Year 12 Business Studies

1. Year 12 Business Studies Finance REVIEW

2. Role of Financial Management • Strategic role of financial management is to ensure that a business operates with a ROI and continues to grow and meet its objectives • Financial objectives identify what the owners of a business want to achieve: • Profitability • Growth • Efficiency • Liquidity • Solvency

3. Role of Financial Management • What is profit? • What is left over after all expenses have been paid • Retained profit is reinvested back into the business as capital • Profitability is represented by the gross profit and net profit earned in a financial year • What is efficiency? • Achieved when a business can generate a greater output with the same level of inputs (or same output using less inputs) • What does liquidity show? • It shows how well working capital is being managed and whether the business can meet its short-term obligations

4. Role of Financial Management • A business needs to hold liquid assets • The most liquid asset is cash • Current assets are more liquid than non-current assets • What is solvency? • The ability of the business to pay its debts as they fall due • The higher the gearing or debt compared to equity finance, the greater the financial burden and the greater the risk.

5. Influences on Financial Management • How can a business finance money? • Internally • Externally • Internal sources of funds are called equity (reinvested profits and capital contributed by owners) • External sources of finance include debt finance (borrowed money) and equity in public and private companies • Types of debt financing are short and long term.

6. Influences on Financial Management Short term types include bank overdrafts, commercial bills and factoring Long term types include mortgage loans, debentures, unsecured notes and leasing Leasing allows a business to finance an asset by effectively hiring it for a given time frame Factoring enables a business to increase its cash to finance the payment of short term liabilities and expenses Private equity refers to selling shares by inviting people to become owners of the business in a private company.

7. Influences on Financial Management • What does the Australian Securities Exchange do? • A market that allows companies to issue shares on the primary market to raise equity finance • Facilitates the buying and selling of shares on the secondary market • Deregulation of the Australian financial sector means Australian businesses can now choose from a greater number of financial products and services at more competitive prices • Businesses can acquire finance from overseas stock exchanges and overseas financial institutions.

8. Processes of Financial Management • Financial management is responsible for the financial planning of the business • A business may acquire funds from both equity and debt sources: • Equity is lent to the business in exchange for ownership • Debt is made up of borrowed funds that must be repaid with interest • What are the three main financial statements? • Cash-flow statement • Income statement • Balance sheet

9. Processes of Financial Management • What is the income statement? • A summary of the income and expenses of a business over a set period of time. • What can you calculate from the income statement? • Total revenue • COGS • Gross profit • Net profit • A summary of the profitability and efficiency of the business over a period of time

10. Processes of Financial Management • What is the balance sheet? • A summary of the assets, liabilities and equity of the business as at a particular date • It provides a look at the financial stability or net worth of the business. • Information can also be used to determine the business’s liquidity and gearing.

11. Processes of Financial Management • Financial ratios are management tools used to analyse the financial statements of a business • Liquidity: current ratio • Gearing: debt to equity ratio • Profitability: gross profit ratio, net profit ratio and return on equity ratio • Efficiency: expense ratio and account receivable turnover ratio • Ratios can be compared with those of previous years (same period) or with industry averages (benchmarking) and competitors.

12. Financial Ratios • Liquidity – current ratio (working capital ratio) • Current assets/current liabilities • Gearing – Debt to equity ratio • Total liabilities/equity • Profitability – Gross profit ratio, net profit ratio and return on equity • Gross profit/sales x 100, net profit/sales x 100, net profit/total equity x 100 • Efficiency – Expense ratio, Accounts receivable turnover ratio • Total expenses/sales x 100 • Number of days in a year, 365 divided by sales/accounts receivable.

13. Financial Management Strategies A business must be able to pay for its expenses and short-term liabilities when they are due Cash-flow statements can be used to predict a business’s cash inflows and outflows over a length of time to identify a period when the business may have liquidity problems Working capital is the current assets used in the day-to-day running of a business Net working capital = current assets – current liabilities

14. Financial Management Strategies • What does inventory include? • Raw materials • Work-in-progress • Finished goods • Businesses must control their current liabilities (accounts payable, short-term loans and overdrafts) • By stretching accounts payable, a business can hold onto its money for longer and pay more urgent expenses on time • Fixed expenses do not change when a business produces more goods (eg. Rent)

15. Financial Management Strategies • Global businesses: • May borrow from financial markets in other countries • Need to take account of the exchange rates in their financial planning • Hedging is used to reduce the financial risk in global transactions due to changes in the exchange rate • Derivatives, a from of hedging, includes forwards exchange contracts, currency option contracts and swap contracts.