Finance - Strategies

Question 1

what are the main financial management strategies

Answer 1

• cash flow management
• working capital management
• profitability management
• global financial management

Question 2

what is cash flow

Answer 2

cash flow is the movement of cash in and out of a business over a period of time

Question 3

what is cash flow management

Answer 3

cash flow management refers to the management of the movement of cash in and our of a business over a period of ttime

Question 4

what is a cash flow statement

Answer 4

a cash flow statement indicates the movements of cash receipts and cash payments resulting from transactions over a period of time
- it can identify trends and be a useful predictor of change

Question 5

what are examples of cash inflows

Answer 5

• accounts receivable
• income of cash/ cash receipts
• dividends received
• sale of assets

Question 6

what are examples of cash outflows

Answer 6

accounts payable
payments to suppliers
purchase of assets
loan repayments

Question 7

what are the 4 main cashflow management strategies

Answer 7

• distribution of payments
• discounts for early payments
• penalties for late payments
• factoring

Question 8

explain distribution of payments as a FMS

Answer 8

involves distributing payments throughout the month, year or other period so that large expenses don’t occur at the same time and cash shortfalls don’t occur
this means theres more equal cash flow each month rather than large cash outflows in particular months

a cash forecast may be useful for helping to identify periods of potential shortfalls and surpluses

Question 9

explain offering discounts for early payments as a FMS

Answer 9

offering debtors a discount for early payment which occurs when a business offers customers a % reduction on the total invoice value when its settled before the payment deadline

pros!
- reduces risk of late payment or non-payment
- may improve customer loyalty and improve customer relationships
- improves working capital and provides extra liquidity

cons!
- will decrease profit margins
- no guarantee that customers will continue paying quickly
- may impact cash forecasting ability

SUBSEQUENTLY, a business could also impose penalties for late payments eg. interest

Question 10

explain factoring as a FMS

Answer 10

factoring = the selling of accounts receivable for a discounted price to a finance specialist factoring company - saves a business the costs involved in following up on unpaid accounts and debt collection

pros!
- immediate cash injection
- quick and easy to arrange
- customers may be more likely to pay on time if there is a factor collecting the debt

cons!
- reduces profit margins for each invoice they sell
- can be more expensive than other forms of short term finance
- could indicate to customers that the business has a cash flow problem - making customers wary

Question 11

what is working capital management

Answer 11

working capital refers the funds available for the short term financial commitments of a business
- a business must have sufficient liquidity so that cash is available or current assets can be converted into cash to pay debts

Question 12

what is working capital and how is it calculated - working capital ratio

Answer 12

CURRENT RATIO = CURRENT ASSETS/ CURRENT LIABILITIES

Question 13

what is the working capital cycle

Answer 13

refers to the length of time it takes a business to convert its net current assets and current liabilities into cash; that is, the time it takes from when a business purchases inventory
to resell (or raw materials if they manufacture their products) to when they receive the cash once it’s sold.

Question 14

what is net working capital

Answer 14

the difference between current assets and current liabilities - represents the funds needed for the day to day operations of a business to produce profits and provide cash for short term liquidity

Question 15

what are the main ways to manage working capital

Answer 15

management of
- current assets: the control of current assets requires management to select the optimal amount of each asset sold, as well as raising the finance required to fund those assets

• current liabilities

Question 16

what are the three ways of controlling current assets

Answer 16

• cash
• receivables
• inventory

Control of current assets requires management to select the optimal amount of each current asset held, as well as raising the finance required to fund those assets. The costs and benefits of holding too much or too little of each asset must be assessed. Working capital must be sufficient to maintain liquidity and access to credit (overdraft) to meet unexpected and unforeseen circumstances.

Question 17

what is the control of cash as a way to control CA

Answer 17

cash ensures a business can pay its debts, repay loans and pay accounts in the short term - careful consideration must be given to the levels of cash that are held by a business
CASH FLOW FORECASTS - helps with planning the timing of cash receipts, cash payments and asset purchases

Question 18

what is the control of receivables as a way to control CA

Answer 18

accounts receivable = the outstanding invoices or payments that a business has - money owed by customers
businesses must monitor its accounts receivable and ensure that their timing allows the business to maintain adequate cash resources - procedures for managing AR include:
- a reasonable credit policy
- incentives for early payments eg. discounts
- following up on accounts that are not paid by the due date
- putting policies in place for collecting bad debts eg. using a debt collection agency

HOWEVER, the disadvantage of operating on a tight credit policy is the possibility of customers choosing to buy from other firms

Question 19

what is the control of inventories as a way to control CA

Answer 19

inventories make a significant amount of current assets - the rate of inventory turnover depends on the type of business

inventory control is a system businesses use to ensure the costs associated with maintaining an inventory of materials are kept to a minimum - control may occur through both physical control of inventory and through accounting control eg. using an inventory recording system

JIT - ensures that the correct materials arrive just as they are needed for production

businesses must ensure that inventory turnover is sufficient to generate cash to pay for purchases and pay suppliers on time

Question 20

what are the three ways of controlling current liabilities

Answer 20

• payables (accounts payable)
• loans
• overdrafts

current liabilities = financial commitments that must be paid by a business in the short term
minimising the costs related to a firms current liabilities is an important part of the management of working capital - involves being able to convert current assets into cash to ensure that the business’s creditors are paid

Question 21

what are accounts payable as a way to control CL

Answer 21

accounts must be paid by their due dates to avoid any extra charges imposed for late payment and to ensure that trade credit will be extended to the business in the future
control of accounts payable involves periodic reviews of suppliers and the credit facilities they provide

Question 22

what are loans as a way to control CL

Answer 22

Management of loans is important, as costs for
establishment, interest rates and ongoing charges must be investigated and monitored to minimise costs

short term loans are usually an expensive form of borrowing and their use should be minimised

businesses should maintain positive ongoing relationships with financial institutions to ensure that the most appropriate short term loan is used to meet their short term financial obligations

Question 23

what are overdrafts as a way to control CL

Answer 23

enable businesses to overcome temporary cash shortages –> involve an arrangement with the bank that allows the business’s account to be overdrawn to a certain amount

interest for overdrafts is usually less for a loan

Question 24

what are the 2 strategies for managing working capital

Answer 24

• leasing
• sale and lease back

Question 25

what is profitability management

Answer 25

involves the control of both the business's costs and its revenue

Question 26

what are the 2 ways to control profitability management

Answer 26

- cost controls - revenue controls

Question 27

what are the 3 main costs controls

Answer 27

- fixed and variable costs - costs centres - expense minimisation

Question 28

what are fixed and variable costs as a cost control

Answer 28

fixed costs don't change when the level of activity changes eg. salaries, depreciation, insurance and lease fixed cost controls! - replacing/ cutting down on workers (replacing full time with part time or casual) - replacing workers with technology variable costs that vary in direct relation to the levels of operating activity or production in a business eg. labour costs, costs of energy Monitoring the levels of both fixed and variable costs is important in a business. Changes in the volume of activity need to be managed in terms of the associated changes in costs. Comparisons of costs with budgets, standards and previous periods ensure that costs are minimised and profits maximised.

Question 29

what are cost centres as a cost control

Answer 29

cost centres are particular areas, departments or sections of a business to which costs can be directly attributed By treating the cost centre as a separate unit, the business can measure how much they are spending on that function each year - allows management to measure, budget and control costs for each specific function - helps management utilise resources more efficiently - main function: tracking expenses - monitoring expenses through the use of cost centres allows for greater control of total costs

Question 30

what is expense minimisation as a cost control

Answer 30

Many businesses will aim to reduce costs and pass these savings on to customers without significantly impacting on the overall value of the product to customers eg. cutting labour costs, arranging deals with suppliers, economies of scale, replacing manual labour with technology

Question 31

what is the main way of revenue control

Answer 31

- marketing objectives

Question 32

what are marketing objectives as a method of revenue control

Answer 32

sales mix changes - businesses should maintain a clear focus on the important customer base on which most of the revenue depends before diversifying or extending product ranges pricing policy changes - pricing decisions should be closely monitored and controlled factors that influence pricing include - COGS - short and long term goals - competitor prices - the image/ quality people associate with the g&s - government policies

Question 33

what is global financial management

Answer 33

management of financial risks associated with global expansion

Question 34

what are the 5 main global financial management strategies

Answer 34

- exchange rates - interest rates - methods of international payment (payment in advance, letter of credit, clean payment, bill of exchange) - hedging - derivatives

Question 35

what are exchange rates and how do they impact a business's global financial management

Answer 35

in order to conduct transactions on a global scale, one currency must be converted into another currency conversions are performed on the foreign exchange market (forex/fx) which determines the price of one currency relative to another

Question 35

what is the foreign exchange rate

Answer 35

the ratio of one currency to another; it tells us how much a unit of one currency is worth in terms of another

Question 35

what is the foreign exchange market (forex/FX)

Answer 35

the market through which one currency is converted into another - determines the price of currency relative to another

Question 36

what are the effects of currency fluctuations

Answer 36

an APPRECIATION: upward movement of the AUD (or any other currency) against another currency - this means that each unit of foreign currency buys fewer AUD and one AUD buys more foreign $ - makes our exports more expensive on international markets but prices for imports will fall - therefore, the result is that appreciation reduces the international competitiveness of aus exporting businesses a DEPRECIATION: lowers the price of AUD in terms of foreign currency - exports will be cheaper and the price of imports will rise - therefore, improves the international competitiveness of Australian exporting businesses Currency fluctuations, therefore, significantly impact on the profitability of global businesses. When revenues and expenses are transferred between nations, the exchange rate can either increase or decrease their value. Currency fluctuations will also affect the business’s ability to meet their financial objectives.

Question 37

what are interest rates and how do they impact a business's global financial management

Answer 37

A business that plans to either relocate offshore or expand domestic production facilities to increase direct exporting will normally need to raise finance to undertake these activities. A global business has the option of borrowing money from financial institutions in Australia, or they can borrow money from financial markets overseas. Traditionally, Australian interest rates tend to be above those of other countries, especially the United States and Japan. Thus, Australian businesses could be tempted to borrow the necessary finance from an overseas source to gain the advantage of lower interest rates. However, the real risk here is exchange rate movements. Any adverse currency fluctuation could see the advantage of cheaper overseas interest rates quickly eliminated. In the long term, the ‘cheap’ interest rates may end up costing more. Changes in interest rates will therefore have a major impact on a business’s profitability if they have borrowed money from finance markets overseas.

Question 38

what are the 4 basic methods of international payment

Answer 38

- payment in advance - letter of credit - bill of exchange (document against payment and document against acceptance ) - clean payment LISTED IN LEAST TO MOST LEVEL OF RISK FOR EXPORTER

Question 39

what is a payment in advance as a method of international payment

Answer 39

a payment method that allows the exporter to receive payment and then arrange for the goods to be sent - all the risk is on the importer as they have no guarantee of receiving what they ordered

Question 40

what is a letter of credit as a method of international payment

Answer 40

a letter of credit is a document that a buyer can request from their bank that guarantees the payment of goods will be transferred to the seller - issued by the importers bank to the exporter promising to pay them a specified amount once certain conditions have been met - in order for payment to occur, the seller has to present the bank with the necessary documents for proving shipment of the goods popular with exporters as it offers less risk because it relies on the overseas bank rather than the importer

Question 41

what are bills of exchange as method of international payment and what are the main 2 types

Answer 41

a bill of exchange is a document drawn up by the exporter demanding payment from the importer at a specified time - most widely used and allows the exporter to maintain control over the goods until payment is either made or guaranteed there are 2 types of bill of exchange - document/ bill against payment - document/ bill against acceptance The risk of non-payment or payment delays when using a bill of exchange is always greater than for a letter of credit. However, documents against acceptance expose the exporter to much greater risk than documents against payment. The risk with documents against payment is that the importer may not collect the documents nor pay for the goods. With documents against acceptance there is the risk the importer may delay payment or not pay at all.

Question 42

differentiate between a document/ bill against payment and a document/ bill against acceptance

Answer 42

document/ bill against payment - using this method, the importer can collect the goods only after paying for them The exporter draws up a bill of exchange with his or her Australian bank and sends it to the importer’s bank along with a set of documents that will allow the importer to collect the goods. The importer’s bank hands over the documents only after payment is made. The importer’s bank then transfers the funds to the exporter’s bank. document/ bill against acceptance - using this method, the importer may collect the goods before paying for them The same process applies as with documents against payment, except the importer must sign only acceptance of the goods and the terms of the bill of exchange to receive the documents that allow him or her to pay for the goods at a later date.

Question 43

what is a clean payment as a method of international payment

Answer 43

an open ended payment method where the exporter ships the goods directly to the importer before payment is received - importer doesn't send payment until after they receive the goods - most risky for exporters

Question 44

what is hedging and how does it impact a business's global financial management

Answer 44

hedging refers to the process of minimising the risk of currency fluctuations SPOT RATE EXCHANGE - the value of one currency in another currency on a particular day

Question 45

what are the 2 main hedging methods

Answer 45

- natural hedging - financial instrument hedging (derivatives)

Question 46

what are derivatives and what are the 3 main types available for exporters

Answer 46

derivatives are simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations - similar concept to having a fixed interest rate on a loan

Question 47

what is a forward exchange contract as a derivative

Answer 47

A forward exchange contract is a contract to exchange one currency for another currency at an agreed exchange rate on a future date, usually after a period of 30, 90 or 180 days - means that the bank guarantees the exporter, within the set time, a fixed rate of exchange for the money generated from the sale of the exported goods

Question 48

what is an options contract as a derivative

Answer 48

foreign currency options provide another strategy for risk management - an option gives the buyer (option holder) the right, but not the obligation, to buy or sell foreign currency at some time in the future - option holders are protected from unfavourable exchange rate fluctuations, yet maintain the opportunity for gain should exchange rate movements be favourable

Question 49

what is a swap contract as a derivative

Answer 49

a currency swap is an agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future - it involves a spot sale of one currency together with a forward repurchase of the currency at a specified date in the future; for example, swapping $50 million Australian dollars for US dollars now and an agreement to reverse the swap within three months businesses also use currency swaps when they need to raise finance in a currency issued by a country in which they are not well known and are, therefore, forced to pay a higher interest rate than would be available to a better-known borrower or a local business main advantage! allows the business to alter its exposure to exchange fluctuations without discarding the original transaction

Question 50

what is sales and lease back as a way to manage working capital

Answer 50

refers to the process of selling an owned asset to a lessor and then leasing the asset back through fixed payments for a specified period of time pros! - improves liquidity as it enables the business to receive a large cash injection from the sale of an asset which can then be used as working capital - other pros are similar to leasing

Question 50

what is leasing as a way to manage working capital

Answer 50

leasing involves the payment of money for the use of equipment that is owned by another party pros! - cash outflows are spread over several years as opposed to one large initial outflow - helps improve working capital - lease payments are tax deductible (considered operating expenses) - allows the business to use high tech assets without purchasing outright

Question 51

what is natural hedging

Answer 51

A business may adopt a number of strategies to eliminate or minimise the risk of foreign exchange exposure. In this way the business provides itself with a natural hedge. Some examples of natural hedging include: * establishing offshore subsidiaries * arranging for import payments and export receipts denominated in the same foreign currency; therefore, any losses from a movement in the exchange rate will be offset by gains from the other * implementing marketing strategies that attempt to reduce the price sensitivity of the exported products * insisting on both import and export contracts denominated in Australian dollars. This effectively transfers the risk to the buyer (importer).