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BUSINESS STUDIES TOPIC 3: FINANCEROLE OF FINANCIAL MANAGEMENTStrategic role of financial management A strategic plan for financial management ensures longevity of the businessFinancial management: is the planning & monitoring of a business’s financial resources to enable the business to achieve its financial objectivesMcDonald’s Case StudyMcDonald’s concerned with how assets are utilised, financed, & overall profitabilityMcDonald’s management is aiming to increase overall debt in companyObjectives of financial managementProfitability: earnings of business after expenses are paidMost recognisable financial objectiveGross profit: profit made on the sale of goods after paying expenses (COGS)Net profit: final amount of revenue after all expenses are paidEarnings before interest & after tax (EBIT)16383010287000McDonald’s Case StudyAim to grow gross profit from 20% 40%GrowthThe ability of the business to increase its size in the longer termCould be done by increasingPhysical sizeMarket shareSales & profitsExpanding range of productsTakeoverMcDonald’s Case StudyMcDonald’s aims for system-wide sales growth of 3-5% each yearAim to increase number of restaurants to 650 by 2019EfficiencyThe ability of a business to minimise its costs & manage its assets so that maximum profit is achieved with the lowest possible level of assetsCalculated as: total expenses/ salesMcDonald’s Case StudyAim to reduce general administration expenses by 1% in 2018LiquidityMeasure of how quickly an asset may be converted into cash & therefore available to pay short-term debtsCash is the MOST liquid assetCalculated as: current assets/ current liabilitiesMcDonald’s Case StudyAims to ensure enough cash in available to meet operating expenses & return equity to shareholdersIn 2016 US$1.2 billion of cash at hand US$2.5 billion in 2017SolvencyAbility of a business to pay both short-term & long-term liabilities as they fall dueMeasure of whether a business is financially stable Most businesses have a mixture of debt & equityGearing: how much debt finance a business has acquired to fund its operations McDonald’s Case StudyRecent years, Maccas has returned billions of dollars to shareholders through share buy-backs 508078930500Short-termAre tactical (1-2 years) or operational (1-2 days)Reviewed regularlyLong-termOver a determined set period of timeUsually more than five yearsMore boarder goals which will be reviewed annuallyQANTAS CASE STUDYEffective management allowed Qantas to meet strategic goals. These include an understanding of liquidity, profitability, growth, solvency, efficiency & return on capital. Qantas’ cost control strategies include:Cut losses by $5 billion in the last 9 years & cutting flying capacity, replacing Qantas with Jetstar for cheap international routesCancelling orders on new planes worth $10 billion during the GFCRestructuring management and freezing executive payReforming employment through new rosters, increased technology use, employing a casual workforce & agreements of wage policiesAligning separate business divisions, fuel conservations & reorganising aircraftsCutting travel agent commissions, outsourcing by functionEntering strategic alliances with other airlines & encouraging sales over the internetInterdependence with other key business functionsRefers to mutual dependence that key functions have on one anotherMarketing, operations & HR all rely on financial funds to operateFinance also relies on the other 3 business functions to operate a successful businessQANTAS CASE STUDYFinance depends on marketing to generate funds Marketing strategies e.g. new lounges, new check in facilities include a major financial dimensionBudgets are needed for each marketing strategies & are judged using financial criteria e.g. sales, market share & profitability analysis HR require funding for effective human resource strategies, training and developmentQantas spends $275 million on training/yearOperations also requires finance e.g. for Qantas 10 year renewalInfluence on financial managementInternal sources of financeComes from business owners or business activities (retained profits)Owners’ equity: the funds contributed by owners/ partners to establish & build the businessRetained profitsMost common source of internal financeNet profit that is reinvested into the businessMcDonald’s Case Study2017 Maccas had US$48.3 billionExternal sources of financeDebt SHORT TERM BORROWINGOverdraftBank allows a business/ individual to overdraw their account up to an agreed limit for a specified time to help overcome a temporary cash short-fallCommercial BillsPrimarily short-term loans issued by financial institutions for larger amounts (usually over $100,000) for a period of 30-180 daysBorrower promises repay with interestFlexible type of paymentFactoringthe cash sale of a business’ accounts receivable at a discount to a factoring companyBusiness will receive up to 90% of accounts in 48 hours Can be riskyIncreases cash flow using unpaid business invoicesSpecialist companies: manage collection of unpaid account under agreementLONG TERM BORROWINGMortgagea secured loan by the property of the borrower (business)To start a business, an entrepreneur may purchase non-current assets using a mortgageUsed to purchase property, land, factory, office or buildingsSecurity is on property assetsCan’t be sold/ use as security until it is repaidDebenturesAre issued by companies for fixed interest rates & time periodSecurity is over companies’ assets not propertyIs a promise made to pay money back with fixed payments + interest, no collateral Debenture holders are business’ that lend money Commonly used for buildingsOn maturity the company repays the amount of debentures by buying back the debentures Unsecured notesIs a loan from investors for a set period of timeNot secured against the business’ assets, more riskyOnly issued if backed by good rep & credit ratingHigher interest rate due to riskUsed to purchase share & acquisitionsLeasing Payment of money for use of equipment owned by another partyA: Enables an enterprise to borrow funds & use equipment without capital outlay (long term purchase an upkeep of capital equipment)McDonald’s Case StudyOverdraft: Maccas currently has a US$2.5 billion overdraft Commercial bills: McDonalds issues these to the public to raise funds (short-term unsecured debt)Leasing: usually Maccas buys land and leases it to franchisees leasing 12000 stores in 2017Unsecured notes/debentures: McDonald’s has borrowed cash at a fixed rate using unsecured notes & debenturesEquityAn extended source of funds refers to the finance raised by a company through inviting new ownersORDINARY SHARESPublic companies can issue securities to the public through ASX, with/without right to vote at annual meetingsMost commonly traded shares in AustraliaPart owners will receive dividends New Issues (primary shares)First time on share marketIssued through a stockbrokerInitial public offering: when company issues shares to public for the first timeRights issuePrivilege granted to shareholders to buy new shares in the same companyUsed to raise additional fundsNo obligation to buyPlacementsAllotment of shares, debentures made directly from company to investorsAim to raise additional fundsUsed to raise funds fastAdditional shares offered at a discount to their current trading price to persuade investors in the companyShare purchase plansAn offer to existing shareholders to purchase more shares in that company without brokerage feesAllow companies to issue max $5000 in new shares to each existing share holder without a disclosure document (prospectus)Permission is needed from ASICVenture capital: acquired from specialist venture finance institutions seeking to be part owners of businesses they have little say in business management Grants: financial gifts from governments to assist in establishment/ expansion of the business. Businesses must meet strict criteriaPRIVATE EQUITYMoney invested in a private company not listed on the ASXAim: to raise capital to finance future expansion/ investment of the businessMcDonald’s Case StudyMcDonalds initially raised capital when it floated in 1965 on NYC stock exchangeHave issues 1700 million shares800 shares are still in the marketMaccas pays shareholders consistent high dividends Maccas AUS requires new franchisees to have 25% of the total cost of a new Maccas restaurant in cash to personally investFinancial InstitutionsDeregulation of the financial sector in Australia since December 1983 has allowed more participants to enter the market for business financial servicesAllowed for funds to be acquired from different institutions, not just banks more competitionGlobalisation caused overseas exchange & borrowing Businesses are able to find the best debt security: any type of loan that a business obtains that is issued by a promise of repayment on a certain date at a specific rate of interestMcDonald’s Case StudyMcDonald’s uses a range of bank & finance companies worldwide to fund its operations Business bust also abide by NYSE, regularly disclosing financial infoBanksAccept deposits from general public & provide funds for loansProvide many financial products including:Online banking, detailed statementsEFTPOS & BPAYBusiness insurance & superLegal & taxation financeRisk managementEconomic outlook reports Investment banksCan gain funds from consumer/ personal banks Referred to as Authorised Deposit Taking Institutions including Commonwealth Bank, NAB & St GeorgeBusiness can acquire funds from investment banksInvestment banks can offer assistance in mergers or takeovers, arrange specific loan needs, new financial profits to increase competitiveness, trade money, financial futures, securities, working capital, project finance & overseas finance Finance companiesProvide different types of secured & unsecured loans Secured loans an asset e.g. property that is security for the loan (collateral)Unsecured loans do not require an asset to act as a securityAdvertised to businesses & are repayable in instalments Can arrange commercial bills, leasing finance & debenturesDo not accept deposits from general publicLife insurance Non-bank financial intermediaries who provide cover & money in event of death or accident causing disabilityParticipants buy policies, pay regular premiums & are guaranteed minimum paymentsOngoing premium payments: provide life insurance companies with funds available for lending to businessesIR higher from these institutions Provide secured & unsecured loansSuperannuation fundsAll employees must have a small part of wage/salary in superannuation fund (9.5%)Super: a scheme set up by the federal government which requires all employers to make a financial contribution to a fund which will provide benefits to an employee when they retireEarn returns by selling debt securities to businesses which repay these loans of interest2005- people have been able to choose their own fundUnit trustsTake funds from a large number of small investors and invest them in specific types of financial assetsInclude short-term money market share, mortgages, property & public securities Australian Securities Exchange (ASX)Primary stock exchange group in AustraliaOverseas compliance with rules & promotes standards of corporate governance among Australia’s listed companiesASX offers: shares, futures, warrants, exchange traded fundsASX acts as a primary market enables companies to raise new capital through issue of sharesASX also operates as a secondary market: where second-hand shares are purchased & soldInfluence of governmentFederal government also participates in financial market to influence Australian EconomyMonetary policy: steps taken by RBA to affect the finance market & assist the federal government to achieve its goals of low inflation & economic growthRBA: the federal government will buy & sell securities, loans in order to alter interest rates to alter economic cyclesGovt. also offers grants e.g. Export marketing Development Grant provided by Austrade Australian Securities and Investment Commission (ASIC 1998)Established to regulate corporations, markets & provision of financial servicesPerforms market assessments of ASX, IMB etc.Ensures company carries duties honestly ASIC is an independent statutory commission who is accountable to the Commonwealth ParliamentEnforces & administers the Corporations Act 2001 while protecting consumers & investors in investment, life insurance, banking, superannuation & general insurance in Australia McDonald’s Case StudyMaccas is legally obligated to report information about directors, company share structure & resolutions to ASICMaccas also have to submit to audited financial statement available to the public, conveying heavy influence of ASICCompany taxation30% of net profitsame as Thailand NZ & Indonesiain financial institutions in Australia, rates applysuper & retirement is 15%tax paid before profits & dividends are distributedIncrease in company tax decrease consumer demand due to increase in $McDonald’s Case StudyTNCs like Maccas operate under different tax systems 2017 company’s effective rate of income tax on profit was 39.4%Due to TNCs being publicly scrutinised for tax issues, ATO publicly releases taxation info on Maccas & other TNCsMcDonalds has been involved in moving money to other countries with extremely low interest rates & lower tax rates to evade company taxation in AustraliaGlobal Market Influencesuncontrollable financial influences: availability of funds, interest rates & global economic outlookglobalisation has increased interdependence, rate of expansion & competitiveness globallyAPRA: Australian Prudential Regulation Australia is the main regulator of finance industry in AustraliaFinance Managers: concerned with cost of finance in the future (IR)RBA monetary policy goals Increasing production of goods and services requires financial managers to purchase additional equipment & employ extra staff in which costs may risePoor economic conditions may adversely impact financial managers as a global economic downturn reduces consumption, investment & consumer confidenceThis hinders a business’ short-term profitability and solvency 2-3% INFLATION3-4% ECONOMIC GROWTH5-7% UNEMPLOYMENTGlobal economic outlookRefers specifically to the projected changes to economic growth globallyMcDonald’s Case StudyMcDonald’s has been perceived as a “recession-proof” business due to cheap pricing of foodTherefore, in upturns/good economic conditions, due to increased disposable income McDonald’s may sufferAvailability of fundsRefers to ease with which a business can access funds (for borrowing) on the international financial marketsInternational financial markets comprise of various institutions, companies & governments who lend money to individuals/ companies seeking to raise capitalVarious conditions & rates that occur when lending that are based primarily on risk, demand & supplyMcDonald’s Case StudyLow global IR have ensured business has relatively easy access to funds Due to this, McDonalds is shifting from equity debt financingInterest ratesCost of borrowing money overseasQANTAS CASE STUDYGlobal market influences for Qantas include:Economic outlook:Before 2009: benefits from strong globalisation demand for services. Qantas recorded a net profit of $980 million in 20082009 (GFC): rapid revenue decrease, especially in the international market. Decreased 88% international profit. People stopped travelling & business cut back corporate travel. Qantas cut the flying capacity, cut orders for new planesAfter 2009: slowly regained profits, but still uncertainInterest Rates:QANTAS is exposed to movements in interest rates in AUS and overseas, As IR increase, so do interest repayments. QANTAS has shifted most of its operations overseas Availability of funds: since GFC supply of funds has been lower in AUS & overseas QANTAS due to the closure of may financial institutionsAvailability of funds:Since GFC supply of funds has been lower in Aus. & overseas QANTAS due to the closure of many financial institutions & implementation of stricter lending criteria QANTAS was assessed to be riskier to lenders due to their reduced profits in 2014 in which their credit rating became higher and their interest increased Processes of financial managementQANTAS CASE STUDYThe strategic planning cycle enables Qantas to be in a better position to cope with the actions of its competitors and any unanticipated changes in the markets. This planning cycle comprises of five stepsAssessing the current financial position by collecting financial dataUsing the information to frame a business planPreparing financial reportsInterpreting financial reports by comparing actual to forecast resultsAdjusting financial controls to minimise risks and lossesPlanning and ImplementingFinancial management is responsible for the financial planning of the businessHelps determine viability of venture, future decisionsFinancial management must plan, obtain & control the business’ finance 85026512636500Financial NeedsNew businesses will have to determine start-up costs e.g.New equipmentObtaining appropriate premisesInventoryStaffMarketingUtilitiesAfter operations, funds should be available or liquidity issues may occur e.g. cash-flow shortagesBusiness will need to make financial forecast based on researchIdentifying financial actions that need to be taken to achieve specific outcomes Financial information includes: balance sheets, income statements, cash flow etc.Dependent on business: size, stage in life cycle, future plans and debt vs equityMcDonald’s Case StudyFinance is a major consideration when large businesses make future plansE.g. 2015 Maccas identified need to redesign restaurants 2018 US$2.5 billion on capital expenditureBudgetsProvide information in quantitative terms (facts & figures) about requirements to achieve a particular purposeCould be for 6,9 or 12 monthsBudgets can be used for:Cash require for planned outlays (expenditure)Cost of capital expenditureEstimated use & cost of raw materials/ inventoryBudgets enable monitoring of objectives & provide a basis for administrative control, identifying threats & problemsImportant for:Reviewing past figures & trendsPotential market/ market shareProposed expansion/ discontinuation of projectsOperating budgets: relate to the main activities in the business and may include budgets relating to sales, production, raw materials, direct labour, expenses and COGSProject budgets: relate to capital expenditure and R & DFinancial budgets: relate to financial data of a business & include budgeted income statement, balance sheet and cash flowsRecord systemsAre the mechanisms employed by a business to ensure that data is recorded & the information provided by record systems is accurate, reliable, efficient & accessible Require by ATO to keep recordsCollect items such as revenue, payment of employees & accounts payable etc. McDonald’s Case StudyDue to large size of business record systems are essential Franchises utilise bookkeeping & accounting e.g. Point of Sale system for assembly line of food to be ordered and servedRecords are kept on a domestic levelFinancial risksIs the risk to a business of being unable to cover financial obligationsRisks could be:TheftNon-payments of account receivable Interest rate increaseTo minimised financial risk businesses must consider the amount of profit generated Financial managers should be proactive to minimise potential downsidesCould lead to bankruptcy McDonald’s Case StudyMcDonald’s utilises interest rate swaps, foreign currency forwards & options, cross-currency swaps to be able to fix and lock-in specific rates of money Financial controlsAre policies & procedures that ensure that the plans of a business will be achieved in the most efficient way E.g. approval of major transactions, payment authorisation process, actual vs. planned resultsMcDonald’s Case StudyFinancial controls are outsourced by third party Ernst & Young Debt & Equity financingDebt finance: relates to the short-term & long-term borrowing from external sources by a businessEquity finance: relates to the internal sources of finance in the businessDEBT FINANCINGADVANATAGESDISADVANTAGESInterest payments are tax deductible business expensesIf bankruptcy or insolvency occurs, debt providers have priority before equity providers Can be simple to acquireLoan terms can be negotiated to meet the business’s specific needsRegular payments make it easy to scheduleOwner will not decrease ownership and the owner can maintain their control of the businessIncreased risk if debt comes from financial institution due to interest, bank chargesSecurity is required by businessRegular payments have to be madeLender have first claim if business is bankruptDebt can be expensiveGood credit rating/ history is neededEQUITY FINANCINGADVANTAGESDISADVANTAGESDoesn’t have to be paid unless owner leavesCheaper than other sources of finance (no interest)Low gearing (low proportion of debt: equity)Firm has more cash flow, meaning it can be used for further investment & expansionLower profits & lower returns for ownersLong, expensive process to obtain funds this wayOwnership is diluted; current owners have less control, due to shareholdersProportion of profits go to additional new ownersNo tax deductionDEBT VS EQUITYDEBTEQUITYLenders have prior claim in event of liquidationDebt must be repaid by period paymentsInterest rates are deductibleShareholders require higher return due to higher riskDividend payments are not fixed & may be reduced due to lack of fundsEquity holders have voting rights Shareholders have a residual claim on assetsEquity has no maturity datesDividends are not deductibleLenders usually require lower rate of returnInterest payments are fixedDebt providers have no voting rightMatching the terms & source of finance to business purposeWhen managing finance accountant must distinguish between short/ long term financeReferred to as the matching principle:Using appropriate finance for purchasing an assetCurrent assets should be purchased with short term finance will non-current assets should be purchased with long-term finance e.g. 15-year mortgage loanMcDonald’s Case StudyMcDonald’s leases most of the land & buildings oh which franchisees runs their business matching terms and sources of financeMonitoring and controllingQANTAS CASE STUDYFinancial statements are issued to shareholders (in the annual report) and are available to the publicKPMG audits Qantas; financial statements to ensure they give a true & fair indication of the company’s finances & comply with accounting standards & corporate lawThese financial statements include income statement, balance sheet & cash flow statement CASH FLOW STATEMENT FORMULAS CASH BALANCE= INFLOWS – OUTFLOWSCLOSING BALANCE= OPENING BALANCE + INFLOWS – OUTFLOWSCLOSING BALANCE OF ONE MONTH IS THE OPENING BALANCE OF THE NEXTCash flow statement shows the flow of money in and out of a businessInflow: money coming in (sales, interest on investment & dividends)Outflow: money going out (paying suppliers, employers, rent, insurance & advertising)Difference between inflows and outflows is net cash flows Problem: managing and controlling cash flowPurpose: to provide management with necessary details for budgeting to monitor & control business functionsCash show statements tells if a business can maintain liquidity (pay debt as they fall due)Insolvency: where expenditure > Y for extended period of time unable to pay debtsCash flow statement can:Determine cash shortagesDetermine where extra finance is neededIdentify spending issuesSee the speed at which creditors are paidIncome StatementIncome statement formulasGROSS PROFIT= SALES – COGS NET PROFIT= REVENUE – EXPENSESCOGS= OPENING STOCK + PURCHASES- CLOSING STOCKAn income statement is a summary of a business’s revenue & expenses over a set financial periodShows a business’s profitability & efficiencyAlso known as a revenue statement or profit & loss statementCategories includeTotal revenueCostsNet profitsExpensesCOGSGross profitsAids in managing market composition & trends as well as a prediction of cost of expenses & profits2354675-51500Shows if:Profitability/ if business is profitableIf expenses should be reduced/ increasedIf the mark-up on COGS is sufficientProfits can be increased by purchasing cheaper stock or increasing price of goodsBalance sheetBalance sheet formulasASSETS + LIABILITIES = OWNERS’ EQUITYRepresents a business’s assets & liabilities at a particular point in time, expressed in money termsShows financial stability of the business & return on owners’ investment, current/ non-current assets/ liabilities & liabilities and equityEasy way to see whether a business can pay off debts, interest & if assets are being used to maximise profitsCurrent Assets: items of value owned by business that can be liquidated in >12 monthsNon-current assets: items of value owned by business that cannot be liquidatedBalance sheet shows LIQUIDITY & SOLVENCY RATIOSOwners’ equity: difference between what is owed and what is ownedShows if business has enough funds to cover debtsShows long and short term financial stability-291871000Financial RatiosLIQUIDITYcurrent Assetscurrent liabilities Is a rough measure of how easily a business can meet its current liabilities by using available cash or assets that can be quickly converted into cashLiquidity indicated the ability to meet short term debtShows relationship between current assets and current liabilities Ratio is obtained from the BALANCE SHEETAlso called the WORKING CAPITAL of a businessSuggested level should be 2:1Businesses dealing in cash may have a lower figure of 1.5: 1Higher ratio: assets are not being used efficientlyStrategies to improve this result include, current ratio too lowManager would be advised to reduce current liabilities e.g. overdrafts by equity financing e.g. retained profitsNon-current assets could be sold to increase current assetsFactoring & leasing could also free up current assets Factoring: sale of inventory (stock) would make some current assets more availableShort term measures include overdraft and using more credit facilitiesQANTAS CASE STUDYQantas’ low rate indicated an inability to meet short term debtsLike most airlines it operates on a negative working capital positionQantas holds very little cash received (often in advance) to pay long term debt reducing interest costsHave facilities in place (including a standby facility of $300 million & issue of short term notes) to draw cash when needed to pay creditors & dividends to shareholdersLiquidity ratio increased in 2015 from 0.68:1 from 0.66:1 in 2014Other airlines, Singapore airlines 1.1:1 & Air New Zealand 0.93:1Liquidity strategies neededControlling assets (cash, accounts receivable & inventories)Controlling current liabilities (payable, interest bearing liabilities & trade creditors)Leasing more aircraft, buildings, plant & equipment freeing cashQantas is one of few airlines which owns its terminals & is considering sale and lease backGEARING (SOLVENCY)Measure of a business’s funding structure & longer term financial stability of a businessCalculates the comparison of a business’s total liabilities (current & non-current) with the value of owner’s equitytotal debttotal equity x :1.0An acceptable ratio: 0.5-0.7:1.0This means that for every $1 contributed by the owners the business has sought an additional 50- 70 cents of funding from outside lendersGives indication of risk in investing in the business (applicable to shareholders & investors)Ratio too high: low level of solvency, more vulnerable to increase in IRQANTAS CASE STUDYDue to the capital intensive nature of the industry airlines like Qantas are highly geared Qantas’ sources of funds: cash, equity, debt & lease financeQantas’ gearing increased dramatically in 2014 due to falling profitability reduced capital expenditure & bond sale, refinancing shorter term debts to extend maturity profilePROFITABILITYIndication of earning performance and efficiency of the businessShown in INCOME STATEMENTTells financial manager what kind of returns a business is receivingTells shareholders what risks are present, necessary changes and lender knowledgeGROSS PROFIT RATIO (%)gross profitsales x 1001Gross profit= sales – COGS (opening stock- closing stock)Calculates for every $1 of sales how much gross profit the business is paying for COGSGPR is a measure of mark up, how much additional cost is added to the productA 50% GPR means the mark up is 100%A good GPR is a mark-up of 100% (doubling the COGS) is fairly highThis means a GPR of 50% is quite highA high GPR indicates the industry has little competitionLow GPR strategiesSource cheaper supplies to reduce COGSIncrease mark ups (seek higher prices)Leave industry and seek opportunities in other industriesNET PROFIT RATIO (%)Net profit ratio is a much better indication of the overall profitability than GPRNET PROFIT= REVENUE- EXPENSESnet profitsales x 1001Works out for every $1 of sales how much profit the business makes after paying expensesA good NPR is 10-18%, less than 10% is lowManagement for a low NPRIndicates costs are highCost reduction strategies should be implementedMay involve reducing wages through downsizingReducing other expenses (outsourcing)Reducing interest costs through leasingRETURN ON OWNERS’ EQUITY (ROE) (%)net profitowners'equity x 1001Calculates how much income the owners receive for their investment in the businessFigures from both income & balance sheet are needed Shows how much income is received back compared to each $1E.g. for every $1 the business contributes, $0.40 is returned as net profitUse retained earnings for Net ProfitHigh return: 18%Moderate return: 12-17%Low Return: >11%QANTAS CASE STUDYProfit performance is important to shareholders & long term creditors as Qantas must have a satisfactory level of profit to surviveAlso important to other stakeholders e.g. employees & suppliersProfitability in the airline industry is poor due to high competition and it being capital intensiveGlobal issues e.g. terrorist attacks & fuel prices have drastic issues on profitabilityGFC & swine flu decreased Qantas profit by 88%Profitability is still quite lowEFFICIENCYFirm’s ability to use resource efficiently to ensure stability & profitabilityShows how well the business keeps expenses under control & how long the business takes to receive payments in accounts receivableExpenses can be measured by financial expenses (interest), selling expenses (marketing costs) and operating expenses (manufacturing costs)EXPENSE RATIO total expensessales x 1001Expense ratio is compared to total expensesShows amount of sales allocated to each expense individuallyLow: good control over cash flowHigh: poor management decrease in salesBusinesses seek to have the lowest expense ratio as possibleManagement strategies of high expense ratioLook for unusually high expenses and lowerQANTAS CASE STUDYAirline industry uses the revenue seat factor ratio as a key indicator of efficiencyMeasures the % of total passenger capacity actually utilised by paying passengersStrategies to improve efficiencyIntroduction of new & more efficient aircraftsNew crew & training basesInvestment in new IT systemsLower costs of sales because of a significant increase in internet bookingsReduced overhead costs due to improved economies of scalesRestructuring of catering, engineering & international operations-ACCOUNTS RECEIVEABLE TURNOVER RATIORatio measures how often debts are collected throughout the yearcredit salesAverage Accounts Receiable x 1001=no. times/yearA business would generally want to achieve an Account receivable turnover ratio of 12 (i.e. 30 days or less)Measure of how long on average account customers take to pay invoices sent by the businessCOMPARATIVE RATIO ANALYSISRatios calculated are used to make comparisons over different time periods, against standards & with similar businessesComparing previous & current year results, financial managers can identify trends in profit, costs & financial stabilityManager can determine whether business is meeting its goals of increasing profitability, efficiency, liquidity and solvencyCan benchmark (see if performance is above industry average)Limitations on Financial ReportsNormalised earningsAre earning adjusted to take into account volatile or cyclical upswings/ downswings, removing one-time unusual influences Removed from balance sheet to show the true earnings of a companyQANTAS CASE STUDYSpecial circumstances may distort the analysis of Qantas’ results e.g. 2011 natural disasters such as Cyclone Yasi may have had adverse effects on Qantas’ profitability of $224 millionCapitalising expensesCost incurred when financing a non-current asset added to the cost of the assetE.g. legal fees for buying a property. Fees are added as assets instead of expenses. They are deducted through depreciation of the assetProcess of adding a capital expense to balance sheet as asset rather than expenseMcDonald’s Case StudyTaxes and legal fees are capitalised up to the date where future benefits are expected to exceed those costs Expenses for a new restaurant site are recorded as an asset & depreciated over the use life of that asset therefore spreading costs over 40 years This therefore means that McDonald’s may overstate its current year profitValuing AssetProcess of estimating the market value of assets or liabilitiesWhen listed on the balance sheet, value is written in historical costsOriginal price is different from market value due to obsolescenceWhen asset/ business is sold balance sheet will not represent the business’s assetsRevaluating non-current assets is done by independent firms or individual expertsIntangible assets cannot be placed on balance sheetOriginal cost of asset may be different to its current value due to depreciation McDonald’s Case StudyMcDonalds have AUD$400 million in goodwill on their 2017 balance sheetIssues with this are that Maccas may be paying much higher than goodwill is actually valued, limiting reliability of figure on balance sheetGoodwill may also not be relevant years after the purchaseTiming issuesAccounts may adjust the timing of revenue inflows & debt repayments to make the business appear more profitableCould delay banking revenue until start of financial year to decrease business’s current taxationWould delay tax liability to following year, decreasing taxesMay also have a shorter accounting period to further decrease costs falselyMatching principle: expenses incurred by a business must be recorded on the income statement for the accounting period in which the revenue is earnedIf matching principle is followed then costs will match when incurred in specific periodDebt repaymentsFinancial reports can be limited because they do not have the capacity to disclose information about debt repaymentDebt repayment includes:Staff leave (paid)Termination paymentsDifficult to determineFirms can set aside liabilities or rollover debt finance & put off repaymentsQANTAS CASE STUDYQantas’ financial reports do not give full picture of their debt as it does not disclose when these debt have to be repaid Notes to financial statementsReport which details additional information left out or main documents such as balance sheet, income statementStakeholders should read thisIncludes pension plan details, methods of recording, transactions etc.Any additional information that is left out of main financial reporting statements Contains information that may be useful to stakeholders to help them make sense of financial statementsE.g. may be on accounting methodologies, inventory valuation techniquesQANTAS CASE STUDYQantas financial reports are useful however should be used with caution due to:Qantas attaches comprehensive notes to its financial statements. These help stakeholders better understand the financial reports & give more clarity to Qantas’ financial positionBusinesses like Qantas can employ a variety of different accounting procedures e.g. underlying PBT as its measure of profitability Ethical issues related to financial reportsChanges in social attitudesforces owners to consider ethics of decisionsmust ensure decisions are made s judged by the current moral climate, social & -environmentally possibleincreased awareness of senior company greater accountabilityAccount expectationsDisplays integrity & truth, objectivity, confidentiality & professional/ technical capabilityChartered accountants oversee set report standardsPeople may falsify to seem more profitableBig businesses: since 2001, senior executives receive payout despite misinformationChanges to corporations act 2001: forces companies to reveal salary package details of directors & executives increases transparency and performance of main directorsTriple bottom line: measure of business’s financial social, cultural & performanceAudits: independent checks of financial levels by accredited accountants. Important as shareholders are able to trust reports & invest appropriately after determining relevant risk. Owners want accuracy of profit results & government for taxQANTAS CASE STUDYQantas has ethical & legal responsibilities in relation to its financial management through:Audits: professional examination of accounting dataProfessional account bodies Accounting standards which establish general principles to be followed in relation to financial statementsASIC which ensures companies adhere to the Corporations ActASX included in its listing rules disclosure requirements and other regulations with listed companies must complyQantas has come into criticism in its failed takeover bid by APAFinancial Management StrategiesCash flow managementBusiness must have enough available cash to pay billsCash flow management: the process of recording, understanding & forecasting cash movements to ensure that it is always liquid and solventCash flow: the movement of cash in and out of a business over a period of timeInflows: sales, accounts receivable, commissions, dividends, rents & interest51039-38439400Outflows: payments to suppliers, interest on loans, operating expenses, drawings, purchasing of assets & loan repaymentsMcDonald’s Case StudyMcDonalds is a cash businessCash will either go directly to company or to franchiseeMcDonalds recent cash flow strategies include:Returning cash to shareholders via buybacks & dividendsIncreasing spending on capital infrastructureDecreasing number of company stores & increasing number of franchised stress generate more instant cash rales from rent & royalties Cash flow statementsContinuous rolling cash budgets can show patterns of short term management of cash inflow & outflowCan be categorised as operational, financial & investmentDetermines how the business will pay for short term liabilities from sales of inventoryManagement strategies:Ensures cash is available to pay when liabilities & debts are dueBusiness may use overdrafts as they would be bankrupt otherwiseBusinesses ensure large predictable expenses are not all due at one cash flow projectionDistribution of paymentsMaking sure large payments are evenly spread out makes more equalInsurance companies offer monthly payments instead of annual due to costCan stretch accounts payable, paying on due dateDiscount for early paymentsBusiness may offer discounts to account customers to speed up cash flowMay be 2-5% discount (small)Other incentives include gifts and future discountsShortening credit terms reduces days for business to be paid back Factoring Accounts receivable can be sold to a factoring business (often finance company) at a discountFactoring firm pays business value of accounts receivable, minus commissionTotal current assets worth less creates immediate cash flow-29210024066500Working Capital managementCurrent assets used in day-day running of the business Need to be well maintained so that the business has enough cash in the bank to pay bills when they are dueCan be done by monitoring account receivable (and ensuring continued payments) & making sure business has stock to sellCurrent ratio: current assets/ current liabilitiesNeeds to be well managed so creditors are paid on time, to pay tax & rent, opportunity to make more profits, meet short term financial obligations & pay loans & overdraft interestControl of current assetsInvolves ensuring there are enough liquid assets to pay current liabilities when dueFinancial manager should develop strategies to increase this amount of cash in the businessCash:Most liquid assetCan be increased by sales of assets or leaseback Advantages of cashEasier to budgetCan update new technologyBusiness can lease its own once used itemsReceivablesAccounts receivable Effectiveness of control over AR Is measured by turnover ratioIf ratio is low, customers are taking too long to payBad debts are debtors who are unlikely to pay debt owedBusiness will increase AR & decrease current assetsBalance sheet will write off bad debtors (perished stock)Payment management is important as it is illegal to impose late feesManagement can put limit to credit accounts & checks on customer’s credit historyAims to decrease customers who don’t pay & freeze their accountsInventoriesMonitored to ensure no excess levelsIncludes raw materials, work in process & finished goodsCommon issue: too much inventory, no cash to pay debtsIncreases need for insurance shortage of space increasing costsSome inventory takes a long time to sell, delaying cash flow obsolescenceDemand fluctuation leads to lost stock, broken products Transport & staff limits liquidity of inventoryA business only wants enough input to satisfy anticipated demand & buffer for unexpected needsJust in time inventory management system reduces cost of storing stock & inputs, only delivering stock when neededDecreases need for storage space, insurance & expenses, saving cash to pay other liabilitiesMcDonald’s Case StudyCash: business has regular payments of royalties & rent from franchisees e.g. monthly report of sales & royalties be paid on 10th day of every monthReceivable: McDonald’s provides strict penalties for franchisees who pay late e.g. high interest paymentsInventory: crucial part of McDonald’s business model FIFOControl of liabilitiesMinimising costs related to a firm’s current liabilities by converting current assets into cash, ensuring creditors are paidPayablesMoney businesses owe to suppliers as per invoice requirements. Number of days given to pay is dependent on credit rating & riskProblems: having too many bills to pay at once, having more cash out than in, paying too early on bills, paying cash too late (bad rep)Businesses control payable & keep a good reputation/ credit rating & avoid penalties by stretching accounts payableLoansBusinesses must compare costs & terms of a loan with providers to increase savingsDone by borrowing money to buy assets (increasing debt) & leasing non-current assetsHelps maintain good reputation with the bank to save & get good terms for future needsConsiderations: cost to establish business, ongoing charges, interest rates & term/ length of loanOverdraftAre intended as a short-term source of finance and should be used to fund short-term needs Can control overdraft by ensuring all cash received is promptly deposited in the business’s overdraft account to reduce amount owedOnline banking gives 24/7 accessMcDonald’s Case StudyMcDonald’s has a US$2.5 billion line of credit facility at its disposal if required @ 0.07% p.a.This equates to US$1.75 million per year even when not utilisedIndividual franchisees may also have access to overdrafts in specific financial positionStrategiesLeasingUsing an asset from another person/ company Doesn’t use up available cash (no deposit required)Makes business’ needs foreseeable, allow asset expansion to spread overtime, increases level of working capital, is tax deductible & increases revenueSale and lease backSelling owned assets to lessor & leasing assets back to original owner by fixed payments for specific no. of yearsIncreases liquidity and ability to pay debtsUsed for equipment/ rentMcDonald’s Case StudyMcDonald’s leases 12000 locations for property with US$12.5 billion worth of property large reliance on working capital strategySale & lease back: McDonald’s derives significant amount of income from property that it leases to franchisees Profitability ManagementGood accounting & financial system has effective controls to ensure the business:Does not overspendDoes not lose assetsRecords financial data & transactions correctlyCost ControlsCan be variable or fixed, needed to increase profitsLabour: outsourcing non-core functions, a popular method to decreases costs in large businessesFixed and variablesFixed: does change when business produces/ sells morecosts paid regularly regardless of successe.g. salaries, insurance premiums, government fees, lease/ rent, fixed interest paymentsVariable: varies within output/ sales changeE.g. wages, advertising, electricity, phone bills, overtime payments, warehouse storage & transportationMethods: negotiating discounts with suppliers, reducing number of suppliers, increasing self-service costs, sharing resources between businesses, JIT inventory, full-time casual employmentCost centresExpenses associated with key business functions to provide the product to the customerManagement provides budget to set limits, monitor expenses & finance manages, can take total costs of making/ supplying products & calculating contribution of each cost centre Direct costs: associated to particular products, departments, there are variable costsIndirect costs: shared by more than product/ activity e.g. depreciating machines used to make multiple productsExpense minimisationUses cost centres to identify different types of expenses that are contributing most to products Can be used to minimise expenses through use of budget toolsMethods:JIT management: buy inventory & reduce costs of warehousingIncreasing efficiency of the workforce can be achieved by multi-tasking & mechanicsDecreasing cash flow can be achieved by increasing skills to stop mangers/ employers overspending/ orderingQANTAS CASE STUDYQantas has cuts its costs by over $6 billion in the last 12 years reducing its overall cost base by 20-25%Qantas has had to move decisively in response to the massive drop in profitability & cut costs by $894 million in 2015Recent strategies include:Replacing Qantas with Jetstar on some international routesRestricting management/redundancies (5000 job losses over the last 3 years)Freezing executive pay18-month wage freeze with all the major unions fuel conservationencouraging internet salesMcDonald’s Case Studyfixed: council rates, insurance premiumsvariable: royalty fees (5% gross sales), food, drinks, packagingmixed: wages, electricity, waterRevenue controlsIncome earned from selling goods and servicesMarketing objectives should aim to increase sales and increase revenueControls are needed to achieve marketing objectivesE.g. sales forecast, pricing policies, analysing sales marketing & considering internal & external business environmentPredicts future sales based on comparison to planned daily/ monthly output, sales patterns in previous years, economic considerations, performance of marketing, competition levels & stage in product life cycleSales mix: marketing for selling for a range of products, focused on costsA report is used to identify which methods worked most efficiently & show which product contributed most to revenuePricing strategy: cost-cased, used to control cash according to % make-up of profitsCost volume profit analysis: checks if level of revenue is enough to cover all costs & predict effect on profit to changes in sale. Prices & costsMcDonald’s Case StudyMcDonald’s plan to become 95% franchised is seen by management as a way of creating more stable revenue streams due to McDonald’s deriving a large amount of revenue from renting of premises to franchiseesGlobal financial managementGlobal influences: open to increased influence from the external environment (increased risk)Exchange ratesAUD value fluctuated according to Australia’s economic performance compared to other economiesExchange rate: value of a country’s currency in terms of anotherFluctuates due to demand & supplyMonitored by: Government, RBA, businesses who export products, investors & people who import productsForeign exchange market: determines the price of currency in terms of another currency. Based on supply & demandCurrency appreciation: raises value of AUD in terms of foreign currencies. $1 AUD buys more foreign currency. Exports more expensive, imports cheaper decreases international competitivenessCurrency depreciation: lowers price of AUD, foreign currency buys more AUD. Exports cheaper, imports more expensive increases international competitivenessQANTAS CASE STUDYQantas is exposed to various financial risks in its international business operations such as changes in foreign exchange rates due to fuel, operational expenditure (lease payments, interest payments & capital expenditure)Approx. 40% of revenue is generated in other currenciesMcDonald’s Case StudyAs of December 2017 McDonalds held US$12.4 billion worth of debt in countries other than US ( 42% long term debt)Business finances local asset purchases with debt in local currency + purchasing g & s in local currencyInterest RatesGlobal businesses can borrow money from interest financial markets to increase competitiveness by seeking cheaper rates & better dealsIf borrowed from overseas, interest may vary depending on rate of AUDAustralian businesses can lend overseasA:Cheaper rates & repayments appreciating currencyLess restrictions on amount borrowed, repayment period & credits of the loanFinance may be needed quicker than domestic companies allowImpact of overseas interest rates on Australian business profitability: effect of firms borrowing from overseas, companies need to research future projection of rates Impact of overseas IR on Australian IR are prevalent if international IR are higher overseasMethods of international paymentImporters want to decrease costs, conflicts exporter interestComplications: language barrier, lack of physical meeting, culture difference, currency exchange, time zones & different legal systems third part (banks) minimise these issuesPayment in advanceExporter receives payments before goods are sent to importerRisky for importerUsed if credit history (importer) is poorLetter of creditIs a document issued by securer to seller of goods with specific instructions giving seller authority to draw the money under certain conditionsImporter may deposit in advance to decrease riskPreferred method, secured by banksCarries low risk for exporterPopular with exporters as they rely on overseas banks rather than the importerClean paymentGoods are shipped before payment is received Only used if long record of prompt payments & trustLength of credit dependent on relationshipGlobal businesses will assess importer prior to clean paymentMost risk for exporterBills of exchangeWritten order from seller requesting importer pays seller specific amount of money at a specific timeBank will ensure importer pays & once delivered, exporter invoices importerBoth exporter and importer agree28257515684500HedgingIs the process of minimising the risk of currency fluctuationsUsed for global business contracts, to buy & sell foreign currency, buy inputs overseas & profits & pay rent owedHedging helps reduce the level of uncertainty involved with international financial transactionsSpot exchange: two parties use to exchange rate of a particular day to finalise a deal immediatelyNatural hedging:using the same currency DerivativesAre simple financial instrument that may be used to lessen the exporting risks associated with currency fluctuations3 main types of derivatives:forward exchange contract: bank guarantees exporter a certain exchange rate on certain datesoption contract: option to buy & sell foreign currency when at their advantageswap contract: is an agreement to exchanges currency in the spot market with an agreement to reverse the transaction in the future. Method advantageous to businesses as they can alter their exposure to exchange fluctuations without discarding original transactionsQANTAS CASE STUDYQantas has hedged 86% of its fuel needs in 2018Qantas uses a number of strategies to minimise the impact of financial risks in order to:Reduce the probability of financial distressProtect its capital baseMinimise the cost of capitalProvide a stable business & profit outlookExploit its financial strengthQantas uses derivatives like forward cover & options to hedge future fuel purchases, future interest payments & future capital expenditure paymentsQantas had hedged 95% of its fuel needs for 2017Qantas gains 40% of revenue in other currencies meaning hedging and derivatives are a must ................
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