ROLE OF FINANCIAL MANAGEMENT- Financial management is one of the functions of management- Financial management is concerned with Profits and losses of operations o Control over fund so Ensuring appropriate cash flow is available Chas management Raising funds / controlling internal fund so Investment of fund so Cost control / pricing o Forecasting / measuring financial performance against expectations- Accounting is a subset of financial management. Financial transactions must be recorded, classified, stored and eventually reported to the managers. – OBJECTIVES OF FINANCIAL Management Liquidity Refers to cash reserves being held, or to the ability to turn and investment into cash with little or no delay or loss of capital Solvency Refers to a business ability to pay its debts when due, and remain a going concern Profitability Refers to how profitable the business is from the perspectives of profit on sales, assets and shareholders equity o Efficiency Examines how well working capital is managed, that is how quickly cash is collected from debtors, inventory sold and creditors paid. o Growth Once a business is formed and operations commence, it enters a growth phase, where there should be an increase in the number of goods or services sold- THE PLANNING Cycle Strategic or corporate plans involve how the business can accomplish its objectives, generally to create a strong competitive advantage Organisational planning processes involve The formulation of mission, goals and objectives, An analysis of key environmental variables that present opportunities, threats, and constraints. It is known as an environmental audit An organisational audit to evaluate strengths and weaknesses and identify where change needs to be met The formulation of strategies within deadlines to achieve specific objectives Monitoring and review to ensure that the mission is on target and that performance indicators are being me to Tactical plans focus on the most efficient resource use by a business unit or department Operational plans are concerned with implementing the strategic plan through day to day processes, procedures, workflow and efficiency o Financial plans represent the dollar quantification of the strategic and operating plan so And business plan should be the result of an integrated approach that encompasses all three The planning cycle involves developing strategies, implementing them, monitoring the progress made, evaluating the success of them, and modifying where necessary One approach that can be taken is Determine the financial elements of the business plan Maintain the record systems Develop budgets Consider the cash flows Interpret the financial reports Address the present financial position Plan financial controls Minimise financial risks and losses- MANAGEMENT OF FUNDS- SOURCES OF Funds Internal Owners equity – where owners of any kind contribute to new capital Retained profits – the business may self-capitalist through retained profits from previous years, the funds are not invested in the owners, but back into the business Sale of assets Changing the ownership of structure External Short term borrowing o Overdrafts – are arrangements between then business and its bank in which the business may borrow through its cheque account up to a certain amount.
Overdrafts may be secured or unsecured. They are a very flexible form of short term finance because the funds are there when the business needs them and interest is only charged on the outstanding daily balance Bank Bills – are bill of exchange where the acceptor and / or endorser is the bank. They are usually drawn for periods of 30, 90 or 180 days and normally a face value of $100, 000 or $500, 000. they are usually traded in parcels of $10 mil. Long term borrowing o Mortgages – a form of security for a loan in which a specific item of property is pledged by the borrower or mortgagor to the lender or mortgagee o Debentures – are a type of debt security backed by the certain assets of the issuer and of other companies in the group. o Leasing – refers to an agreement between two parties that allows one party to use an asset, such as property owned by the other party for a specified time period Factoring – refers to the cash purchase of the business’s sales invoices at a discount o Venture capital – is capital that is subject to more than a normal degree of risk Venture capital investors structured as price equity funds, that pool money provided by institutional and other large investors who buy into unregistered companies with the aim of selling out at a profit when the company eventually lists on the stock exchange Grants – sometimes governments decide that a certain business is in the national interest and it pays them subsidies or a one off grant to assist them to continue – FINANCIAL CONSIDERATION So Short term assets will typically be financed by overdrafts.
o Long term loans will typically use leasing or term loans for the financing, so that repayments of the loan can be matched to the business’s cash flow- COMPARISON OF DEBT AND EQUITY Finance Gearing, or leverage is the ration between long term debt and equity in the Balance sheet of a business entity o Debt to equity ratio = total liabilities / owners equity o An investor would be very concerned about a company with a gearing over 75%. There is no ideal gearing- USING FINANCIAL INFORMATION- THE ACCOUNTING Framework A company’s profit and loss statement shows expenses, revenue and the resultant profit or los so A revenue statement is a statement showing income and expenditure that can be used to calculate net profit The balance sheet is a report that shows the assets, liabilities and owners equity of a business at a given point in time. o The accounting equation is given as Assets = owners equity + liabilities- TYPES OF FINANCIAL Ratios Liquidity The liquidity ratio is called the current ratio o Current ratio = current assets / current liabilities o Solvency The solvency ratio is called the debt to equity ratio o Debt to equity ratio = total liabilities / owners’ equity o Profitability There are 3 ratios to measure profitability o Gross profit ratio = gross profit / sales x 100 o Net profit ratio = net profit / sales x 100 o Return on owners’ equity ratio = net profit (before tax) / owners equity x 100 o Efficiency There are 2 ratios to measure efficiency o Asset turnover ratio = sales / total asset so Accounts receivable turnover = sales / accounts receivable o Expenses The expense ratio iso Expense ratio = total expenses / sales- LIMITATIONS OF FINANCIAL Reports Values of intangibles They are assets that have a value but are not material. For example, goodwill and patents. It can be extremely difficult to allocate values to intangible assets- THE WORKING CAPITAL Ratio Working capital is the amount of capital required to finance the day to day running of the business Working capital = current assets – current liabilities o Working capital ratio = current assets / current liabilities- CONTROL OF CURRENT Assets Current assets are assets that are expected to be converted into cash The following formula is a method of proving the effectiveness of quality control Days till credit = trade credits / sales x 365- CONTROL OF CURRENT Liabilities Overdrafts can become expensive if the business is unable to repay the extended withdrawal o It can be drawn down and repaid the same way as an overdraft, but the interest is significantly lower than overdraft rates and only slightly higher than mortgage rates- STRATEGIES FOR MANAGING WORKING Capital Leasing Represents an agreement between the owner of an item and the potential user of an item in return for payment of a periodic charge Financial lease so Which are often indistinguishable from debt finance, provide the required item to the user, with the eventual purchase terms clearly written into the lease o The lessee is responsible for all maintenance, insurance, operating costs etc Operating lease so Operating leases differ from financial leases in not providing as a right, and opportunity to purchase the item, being leased when the lease agreement come to an end. Here the emphasis is on rental, rather than what is effectively deferred purchase.
o The lessee may be responsible for paying all or any of the maintenance, insurance operating costs etc Factoring o Is the selling of accounts receivable or debtors ledgers to a third party for less than the book value Sale and leaseback o Refers to a transaction in which the seller retains the use of an asset such as occupancy of a building, by simultaneously signing a lease, with the purchaser of the asset at the time of sale- EFFECTIVE FINANCIAL PLANNING o EFFECTIVE CASHFLOW MANAGEMENT Source of funds = use (application) of funds Sources include o Injection of new capital Raising new loan so Reductions in stock Applications include Pay out of loan so Tax pai do Purchase of fixed assets Management strategies for cash flow problems include Shortening the operations cycle o Increasing net profit margin so Increasing trade payable o Borrowing money Maintaining a minimum cash reserve.