Business Studies- Finance

Role of financial management

Strategic role of financial management

Strategic financial management is the process of setting long-term objectives throughout the

business and deciding what will be needed to achieve these objectives

Developing a strategic plan a part of a firms financial management will ensure the business

grows

Business goals such as increasing profits are translated into business objectives that provide

detail about the firms mission, purpose and function

Business objectives: Break the business operations into achievable and manageable outcomes

that can be measured and evaluated

Financial management: Refers to the planning, organising and monitoring/controlling of the

financial or monetary resources to achieve the goals, objectives and plans of the business

Managing business finances are crucial to ensure the success of a business, with the following

possibly occurring if finances are not correctly managed:

Overstocking materials

Insufficient cash to pay suppliers

Inadequate capital for expansion

The main role of financial management can be broken down into three types of decisions:

Finance decisions where will the business source its money from?

Investment decisions how will the business use its finance to generate income?

Dividend decisions how will the business distribute any profits?

Objectives of financial management - Profitability, growth, efficiency, liquidity, solvency

In order to achieve its long term goals, firms must first set out and achieve a number of short

term goals including:

Goal Description

Profitability The ability of a business to maximise its profits In order to increase profitability, firms must monitor and aim to increase

revenues whilst reducing costs at the same time

Growth The ability of the business to increase its size in the longer term A significant financial objective as it ensures the firm is sustainable in the future, The growth of a firm depends on the firms ability to use its asset structure to

increase sales, profits and market share

Efficiency The ability of a business to utilises its resources effectively in ensuring financial stability and profitability

Occurs when a firm can minimise costs and manage assets in order to maximise profits

By increasing productivity through staff or technological machinery, a firm can

increase its efficiency and thus minimise costs

Liquidity The ability of a business to pay its debts as they fall due In order to, a firm must have sufficient positive cash flow or convert assets to

liquid funds to pay debts

Solvency The extent to which the business can meet its financial commitments in the longer term, usually greater than 12 months

Important to owners, shareholders and creditors as it is an indication of the risk associated to their investment in the particular firm

- Short term and long term objectives

Short Term Long term

Are the operational (day-to-day) and tactical (1-2 years) plans

Reviewed regularly to see if targets are achieved, and could include sales targets for each month or output increases

are the strategic (5 years +) plans of a business

can involve aims to expand into emerging markets such as Asia, become a market leader and increase market share

in order to be achieved, the shorter term operational and tactical goals must be achieved first

performance is reviewed annually to see if the targets for each year are met, such as growing 5% each year in order to gain 20% market share in 4 years

Interdependence with other key business functions (KBF) The key business functions include operations, marketing, finance and human resources

In order to achieve certain goals such as market share, all functions must work together in

order to achieve this

If, for example, a business was to set a strategic goal of increasing its market share by 5%, this

would affect:

Operations, as production methods would need to be altered to become more

efficient/productive and thus minimise costs

Marketing, as extensive advertising to increase market awareness would be required

Human resources, as additional labour would be required to produce higher outputs

Finance, as additional funds may be needed in order to alter operations production

methods, pay for additional marketing and additional labour costs

Influences on financial management

Internal sources of finance-retained profits A business can finance its operations from external sources, internal sources, or, more

commonly, a combination of both

The Internal Finance: The funds provided by the owners of business or from the outcomes of

business activities (retained profits)

Internal finance comes from the following sources:

Owners Equity: The funds contributed by owners or partners to establish and build the

business

Retained Profits: Involve retained earnings which arent redistributed to dividends and other

means. In Australia about 50% of profits are retained for future reinvesting, and provides firms

with a cheap and accessible form of finance

External Sources of Finance External Finance: The funds provided by sources outside the business including banks,

other finance institutions, government, suppliers or financial intermediaries

- Debt: Short term borrowing (overdraft, commercial bills, factoring), long-term borrowing

(mortgage, debentures, unsecured notes

Short term Borrowing

Used to finance temporary shortages in cash flow or finance for working capital

Repaid within 1-2 years

Type of Debt Description

Bank overdraft Common type of short term borrowing Consists of businesses able to overdraw its account to

an agreed limit Overdrafts assist firms with short term liquidity

problems, due to a slum in sales etc Interest rates are lower than on other forms of

borrowing, other costs and fees are minimal

Commercial Bills A type of loan for large amounts of money (over 100k) issued by institutions other than banks, basically an IOU for the period of between 90-180 days

Borrower receives the money immediately and then promises to pay the principal + Interest by the time the period has ended

Factoring The selling of accounts receivable for a discounted price to a finance or factoring company

A firm can receive up to 90% of the amount of receivables within 48 hrs of submitting its invoices to the factoring company

Obvious downside is that not all of accounts receivable go to the business, as the factoring company charges a fee/commission cost of finance

A factoring company can offer: Without recourse: The business transfers responsibility for

non-collection to the factoring company With recourse: The business will still have the responsibility

of its bad debts Comes with greater risks and higher costs than other

sources of finance Previously viewed negatively but attitudes towards

factoring have improved over the last decade

Long-term Borrowing

Funds borrowed for periods longer than two years, and is able to be both secured or

unsecured with interest rates also having the options of variable or fixed

Used in real estate, offices and factories and capital equipment

Type of Debt Description

Mortgage

A loan secured by the property of the borrower (business) A loan secured by the property of the borrower (the business), which

cannot be sold or used as security for another loan until the current loan has been repaid in full

Debentures (bond)

Issued by a company for a fixed rate of interest and for a fixed time The amounts of profits made by the firm have no impact upon the interest

as it is fixed Not secured to specific property

Unsecured notes

A loan for a set period of time but is not backed by any collateral or assets Most risk to lenders, thus attracting high rates of interest compared to a

secured note Firms sell these to generate money for initiatives such as acquisitions

Leasing

Involves the payment of money for the use of equipment that is owned by another party

The lease is an agreed period of time, and both the costs and benefits of the equipment is transfers from the leaser to the lessee

Long term lease cant usually be cancelled Two types of leasing:

Operating leases short-term, usually less than the life of the asset

Financial leases lessor buys asset on behalf of lessee and as

such the lease usually lasts for the life of the asset

- Equity-ordinary shares (new issues, rights issues, placements, share purchase plans), private

equity

Refers to finance raised by a company by issuing shares

Ordinary shares

Most commonly traded shares in Australia, with purchasers becoming part owners of a

publicly listed company

The return on these shares is capital growth and dividends

Dividends: A distribution of a firms profits (either yearly or half yearly) to shareholders and is

calculated as a number of cents per share (Dividend yield)

Types of ordinary shares include:

New Issue: A security that has just been issued and sold for the first time (primary

market)

Rights Issue: The privilege granted to shareholders to buy new shares in a company

which they already hold shares in

Placements: Allotment of shares, debentures etc made directly from the firm to

investors

Share purchase plan: An offer to existing shareholders in a listed company to

purchase more shares in that company without brokerage fees. These shares can also

be offered at a discount compared to the current market price

Financial Institutions- Banks, Investment banks, finance companies,

superannuation funds, life insurance companies, unit trusts and the

Australian Securities Exchange

Financial Institutions

Description

Banks Major operations in the financial markets and most important source of finance for businesses

Receive deposits from individuals, business and governments, make investments and loans to borrowers

Since the GFC in 2008, banks have been more cautious in lending policies making it harder for businesses the obtain finance

E.g ANZ, CBA, Westpac,

Investment Banks One of the fastest growing sectors in Australia They provide services in both borrowing and lending primary to the

business sector They:

Advise on mergers and acquisitions Arrange project finance Trade money, securities and finance futures Operate unit trusts, cash management trusts, property trusts and

equity trusts E.g JP Morgan, Goldman Sachs, CITI, UBS, RBS,

Finance Companies Non-bank intermediaries that specialise in smaller commercial finance Regulated by the Australia Prudential Regulation Authority (APRA) They act as intermediaries in financial markets by providing loans to

both individuals and businesses Some companies also specialise in factoring or cash flow financing Capital leant out is raised through debentures (fixed term with fixed

interest) These loans are secured, thus the asset can be sold off if the business

paying the loan fails e.g Aussie and Yellow Brick Road

Superannuation Funds

Rapid growth in the last 20 years due to compulsory superannuation contribution legislation

Provide funds to the corporate sector through the investment of funds received from contributions

They invest in long term securities such as company shares, government and company debt due to long term nature of superannuation

e.g ING Direct

Life insurance companies

Provide corporate loans through receipts of insurance premiums Provide large amounts of both equity and loan capital to firms Can sometimes be very risky for those who depend upon insurance

payouts (eg QLD floods) E.g Allianz, AIA

Unit Trusts Known as mutural funds, and take funds from a large number of small investors and then invest in certain types of financial assets

Include on the short term money market (cash management trusts), shares, mortgages, property and public securities

Some trusts are connected to management firms that manage a diversified investment portfolio for investors

E.g AXA

ASX Australian securities exchange is the primary stock exchange in Australia

Functions as a market operator which offers products and services including shares, futures, real estate investment trusts, exchange traded options etc

Both the primary and secondary market, and oversees all share transactions with public companies

Influence of Government- ASIC, company taxation Government can influence business behaviour and financial management decision making

through economic policy making such as Fiscal and Monetary policy, and also microeconomic

reform

Australian Securities and Investments Commission (ASIC)

Ensures that companies adhere to laws concerning investments and collects & publishes

information about companies

Aims to assist in reducing fraud and unfair practices in financial markets and financial products

such as insider trading

Since 1998 has been responsible for enforcing the Corporations Act

Company Taxation

Tax is paid on profits, and is currently a flat rate of 30% unlike personal tax which is

progressive

Is paid BEFORE profits are distributed to shareholders as dividends

Has been systematically reduced over the last decade to increase global competitiveness and

attract foreign investment

This rate was reduced from 36 to 34% for 2000-01 and then 30% until 2013

Global Market Influences

Almost uncontrollable by businesses, however management strategies can be implemented in

order to minimise the effects on a business

Globalisation has created a larger interdependence between economies and their business

sectors which relies on trade for expansion and increased profits

The three main global market influences upon firms include:

Economic outlook (bull market-boom, bear market-bust/economic slowdown)

Availability of funds (the difficulty to obtain funds)

Interest rates (cost of finance)

Global economic outlook

Refers specifically to the projected changes in the level of economic growth throughout the

world

Positive prospects = easier availability to finance, higher consumer confidence thus increased

consumption and demand for G&S = Higher levels of economic growth, business profits etc

Negative prospects = more difficult to gain finance, lower consumer confidence thus reduced

demand for G&S = lower levels of economic growth, business profits etc

Availability of Funds

Refers to the ease with what a business can access funds on the international finance markets

These international financial markets are made up of governments, companies, institutions etc

which are prepared to lend money

Lending is determined on various conditions including:

Risk

Demand and supply

Domestic economic conditions

GFC is good example of how the availability (or rather unavailability) of funds on a global level

can have a negative impact on businesses in Australia

Interest Rates

The cost of borrowing money

Higher levels of risk = higher interest rates

Interest rates in Australia have historically been higher than most other nations, increasing the

incentive for Australian businesses to borrow from overseas sources

Changes in exchange rates can either amplify or negate the advantages of overseas borrowing,

depending on the direction of the change)

Processes of Financial Management

Planning and Implementing- Financial needs, budgets, record systems,

financial risk, financial controls Planning processes involve the setting of goals and objectives, determining the strategies

to achieve those goals and objectives, indentifying and evaluating alternative courses of

action and choosing the best alternative for the business

Financial Needs

In order to determine where a business is heading, it is important to know what its needs

are

Financial information must be connected before future plans are made, and include

balance sheets, income statements, cash flow statements, sales forecasts etc

The financial needs of a firm are determined by:

Size of the firm

Phase in the business cycle

Future plans for growth and development

Capacity to source finance- debt and/or equity

Financial information is needed to show that the business can generate an acceptable return

for the investment being sought and should, therefore include an analysis of financial

performance such as a cash flow statement and balance sheet

Budgets

Provide information in quantitative terms (facts and figures) about requirements to achieve a

particular purpose

They provide the facts and figures for planning and decision making and enable constant

monitoring of progress and problem areas

They reflect the strategic planning decisions about how resources are to be used and provide

financial information for a businesss specific goals and are accordingly used in strategic,

tactical and operational planning

Enable constant monitoring of objectives and provide a basis for admin control, production

planning, price setting and control of expenses

Used in both the planning and controlling aspects of a firm

Planning: Can be used to review past figures and trends to plan for realistic goals for

the future etc

Control: Planned performance can be compared to actual performance with

corrective action taking place if required

Operating Budgets: Relate to the main activities of a business and may include budgets

relating to sales, production and raw materials

Project Budgets: Relate to capital expenditure and R&D

Financial Budgets: Relate to financial data of a business and include budgeted income

statements, balance sheets and cash flow statements

Record Systems

Record systems are the mechanisms employed by a business to ensure that data is recorded

and the info provided by record systems is accurate, reliable, efficient and accessible

The double entry recording system is used to minimise errors, as entries can be seen to

balance, and checks to find errors can be carried out quickly and easily

This is done as management base decisions on previous records when needed, therefore all

records must be reliable and accurate

Financial Risks

The risk to a business of being unable to cover its financial obligations such as debts incurred

through short & long term borrowing

Businesses must consider whether the profit generated as a result of borrowing is enough to

cover the repayments

Generally, the higher the risk, the higher the return both the business and the financial

institution lending the funds will expect. (e.g higher risk for banks = higher interest rates)

Financial Controls

The policies and procedures that ensure that the plans of a business will be achieved in the

most efficient manner

The most common causes of financial problems are:

Theft

Fraud

Damage/loss of assets

Errors in record systems

Common policies/procedures that promote control within a business include:

Clear responsibility for tasks

Separation of duties

Rotation of duties

Debt and Equity Financing- advantages and disadvantages of each Business can choose to gain finance from both external and internal sources, and usually

adopt an approach to utilise both sources

Debt Finance

Debt finance refers to the short and long term borrowing from external sources by a business

Include mortgages, loans, overdrafts etc from banks and other financial institutions

Equity Finance

Equity finance refers to the internal sources of finance in the business, such as owners equity

and retained profits

Include retained profits, owners equity and primary shares

Comparing debt and equity finance

Matching the terms and source of finance to business purpose The terms of finance must be also suitable for the structure of the business and the purpose

for which the funds are required

The costs of each source of funding must be determined and balanced against the expected

rate of return

Structure of a business can also influence financial decisions, eg unincorporated businesses

will have difficulties obtaining equity finance

Other costs associated with a source of finance, eg setup costs and interest payments must

also be considered

Flexibility of finance should also be considered eg overdraft v debentures

Availability of finance cannot be taken for granted and must also be considered

Level of control maintained must also be considered, especially when choosing between debt

and equity finance

Monitoring and Controlling- Cash flow statement, Income statement,

Balance Sheet

Financial Statements

Monitoring and controlling is essential for maintaining business viability and affects all aspects

of financial management

The main financial controls used for monitoring are:

Income statements

Balance sheets

Cash flow statements

Cash flow Statement

A financial statement that indicates the movement of cash receipts and cash payments

resulting from transactions over a given period of time

Provides the link between the income statement and balance sheet, and gives important

information regarding the firms ability to pay its debts on time

Creditors, lenders, owners and shareholders all use a CFS to assess the ability of a

business to manage its cash and identify cash flow management trends over time

A better predictor of a firms status rather than profitability, and shows whether a firm

can:

Generate positive cash flow

Have sufficient funds for future Investment

Pay servicing costs (rent, interest, dividends, accounts payable)

The activities of the firm are separated into 3 distinctive categories on the cash flow statement

including:

Operating Activities: The cash inflows/outflows relating to the main activity of the

firm (provision of G&S, income from sales, dividends and interest received whilst

outflows consist of payments to suppliers and employees

Investing Activities: Cash inflows/outflows relating to the purchase and sale of non-

current assets and investments, such as selling a company car or purchasing new

capital machinery

Financing Activities: The cash inflows/outflows relating to equity or debt. Inflows

involve the $ received from issuing shares or borrowing from financial institutions,

whilst outflows consists of servicing costs such as interest

Income Statement

Shows the operating results for a given period of time. It shows the revenue earned and

expenses incurred over the accounting period with the resulting profit or loss

Operating income: Earned from the main function of the business such as sales of

inventories, services and other operations such as interest and rent

Operating expenses: Including purchase of inventories, payments for services and

other operations including advertising, rent, telephone and insurance

Managers can compare and analyse trends using a collection of previous income statements

before making important financial decisions, and can identify the reasons for

increases/decreases in profits etc

Balance Sheet

Represents a businesss assets and liabilities at a particular point in time, expressed in money

terms, and represents the NET worth of the business and the stability of the firm

Assets: The items of value owned by the business, current can be turned into cash

within 12 months whilst noncurrent assets are not expected to be turned into cash

within 12 months

Liabilities: Claims by people other than owners against the assets (items of debt) and

represent what is owed by the business. Current liabilities must be paid within 12

months, whilst noncurrent liabilities are expected to be paid in a period longer than 12

months, such as a mortgage

Owners Equity: Represents the owners financial interest in the business or net worth

of the business, also referred to as capital

Shows the financial stability of a business, and analysis of the sheet can indicate weather:

The firm has enough assets to cover its debts

The interest and principal borrowed can be repaid

The assets are being used to maximise profits

The accounting equation (Assets = Liabilities + Owners Equity) forms the basis

of the accounting process and shows the relationship between assets, liabilities

and owners equity

Financial Ratios Analysis involves working the financial information into significant and acceptable forms that

make it more meaningful, and highlighting relationships between different aspects of a

business

Interpretation involves making judgements and decisions using data gathered from analysis

Gearing is the proportion of debt finance compared to the proportion of equity used

determines solvency

3 types of analysis including vertical, horizontal and trend analysis

Vertical: Compares figures within one financial year, e.g expressing gross profit as a %

of sales

Horizontal: Compares figures from different financial years, such as 2011 to 2012

Trend: Compares figures from periods of 3-5 years

The type of analysis utilised will depend on the reasons that the information is required for,

such as comparing figures, percentages or ratios for different firms within the same industry

Financial Ratio Ratio Example Purpose

Liquidity

450 000/150 000 = 3:1 - The firm has $3 of

assets for every $1 of current liabilities, indicating that the firm is in a sound financial position, that is, it is liquid and will be able to pay for its debts in the short term

Identifies a limited indication of the ability of the firm to meet its liabilities

- Analyses short-term stability

- Generally accepted that 2:1 is sound

- HIGHER is better

Gearing Debt to Equity Ratio

50 000/ 150 000 = 33.3% - The firm has

$0.33 in external debt (liabilities) for every $1 of internet debt (owners equity). A ratio of 1:1 indicates a sound financial position this firm is in a safe position

it shows the extent to which the firm is relying on debt or outside sources to finance the business

- LOWER is better - Under 100% is

accepted

Profitability Gross Profit Ratio

Net Profit Ratio

Gross Profit Ratio 20 000/100 000 x100 = 20% Net Profit Ratio 15 000/100 000 x100 = 15%

Gross Profit Ratio Represents the amount of sales that is available to meet expenses resulting in net profit. It Shows changes from one accounting period to another, and indicates the effectiveness of

Return on Equity Ratio

Return on Equity Ratio 15 000/150 000 x100 =10%

planning policies concerning pricing, sales etc

- Usually compared to previous years

- Indicates effectiveness of policies regarding pricing, discounts, sales and supply chain.

- HIGHER is better Net Profit Ratio Represents the profit or return to the owners, and shows the amount of sales revenue that result in net profit.

- Represents final % of sales received by owners

- HIGHER is better - Can identify COGS

or expenses as problem when compared to gross profit ratio

Return on Equity Ratio Shows how effective the funds contributed by the owners have been in generating profit, and hence a return on their investment.

- Shows how effective equity has been in generating profit

- HIGHER is better

Efficiency Expense Ratio

Accounts Receivable turnover Ratio

Expense Ratio 5000/100 000 x100 = 5% Accounts Receivable turnover Ratio 100 000/10 00 = 10%

Expense Ratio Compares total expenses with sales and indicates the amount of sales that are allocated to individual expenses such as selling,

admin etc, therefore indicating the day to day efficiency of the firm

- Can be used on individual expense categories or expenses as a whole

- LOWER is better Accounts Receivable turnover Ratio Measures the effectiveness of a firms credit policy and how efficiency it collects it debts. It measures how many times the account balance is converted into cash or how quickly debtors pay their accounts. By dividing it by 365, firms can determine the average length of time it takes to convert the balance into cash

Comparison of Financial Ratios

Financial ratios are meaningless until compared to one or more of the following:

Previous years

Industry averages/competitors

Business goals

Limitations of financial reports- normalised earnings, capitalising

expenses, valuing assets, timing issues, debt repayments, notes to the

financial statements

There are six key limitations of financial reports:

o Normalised earnings the process of removing one-time or unusual income

(including high/low sales due to level of economic activity) for the balance

sheet to show the true earnings of a company

o Capitalised expenses the process of incorporating costs incurred in financing

a non-current asset into the assets value in the balance sheet

o Valuing assets either original/historical cost or depreciated/appreciated cost

o Timing issues seasonal influences may distort a financial statement since they

only represent a given period of time

o Debt repayments financial statements do not show the business ability to

collect its debts

o Notes to financial statements contain information such as accounting

methods used and how they affect the results of the financial statements

Ethical issues related to financial reports

Ethical considerations are closely related to legal aspects of financial management

Legislation exists to guard against unethical business activity, but there is often a time

lag between the recognition of a problem and its legal implementation

The ASX officiates requirements for public companies

Audited Accounts

An audit is an independent check of the accuracy of financial records and accounting

procedures

There are three main types of audits:

o Internal audits conducted by employees

o Management audits conducted to review strategic plans

o External audits required by federal law, performed by specialised

accountants outside the business

In 2005 Australian businesses were required to adopt international financial reporting

standards (IFRS)

Record Keeping

Records must be kept for ALL transactions, including cash transactions, else the

business can be found guilty of tax fraud

Accurate record keeping is necessary for taxation purposes as well as for other

stakeholders

GST Obligations

All businesses must complete a BAS every 3 months, which reflects the sum of

transactions with customers

Failure to declare all GST or claiming input credits to which they are not entitled is

both unethical and illegal

Reporting Procedures

Businesses must provide the government (ATO) and shareholders (if any) with

accurate financial reports, as well as making them available to any other stakeholders

Inaccurate and/or dishonest reporting is both unethical and illegal

Financial management strategies

Area of Management

Identify strategies and outline features How effective is this strategy

Cash flow management

Distribution of payments - Involves distributing debits through

the month, year or other period to ensure cash shortages dont occur

Discounts for early payments - Involves offering discounts for early

payments by creditors Factoring

- The selling of accounts relievable for a discounted price to a finance or specialist factoring company

Distribution of payments - Is effective in identifying

periods or potential shortages and surpluses, so the firm can overcome these problems before the actual event occurs

Discounts for early payments - Is effective when

targeting creditors who owe large amounts, although these discounts do reduce the overall level of revenue and the profitability of the firm

Factoring - Growing in popularity as

a way to improve working capital

Working capital management

Control of CA Cash

- Planning for the timing of cash shortages to ensure overdrafts or other forms of debt finance do not need to be taken out to cover short term liabilities

Receivables - Monitoring the firms accounts

receivables and ensuring their timing allows the business to maintain adequate cash resources

Inventories - Must ensure an efficient inventory

management to reduce holding costs

Control of CA Cash

- Effective in guarding against sudden shortages or distributions of cash

Receivables - Effective in improving

shot term liquidity although tight credit control policies can sway potential consumers away

Inventories - Effective in generating

cash to pay for purchases and pay suppliers on time

Control of CL Accounts payables

- Monitoring payables and paying these debts close to the due date to improve the liquidity of the firm, as some suppliers allow a period of interest fee trade credit before requiring payment for goods purchased

Loans - Managing short term loans or

utilising other types of short term finance can reduce interest rates

overdrafts - A relatively cheap form of debt

finance, however they need to be carefully monitored as bank charges may vary depending on the type

Leasing - The hiring of an asset from another

individual or company who has purchased the asset and retains ownership of it. Allows 100% finance

Sale and Lease-back - The selling of an owned asset to a

lessor and leasing the asset back through fixed payments for a specified number of years

Control of CL Accounts payables

- Frees up funds to cover other short term liabilities

Loans - This is effective in

reducing costs of a business, as short term loans are generally an expensive form of debt finance

Overdrafts - Allows cash supplies to

be controlled and provides the firm with short term finance to cover liabilities and debts

Leasing - Frees up cash that can

be used elsewhere in the business so the level of working capital is improved, whilst also allowing a firm to increase its number of assets, consequently leading to an increase in revenue and profits

Sale and Lease-back - Is highly effective in

increasing the firms liquidity because the cash that is obtained from the sale is the used as working capital

Profitability Management

Cost Controls Fixed + variable

- Monitoring the levels of both fixed and variable costs are important, with changes in the volume of activity needing to be managed with the rising variable costs

Cost centres - A cost centre is part of an

organization that does not produce direct profit and adds to the cost of running a company. Examples of cost centres include research and

Cost Controls Fixed + variable

- Comparing costs with budgets, standards ad previous periods can ensure that future costs are minimised and profits maximised

development departments, marketing departments, help desks

- Firms must identify the source and amounts of its costs in order to effectively reduce these costs. Cost centres pose both direct and indirect costs, with direct costs being allocated solely to a particular department, activity etc whereas indirect costs are those shared by all aspects of the business, such as electricity

Expense minimisation - Involves the business implementing

guidelines and policies to promote employees working more efficiently and minimising waste

Revenue Controls Marketing objectives

- Altering pricing policies can influence the profitability and consequently the working capital of a firm. The business must decide the price of their product based on the costs associated with producing the good, competition pricing, short and long term goals (e.g market share etc) and the image and positioning of the product, such as a high end product which is priced highly

Expense minimisation

- This can effectively reduce costs and increase the firms profitability as these policies can make the firm more efficient and minimise expenses as much as possible

Revenue Controls Marketing objectives

- These pricing strategies can effectively improve or worsen the current position of the firms working capital stance, as overpricing could reduce sales levels and consequently reduce working capital, whilst underpricing can increase sales but reduce the profitability of the firm, also impacting negatively upon the working capital of the business

Global Financial Management

Exchange Rates - Cyclical factors which a firm has no

control over, so the firm must adapt - Can significantly impact upon the

international competitiveness of the firm

- An appreciation would result in higher prices for individuals overseas, consequently reducing international competitiveness and demand for the firms goods

- A depreciation will increase

Exchange Rates - this will accordingly

increase sales and working capital of the firm as their international competitiveness has improved

international competiveness as the goods will be cheaper on the world market, accordingly increasing demand and sales

- If a firm is facing a situation of an appreciation, they must find ways to minimise costs so they can reduce prices in order to regain international competitiveness which was diminished by the appreciation

Interest Rates

- Firms can utilise overseas debt finance as it generally has lower interest rates compared to domestically in order to reduce costs, however these savings can easily be shifted into increased costs if the $AUD depreciates greatly

Methods of International payment Payment in advance

- Involves the exporter to receive payment and then arrange for goods to be sent,

Letter of credit - A commitment made by the

importers bank which promises to pay the exporter the amount when documents proving the shipment of the goods are presented

Clean payment - Where the payment is sent to, but

not received by the exporter before the goods are transported

Bill of exchange - Document drawn up by the exporter

demanding payment from the importer at a specified time. Widely used by exporters to main control over the goods until payment is made or guaranteed, two methods include:

- Document against payment: The importer can collect the goods only after paying for them

- Document against acceptance: The importer may collect the goods before paying for them

Hedging - The process of minimising the risk of

currency volatility. Involves a spot

Interest Rates

- highly risky, the risk reward ratio is low as there is always uncertainty that the $AUD could depreciation, which would effectively increase costs instead of save money which was intended with foreign borrowing

Methods of International payment Payment in advance

- very low risk for exporters as the payment has already been made, however very few importers to this as it is highly risky for them

Letter of credit - low risk and popular

amongst many exporters as when the bank is involved the transaction cannot be withdrawn, ensures working capital and is effective at doing so

Clean payment - minimal risk to the

exporter and ensures working capital as the goods will be paid for, however it is not favoured by importers

Bill of exchange - high risks as importers

may not pay at for an document against acceptance, which will significantly impact upon the working capital of the firm.

Hedging - is effective in

minimising the risks of

exchange rate which fixes the exchange rate for the transfer of financial flows at the rate on the day or agreement. E.g deciding a rate of $AUD 1.05, with imports being paid for this 3 weeks later despite the rate at that point of time depreciating to $AUD 1.02

- Natural Hedging: Can include arranging for import payments and export receipts denominated in the same foreign currency, thus any losses from a movement will be offset by gains from the other. Along with this, insisting on both import and export contracts denominated in $AUD to effectively transfer the risk to the importer only

- Financial instrument hedging: Through derivatives to minimise or spread risk of exchange rate volatility

Derivatives - Financial instruments which when

used can lessen the exporting risk associated with exchange rate volatility, however if used incorrectly can pose significant negative implications

- Forward exchange contract: A contract which allows an agreed exchange rate after a period of 30,90 or 180 days guaranteed by the bank

- Options contract: gives the buyer the right, but not the obligation to buy or sell a foreign currency at some time in the future. This protects holders from unfavourable fluctuations yet maintain the ability for gains if the rate upswings whilst holding

- Swap contract: An agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future.

exchange rates which are a cyclical factor which cannot be controlled by the firm

Derivatives - Can be effective in

minimising risk of exporting goods for a firm, however if done incorrectly costly implications can arise.