Len Nixon Finance 1 - uow.edu.auweb/@ibsr/documents… · internal sources of finance ... income...

Len Nixon – Finance 1


Finance

Role of financial management

strategic role of financial management

objectives of financial management

– profitability, growth, efficiency, liquidity, solvency

– short-term and long-term

interdependence with other key business functions

Influences on financial management

internal sources of finance – retained profits

external sources of finance

– debt – short-term borrowing (overdraft, commercial bills, factoring), long-term borrowing

(mortgage, debentures, unsecured notes, leasing)

– equity – ordinary shares (new issues, rights issues, placements, share purchase plans), private

equity

financial institutions – banks, investment banks, finance companies, superannuation funds, life

insurance companies, unit trusts and the Australian Securities Exchange

influence of government – Australian Securities and Investments Commission, company taxation

global market influences – economic outlook, availability of funds, interest rates

Processes of financial management

planning and implementing – financial needs, budgets, record systems, financial risks, financial

controls

– debt and equity financing – advantages and disadvantages of each

– matching the terms and source of finance to business purpose

monitoring and controlling – cash flow statement, income statement, balance sheet

financial ratios

– liquidity – current ratio (current assets ÷ current liabilities)

– gearing – debt to equity ratio (total liabilities ÷ total equity)

– profitability – gross profit ratio (gross profit ÷ sales); net profit ratio (net profit ÷ sales);

return on equity ratio (net profit ÷ total equity)

– efficiency – expense ratio (total expenses ÷ sales), accounts receivable turnover ratio (sales ÷

accounts receivable)

– comparative ratio analysis – over different time periods, against standards, with similar

businesses

limitations of financial reports – normalised earnings, capitalising expenses, valuing assets,

timing issues, debt repayments, notes to the financial statements

ethical issues related to financial reports

Financial management strategies

cash flow management

– cash flow statements

– distribution of payments, discounts for early payment, factoring

working capital management

– control of current assets – cash, receivables, inventories

– control of current liabilities – payables, loans, overdrafts

– strategies – leasing, sale and lease back

profitability management

– cost controls – fixed and variable, cost centres, expense minimisation

– revenue controls – marketing objectives


LIquidity

Solvency

Profitability

Efficie ncy

Growth

Contributes to

achieving the

goals of the

bus iness

Marketing

HR

Operations

Savings

Shares

Debt

Short Term

Long Term

ASIC

Economic outlook

Availability of

funds

interest rates

Banks and

NBFI's

Cashflow

Statement

Cost Control

Revenue control

Current of Asse ts

Control of

Liabilities

Strate gie s

Profitability

Gearing

Liquidity

Efficie ncy

Financial

Statements

Budge ts

Financial Risks

Normalsied

earnings

Financial re ports

Finance

Role of

Finance

Influe nces

Financial

Strate gie s

Processess

Obje ctives

of financial

Manage ment

Straegic

Role Interdepende nce

Internal

External

Governme nt

Global

Influe nces

Finnancial

Institutions

Cash flow

Profitability

Working

Capital

Ratios

Monitoring

and

Controlling

Planning and

implementing Limitation

of financial

re ports

Ethical

issues


The role of Financial Management – to ensure there is sufficient finance to meet the financial needs of the business

Vision

Mission Statement

Long term Goals

Objectives

Strategies

Monitoring and evaluation

Financing decision

Source of finance-Debt and or Equity

Financial objective: Solvency

Current assets and current liabilities

Ability to pay short debts

Financial objective: Liquidity

Profits and Losses Surplus or deficit

generated from business activities

Financial objective: Profitability

Minimisation of costs and an

indicator of how assets are

contributing to generating revenue

and profits

Financial objective: Efficiency

The perimeter of the cycle is the flow

of funds. These are funds to finance

strategies such as marketing, HR and

operations.


Role of financial management – continued

Objectives of financial management Interdependence with other key business functions

There are a number of financial objectives to be established in order to achieve

the business’s strategic or long-term financial goal.

Profitability________________________________________________

Growth ___________________________________________________

Efficiency__________________________________________________

Liquidity ___________________________________________________

Solvency____________________________________________________

The key business functions are:

Human Resources

Marketing

Finance

Operations

All these functions or activities must interact with each other if a

business is going to achieve the business’s strategic, tactical and

operational goals and objectives. In other words, they are

dependent on each other.

Outline how finance is related to human resource and marketing

____________________________________________________

____________________________________________________

Strategic or

long-term

goal.

e.g. to

increase

Profitability

Profitability

Increase

Net profit

Growth

Increase

Market share

Efficiency

Decrease

expenses

Solvency

Ability to pay

off long term

debt

Liquidity

Control

cashflow

Short term

Within a year

Long term

e.g. 5 years

Finance

Marketing

Operations

Human Resources


Finance – Internal and external sources of funds

Scenario – hypothetical –Squeezed Now Ltd.

Squeezed Now is a manufacturer of a range of juices for Australian and global

markets.

In 2013, the management of Squeezed decided upon adopting a new strategic goal of

increasing the business’s growth. The business wanted to increase its market share

currently 35% to 50%.

To achieve this goal however, has meant the business would have to revamp its

manufacturing plant. Built in the late 1900’s, the current plant and technology used

was aging where breakdowns were becoming a regular feature coupled with

increasing maintenance costs and lower productivity.

In light of this, management decided to purchase new state of the art machinery with

the triple aims of increasing its productive capacity, productivity and reducing the

overall costs of production.

In addition, management had recently completed a strategic review of human

resources and it marketing activities revealing a need for additional training of

existing staff and the recruitment of additional operational, marketing and sales staff.

However, such changes required funding. Given the business’s current state of its

balance sheet as shown in table 1, the business had previously funded its assets

through an equal amount debt and equity.

Squeezed Balance Sheet

As at the 30th

of June 2013

Current Assets (000) Current Liabilities (000)

Cash 10 Accounts Payable 25

Accounts Receivable 25 Commercial Bills 20

Stock 10

Non Current Liabilities

Mortgage 975

Non Current Assets Total Equity

Plant and Machinery 2000 Shares 1000

Furniture and Fittings 75 Profit 400

Delivery Vans and Cars 300

Total Assets 2420 Total Liabilities 2420

From a solvency point of view, that is Total Liabilities/ Total Equity (1020/1400)

the solvency ratio is .72%. This means for every $1 of equity the business is only

using .72cents of debt. Given the industry average is usually $1 to $1 the business

has used equity as the primary means of funding its business activities. From a

financial management perspective, the business has been very conservative


relying significantly on equity finance as the primary means of financing its

activities.

Problems to be solved.

Financial questions to be asked by Squeezed Now Management? Will the funds come from within the business (internal) or from outside the

business (external)?

What sources will be used debt or equity or a combination of both?

What type of finance is appropriate to purchase the current and non current

assets and pay expenses required by the business? The matching principle

Will the finance be long term or short term in terms of time?

What is the cost of using the various types of finance?

How will the choice of finance affect existing solvency, efficiency, liquidity

and profitability?

What the risks associated with using the various types of finance?

Will leasing and factoring as a better option in regard with respect to

managing the business’s cashflow better?

Financial questions needing to answered

1. What type of finance to use?

Debt

Current Liabilities (external debt)

Short Term means -

_______________________________________________________________

1.

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Use ___________________________________________________________

2.

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Sources of finance

Internal - Eq External - D


Use ___________________________________________________________

3.

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Use ___________________________________________________________

4.

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Use ___________________________________________________________

Long Term – (External) Non-Current Liabilities

Long term means__________________________________________________

1.

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Purpose

________________________________________________________________

2.

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Purpose___________________________________________________________

3.

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Purpose _________________________________________________________


4

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Purpose

________________________________________________________________

Financial Management issues

The use of short and long-term debt will affect:

Profitability - ______________________________________________

Solvency ___________________________________________________

Efficiency __________________________________________________

Important financial management principle

The matching the terms and sources of finance to the purpose

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

Equity – internal and external equity

Internal Equity – relates to an Unincorporated business structures such as

_______________________________________________________________

Sources of funds

__________________________________________________________

External Equity sources – relates to Incorporated business entity such as

Type ___________________________________________________________

Cost ___________________________________________________________

Source _________________________________________________________

Purpose

___________________________________________________________


Propose a set of financial strategies Squeezed Now management could use totally

$25 million dollars to purchase new equipment and to fund a training and

development program together with recruiting new staff.

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

____________________________________________________________________

Advantages and disadvantages of using Debt finance

Advantages Disadvantages

Advantages and disadvantages of using Equity finance

Advantages Disadvantages

Other Financial institutions

Australian Securities Exchange _________________________________________

Insurance companies’ __________________________________________________

Superannuation Funds_________________________________________________

Unit trusts____________________________________________________________


Influences on financial management

S

Increasing

Case study

Juiced Up, is a manufacturer of

juices for the Australia and global

markets.

Management has just appointed a

new marketing, operations and

human resource manager.

As part of the company’s induction

program the chief accountant has

been asked to brief these managers

on a number of financial issues.

Discuss the role of the ASIC

______________________________

______________________________

______________________________

______________________________

______________________________

______________________________

Outline the effects of the company

tax on profits and international

competitiveness

______________________________

______________________________

______________________________

______________________________

______________________________

______________________________


Influences on financial management –

Global market influences – global economic outlook, availability of funds and interest rates. These external influences are out of the

direct control of management but can affect a business in the following areas

Growth

Liquidity

Solvency

Profitability

Efficiency

Global economic outlook Availability of funds Interest rates

Case Study

For example, assume the global demand for

goods and services increases.

For Juiced Up, being an Australian

company selling it juices overseas, this

trend represents an opportunity to possible

sell more of its products overseas.

The financial implications for the business

are the following:

Increased prof______________

Increased growth

Increased market share

Need to finance operations through

debt and equity - Solvency

Businesses can access funds from overseas

Debt markets

Equity markets

Because of the removal of many barriers by

owing to the removal of regulations, many

Australian businesses have been able to

raise funds in European and USA debt and

equity markets.

There are a number of management issues

to be considered when undertaking such a

strategy. This include:

Interest rates

Interest rate __________________

Exchange rate __________________

The bigger pool of funds available

The length time of the loan

Sec______ required against the loan

This is the cost of borrowing funds.

Note that interest rates are an expense and

hence will affect financial efficiency of the

business together with net profitability.

At present, Australian interest rates are

lower than many of its trading partners

such as Japan and USA.


Processes of financial management

Planning and control

The financial planning cycle – To ensure the business’s flow of funds is achieved and all the financial objectives have been managed

effectively and efficiently a planning process must used

Determining

financial needs

Developing

Budgets Maintaining

Financial risk

Indentifying

financial risk

Establishing

financial controls

Addressing present financial needs


Direct Links Sales generated = Marketing Advertising = Marketing Cost of Goods Sold = Operations Franchise Fees = Operations Rent = Operations Wages = Human Resources


Various Limitations of financial reports and ethical issues related to financial reports – CRS References to the financial information

Normalised earnings – Sales of $810,0000

Limitation _________________________________________________________________________________________________________

Valuing assets . Total assets of $655,0000

Limitation _________________________________________________________________________________________________________

Debt Repayments. Bank Overdraft $56000 and Mortgage $120000

Limitation ________________________________________________________________________________________________________

Timing issues ____________________________________________________________________________________________________

Ethical issues are closely related to Legal issues

Audit accounts

In

External

Management

Recording

Cash

Reporting practices

Accurate for ATO

Stakeholders


Ratio Formula Working Interpretation

Liquidity Industry Average 0.75:1

Current Assets

Current Liabilities

Solvency Industry Average 1:1

Total Debt

Total Equity

Profitability Industry Average Gross Profit : 80% Net Profit: 40% Return on Owner’s Equity: 58%

Gross Profit

Total Sales

Net Profit

Total Sales

Net Profit

Total Equity

Efficiency Industry Average 40%

Total Expenses

Total Sales

Ratio Analysis of Part and Parts PTY Ltd Financials


found in

Types

ProblemsSolutions

SolutionsProblems

Problems Solutions

Liquidityability to

pay short

term debts

Balance

Sheet

Current

AssetsCurrent

Liabilities

Types of

short term

debt

Sources

Banks

Finance

Companies

Large

Companies

Bank

Overdraft

Calculated

CA/CL

Accounts

Payable

Credit

Card

Bank Bill

Cash

Stock/

Inventory

Accounts

Receivable

Storage

Transport

Insurance

Costs

J.I.T

Stocktakes

Two Bin

method.

Cash

Budgets

Too much

or

Too little

Poor credit

policies

Clerical

problems

High

Acounts

Receivable

Turnover

Age

accounts

Factoring

Cash only

Discounts

Credit

restrictions

Working capital managementLiquidity

Problems and Solutions

The use of all these types of finance will be a cost or expense to

the business.Their use will decrease

profits

Problems with the current assets will have and effect on the business's cashflow

cycle

Use of

funds

Financial ManagementCurrent Assets = Current Liabilit ies

Financial Objective

Financial management

strategies

Terms, Definitions, Problems and


Revenue inflow

Influenced by

Sales obj ectives

Pricing policy

Determined by

Market Segmentation

Good and poor

management centres

on the purchase of

stock

Problems

and Costs

Solutions

Outflow

Cost control

Outlays to generate

revenue and profit

arising from

Strategies and

Solutions

Cost control

Management

Profit

Financial manage ment issues related to

Profitability

Sales revenue

Marketing

Issues and

strategies

Marketing

research

Target

Market

4 P

strategiesPrice

Place Product

Promotion

Profit may increase or

decrease owing to sales.

This is the outcome of

good or poor marketing

decisions

Cost of

goods sold

Opening

Inventory +

Purchases

less ending

stock

Liquidity

issues

Too much

Not enough

Stock

Storage

Ordering

Transport

J. I. T

Stocktakes

Two Bin

Method

Expenses

Selling

Marketing

Administration

Human

Resources

Financial

Rates of

interest

(borrowed

funds)

Bad Debts

(A/C

Receivable More efficient

management

of marketing

Employment

relations and

operations

These transactions are to be found in a business's Profit and Loss Statement Known as a Statement of Financial Performance

Expenses directly affect

the EFFICIENCY of a

Business

Calculations

Gross Profit

Margin

Net Profit

Margin

Return on

Equity

Fixed

CostsVariable

Costs

Cost centres


Cashflow Management

Cashflow the problem Management Strategies to overcome potential cashflow problems

The example below represents a summary of a

cash in and cash out for a clothing store and

the cyclical flow of funds

Jan Feb Mar April May

2000 4000 -1000 -5000

Cash In 2000

0

22000 16000 16000 17000

Cash

Out

1800

0

19000 21000 20000 17000

Surplus/

shortag

e

+

2000

+4000 -

1000

-5000 -5000

Strategies to manage cashflow

Factoring

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--

Discounts for early payment

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-----------------------------

Distribution of payments

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Other Strategies

--------------------------------------------------------------------------------------------------------------

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-----------------------------

Outflow of cash for

stock purchased

Credit sales

Accounts Receivable

Receipt of cash

from credit sales

Len Nixon Finance 1 - uow.edu.auweb/@ibsr/documents… · internal sources of finance ... income...

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Transcript of Len Nixon Finance 1 - uow.edu.auweb/@ibsr/documents… · internal sources of finance ... income...