Finance - Financial Management Strategies Flashcards
(37 cards)
1
Q
Identify the four key financial management strategies
A
- cash flow management
- working capital management
- profitability management
- global financial management
2
Q
Outline cash flow as a key financial management strategy and identify 3 key strategies
A
- cash flow management is the management of cash going in and out of the business over a specific period of time
- cash flow management is crucial as long term cash shortages can result in insolvency or bankruptcy
- distribution of payments
- discount for early payments
- factoring
3
Q
Describe the distribution of payments as a financial management strategy for cash flow
A
- the process of trying to spread cash flows evenly over the whole year rather than one large payment
- delaying payments until due, distributing payments so cash shortfalls don’t occur
- e.g. insurance payments monthly, use of leasing, paying suppliers and wagers in alternate weeks
- improves cash flow, minimises risk of non-payment and late fees
- can be difficult to time payments, fixed repayment periods required by creditors
4
Q
Describe discount for early payments as a financial management strategy for cash flow
A
- where a business offers a discount to customers who pay bills early, injecting cash into the business
- e.g. 2% discount for invoices paid in 10 days rather than 30 days
- reduces risk of late payment, non-payment and bad debt
- increases customer loyalty and relationships, improves working capital
- will decrease profit margins from discounts, may impact forecast of cash flow
- no guarantee that customers will keep paying quickly
5
Q
Describe factoring as a financial management strategy for cash flow
A
- the selling of accounts receivable for a discounted price to a finance company, provides a quick cash flow boost
- businesses can be protected from bad debts without recourse
- immediate cash injection, no interest or debt
- quick and easy, no hassle to collect debts
- reduces a business profit margin, can damage relationships with customers
6
Q
Outline working capital management
A
- involves determining the best mix of current assets and current liabilities needed to achieve business objectives
- liquidity is important because it enables businesses to take advantage of profit opportunities when they arise and meet short term financial obligations
- working capital is the funds available for a business to operate
- working capital = current assets - current liabilities
7
Q
Identify three ways a business manages working capital
A
- control of current assets
- control of current liabilities
- strategies for working capital management
8
Q
Outline control of current assets as a way of working capital management and identify 3 ways assets are managed
A
- management of current assets is important for monitoring working capital and involves selecting the optimal amount of each current asset
- cash
- accounts receivable
- inventories
9
Q
Outline cash as a way of managing control of current assets
A
- level of cash needs to be managed to ensure no shortage or excess for payment of debts and taking on investment opportunities
ways to manage cash: - plan timing of cash receipts and payments
- maintain minimum level in cash balance
- hold securities to guard against unforeseen cash flows
10
Q
Outline accounts receivable as a way of managing control of current assets
A
- timely collection of accounts receivable is important to generate cash
ways to manage receivables: - check credit rating of customers
- follow up on overdue accounts
- set reasonable payment periods e.g. 30 - 90 days
- offer discounts for early payments
- establish policies for collecting bad debt
11
Q
Outline inventories as a way of managing control of current assets
A
- level of inventory must be managed to ensure no shortage or excess
- businesses must ensure that inventory turnover is sufficient to generate cash to pay for purchases and suppliers on time
ways to manage inventories: - use bar codings and computer systems for accurate records
- physical stock take to check for discrepancies
- JIT: just enough materials arrive as needed
12
Q
Outline control of current liabilities as a way of working capital management and identify 3 ways of management
A
- management of current liabilities is important for monitoring working capital and involves minimising costs
- accounts payable
- loans
- overdrafts
13
Q
Outline accounts payable as a way of managing control of current liabilities
A
- accounts payable must be managed to ensure their timing allows businesses to maintain adequate cash resources
ways to manage accounts payable: - regularly review suppliers and policies
- pay by due date to avoid extra charge
- investigate alternative financing plans with suppliers
14
Q
Outline loans as a way of managing control of current liabilities
A
- short term loans are generally an expensive form of borrowing and should be minimised
ways to manage loans: - investigate alternative sources of funds from different financial institutions
- establishing positive ongoing relationship with creditors
- pay off loans in a timely manner
15
Q
Outline overdrafts as a way of managing control of current liabilities
A
- overdrafts allow businesses to overdraw what is available in an account
- banks will require regular payments on overdrafts and account keeping fees, establishment fees and interest
ways to manage overdraft: - check features of overdraft
- monitor budgets
- establish a policy for using overdrafts
16
Q
Identify additional strategies for working capital management
A
leasing
- lease payments help with cash flow forecasting and budgeting as payments are fixed for a specific time
- leasing also avoids large outflows of cash at once
sale and lease back:
- selling an owned asset to a lessor and then leasing the
asset back through fixed payments for a specific period of time
- enables the business to receive a large cash injection from the sale of the asset which can be used as working capital
17
Q
Outline profitability management and identify 2 ways to manage profits
A
- profitability management involves the control of both costs and revenue
- a business’s main aim is to generate a profit
- profit = revenue - cost
- financial ratios and comparative ratio analysis can indicate profitability problems
- cost control
- revenue control
18
Q
Outline cost control as a way of profitability control
A
- fixed costs: costs which are not dependent on business’s operative activities - do
not change when level of activity changes - variable costs: costs which are dependent on the business’s operative activities do change when level of activity changes
19
Q
Outline cost centres in cost control as a way of profitability management
A
- cost centre: departments within a business where costs can be traced from, engages in activities that contribute to the business
- the manager of a cost centre is responsible for managing the costs their department incurs and keeping them within budget
- cost centres track expenses which allows the business to ensure resources are being allocated efficiently
20
Q
Outline revenue controls and expense minimisation in cost control as a way of profitability management
A
- expense minimisation: reducing business expenses to maximise profits
- marketing objectives: objectives should lead to an increase in sales and revenue
- sales mix: research should be conducted before deciding to diversify or remove profucts
- pricing policy: price needs to be set appropriately for the product
21
Q
Describe global financial management and identify 2 global financial risks and 3 management strategies
A
- businesses face risks from global environments as they operate across various countries
global financial risks: - exchange rates
- interest rates
management strategies: - hedging
- derivatives
- methods of international payment
22
Q
Describe exchange rates as a global financial risk
A
- the exchange rate is the price or value of currency used to exchange goods and services with other countries
- global transactions involve the conversion of domestic currency, done through the Foreign Exchange Market
- foreign exchange rate: the ratio of one currency to another
- due to fluctuations in demand and supply, exchange rates are never static → financial risk
23
Q
Outline the fluctuation of appreciation in exchange rates
A
- value of AUD increases in foreign currency, AUD is able to buy more of another currency
- exports: more expensive for foreigners to buy, reduces international competitiveness
- imports: are cheaper, more appealing for us to buy foreign goods
- decreases debt borrowed and interest payments from foreign institutions
e.g. 1 AUD = 10 USD
24
Q
Outline the fluctuation of depreciation in exchange rates
A
- value of AUD decreases in foreign currency, AUD is able to buy less of another currency
- exports: are cheaper, increases international competitiveness
- imports: more expensive, less appealing for us to buy foreign goods
- increases debt borrowed and interest payments from foreign institutions
- e.g. 1 AUD = 0.1 USD
25
Describe interest rates as a global financial risk
- globalisation has increased availability of funds, meaning businesses has more options and can take advantage of better interest rates
- interest rates can fluctuate depending on economic conditions and the amount needed to pay back in interest can be affected by exchange rate fluctuations
- Australian interest rates are usually higher than other national rates
- appreciation: AUD is more valuable, decreases amount of interest to be paid back
- depreciation: AUD is less valuable, increases amount of interest to be paid back
26
Describe hedging as a global financial management strategy and identify the two types of hedging
- a risk management process minimising financial risks in transactions from fluctuating currencies
- involves engaging in arrangements that reduce potential losses arising from market fluctuations
- natural hedging
- financial instrument hedging (or derivatives)
27
Outline natural hedging as a type of hedging
- reducing risk by limiting exposure to potential fluctuations
- both parties use the same currency during the transaction → beneficial as
receipts and payments will both experience a consistent change
- e.g. arranging for import payments and export receipts to be denominated in the same currency
28
Outline financial instrument hedging (derivatives) as a type of hedging
- derivatives: contracts between two or more parties that specify the transaction of an underlying asset at an agreed price and date
- the price of the transaction is derived from the performance of the underlying asset
- the asset being traded in the contract is called an underlying asset
29
Describe derivatives as a global financial management strategy and identify three main types
- a contract that gives its holder the right to purchase an asset at a fixed price at
a certain time in the future (based on the future market value), thereby lowering
risk of currency fluctuations
- forwards
- options
- swaps
30
Outline forwards as a type of derivative
- a contract between two parties to make a transaction on an underlying asset at an agreed price and date
- forwards exchange contract: where the bank guarantees the trader to exchange one currency for
another at an agreed fixed rate on a future date, regardless of the day’s spot
rate
- forwards are tools to protect against fluctuating prices by locking in a price and preventing potential loss if spot rates fall
31
Outline options as a type of derivative
- a contract between two parties that gives the buyer of the option the right but not the obligation to make a transaction on an underlying asset at an agreed price and date
- similar to a forwards contract except the option holder can choose whether they want to transact or not prior to the expiry date
- foreign currency option contract: gives trader the option to buy or sell foreign currency when the exchange rate is advantageous
32
Outline swaps as a type of derivative
- a contract between two parties that swap cash flows related to an underlying asset with one another at an agreed price over a period
- currency swap: an agreement where two parties swap their currencies with one another then reverse the swap at an agreed exchange rate and date in the future
- used when businesses need to raise funds in another currency and lock in an exchange rate and protect against potential losses arising from fluctuating exchange rate
33
Describe methods of international payment as a global financial management strategy and identify four methods
- a major concern in international transactions is either the goods are not delivered or not paid for
- to counter this problem, a third party will act as an intermediary for the transaction
- payment in advance
- letter of credit
- bill of exchange
- clean payment
34
Outline payment in advance as a method of international payment
- importer pays first then the exporter ships once they have received the payment
- commonly used method for when the creditworthiness of importer is uncertain
- importer initiates
- lowest risk for exporter and highest risk for importer
35
Outline letter of credit as a method of international payment
- a document issued by the importer's bank on their request to the exporter that guarantees payment once they have presented the bank with documents proving shipment of the goods
- if the importer fails to pay, the bank will cover. The bank will only issue a LOC if they know the importer can pay
- a popular payment method with exporters
- importer initiates
- low risk for exporter and high risk for importer
36
Outline bill of exchange as a method of international payment
- a document issued by the exporter's bank on their request to the importer's bank that demands payment at a specific time
- most widely used payment method, exporter initiates
- document against payment (D/P): importer can collect goods only AFTER paying
- document against acceptance (A/P): importer can collect goods BEFORE paying
- high risk for exporter, low risk for importer
37
Outline clean payment as a method of international payment
- exporter ships the goods first then the importer pays once they have received the goods
- goods are shipped with an invoice specifying the credit terms (e.g. 30, 60, 90 days)
- exporter initiates
- method is only used when exporter is confident importer will pay by the agreed time
- highest risk for exporter, lowest risk for importer
