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PART 3 - FINANCE Role of financial management Strategic role of financial management: Businesses have specific goals they wish to achieve in relation to the investment in capital (machinery and technology), training of staff, marketing and the expansion of operations. The strategies that a business adopts work towards achieving its goals both in the short and longer term. Developing a strategic plan as part of a business’s financial management will ensure that the business survives and grows in the competitive business world. SUMMARY:  FINANCIAL MANAGEMENT – REFERS TO HOW A BUSINESS MANAGES ITS FUNDS, BORROWINGS, CASHFLOWS AND PROFITABILITY.  Financial planners must estimate the cost of business activities, cost and allocate resources and make decisions on funding options.  Developing a strategic plan as part of an organizations financial management will ensure that the organisation survives and grows in the competitive business world.  Organisational Goals / Objectives - these break the business operations into achievable and manageable outcomes that can be measured and evaluated.  Strategic Plans - these encompass a long-term view of where the organisation is going, how it will get there and a monitoring process to keep track of progress along the way.  Managing Financial Resources - this is the planning and monitoring of an organizations financial resources to enable the organisation to achieve its financial goals. Its resources are which that have a monetary value within the business.

Business goals and objectives

Goals/purpose Busines Strategic Tactical Operational objectives plan ing plan ing plan ing

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Businesses exist for a number of purposes that are translated into goals. For example: o To increase dividends to shareholders o To maintain an environmentally friendly business o To be market leader within 5 years These goals are translated into business objectives that provide greater detail about the businesses purpose and function. Main purpose/goal of a business is to maximize profits. The strategic role of financial management refers specifically to the strategies that are adopted by the business to achieve its short and long-term objectives.

Strategic plans  Strategic plans are most important to a business as they encompass a long-term view of where the business is going, how it will get there, and a monitoring process to keep track of progress along the way.  Strategic plans may cover periods for up to 10 years.  Goals are incorporated in the strategic plan. Managing financial resources  Financial resources are those resources of a business that have a monetary/money value.  Financial management is the planning and monitoring of a business’s financial resources to enable the business to achieve its financial goals.  Mismanagement of financial resources can lead to problems such as: o Insufficient cash to pay suppliers o Inadequate capital for expansion o Too many assets that are non productive  Strategies for monitoring the financial resources of a business must be incorporated into a strategic plan. This involves: o Monitoring a business’s cash flows o Paying its debts o Developing financial control techniques Objectives of financial management: SUMMARY:  Profitability  Growth  Efficiency  Liquidity  Solvency

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Profitability – the ability of a business to maximize its profits. To ensure profit is maximized, a business must carefully monitor its revenue and pricing policies, costs and expenses, inventory levels and levels of assets. Growth - Is the ability of a business to increase its size in the longer term. Growth of a business depends on its ability to develop and use its assets structure to increase sales, profits and market share. Efficiency - Efficiency is the ability of a business to minimize its costs and manage its assets so that maximum profit is achieved with the lowest possible level of assets. A business that aims for efficiency must monitor the levels of inventories and cash, and the collection of receivables. Liquidity - Is the extent to which a business can meet its financial commitments in the short term. Controls over the flow of cash into and out of the business ensure that it has supplies of cash when needed. The amount of working capital a business has is used to measure a business’s abilities to pay its short term debts. Solvency - Is the extent to which a business can meet its financial commitments in the longer term. Solvency indicates whether a business will be able to repay amounts that have been borrowed for

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investments in capital (such as equipment and machinery and/or premises). It is measured by the level of gearing. Short-term financial objectives: o Financial objectives (1 – 2 years) o These include both tactical and operational (day to day) plans. o A tactical plan might involve purchasing additional machinery, updating old equipment and providing new services. Long-term financial objectives: o Financial objectives (more than 5 years) o They tend to be broad goals such as increasing profit or market share, and each will require a series of short term goals to assist in its achievement.

Interdependence with other key business functions: SUMMARY:  Interdependence of the KBF means that each function is not able to operate in isolation successfully – it relies on the others to perform its role in achieving the broader goals of the business.  Finance plays a crucial role in funding extra resources. 

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KBF’s = o Operations o Marketing o Finance o Human Resources The interdependence of these business functions means that each one must interact with all of the other functions in order to achieve the goals of the business. Businesses goals tend to be based on improvements to profit levels and have their origins within the financial function of a business.

Influences on financial management

External sources of finance

Global market influences

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Financial institutions

Influences on Financial Management

sources of finance:

Internal finance comes either from the business’s owners (equity or capital) Influences Internal or from the outcomes of of sources of business activates government finance (retained profits). o OWNERS EQUITY: is the funds contributed by owners or partners to establish and build the business. Equity capital can be raised in other ways such as selling off any unproductive assets or through the issuing of private shares.

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RETAINED PROFITS: is the most common source of internal finance and is the retained earnings and profits in which all profits are not distributed, but are kept in the business as a cheap and accessible source of finance for future activities.

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External finance refers to the funds provided by sources outside the business including banks, other financial institutions, government, suppliers or financial intermediaries. There are two types of external finance: debt and equity. Finance provided from external sources through creditors or lenders is known as debt finance. o Using debt finance means that the business relies on outside sources rather than the owners to finance the business.

Debt: Short-term borrowing Short term borrowing is provided by financial institutions through bank overdrafts, commercial bills and bank loans. This type of financing is used to finance temporary shortages in cash flow or finance for working capital. Short-term borrowings are funds that are repaid within 1-2 years. 

Bank overdraft- with a bank overdraft, the bank allows a business or individual to overdraw their account up to an agreed limit and for a specified time, to help overcome temporary cash shortfall. o They assist businesses with short-term liquidity problems, for example, a seasonal decrease in sales. o Bank overdrafts are minimal and interest rates are lower. o Interest is paid on the daily outstanding balance of the account.

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Commercial bills- a type of bill of exchange issued by institutions other than banks, and are given for larger amounts, usually over 100,000 for a period between 90-180 days. o Commercial bills play a significant role in Australia’s financial markets, with bills of exchange forming an important segment of the short-term money market.

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Factoring- the selling of accounts receivable for a discounted price to a finance company. o It enables a business to raise funds immediately. o Important source of short term finance because the business will receive up to 90% of the amount of receivables within 48 hours of submitting its invoices to the factoring company. o Involves greater risk because of the liklihood of unpaid debts.

Debt: Long-term borrowing Long-term borrowing, relates to funds that are borrowed for a period of time over 2 years. It can be secured/unsecured, and interest rates are usually variable.

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Mortgage- a loan that is secured by the property of the borrower (business). o Property mortgaged cannot be sold or used as a security until the mortgage is repaid. o Mortgage loans are used to finance property purchases. o They are repaid through regular repayments, over an agreed period of time.

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Debentures- issued by a company at a fixed rate or interest and fixed rate of time. o Not secured. o The company repays the amount of the debenture by buying back the debenture.

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Unsecured notes- a loan for a set period of time, which is not backed by any collateral or assets. o Presents most risk to the investors in the note (the lender) for not for not being backed by any collateral or assets. o For this reason, it attracts a higher rate of interest than a secured note. o Companies generate unsecured notes to generate money for their initiatives such as share repurchases and acquisitions.

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Leasing- is a long-term source of borrowing for businesses. It involves the payment of money for the use of equipment that is owned by another party. o Leasing enables an enterprise to borrow funds and us the equipment without the large capital outlay required.

Equity Equity refers to the finance (cash) raised by a company by issuing shares to the public for purchase through the ASX. This is an alternative to debt financing. Equity as source of external finance includes: ordinary shares and private equity.  Ordinary shares- the purchase of ordinary shares by individuals means they have become part owners of a publically listed company and may receive payments called dividends.  Private equity is the money invested in a (private) company not listed on the ASX. The aim of a private company is to raise capital to finance future expansion/investment of the business.

Financial Institutions: 

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Banks: are the major operators in financial markets and are the most important source of funds for a business. Banks receive savings as deposits from individuals, businesses and governments, and in turn, make investments and loans to borrowers. o The big four: National Australia Bank, Commonwealth Bank, Westpac and Australia and New Zealand Banking Group (ANZ) Investment banks: primarily trade with businesses, they trade in securities and advise on mergers and acquisitions. Macquarie Bank is Australia’s largest investment bank. Finance and Life insurance companies: are non-bank financial intermediaries that specialize in smaller commercial finance. They are regulated by APRA (Australian Prudential Regulation Authority). They provide loans to businesses, personal loans and secured loans. Insurance companies provide loans through receipts of insurance premiums. Superannuation funds: these organisations provide funds to the corporate sector through investment of funds received from superannuation contributions. For example, AMP Super. Unit trusts: also known as mutual funds, they take funds from a large number of small investors and invest them in specific types of financial assets. They are usually connected to a firm that manages investment portfolios. Australian Securities Exchange (ASX): is the primary stock exchange in Australia. It acts as both a primary market and secondary market for the sale of shares to the public.

Influence of government:

Australian Securities and Investments Commission (ASIC):  It enforces and administers the Corporations Act and protects consumers in the areas of investments, life and general insurance, superannuation and banking.  ASIC ensures that companies adhere to the law, collects information about companies and makes it available to the public. This includes the financial information that companies must disclose in their annual reports.  The aim of ASIC is to assist in reducing fraud and unfair practices in financial markets and financial products. Company taxation:  Companies and corporations in Australia pay company tax on profits. This tax is levied at a flat rate of 30%.  Company tax is paid before profits are distributed to shareholders as dividends. Global market influences: Financial risks associated with global markets are greater than those encountered domestically, but such risk taking is necessary for a business strategy to be implemented.  These influences are uncontrollable.  Globalisation has created more interdependence between economies and their business (and financial) sector that relies on trade for expansion and increased profits. Global economic outlook:  The global economic outlook refers specifically to the projected changes to the level of economic growth throughout the world.  If the outlook is positive (that is, world economic growth is to increase) then this will impact on the financial decisions of a business. For example it may result in: o An increasing demand for products and services o Decrease the interest rates on funds borrowed internationally from the financial money market  However, a poor economic outlook will impact on financial decisions of a business in the opposite way to those previously mentioned. Availability of funds:  The availability of funds refers to the ease with which a business can access funds (for borrowing) on the international financial markets.  The international financial markets are made up of a range of institutions, companies and governments that are prepared to lend money to individuals, companies or governments who may need to raise capital.  The global financial crisis that occurred in 2008–09 had a major impact on the availability of funds for all companies and institutions. It caused a sharp increase in interest rates that was a reflection of the high level of risk in lending. Interest rates:  Interest rates are the cost associated with borrowing money. The higher the level of risk involved in lending to a business, the higher the interest rate.  Australian interest rates tend to be above those of other countries, such as the United States and Japan. Therefore, Australian businesses could be tempted to borrow the necessary finance from an overseas source to gain the advantage of lower interest rates.

Processes of financial management Planning and implementing:

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Financial planning determines how a business’s goals will be achieved. The financial planning process begins with long term of strategic financial plans. Long-term plans include a business’s planned capital expenditure and/or planning investments. Long-term plans cover a period between 2 and 10 years. Short-term plans are more specific and cover a period of 1 to 2 years. Planning processes involve the setting of goals and objectives, identifying and evaluating alternative courses of action to achieve these goals and objectives, identifying and evaluating alternative courses of action and choosing the best alternative for the business.

Financial needs:  The financial needs are essential to determine where a business is headed and how it will get there; it is important to know what its needs are. These needs are determined by: o The size of the business o The current phase of the business cycle o Future plans for growth and development o Capacity to source finance – debt and/or equity o Management skills for assessing financial needs and planning  A business plan sets out the finance required, the proposed sources of finance and a range of financial statements. Developing budgets:  Budgets provide information in quantitative terms about requirements to achieve a particular purpose. Budgets can be drawn up to show: o Cash required for planned outlays for a particular period o The cost of capital expenditure and associated expenses against earning capacity o Estimated use and cost of raw materials and inventory o Number and cost of labour hours required for production  Budgets enable constant monitoring of objectives.  Budgets are used in both the planning and the control aspects of a business. They can be classified as operating, project or financial budgets. o Operating budgets – relate to the main activates of a business and may include budgets relating to sales, production, raw materials, direct labour, expenses and cost of goods sold. o Project budgets – relate to capital expenditure, and research and development. o Financial budgets – relate to the financial data of a business. The predictions of the operating and project budgets are included in the budgeted financial statements. Record systems:  Are the mechanisms employed by a business to ensure that data is recorded and the information provided by record systems is accurate, reliable, efficient and accessible.  The double entry system ensures reliability. Financial risks:  Is the risk to a business of being unable to cover its financial obligations, such as a debt that a business incurs through borrowings, both short term and longer term. To minimize risk, businesses must consider the amount of profit that will be generated. Financial controls:

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Are the policies and procedures that ensure that the plans of a business will be achieved in the most efficient way. Control is particularly important in assets such as accounts receivable, inventory and cash. Some common policies and procedures that promote control within a business are: o Separation of duties o Clear authorization and responsibility for tasks in the business o Control of credit procedures o Protection of assets o Rotation of duties Debt and equity financing:

Debt finance  Debt finance – relates to the short and long term borrowing from external sources by a business. Advantages of debt Funds are usually readily available.

Increased funds should lead to increased earnings and profits. Tax deduction for interest payments.

Disadvantages of debt Increased risk is debt comes from financial institutions because the interest, bank charges, government charges and the principal have to be repaid. Security is required by the business. Regular payments have to be made. Lenders have to first claim on any money if the business ends in bankruptcy.

Equity finance  Equity finance – refers to the finance (cash) raised by a company by issuing shares. Advantages of equity Does not have to be repaid unless the owner leaves the business. Cheaper than other sources of finance as there are no interest payments. The owners who have contributed the equity retain control over how that finance is used. Low gearing (use of resources of the owner not external sources of finance). Less risk for the business and the owner.

Disadvantages of equity Lower profits and lower returns for the owner. The expectation that the owner will have about the return on investment (ROI).

Comparison of debt and equity Debt Lenders must have prior claim in the event of liquidation. Debt must be paid by periodic repayments. Interest payments are tax reducible. Lenders usually require a lower ra...