Part 1: Financial Objectives and Interdependence
To understand financial management, we start with the five key objectives, remembered by the acronym PLEGS.
Profitability is the ability of a business to maximise its profits.
Liquidity is the ability to pay short-term debts as they fall due.
Efficiency involves minimising costs and managing assets to achieve maximum profit with the lowest expenditure.
Growth is the ability of the business to expand its size in the long term.
Solvency is the extent to which the business can meet its long-term financial commitments.
Financial management does not exist in a vacuum; it is interdependent with other functions including:
Finance and Marketing: Finance provides the essential budget for marketing campaigns. In return, Marketing generates the sales and revenue that Finance must manage and reinvest.
Finance and Human Resources: Finance funds staff wages, training, and redundancy packages. HR manages the employees who drive the productivity needed to meet the business's financial targets.
Part 2: Sources of Finance
Businesses fund themselves through internal and external sources. The main Internal source is Retained Profits, which are profits kept in the business for reinvestment rather than being distributed to owners.
External Debt can be short-term or long-term, these are things like:
Factoring is a short-term strategy where a business sells its accounts receivable to a third party at a discount for immediate cash.
Debentures are a long-term strategy. They are a promise by a company to repay a fixed amount of money at a set time with a fixed interest rate, usually secured against assets.
External Equity involves selling ownership, these include
A Rights Issue: this offers existing shareholders the right to buy new shares in proportion to their current holdings, usually at a discount.
Private Equity: is money invested in a private company that is not listed on the ASX, often to help it grow or turn it around.
Part 3: Financial Institutions and Influences
We remember the key financial institutions with the acronym BUF SAIL.
Investment Banks, they provide specialized services like underwriting share issues and arranging mergers.
Unit Trusts pool money from small investors to invest in specific assets like property or shares.
The ASX, or Australian Securities Exchange, is the public market where equity is traded to raise capital.
Superannuation Funds are major players because they invest massive amounts of member money into businesses as long-term funding.
Government and Global influences also shape finance.
ASIC is the independent government body that enforces company laws to protect consumers and ensure a fair market.
Company Taxation reduces net profit and must be planned for to stay solvent.
Globally, the Economic Outlook matters; a positive outlook increases demand, while a negative one increases risk.
The Availability of Funds refers to how easily a business can access international credit. If global markets are "tight," borrowing becomes harder and more expensive.
Finally, Interest Rates and Exchange Rates create risk. Rising global rates increase repayment costs, and currency fluctuations can make foreign debt or imports much more expensive.
Part 4: The Financial Management Process
The planning cycle follows a specific flow: addressing the present position, determining needs, developing budgets, maintaining record systems, identifying risks, and establishing controls.
Financial Needs are determined by business size and life cycle phase.
Budgets provide quantitative plans and benchmarks for performance.
Record Systems ensure data is recorded accurately for decision-making.
Financial Risks must be identified, and Financial Controls, like credit policies, must be established.
When monitoring performance, we use three main statements:
1 is the Cash Flow Statement tracks the movement of cash to ensure liquidity.
2 is the Income Statement calculates profit: Revenue minus COGS equals Gross Profit, and Gross Profit minus Expenses equals Net Profit.
3 is the Balance Sheet follows the equation: Assets equal Liabilities plus Equity. It shows the business's net worth.
Part 5: Ratio Analysis and Strategy
To assess performance, we calculate ratios.
1. Liquidity (The Current Ratio)
The Formula: Current Assets divided by Current Liabilities.
The Logic: This measures a business's ability to pay its short-term debts. A ratio of two to one is the "gold standard."
How to write the answer: "A current ratio of two to one indicates a sound financial position, as the firm has double the amount of short-term assets to cover its short-term liabilities. If the ratio is below one to one, the business is at risk of being unable to pay its bills. If it is significantly higher than two to one, the business may be 'too liquid,' meaning they are leaving cash sitting idle instead of investing it for growth."
2. Gearing (The Debt to Equity Ratio)
The Formula: Total Liabilities divided by Total Equity.
The Logic: Gearing measures the firm's solvency and long-term stability. It compares how much the business relies on borrowed money versus the owners' own money.
How to write the answer: "This ratio determines the degree of financial risk. A high gearing ratio means the business is heavily reliant on debt, which increases risk because interest must be paid regardless of profit levels. A lower ratio is safer but may suggest the business is not using enough 'leverage' to expand. In a response, state that: 'This ratio shows the relationship between the funds contributed by creditors and the funds contributed by owners.'"
3. Profitability (Gross and Net Profit Ratios)
The Formula for Gross Profit: Gross Profit divided by Sales, then multiplied by one hundred to get a percentage.
The Formula for Net Profit: Net Profit divided by Sales, then multiplied by one hundred to get a percentage.
The Logic: These show how many cents of every dollar in sales actually ends up as profit.
How to write the answer: "The Gross Profit ratio shows the effectiveness of the business's pricing and its ability to manage the Cost of Goods Sold. The Net Profit ratio is the 'bottom line'—it shows how well the business manages its total expenses. If the Net Profit ratio is falling while the Gross Profit ratio is steady, it indicates that operating expenses—like rent or wages—are rising too fast and need to be controlled."
4. Efficiency (Expense Ratio and Accounts Receivable Turnover)
The Formula for the Expense Ratio: Total Expenses divided by Sales, then multiplied by one hundred.
The Formula for Accounts Receivable Turnover: Sales divided by Accounts Receivable.
The Logic: Efficiency is about how well the business uses its resources to generate profit without wasting money.
How to write the Expense answer: "The expense ratio measures the percentage of each sales dollar consumed by operating costs. A lower ratio indicates higher efficiency. If this ratio increases over time, management must look at 'Expense Minimization' strategies to protect the profit margin."
How to write the Turnover answer: "This measures how many times a year a business collects its average accounts receivable. To turn the answer into 'days,' divide three hundred and sixty-five by the ratio result. A high ratio is positive; it means customers are paying their bills quickly, which keeps cash flowing into the business to meet other obligations."
To improve these numbers, businesses use Financial Management Strategies.
Working Capital Management includes controlling receivables by checking credit ratings and using Sale and Lease Back—selling an asset and leasing it back to inject immediate cash while keeping use of the asset.
Profitability Management involves Cost Centres to identify waste, and Expense Minimisation through outsourcing or better technology.
Global Financial Management uses Hedging and Derivatives to lock in prices and minimise exchange rate risk. Methods of international payment include Payment in Advance, Letters of Credit, Clean Collection, and Bills of Exchange.
Part 6: Marketing Strategies
The marketing process is remembered by SMEIDI: Situational analysis, Market research, Establishing objectives, Identifying target markets, Developing strategies, and Implementation, monitoring, and control.
Key marketing strategies include the 4 P's plus PEG: Product, Price, Promotion, and Place, plus People, Processes, and Physical Evidence, E-marketing, and Global Marketing.
Pricing strategies include Skimming, Penetration, Loss Leaders, and Price Points.
Promotion involves the communication process using opinion leaders and word of mouth.
Global Marketing requires a choice between Standardised Pricing, which is the same price worldwide, or Customised Pricing, where prices vary based on local costs and competition.