Business Studies Revision
Topic: Finance
Role of Financial Management
- Strategic Role of Financial Management
Business Goals and Objectives | - Goals are longer outcomes of a business (usually to maximise profits)
- Thus needs a determined process (strategy) to achieve its goals (major tool)
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Strategic Plans | - Most important as they encompass long-term view of where, how and monitor the path to the goals of the business
- May cover periods of up to 10 years
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Managing Financial Resources | - Financial management is the planning, directing, monitoring, organising and controlling of the monetary resources of a business
- Mismanagement can leads to problems such as insufficient cash to pay suppliers, inadequate capital for expansion, too many assets that are non-productive, delays in accounts being paid, possible business failure and overstocking of materials.
- Monitoring must be implemented by analysing cash flows, paying debts, developing financial control techniques, auditing financial accounts and making profits.
- Strategic planning of financial resources is essential to a business’s success and growth
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- Objectives of Financial Management
Profitability | - Ability to maximise profits
- Business must carefully monitor its revenue and pricing policies, costs and expenses, inventory levels and levels of assets
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Growth | - Ability to increase its size in the long term.
- Depends on its ability to develop and use its asset structure to increase sales, profits and market share.
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Efficiency | - Ability to minimise its costs and manage its assets
- Thus maximum profit is achieved with the lowest possible level of assets
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Liquidity | - Ability to pay its debts as they fall due.
- Must have sufficient cash flow to meet its financial obligations.
- Or be able to convert current assets into cash quickly e.g. selling inventory
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Solvency | - Extent to which the business can meet its financial commitments in the longer term.
- Indicates whether a business will be able to repay amounts that have been borrow for investments in capital e.g. equipment, machinery, premises.
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Short Term Financial Objectives | - Tactical (one to two years)
- Operational (Day to Day)
- If strategic goal is to increase profits by 15% in 10 years, tactical goal may be buy additional machinery, expand to new markets, etc.
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Long Term Financial Objectives | - Strategic plans of the business, usually more than 5 years.
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- Interdependence with other key business functions
- Critical to the key business functions as it decides and plans out the possible monetary expenditure for the other functions.
- Without a carefully run financial department, the business will fail to allocate money in appropriate ways (marketing requires funds, operational needs funds to deliver products to demand and funds for recruiting in human resources) which will lead to debts and possible failure.
Influences on Financial Management
- Internal Sources of Finance
Owner’s Equity | - Funds contributed by owners or partners to establish and build the business.
- Equity capital can be raised by taking another partner, seeking funds from an investor (shareholder), selling off any unproductive assets or issuing private shares.
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Retained Profits | - Profits which are not distributed but are kept in the business as a cheap and accessible source of finance for future activities.
- Keep some of their profit in the form of retained earnings.
- Approximately 50% of profits on average are retained to be reinvested.
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- External Sources of Finance
External Debt |
Short Term (funds that will be repaid within 1 to 2 years) | Bank Overdraft | - Overdraw its account to an agreed limit
- Assists with short-term liquidity problem e.g. seasonal sales decrease.
- Costs are minimal, interest rates lower (paid on daily outstanding balance)
- Offers greater flexibility than loans and requires some security
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| Commercial Bills | - Type of bill of exchange issued by institutions other than banks, larger amounts i.e. over $100,000 and for a period of 90 to 180 days.
- Receives the money immediately.
- Type of large IOU
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| Factoring | - Enables a business to raise funds immediately by selling accounts receivable at a discount to a firm that specialises in collecting accounts receivable.
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Long Term (repaid in 2+ years) | Mortgage | - Loan secured by property, repaid in regular repayments over an agreed period e.g. 15 years.
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| Debentures | - Issued by a company for a fixed rate of interest and for a fixed time.
- Not secured by property rather the company’s assets.
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| Unsecured Notes | - Loan for a set period of time but not backed up by collateral or assets. (Greater risk).
- Higher interest rates and company sell unsecured notes to generate money for their initiatives such as share repurchases and acquisitions.
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| Leasing | - Involves the payment of money for the use of equipment
- Operating Leases: shorter than the life of the asset. Owner repairs and maintains.
- Financial Leases: Lessor purchases asset on behalf of the lessee for the life of the asset. Penalties for cancellation
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