Financial Planning and Management

Section 1: Role of Financial Planning

• Financial management: planning and monitoring of an organization’s financial resources to enable the organization to achieve its financial goals.
• Liquidity: the ability of an organization to pay its debts as they fall due.
• Profitability: the ability of an organization to maximize its profits.
• Efficiency: the ability of an organization to manage its assets to maximize profits with the lowest possible level of assets.
• Growth: involves the development and use of assets to increase sales, profit and market share.
• Return on capital: the amount of profit returned to owners or shareholders as a percentage of their capital contribution.
• Budgets: provide information in quantitative terms (facts and figures) about requirements to achieve a particular purpose.
• Cash flow budget: records the expected receipts of cash (inflows) and expected payments of cash (outflows) over a period of time.
• Records system: mechanisms employed by an organization to ensure that data is recorded and the information provided by record systems is accurate, reliable, efficient and accessible.

Strategic Role of Financial Management

Organizational planning

Goals/purposes/mission

Organizational objective

Strategic planning

Tactical planning

Operational planning

• Strategic plans may cover a period of 10 years. The goals a business wants to achieve will be incorporated into the strategic plan. These goals will be translated into short term, specific objectives.
• Tactical planning is flexible and adaptable, covering 1 to 2 years and allows the firm to respond quickly to changes. Operational plans provide specifics about the way in which the firm will operate in the short term.
• The 3 elements to sound financial planning are:
• Monitoring an organization’s cash flows
• Paying its debts
• Continuing to make profits for its owners and shareholders

Objectives of Financial Management

• Liquidity – a business must be able to predict whether they have sufficient current assets to cover current liabilities + any unexpected expenses – benchmark = 1.5 : 1
• Profitability – to maximize profits, sales revenue, expenses, pricing policy and investment in assets must be monitored.
• Efficiency – achieved by monitoring cash levels, inventory levels and collection of receivables.
• Growth – important as it can result in increased sales, increased profit, increased market share.
• Return on capital – shareholders are interested in the amount of profit to be returned on top of their capital investment

The Planning Cycle

The 8 stages of the planning cycle are:

1. Addressing present financial position
2. Determining financial elements of the business plan,
3. Developing budgets
4. Monitoring cash flows
5. Intercepting financial reports
6. Maintaining record systems
7. Planning financial controls
8. Minimizing financial risk and losses

The 2 sources of data are internal (present/past performance) and external (predictions in demand and competition).

Addressing present financial position – financial information includes balance sheets, revenue statements, cash flow statements, sales and price forecasts, budgets and ratio analysis.

Determining financial elements of the business plan – business plan sets out finance required, proposed sources of finance and a range of financial statements.

Budgets – can show cash required for planned outlays for a particular period and the estimated use and cost of raw materials/inventory. Budgets are planning and controlling – outline goals and how to achieve them, and then can be used to constantly monitor the objectives by comparing actual to planned. Factors to be considered in preparation of a budget include a review of past figures and trends and considerations from the external environment (availability of labor/materials).

Operating budgets – sales production expenses, raw materials/labor hours

Project budgets – capital expenditure information to be found research and development in each budget

Financial budgets revenue statement – balance sheet cash flow statement

Cash flows – if there is a cash surplus, short term investments can be researched to profit from the surplus – plans can be made for how long it can be invested. If a shortage is identified, short term borrowing plans may need to be made (overdraft, short term loan).

Financial reports – They show what the organization plans to achieve by the end of the period. The 3 essential reports are budgeted revenue statement, budgeted balance sheet and budgeted cash flows.

Record systems – the double system of accounting is a control tool in the sense that by recording all items twice, the entries can be seen to balance and checks to find errors can be carried out quickly.

Planning financial controls – common causes of financial problems/losses include theft, fraud, damage/loss of assets. Financial policies to control financial problems/losses include:

* clear authorization/responsibility for tasks in the organization

* rotation of duties – staff skilled in other areas and rotated

* control of credit procedures – following up overdue accounts, credit checks of customers

Budgets are used as control tools by comparing them with actual results. By determining the variance between budget and actual results, changes can be made as needed.

• Minimizing risk and losses – the following need to be assessed when assessing financial risk :

* amount of organization’s borrowings

* interest rates

* required level of current assets needed to finance operations

To minimize financial risk, organizations must consider the amount of profit that will be generated must be sufficient to cover the cost of debt + increasing profits to justify risk taken by owners and shareholders.

Section 2: Financial Markets Relevant to Business Financial Needs

Financial markets are made up of the individuals, institutions and systems supplying excess funds to those who require them. Financial markets provide:

• Access to funds
• Investment opportunities/contacts in managing funds
• Expertise in financial market dealings

The bank’s role is as a major operator in finance markets, and as a source of funds for business. Finance and insurance companies specialize in smaller commercial finance. Insurance companies provide secured loans to businesses. Finance companies raise their finance through debentures – share issues.The roles of merchant banks include:

• trade in money, securities and financial fixtures
• arrange long term finance for company expansion
• provide working capital
• arrange project finance
• advise clients on foreign exchange cover
• advise on mergers and takeovers
• provide portfolio investment management services
• underwrite corporate + semi-government issues of securities
• operate unit trusts – cash management trusts, property trusts and equity trusts
• arrange overseas finance

Superannuation funds have grown rapidly in Australia due to tax incentives + compulsory superannuation introduced by the government. Public/private cmpanies participate in financial markets through:

• Borrowing money to fund their operations
• Investing their excess funds
• Dealing in foreign exchange + commodities with overseas suppliers

The role of the Reserve Bank of Australia (RBA) is to act as a banker and financial agent for the federal government, as well as be Australia’s central bank. It supervises the financial system and manages monetary policy with the objectives of contributing to the stability of the Australian economy + welfare of the people. The RBA can push up interest rates to reduce reducing the amount of money in the economy, affecting business by increasing expenses and altering overseas trade.

Role of Australian Stock Exchange (ASX)

<It ssists businesses by acting as a primary market, enabling a company to raise new capital through the issue of shares + through the receipt of proceeds from the sale of securities.

A primary market enables a company to raise new capital through the issue of shares + through the receipt of proceeds from the sale of securities. A secondary market sees pre-owned/second-hand securities – shares – are traded between investors: individuals, businesses, governments.

Overseas and Domestic Market Influences

Factors in the domestic market which can influence businesses include:

• Competing demands for funds
• Changing demands for products
• Employment rates
• Overseas (external) influences on Australian business/financial markets include:
• World events (September 11)
• Tax regulations for foreign operations
• Political risks
• Foreign government intervention
• Changing technology (e-commerce) provide new online markets + software that connect companies to each other + their suppliers

Section 3: Management of Funds

• Internal finance: funds provided by the owners of the business (capital) or from the outcomes of the business activities (retained profits).
• Owners Equity (OE): funds contributed by owners or partners to establish + build the business.
• External finance: funds provided by sources outside the business – banks, other financial institutions, government, suppliers of financial intermediaries.
• Bank Overdraft: bank allows a business/individual to overdraw their account up to an agreed limit + for a specified time to help overcome a temporary cash shortfall.
• Mortgage: loan secured by the property of the borrower (business).
• Debenture: shares issued by a company for a fixed rate of interest + for a fixed period of time.
• Leasing: long term source of borrowing for businesses. Involves the payment of money for the use of equipment that is owned by another property.
• Factoring: the selling of accounts receivable for a discounted price to a finance or factory company. The company will receive up to 90% of the amount receivable within 48hours of submitting the invoices.
• Debt finance: the short term and long term borrowing from external sources (banks) by an organisation.
• Equity finance: the internal sources of finance in the organisation.
• Leverage (gearing): proportion of debt (external finance) and the proportion of equity (internal finance) which is used to finance the activities of a firm.

Source of Funds

• External (debt) sources of funds include:
• Bank overdraft
• Bank bills
• Trade credit short term
• Factoring
• Mortgage
• Debentures long term
• Leasing
• Internal (equity) sources of funds include:
• Owners Equity
• Retained profits

Internal – OE and Retained profits

• An advantage of OE is that does not have to be repaid unless the owner leaves the business, as well as being cheaper than other sources as there is no interest payments
• One disadvantage of OE is the expectations that owners will have about a return on their investment
• Retained profits: profits which are not all distributed but kept in the business as a cheap + accessible source of finance for future activities.

External funds

• One advantage is that due to the increased funds, increased earnings should therefore be a result, and hence, increased profits
• A disadvantage is that there is an increase in risk – interest, bank and government charges have to be paid on top of the principal amount borrowed
• Short term types of debt finance are bank overdrafts and bank bills – bill of exchange given for larger amounts, period of 90 and 180 days.
• Long term types of debt finance are mortgages, debentures and leasing.
• Long term borrowing is to meet the financial needs of a business in the long term – more than one year. Short term is to meet current debts as they fall due – less than one year.

Short Term

• Overdraft – should be used when needed to cover a temporary cash shortfall, to meet current liabilities/debts.
• Bank Bills – attractive for both borrowers/lenders because they can be traded in the secondary bill market. More attractive for borrowers because the bill can be re-borrowed, extending the period of short term borrowing.

Long Term

• Long term borrowing should be used to meet long term needs and if a great amount of money is needed – purchasing new property for expansion
• Mortgage – loan is used to finance property purchases – factory, office. Repaid regularly over agreed period – 10, 15, 20 years.
• Debentures – used by finance companies to raise funds.

Leasing

• Main participants are the lessor – owner of property – and the lessee – party wishing to use property
• Operating leases: assets leased for short periods, usually shorter than the life of an asset. Owner carries out the maintenance on the property.
• Financial leases: lessor purchases the asset on behalf of the lessee. Usually for the life of the asset. Leasing assets for long periods as financial leases cheaper than operating leases.
• Advantages of leasing include:
• Costs of establishing may be lower than other methods of financing
• Permits 100% financing of assets
• Lease payments are a tax deduction
• One disadvantage of leasing is that inters charges may be higher than for other forms of borrowing

Factoring

This is an important source of finance because the company will receive up to 90% of the accounts receivable sum within 48hours of lodging the invoices enabling them access to quick finance to cover any short term debts due or unexpected expenses The 2 types of factoring are:

• Without recourse – business transfers responsibility for non-collection to the factoring company
• With recourse – bad debts will still be the responsibility of the business.

Trade Credit

• Widely used short term borrowing system for businesses – 30-90 days given before payment due
• Attractive because it is a cheap from of finance
• Stretching: postponement of payments.

Venture Capital

• Used when a business needs to supply seed capital or diversification needs

Grants

• Given to businesses seeking to expand and develop by the government in an attempt to promote international competitiveness

Financial Considerations

Short term finance should be used for matching the short term purpose – managing a temporary cash shortfall. Long term finance should be used for long term needs – expansion of a business domestically/overseas. The 4 factors to be considered with financing activities are:

• Costs – set up costs and interest rates – must be measured for each of the available sources of funds.
• Flexibility – bank overdrafts provide better flexibility than debentures + factoring
• Availability of finance – if a too heavy dependence on a small number of investors, can increase risk if investor pulls out + commitments cannot be met.
• Level of control – if the receivables are factored than the liquidity of an organisation is reduced – this may impact on credit rating of organisation.

Debt versus Equity

In Australia, debt finance does not normally exceed equity finance – decision on which to use rests on the business. Debt finance can be attractive as funds are usually readily available + interest payments are tax deductible – reducing cost of debt finance. The costs of debt finance include:

• Repayment of principal
• Interest payments
• Tax considerations

The important points to consider when comparing debt to equity finance include:

• If organization has high level of debt finance, greater risk than equity
• Risk influenced by amount borrowed – higher the risk, higher the return if the business is successful
• Business must maintain sufficient liquidity + cash flow to ensure commitments are still paid as they fall due

The following factors influence the level of leverage:

• Type of industry + management of the firm
• Risk
• Amount of return
• Degree of control over the enterprise

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