dollar of sales results in gross profit
  • Higher results show better profitability and more space for expenses
54
Q

Net profit ratio

A

Net profit/sales (x100%)

  • Measures profitability - how much each dollar of sales results in net profit
  • Lower results show that the business is struggling overall whilst negative results indicate a failing business
55
Q

Return on equity ratio

A

Net profit/total equity (x100%)

  • Measures profitability - how much of a return the owners are getting from the business
  • Higher returns indicate a more successful busienss
  • Influenced directly by gearing levels
56
Q

Expense ratio

A

Expenses/sales (x100%)

  • Measures efficiency - percentage of sales absorbed by business expenses
  • Lower results lead to higher net profits whilst businesses with increasing ratios should focus on cost cutting
57
Q

Accounts receivable turnover ratio

A

365 days/(sales/accounts receivable)
- Measures efficiency - amount of days it takes a business to collect their accounts receivable
- Less days indicates and efficient business whose liquidity is not impacted by awaiting payments and vice-
versa

58
Q

Capitalising expenses

A

Listing an expense as an asset (from the income statement to the balance sheet)

  • Makes the business appear more profitable than it is, adding to asset value
  • Research and development is an example
59
Q

Valuing assets

A

Monetary value attached to assets is subject to dispute. Valuation methods include:

  • Discounted cash flow method: projected revenues from asset
  • Guideline company method: how similar companies value their assets
  • Historical cost accounting: listing asset value at purchased price, ignoring market value
60
Q

Timing issues

A

Firms can alter the time periods of reports in order to represent more favourable financial results than reality

61
Q

Debt repayments

A

The nature of debt agreements are not reflected on the balance sheet. This includes:

  • Interest rate
  • Date due
  • Security attached
  • Length of time the debts has been held
62
Q

Notes to the financial statement

A

Extra notes to provide clarity on issues are often attached to the end of reports as the limitations are acknowledged. These issues include:

  • Accounting methodology used
  • Asset valuation methods
  • Debt descriptions
63
Q

Creative accounting

A

Intentionally using the limitations of financial reports to hide bad debts, poor results and overinflate good results adding to the firm’s overall value

64
Q

Independent auditing

A

Mandatory use of independent accountants to verify accounting statements to check accuracy/fairness in order to be used by investers

65
Q

External audits

A

Required by the Corporations Act 2001 to ensure nobody is deceived by firm value through fair, transparent and standardised accounting practices

66
Q

Record keeping

A

Firms can intentionally withhold information to evade taxes or move revenue to nations with lower tax rates

67
Q

Reporting practices

A

Stakeholders are entitled to receive timely and accurate information through Annual Reports whilst public companies must make announcements sensitive to the firm through the ASX so all investors have information access simultaneously

68
Q

Financial management strategies

A

Tools that firms can use to achieve strategic financial objectives. Important because:

  • A business will become unable to pay obligations without cash flow
  • All other KBFs are measured by financial performance
  • Without strategies in place, wastage occurs, inefficiencies arise and profitability is reduced
  • Provide clear direction to firms in financial difficulty
69
Q

Cash flow management

A

Firms require cash to pay obligations as they fall due

  • Accounts receivable management is critical
  • Poor cash flow management leads to poor liquidity
70
Q

Distribution of payments

A

Firms should aim to spread larger payments out over a long period of time to decrease risk of liquidity issues
- Can be determined off cash flow statement

71
Q

Discounts for early payment

A

Offering creditors the opportunity to receive a discount if they pay early

  • Usual credit terms are 30 days
  • Offering incentive to pay early improves liquidity and reduces customer costs
  • Negatively impacts profitability
  • Best targeting larger customers for larger impact
72
Q

Factoring (strategy)

A

The sale of accounts receivable to an external firm to receive an instant cash injection at an discounted overall value
- Impacts profitability negatively however immediately improves liquidity

73
Q

Working capital

A

Capital the business has to work with short term
- Difference between current assets and current liabilities
- Profitable firms will see an increase in working capital that can be withdrawn or re-invested into business
growth and vice-versa

74
Q

Control of current assets

A 
Accounts receivable must be monitored and controlled by:
- Checking customer credit ratings
- Enforcing credit sale conditions
- Having processes to pursue money owed
Inventory management is critical to ensure working capital is not:
- Tied up in slow moving stock
- Wasted on stock spoilage
- Decreasing liquidity
75
Q

Control of current liabilities

A
  • Accounts payable can be managed by paying early if discount offered or waiting full trade credit payment
    period
  • Loans can be managed my monitoring establishment costs, interest rates and ongoing charges
  • Overdrafts need to be similarly monitored
76
Q

Leasing (strategy)

A
  • Reduces liabilities and increases working capital

- Payments are tax deductable and increase assets used by a firm, increasing productivity and profit

77
Q

Sale and lease back

A

The sale of a long-term asset to a lessor to lease back in order to provide a cash injection to improve liquidity along with receive the benefits of leasing

78
Q

Profitability managements

A

Control of costs and revenue within a firm

  • Cost controls heavily linked with operations and HR
  • Revenue controls heavily linked with marketing
79
Q

Fixed and variable costs

A
  • Negotiate better contracts on fixed costs

- Increase productivity and minimise waste on variable costs

80
Q

Cost centres

A

Creation of separate cost accounts for units within the firm to identify inefficiencies in order to more accurately minimise expenses

81
Q

Expense minimisation

A

Overall focus on cost cutting, finding all ways to remove unnecessary costs without risking quality
- Firm must continually create new value for customers before cutting costs

82
Q

Marketing objectives

A

Elements of the 4Ps must be tailored in order for the firm to maximise revenue and profit

83
Q

Pricing policies

A

Need to be set right or else fewer sales will be made and costs may not be adequately covered

84
Q

Reviewing sales mix

A

Continually changing the items for sale, removing underperforming products and diversifying offerings

85
Q

Global financial management

A

Globally operating firms are exposed to greater financial risk which must be mitigated

86
Q

Interest rates (GFM)

A

Cost of debt; percentage of principal to be repaid by the firm for the firm’s use

  • Other nations can offer cheaper interest rates, reducing finance obtainment costs
  • Rates can fluctuate depending on local economic conditions impacting financial costs
  • Currency exchange rate fluctuations can also greatly alter the volume of money owed
87
Q

Exchange rates

A

The rate at which two currencies can be exchanged through the FOREX market, as facilitated by an investment bank
- Fluctuations lead to costs and revenues being greatly impacted
Appreciation:
- Importers win: buy more for same local currency, reducing global input costs
- Exporters lose: less revenue in local currency, lift global prices and lose sales
- Domestic firms experience increased global competition due to increased affordability
Depreciation:
- Importers lose: More local currency required for same input, reducing profitability
- Exporters win: More local revenue from global sales
- Domestic firms experience less global competition due to decreased affordability

88
Q

Payment in advance

A

Importer pays prior to shipment

- Most risk on importer, none on exporter

89
Q

Letter of credit

A

Commitment by importer’s bank to pay upon receipt of goods for a fee

90
Q

Clean payment

A

Payment is sent to the exporter before shipping but not received until shipment

  • Easiest and quickest method
  • Mutual trust is required - risk is shared
91
Q

Bill of exchange

A

Payment made only upon receipt of goods
- Documents against payment: importer only collects goods after pay
- Documents against acceptance: importer collects goods before paying but must sign “acceptance of the bill
of exchange” before banks allow collection

92
Q

Hedging and derivatives

A

Process of mitigating risk exposure to fluctuations in the spot rate for interest rates, exchange rates and commodity prices

93
Q

Natural hedging

A

Establishing physical offshore subsidiaries, arranging to receive payments/receipts in same currency
- No risk of transferring funds between currencies

94
Q

Derivatives

A

Financial instruments that derive their value from the underlying asset used to mitigate risks of future exchange rates

95
Q

Forward exchange cover

A

Set a currency value for a future exchange date, no matter the fluctuation

96
Q

Options cover

A

Grant the right, not the obligation, to the buyer to exchange at a contracted rate if that is beneficial

97
Q

Swaps cover

A

Agreement to reverse a currency transaction for the same value of currency at a future date

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