Topic 2- Finance Flashcards

Question

What is a Debenture

Answer 1

Companies provide them as a way to raise funds from investors, as opposed to financial institutions. Are issued by a company for a fixed rate of interest and for a fixed time. On maturity, the company repays the amount of the debenture (including interest) by buying back the debenture. The company’s assets are used as security for the loan.

Answer 2

Is a loan for a set period of time but is not backed (secured) by assets and therefore presents the most risk to investors in the note (the lender). For this reason, an unsecured note attracts a high rate of interest.

Answer 3

Is when a business rents or hires an asset (machinery, delivery vehicles, land, computers, software) owned by someone else. Leasing enables a business to use the asset (for an agreed period of time) without a large capital ($) outlay.

Answer 4

Is a loan for the purchase of property (land, buildings, factory, office retail premises). The property is used as security and cannot be sold or used as security for further borrowing until the mortgage is repaid. The loan is repaid over many years.

Answer 5

the purchase of ordinary shares by individuals means they have become part owners of a public company (they are providing equity finance for that business) and may receive payments called dividends. The value of the share is determined by a company’s current and future performance.

Answer 6

1. New Issue 2. Right Issue 3. Placements 4. Share purchase plan

Answer 7

– a stock that is being issued and sold for the first time on a public market i.e. on the securities (stock) exchange; sometimes called primary shares or new offerings. An Initial Public Offering (IPO)- or ‘float’ when a company issues shares to the public for the first time. -> The company must first prepare a prospectus (document containing relevant details about b.) and lodge it with ASIC.

Answer 8

the opportunity given to existing shareholders to buy new shares in the same company at a discount. This occurs after the IPO & commonly done to raise additional funds or to pay down debt, especially if they are unable to borrow more money.

Answer 9

allotment of shares, debentures etc. made directly from the company to investors. (additional shares are offered at a discount to special institutions or investors) -> designed to persuade specific investors to invest in the company.

Answer 10

an offer to existing shareholders to purchase more shares without brokerage fees. (can also be offered at a discount) -> allows a company to issue new shares without issuing a prospectus

Answer 11

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.

Answer 12

(BISLUAF) 1. Banks 2. Investment Banks 3. Finance Companies 4. Superannuation Funds 5. Life Insurance Companies 6. Unit Trusts 7. ASX (Australian Securities Exchange)

Answer 13

Use savings deposits to lend to businesses. Provide a range of business services eg. cheque accounts, fixed deposits, overdrafts, loans, & commercial bills. Banks also trade in financial markets, stockbroking, insurance and funds management.

Answer 14

Also known as merchant banks. Long–term & Overseas finance Advise on mergers and takeovers Provide working capital ($) for the day-to-day operations of a business. Arrange project finance and financial futures

Answer 15

Non–bank financial intermediaries that specialise in smaller commercial finance. Provide quick access to $ - but for higher interest rate Provide secured (by assets) loans to businesses and individuals Some specialise in factoring

Answer 16

Employers must pay an amount equal to 11.5% of their employee’s salary into a super fund account (on top of the employee’s salary or wages) Invests these funds in shares, property and debt

Answer 17

Non - bank financial institutions that sell insurance policies to make a future payment if a particular event occurs. Use the fees collected (from insurance premiums/fees) to invest in financial assets (shares, property etc) or to lend to the corporate sector.

Answer 18

Also known as mutual funds. Take funds from a large number of small investors and invest them in specific types of financial assets Usually connected to a management firm that manages a diversified investment portfolio for its investors

Answer 19

Acts as a primary market – enabling a company to raise new capital through the issue of new shares. Also acts as a secondary market where existing securities are bought and sold (second-hand shares are traded). -> Transactions in this market do not increase the total amount of financial assets – the secondary market increases the liquidity of financial assets

Answer 20

Enforces the Corporations act Protects consumers (reduces fraud & unfair practices) Collects financial information about companies to make public Supervises retail and trading industries

Answer 21

All b.s pay a flat rate of company tax (approx. 25%) on net profit. -> paid before profits are distributed to shareholders as dividends. The Australian Government has reduced company tax since 2015 to make Australia an even more attractive place to invest -> thereby driving long-term economic growth = more jobs for Aussies.

Answer 22

1. Economic Outlook 2. Availability of Funds 3. Interset Rates

Answer 23

-> Projected changes to economic conditions throughout the world E.g. If the outlook is good, economic activity increases -> increases demand for goods and services -> resulting in increased production (output). B.s will then require more funds to expand the b.. ★decreasing global interest rates means that businesses can borrow $ internationally overseas (cheaper than domestically, in Aus).

Answer 24

-> How easy it is for a business to access funds (for borrowing) on international financial markets. (Australians are free to borrow and invest in financial assets overseas, and foreigners can do likewise in Australian markets) Conditions rely on: Risk - Demand + Supply - Domestic economic conditions Example: Global Financial Crisis Decreased availability of funds due to sharp increase in interest rates

Answer 25

-> the cost of borrowing (the higher the level of risk in lending to a business, the higher the interest rate) Australia’s interest rates are generally higher than US & Japan Overseas sourcing = lower interest rates Exchange rate fluctuations can quickly eliminate the advantages of overseas sourcing COVID caused ultra-low interest rates around the world

Answer 26

are financial documents used to estimate future revenue and expenses over a period of time. Budgets can be drawn up to show: cost cutting measures, cash requirements for a particular project or activity, the cost of capital (machinery), the cost of raw materials or inventory and labour costs. -> used for both planning and controlling in a business.

Answer 27

are the procedures and means by which a business monitors and controls the allocation/usage of its resources. Businesses need to control accounts receivable (by following up overdue accounts and doing customer credit checks), inventory (by regularly checking inventory levels), cash (by requesting payment by cheque instead of cash to reduce risk) and other assets (by having building security procedures in place)

Answer 28

★ Can be acquired at short notice ★ Regular payments can be planed enabiking a business to effectively manage cash flow ★ Interests payments are tax deductible ★ Suppliers of debt (eg. banks) have no ownership rights.

Answer 29

★ There are no interest repayments ★ The money ($) does not have to be repaid unless the owner(s) leaves the business ★ Low gearing (dependence on debt) – the business is using the owner(s) resources (money) and not external sources of finance.

Answer 30

★Interest rates may change (increase) increasing loan repayments ★ Regular repayments have to be made and the debt must be repaid by a specific date ★ Security is required by the business. (secured by assets) ★ Lenders have first claim on any money if the business ends in bankruptcy

Answer 31

★ Profits are shared – dividend payments to shareholder ★ Ownership is diluted, i.e. the current owners will have less control. ★ Long, expensive process to obtain funds this way. ★ Expectations about ROI

Answer 32

refers to the level of debt (external finance) a business has (compared to equity or internal finance). -> Highly geared businesses have a high level of debt. The higher the gearing, the higher the risk (but greater potential for growth and profit).

Answer 33

a financial statement that shows cash receipts (cash inflows) and cash payments (cash outflows) over a period of time

Answer 34

Cash Balance (Closing Balance) = Opening Balance + Cash Receipts (inflows) – Cash Payments (outflows)

Answer 35

generate positive cash flow (cash receipts > cash payments) pay its expenses when they are due (eg. rent, wages) obtain finance from external sources when needed pay dividends to shareholders finance future expansion

Answer 36

show the revenue (income) and expenses of the business over the accounting period and whether the business is making a profit or loss.

Answer 37

Cost Of Goods Sold (COGS) = Opening Stock + Purchases – Closing Stock ———————————————————— Gross Profit (GP) = Sales Revenue (Income) – Cost Of Goods Sold (COGS) ———————————————————— Net Profit (NP) = Gross Profit (GP) + Other Revenue (Income) – Other Expenses

Answer 38

shows assets (what the business owns), liabilities (what the business owes) and net worth (what the business is worth) of the business at a specific point in time.

Answer 39

- 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

Answer 40

Assets = Liabilities + Owner(s) Equity ———————————————————————————— Owner(s) Equity = Capital + Net Profit - Drawings Owner(s) Equity = Capital - Net Loss - Drawings

Answer 41

are a way of analysing financial information. They are a tool used to analyse: Financial stability (liquidity and gearing/solvency) Profitability Efficiency

Answer 42

measures the ability of the business to pay short term debts (i.e. debts the business is expected to repay within 1 year) when they are due. indicates short - term financial stability or liquidity. compares Current Assets with Current Liabilities.

Answer 43

Current Ratio ->Found on Balance Sheet Current Assets ----------------------- Current Liabilities Usual acceptable ratio is $2 of Current Assets to cover $1 of Current Liabilities (2:1 or 200%).

Answer 44

measures the ability of the business to pay short (i.e. debts that take less than 1 year to repay) and longer term debts (i.e. debts that take longer than 1 year to repay). indicates long term financial stability or solvency compares total external liabilities/debt (current and non – current liabilities) with internal finance/owner(s) equity

Answer 45

Debt to Equity Ratio -> found obn Balance Sheet Total Liabilities (current and non + current liabilities) ----------------------- Owner(s) Equity Shows reliance (dependence) on debt. Higher the ratio → higher the debt → higher the risk → less solvent the business. 7:1 (700%) - high gearing, 1:2 (50%) – low gearing. Usual acceptable level is 1:1 (100%) or slightly higher. But there is no optimal level of gearing for a business

Answer 46

measures the ability of the business to generate (produce) profits. compares profit with sales (revenue) – Gross Profit and Net Profit Ratios compares profit with owner(s) equity – Return on Owner(s) Equity Ratio

Answer 47

Gross Profit Ratio -> Found on Income Statement Gross Profit ----------------------- Sales X 100 (%) Indicates level of earnings/profit from sales after Cost Of Goods Sold (COGS) have been accounted for. Higher the ratio (%) – greater the profitability from trading (selling products). Usual acceptable level – 15 - 40%

Answer 48

Net Profit Ratio -> found on Income Statement Net Profit ----------------------- Sales X 100 (%) The NPR provides are more accurate indication of a business’s profitability because it considers BOTH the cost of inventory/stock + other expenses (wages, electricity, advertising etc). Higher the ratio (%) – greater the profitability from all business activities. Usual acceptable level – 5-20% (varies across industries).

Answer 49

Return on Owner(s) Equity -> found on Income Statement and Balance Sheet Net Profit ----------------------- Owner(s) Equity X 100 (%) Compares Net Profit with owner(s) investment in the business - indicates how effective capital has been in generating (producing) profit. Higher the ratio (%) – greater the profitability– higher the return on owner(s) investment.

Answer 50

Measures the ability of the business to use its resources efficiently. Increased efficiency = increased profits.

Answer 51

Expense Ratio -> found on Income Statement Total Expenses ----------------------- Sales OR Specific Expense ----------------------- Sales X 100 (%) Indicates level of profit (proportion of each sales dollar) left after expenses have been paid. Lower the ratio (%) – greater level of earnings left. Low ratios indicate good management (efficiency). ★ Note: the difference between the Gross Profit ratio and the Net Profit ratio = the Expense ratio.

Answer 52

Accounts Receivable Turnover Ratio OR Debtors Turnover Ratio -> Found on Income Statement and Balance Sheet (Credit) Sales Accounts ----------------------- Receivable -> 365 divided by this figure (no. times a year) Indicates effectiveness of credit policy/ efficiency in collecting debts. Usual credit period given to debtors is 30 days -> Sooner debts collected the better – the money can be used to invest in new machinery (technology), product development and/or business expansion – these activities will increase the profitability of the business in the long term.

Answer 53

Ratios analyse financial information in a number of ways: 1. Over different time periods – a comparison of figures across a number of financial years (a comparison of income statements for a period over 3 to 5 years to identify trends/patterns in profit figures). 2. Against standards – a comparison to industry benchmarks (standards) – acceptable performance standards developed for businesses within an industry group – these may be Australian standards or international standards. 3. With similar businesses - a comparison with other similar businesses – interbusiness comparisons may use

Answer 54

1. Normalised Earnings 2. Capitalising Expenses 3. Valuing Assets 4. Timing Issues 5. Debt Repayments

Answer 55

Normalised earnings: the process of averaging the earnings of a business over a number of years to remove inaccuracies created by changes in the economic cycle such as a recession or to remove one off or unusual events that affect profitability. -> provide a more realistic indication of the earnings performance of a particular business. This makes it easier to compare profitability figures E.g. Many businesses experience one-off expenses (large lawyer fees) or one-off gains (the sale of an asset) - even though the costs and revenues affect the business’s short-term cash flow, they are not indications of the business’s long-term performance.

Answer 56

Capitalising expenses: is where expenses, such as putting in a new computer system to process sales, are considered as a capital item and put into the Balance Sheet (as an asset) rather than the Income Statement (as an expense). -> This does not represent the true financial condition of the business as it understates expenses and overstates profits as well as the assets of the business. E.g. of capitalising expenses include research and development expenditure.

Answer 57

Valuing assets: is where the value of a particular asset is estimated. Assets such as land, buildings and equipment may be valued optimistically -> this will make financial reports inaccurate. -> Historical cost is an accounting method where assets are listed on a balance sheet with the value at which they were purchased. The disadvantage is that this value may distort the business’s balance sheet, meaning that it will not accurately represent the true worth of the business’s assets. (Assets value changes over time) -> Some assets are difficult to value. Intangible assets are of value to the business, but they do not physically exist e.g. goodwill, trademarks, patents and brand names. - not included in the balance sheet because their value is too difficult to determine. If they are included, may be overvalued to make the business appear more financially stable than it really is.

Answer 58

1. Audited Accounts 2. Record Keeping 3. Misuse of Funds

Answer 59

Audited Accounts: audits may be carried out internally (by employees to check accuracy), by management (to check plans and the need to make changes to plans) or externally (by an independent audit accountant employed by the business). Under Corporations Law public companies and clubs must carry out annual external audits to ensure business accounts and financial procedures are accurate and comply (follow) with Australian and International Financial Reporting Standards (IFRS).

Answer 60

Record Keeping: Businesses may receive payment in cash, and not record the transaction. If cash received in this way is not recorded, it will not show up as business revenue, and will reduce the business’s profit for the year, possibly resulting in a lower tax burden.

Answer 61

Misuse of Funds: when managers or other employees steal money (eg. small change) or goods (eg. stationery items) from a business it is unethical, but it is unlikely to result in criminal charges. Major theft involves large amounts of money and is illegal.

Answer 62

DEF 1. Distribution of Payments 2. Early Payment Discounts 3. Factoring

Answer 63

-> Using cash budgets to predict periods of potential cash surplus and deficit – this enables a business to distribute payments across the period or year to reduce cash shortages

Answer 64

discounts for early payment to credit customers (debtors) and/or discounts for paying in cash an effective strategy when targeted at debtors who owe the largest amounts of $ (as they are the ones able to save the most amount of $ by paying early). late/ unpaid accounts cost businesses (debt interest, administrative costs, wasted time chasing payment) increase customer loyalty as customers use the discount as an incentive improves working capital/liquidity and reduces the risk of non-payment/bad debt

Answer 65

-> the selling of accounts receivable for a discounted price to a finance or factoring company. Factoring reduces the costs of debt collection and following up unpaid accounts

Answer 66

Bank overdrafts - cover shortages Delay payments of accounts payable Keep minimum inventory levels - JIT, LIFO, FIFO Leasing - avoids large initial payment and tax-deductible

Answer 67

refers to the funds ($) used to operate (work) the business on a day to day basis. Also referred to a liquidity management. - so that cash is available to pay short-term debts (current liabilities). - deciding the best mix (combination) of current assets and current liabilities for the business Net Working Capital = Current Assets – Current Liabilities

Answer 68

A ratio of 7:1 or 700% - $7 of Current Assets to cover every $1 of Current Liabilities indicates that liquid assets are not being used efficiently i.e. Too much stock is being held, too much money is owed by debtors (high accounts receivable) -> Not Using Cash Efficiently - could be used for: - marketing - research and development

Answer 69

Usual acceptable ratio – 2:1 or 200%($2 of Current Assets to cover every $1 of Current Liabilities)

Answer 70

If a business has a < 1 (ie. 0.65:1 or 65% - only 65 cents of Current Assets to cover every $1 of Current Liabilities) is not satisfactory because the business is unable to meet its short term debts even if it changed all their current assets into cash immediately

Answer 71

(CRI) 1. Cash (C) - Cash budgets can help businesses to plan and control cash so that they always have enough cash for the day to day operation 2. Accounts Receivables/Debtors (R) - is money owed to the business by customers who have purchased on credit - encouraging customers to pay in cash by giving discounts for cash sales or giving credit customers a discount for making early payments - penalties (extra charges) for late payments - checking the credit rating (or history) of customers before extending them credit. - giving customers a credit limit 3. Inventory/Stock (I) - must carry enough stock to meet customer demand otherwise customers will go elsewhere and sales will be lost Just - In - Time (JIT) inventory management is concerned with the elimination of waste

Answer 72

(POL) 1. Accounts Payable/Creditors (P) - not paying accounts payable until final due date -> cheap way of improving a business’s cash position as some suppliers allow a period of interest- free trade credit before requiring payment for goods purchased 2. Overdraft (O) - Bank overdrafts enable businesses to overcome temporary shortages of cash. (The interest payable on an overdraft is usually less than a loan) 3. Loans (L) - Businesses may need to borrow funds in the short term (i.e. use bridging finance) because customer debts are not collected efficiently and the cash is therefore not available to pay suppliers and wages. (can increase risk to business)

Answer 73

1. Leasing 2. Factoring 3. Sale and Lease Back

Answer 74

Leasing (L): renting or hiring assets (eg. land, machinery, vehicles) owned by another person or business. Advantages - Tax-deductible expense - Frees up cash to use elsewhere - Enables businesses to keep up with changes in technology - Repair and maintenance of the asset may be included Disadvantages - The lease payment will increase expenses throughout the life of the lease - No capital ($) gain if the leased asset

Answer 75

Factoring (F): the sale of accounts receivable/debtors to a factoring company at a discounted price. Advantages - Factoring enables business to receive cash as soon as it makes a sale. $ is not tied up while the business waits for its credit customers to pay - Isn’t a loan (businesses won’t be taking on debt/paying interest) Disadvantages - Reduces a business’s profit margin on each invoice they sell - Can damage a business’s relationship with their customers

Answer 76

Sale and Lease Back (SL): the selling of an owned asset (eg. buildings, mineral mines, ships and aeroplanes) to a lessor, then leasing the same asset for an agreed period of time. Advantages - Increases a business’s liquidity as the cash received from the sale of the asset is used as working capital Disadvantages - Risk of losing premises - No more Capital Gains

Answer 77

(FVEC) 1. Fixed & Variable Costs 2. Cost Centres 3. Expense Minimisation

Answer 78

Fixed costs: do not vary with output e.g. rent, salaries (paid to skilled labour – professionals such as teachers, executives, managers), insurance, lease repayments -> hard to reduce – they are already paid before production & sales. Variable costs: increase as output increases e.g. wages (paid to unskilled labour – workers trained on the job such as factory workers, sales assistants), electricity, raw material costs. -> easier to reduce.

Answer 79

A cost centre may be a department (section/area), a factory or a retail shop – the idea is to separate it from the rest of the business in terms of its costs. -> making someone (a manager) responsible for the costs. This person could identify areas of waste and do something about it so that costs are minimised. ★ Monitoring expenses through the use of cost centres allows for greater control of total costs

Answer 80

Labour - by employing people on a casual, part time or contract basis (to reduce on - costs such as sick and holiday leave), reducing staff and multi-skilling remaining staff and introducing self service Inputs - by finding cheaper suppliers and negotiating discounts by buying in bulk through supplier rationalisation

Answer 81

Marketing objectives (MOP) - Sales objectives need to be aimed at a level of sales that cover costs (fixed and variable) and result in profit. Cost Volume Profit (CVP) analysis or Break Even Analysis: shows the level of sales and revenue necessary to cover costs and make profit. Businesses change the sales mix (product range offered for sale) to maximise revenue. Pricing decisions need to be monitored and controlled to avoid overpricing (lost customers) and underpricing (lower profits) -> businesses need to check production costs, competitors’ prices, government policies, product image and quality, business goals.

Answer 82

MIHED 1. Methods of International Payment 2. Intrest Rates 3. Hedging 4. Exchange Rates 5. Derivatives

Answer 83

BLAC 1. Bill of exchange 2. Letter of Credit 3. Payment in Advanced 4. Clean Payment

Answer 84

Document drawn up by exporter demanding payment at specific time allows the exporter to maintain control over the goods until payment is made or guaranteed 2 types of bill of exchange: - Document (bill) against payment (the importer can collect the goods only after paying for them) - Document (bill) against acceptance (the importer may collect the goods before paying for them)

Answer 85

Commitment by the importer’s bank to pay when documents showing goods have been shipped are sent -> good for the exporter because the bank is taking on the risk of non - payment and the importer is satisfied because there is no risk of paying for goods that may not arrive

Answer 86

allows the exporter to receive payment and then send the goods overseas ★ Best option for Exporter most risky for the Importer -> E.g. Amazon

Answer 87

is an open account payment method. The exporter ships the goods before payment is received. They have 30-90 days to pay

Answer 88

Can increase cost of borrowing Impact willingness to invest & purchase goods and services Mostly Australian interest rates are higher than those in other countries such as Japan and the US -> Businesses can opt to borrow overseas to take advantage of lower interest rates - Risk of exchange rates

Answer 89

Is the price of one currency in relation to another. Fluctuations occur due to variations in demand and supply carried out in the foreign exchange (Forex) market Spot contracts Lock in a price for 48 hrs Avoids risk of fluctuations (can affect profits) Effects of Fluctuations: Appreciation - exports more expensive, imports cheaper Depreciation - exports cheaper, imports more expensive -> Strategy - plan ahead, use spot contracts to minimise the exchange rate

Answer 90

Process of minimizing risk of currency fluctuations Natural Hedging: - Trade in AUD (put in contracts) - Insurance - Marketing strategies - reduces price sensitivity, increases demand

Answer 91

financial tools used to reduce the exporting risks associated with currency fluctuations 3 Main Derivatives: 1. Forward exchange contract 2. Currency options contract 3. Swap contract

Answer 92

- involving a bank guaranteed exchange rate for an exporter on a specific date (up to 6 months) -> Allows profits to be calculated without changes

Answer 93

- Buyer pays a premium to have the option to buy a currency at a cheaper price in the future even if currency becomes more expensive.

Answer 94

- Agreement between two businesses to exchange their currencies with each other. Eg. Australian business needs Japanese Yen but can’t borrow it

Topic 2- Finance Flashcards

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