Financial Management Strategies

Financial management strategies include 

• working capital management
  
  

• debt and equity financing,
  
  

• profitability management,
  
  

• minimisation of expenses
  
  

• global financial management. 

1. Distribution of payments- By spreading expenses over the whole year there is a more equal cash outflow each month rather than one huge outflow during one month. Another strategy is to prepay expenses, such as rent or interest.

 2. Factoring - accounts can be sold to a factoring business at a discount. The factoring firm pays the business the value of accounts minus its fee or commission.

 3. Discounts for early payments- A business may offer discounts to speed up cash inflow. Some incentives include small gifts and discounts on future orders. 

Working capital - the current assets used in the day-to-day running of a business. The business needs to ensure that payments are received on goods it has sold on credit to customers. The formula for working capital is:

o   Net working capital = current assets − current liabilities

Working capital must be managed effectively and efficiently. The formula for the  working capital ratio is:

o   Current ratio = current assets ÷ current liabilities

Example

Control Current Assets

• Cash

• Accounts Receivable 

• Inventories

Control of Current Liabilities 

• Accounts Payable - Control of accounts payable involves periodic reviews of suppliers and the credit facilities they provide: discounts, interest-free credit periods and extended terms for payments 

• Loans

• Overdraft

Strategies 

1. Leasing and 

2. Sales Lease back

Profitability  management

o   A good accounting and financial system has effective controls to ensure the business:

o   does not overspend

o   does not lose assets

Records financial records and transactions correctly. 

1. Cost controls

Fixed and variable

o   Businesses can reduce costs in 2 areas: labour and inputs.

o   Outsourcing of non-core functions has been the most popular method, e.g. contracting a call centre to handle customer inquiries or hiring a specialist firm to handle payroll, cleaning. These organisations are aiming to achieve greater efficiency.

o   Fixed costs do not change when a business produces more goods, e.g. salaries, rent, lease payments.

o   Variable costs do vary as output and sales change. Examples are employee wages and overtime payments, advertising.

o    Strategies to cut variable costs include:

o   negotiating discounts with all suppliers

o   reducing the number of suppliers

o   switching to a cheaper supplier

2. Cost Centres

Cost centres - The expenses associated with each key business function.  Management may provide them with a budget and monitor their expenses to minimise waste and achieve maximum use of resources. They can be used to identify which type of expense contributes most to the product.

Cost centres use budgets as tools to evaluate the performance of by comparing actual to the real amount spent 

3. Revenue controls

Marketing objectives

• Revenue controls include sales forecasts, analysing the sales mix and the pricing policy of a business.

• A sales budget (The predicted future sales a business expects to make during the year)  is used to predict future sales of the business based on:

o   patterns of sales in previous years

o   economic conditions

• Sales mix is the marketing strategy used to sell the range of products a business supplies. It is a report that can be used to identify which method of promotion works best. 

Global financial management

·       When operating globally, there are factors or additional risks that must be considered, They include exchange rates, interest rates, methods of international payment, hedging, derivatives.

o   Exchange rates-  the value of  a country’s money calculated using another country’s money. When costs are transferred it can decrease the value of net profit. If the Australian dollar depreciates, it will cost more to import.

o   Interest rates- It is important to find the lowest interest rate, as exchange rate fluctuations can make repayments more costly. The advantages of overseas borrowing are:

§  the rate of interest can be cheaper

§  there are fewer restrictions 

§  finance may be acquired more quickly and easily

o   Methods of international payment- there are many methods of payment used but the main ones are payment in advance, letter of credit, bills of exchange and clean payment.

§  payment in advance- to receive payment for goods before they are sent.  There is the risk of the goods never being sent.

 §  letter of credit- a document issued by a bank to the seller of goods that has specific instructions from the buyer of the goods giving the seller the authorisation to draw a specified sum of money from the buyer’s bank account under certain conditions.  

§  bills of exchange- A bill of exchange is a document drawn up by the exporter demanding payment from the importer at a specified time. This method of payment is one of the most widely used and allows the exporter to maintain control over the goods until payment is either made or guaranteed

a) Document (bill) against payment - the importer can collect the goods only after paying for them.

b) Document (bill) against acceptance - the importer may collect the goods before paying for them.

 §  clean payment- The goods are shipped before payment is received. This is used when businesses and their exporters have a good relationship and history. 

o   Hedging- Any strategy used by a business to reduce financial risk. This is done to reduce foreign exchange risks. Businesses enter into contracts and buy/sell foreign exchange to purchase inputs. It can also be done by using subsidiaries (a business owned by the global corporation that supplies inputs).

§  Derivatives-  a special contract between global businesses and suppliers. The three main types are:

• • • • • forward exchange contracts- the bank will guarantee the exporter a certain exchange rate on a certain date. A forward exchange contract is an agreement under which a business agrees to buy a certain amount of foreign currency on a specific future date. The purchase is made at a predetermined exchange rate. By entering into this contract, the buyer can protect itself from subsequent fluctuations in a foreign currency's exchange rate.  

        •  currency option contracts - it has the option to buy or sell foreign currency when the exchange rate movement is to its advantage. It allows business to use the spot rate (exchange rate on a particular day).

        •  swap contracts - written contract allowing the Australian business to pay the US supplier in euros at a spot rate.  In a currency swap, the parties agree in advance whether or not they will exchange the principal amounts of the two currencies at the beginning of the transaction. The two principal amounts create an implied exchange rate. For example, if a swap involves exchanging €10 million versus $12.5 million, that creates an implied EUR/USD exchange rate of 1.25. At maturity, the same two principal amounts must be exchanged, which creates exchange rate risk as the market may have moved far from 1.25 in the intervening years. (summarise from textbook) 

2011

Q17 How is the role of the Reserve Bank of Australia best described? 

(A)   It provides loans to small businesses. 

(B)  It provides insurance services for farmers. 

(C)  It facilitates the buying and selling of shares. 

(D)  It oversees the stability of the financial system

22 (b)   Explain ONE cost control strategy and ONE revenue control strategy that Kendall’s Cafe could use to improve its profitability 6 marks 

2012

8 What would be the best strategy for a business to increase its gross profit?

(A) Use cost centres 

(B) Reduce fixed costs 

(C) Minimise expenses

(D) Use sale and leaseback

20 Which of the following groups would suffer the worst financial impact as a result of an increase in the value of the Australian dollar?

(A) Japanese shareholders of an Australian bank 

(B) Australian producers selling wine to New Zealand 

(C) Australian car makers purchasing inputs from Italy 

(D) American travel agents organising tours for Australians

2013

6 Which of the following would immediately improve the working capital of a business? 

(A) Increasing credit sales 

(B) Using sale and lease back 

(C) Preparing a cash flow statement 

(D) Repaying debt to creditors more quickly 

Question  24  (7  marks) 

An  Australian­ owned  business  manufactures  bicycles  in  China  and  sells  them  to wholesalers  in France.  These  wholesalers  do  not  pay  in  advance. 

(a) Describe  ONE  method  of  payment  the  business  could  use  to  ensure  that  it  receives payment  for  the  sales. 3 marks

(b)  How  could  this  business  protect  itself  against  a  change  in  the  value  of  the Australian  dollar  relative  to  another  currency? 4 marks

2014

Question 24 (continued) 

(c) Discuss factoring as a strategy for cash flow management. 4 marks

2015

Question 28 (20  marks)

Evaluate the importance of financial management strategies in improving business performance.

2016

Q26 Lee’s Catering, a small business. It has a high profile chef and the food is of excellent quality. It has many bookings for future events.

Extract from financial reports for Lee’s Catering

Cash ($) 1000

Accounts receivable ($) 10 000

Inventory ($) 50

Accounts payable ($) 11 050

• recommend appropriate working capital management strategies for the business

• evaluate a pricing strategy the business could use.

2017

13    Why would a business factor its accounts receivables? 

A.  To improve cash flow 

B.  To increase owner’s equity 

C.  To increase the value of current assets 

D.  To improve the value of the business 

Question 24 (7 marks) 

A business imports computers from China and sells them to customers in Australia. 

(a)   How will an appreciation of the Australian dollar affect the competitive position of this business 2 marks

(b)   Justify the method of payment that would be most effective in reducing the business’s financial risk. 5 marks

2018

18    Australian businesses export to Canada. What would happen if the value of the Australian dollar increased compared to the Canadian dollar? 

A.   There would be no effect on Canadian businesses. 

B.  Australian imports from Canada would become more expensive. 

C.  Canadian businesses would find Australian products more affordable. 

D.  Australian products would become more expensive for Canadian businesses

Question 24

(b)   How could a business improve management of its accounts receivable turnover? 3 marks

Question 26 (20 marks)

Explain the influence of global markets on financial management of businesses

2019

none

2020

(c) Recommend ONE financial strategy this business could implement to improv efficiency in the collection of accounts receivable. ATAR 7.2 3 marks

(d) Explain TWO ways in which comparative ratio analysis can be used by this business to assess its financial position.

Question 26 (20 marks) 

Evaluate the effectiveness of financial management strategies used to achieve profit and growth objectives. 

2021

1 The role of a cost centre within a business is to monitor and control 

A. assets. 

B. expenses. 

C. liabilities. 

D. receipts. 

18 When a business uses factoring, they improve their 

A. cash flow by increasing their revenue. 

B. cash flow but reduce their profitability. 

C. working capital by reducing their costs. 

D. working capital but increase their liabilities. 

19 An Australian farmer has been contracted to sell 1000 tonnes of oranges to an American juice manufacturer at a set price. Payment is required in 60 days in Australian dollars. Which of the following would be an effective method of hedging in this transaction? 

A. The Australian farmer using a derivative to protect themselves from a falling Australian dollar. 

B. The Australian farmer using a derivative to protect themselves from a falling American dollar. 

C. The American manufacturer using a derivative to protect themselves from a falling Australian dollar. 

D. The American manufacturer using a derivative to protect themselves from a falling American dollar.

 20 Company A intends to buy Company B. Company A might pay too much for Company B if Company B’s financial manager decides to 

A. normalise a large one-off asset sale. 

B. capitalise their research and development expenses. 

C. fully disclose the nature of the receivables owed to the company. 

D. record their buildings at historical cost although they increased in value. 

22 b) 

A luxury Australian handbag business is going to expand. They intend to borrow 30 million US dollars to buy several new retail properties across Australia. 

Explain a financial risk associated with borrowing funds from the USA  3 marks