HSC Business Studies 2009Topic 2 -1Financial Planning and Management

Objectives of Financial Management

The objectives of financial management are to maximise a businesss liquidity, profitability, efficiency, growth and return on capital.

LiquidityThe ability of a business to meet its financial commitments as they fall due.

ProfitabilityExcess of revenue over expenses which a business seeks to maximise

EfficiencyThe ability of a business to use its resources effectively in ensuring financial stability and profitability.

GrowthThe ability of a business to increase its size or market share in the long-run.

Return on CapitalThe amount of profit returned to owners or shareholders as a percentage of their capital contribution.

Strategic Role of Financial Management

Goals/Purpose/MissionOrganisational ObjectivesStrategic PlanningTactical PlanningOperational Planning

The goals a business sets are translated into organisational objectives which give a clear indication to management of what the business wants to achieve. The main objective of most business is to make a satisfactory level of profit. This will only occur if it has well defined and achievable goals.

The strategies that an organization adopts work towards achieving its goals both short and long term ones. Developing a strategic plan as part of an organizations financial management will help guarantee its success.

Strategic plans are the most important. They encompass a long-term view of where the business should go and how to get there. In the process, it monitors progress towards its stated goals, making provision for remedial intervention if actual outcomes deviate significantly from the strategic plan.

Managing Financial Resources

Financial resources are those resources of a business that have a monetry value. Financial management is the planning and monitoring of an organisations financial resources to enable it achieve its financial goals.

The mismanagement of financial resources can lead to problems such asInsufficient cash to pay suppliersInadequate capital for expansionToo many assets that are not productiveDelays in accounts being paidMisappropriation of funds Business failure.

Strategies for monitoring the financial resources of an organization must be incorporated into its strategic plan and should include:

Monitoring cash flows and payment of debts

Developing financial control techniques

Auditing of financial accounts

Profit and dividend projections.

The Planning Cycle

The planning process involves the setting of goals and objectives, determining strategies to achieve them, identifying and evaluating alternative courses of action and choosing the best alternative.

Financial planning is essential if a business is to achieve its goals. The financial planning process begins with long-term or strategic financial plans.

Long-term plans cover a period of between 2 to 10 years. Short-term plans are more specific and cover periods of 1 to 2 years or less.Financial Planning Process

Long-term plans include an organisations planned capital expenditure and planned investments. Capital expenditure is spending on non-current assets such as buildings and vehicles. It is used to generate revenue and returns to owners and shareholders. Long-term plans also cover planned sources of finance, spending on research and development, marketing and product development activities.

A business plan might be used when seeking finance or support for a project from a bank or other financial institution or other potential investors. A business plan should set out finance required, the proposed sources of finance and a range of financial statements.

The information contained in a financial plan will be determined by the audience to which it is directed: owners, employees, lenders, potential investors etc.

Accounting as Recording System

Record systems are the mechanisms employed by an organisation to ensure that data are recorded and the information provided by the record keeping system is accurate, reliable and efficient.

Every step must be taken to minimise errors in the recording system. The double entry system of accounting is used. By recording each transaction twice, the entries can be seen to balance and the check to identify errors when they fail to balance can be carried out quickly.

Financial ReportsImportant financial information needs to be collected before future plans can be made. This financial information includes:

Balance SheetsRevenue StatementsCash Flow StatementsSales and Price Forecasts BudgetsBank StatementsWeekly reports from departmentsBreak-even AnalysisFinancial Ratio Analysis and Interpretation of Reports

Financial reports are crucial for effectivefinancial management. There are two main types of financial reports:

General Purpose Financial Reports (GPFRS)Special Purpose Financial Reports (SPFRS)

GPFRs are financial statements that all public companies are required by law to produce. They Include:Balance SheetsRevenue StatementsStatement of Cash Flows

GPFRs are useful to or required by:ATOShareholdersCreditorsRegulatory Authorities (ASIC, ASX)Shareholders

GPFRs are produced in accord with Generally Accepted Accounting Principles (GAAPs)

SPFRs are financial statements prepared by a business for use by internal stakeholders. More detailed than GPFRs and do not have to comply with externally determined criteria. SPFRs includes:

BudgetsSales ReportsBreak-even analysis.

SPFRs allow management compare actual with predicted performance. They give management information on which to make informed decisions.

Financial Accounting revolves around GPFRs and Management Account around SPFRs.

Revenue Statement A Revenue Statement shows the revenue and expenses ofa business for a particular period of time.

Revenue statement for year ended 30 June 2006

Sales 150 000 Cost of goods sold 105 000 Gross profit 45 000

Operating expenses Administrative 5 000 Selling & distribution 7 000 Financial 3 000

Net Profit 30000

Balance SheetA Balance Sheet is a statement of financial position of a business at a particular point in time.

A Balance Sheet shows assets and liabilities. The difference between Assets and Liabilities is Owners Equity (Capital, Net Worth, Proprietorship). On this basis, a Balance Sheet is based on the Accounting Equation which is:

OE (owners equity) = ASSETS LIABILITIES

Cash Flow StatementsAdequate cash flow is essential to the success of a business. Some business operate on a cash only business. In such a case cash flow is easier to manage.Most businesses operate on a cash/credit basis. Here the business will need to ensure it will have sufficient cash on hand to meet its day-to-day operations and debts that have to be paid, as well as sufficient cash to replace equipment.

A Cash Flow Budget records the expected receipts of cash (inflows) and payments of cash (outflows) over a period of time. The budget will show whether the business can expect either a surplus or shortage (deficit) of cash. Cash flow budgets are usually prepared for 1-3 month periods.

If excess cash is identified in the cash flow budget, plans can be made for its placement in short term ibvestments to maximise income. If a shortage of cash is expected, then plans can be made to borrow short term or reorganise current assets. If borrowing necessary to meet a shortfall of cash, it should be at the lowest interest rate possible, which is often a bank overdraft.

How to Avoid a Cash Flow Crisis

Account for every dollar spent and do your banking regularlyInstall an up-to-date and relevant accounting systemKeep your financial records up-to-dateKeep a detailed account of all debtors and act promptly on overdue accounts and dishonoured chequesDraw up budgets and cash flow forecastsBe prepared for anticipated tax instalments and other paymentsReconcile your bank statements regularly: double-check receipts and payments with your own recordsNever pay accounts unless a tax invoice bearing an ABN is providedRetain all records for GST taxable purchasesConsider offering discounts for cash payments or early settlement of accounts receivableKeep a detailed list of accounts owing and when they are due for payment. Ask for discounts on early payment.

Break-even AnalysisBreak-even analysis is an example of a SPFR. It is prepared for management and shows at what point a project or process will start earning profit. It is crucial for management decision-making.

Developing Budgets

Budgets provide information in quantitative terms (figures) about requirements to achieve a particular purpose.

A business should produce a budgeted Cash Flow Statement, budgeted Revenue Statement and budgeted Balance Sheet.

Budgets will show:

Cash required for planned outlays for a particular periodCost of capital outlay and estimated earning capacityEstimated cost of raw materials and other inventoriesNumber of hours and cost of labour for production.

Budgets are used in both the planning and control aspects of business. They reflect strategic planning decisions about how resources are to be used. Budgets enable constant monitoring of objectives and provide a basis for administrative control, production planning, direction of sales and marketing efforts, control of inventories etc.

Various factors need to be taken into account in preparing a budget such as:

Review of past forecasts and actual results, as well as trends in the industry and in the economyPotential growth in market and current market shareProposed expansion or discontinuation of projectsProposals to alter price of productsCurrent orders and plant capacity.

Budgets can be classified under 3 headings

Operating BudgetsProject BudgetsFinancial BudgetsSales productionExpensesRaw materialsLabour costsCapital expenditureResearch and developmentRevenue statementBalance sheetCash flow statement

Planning Financial Controls

The most common causes of financial problems and losses are: TheftFraudDamage to or loss of assetsErrors in record system.Theft and fraud include unnecessary or over-purchase of stock for personal use, conflict of interest, misuse of expense accounts, false invoices, theft of inventory or assets and credit card fraud.

Financial controls ensure plans will lead to the achievement of the organisations goals in the most efficient way. Control is especially important in assets such as accounts receivable, inventory and cash.

Policies and procedures promoting control within an organisation are:

Clear authorisation and responsibility for tasks in the organisationSeparation of duties, eg. one person is responsible for ordering and another for receiving inventories; one person writes cheques and another signs themRotation of duties, eg. staff are skilled in a number of areas and can rotate dutiesControl of cash: use of cash registers, cash banked daily, payments made by cheque not cashProtection of assets: buildings kept locked, registry of assets maintained, regular checks of inventory, surveillance systems are installedControl of credit procedures: following up overdue accounts and credit checks of customers.

Minimising Financial Risks and Losses

Financial risk is the risk to a business of being unable to cover its financial obligations. If this occurs, bankruptcy will result. Questions a business should ask in relation to financial risk are:

Should the business borrow to expand operations?Will owners/shareholders finance expansion or will the money be borrowed?

Should excess funds be used to purchase assets or be invested in the short-term money market?What direction are interest rates likely to move?Will the business be affected by changing exchange rates?What is the current level of borrowings and when is it due to be repaid?Has the business sufficient current assets to finance operations.

To minimise financial risk, business must consider the amount of profit that will be generated. The profit must be sufficient to cover the cost of debt as well as increasing the net wealth of owners.