Financial Management Strategies

Financial Management Strategies

Financial Management Strategies consist of 4 areas:
Cash Flow Management
Working Capital Management
Profitability Management
Global Financial Management

Acronym: CWPG
Can we possibly grow?

Financial Management Strategies#1. Cash Flow Management

Cash Flow is the movement of cash in & out of the business.
Matching cash flow in with cash flow out is essential.
If more money goes out than comes in, or if money must be paid out before cash
payments have been received, there is a cash flow problem.
Question: what are some common cash inflows and outflows in a business?

Financial Management Strategies#1. Cash Flow Management

Purpose: shows the movement of cash (receipts and payments) of a business.
Liquidity: whether the business has adequate cash to meet its debts as they fall
due.
Cash Receipts: Any financial transactions result in cash flowing INTO the entity.
Cash Payments: Any financial transactions result in cash flowing OUT of the entity.
However, this record does not tell you what debts you have or what is owed to you
by others.

Financial Management Strategies#1. Cash Flow Management

A business can summarise its cash inflows and outflows through the use of cash flow
statements.
In a Cash Flow Statement, it is necessary to show the opening balance & closing
balance.
The closing balance of this period, becomes the opening balance of the next.
The closing balance of cash should equal to the amount in the Balance Sheet.
ANY TRANSACTIONS THAT DO NOT INVOLVE CASH, WILL NOT BE INCLUDED.

Financial Management Strategies#1. Cash Flow Management

For Medium & Large Companies, it can be broken down into:
Cash Flows from Operating Activities-relate to business prime function and
operation.
Cash Flows from Investing Activities-cash flows that arise as a result of the sale
and purchase of business assets.
Cash Flows from Financing Activities- cash flows that arise as a result of funding
(both debt and equity sources (E.g. dividend).

Example

Financial Management Strategies#1. Cash Flow Management

Management must implement strategies to ensure that cash is available to make
payments when they are due
 for example, to:
the Australian Taxation Office
suppliers for accounts payable
employees for wages
owners and shareholders for profits and dividends
banks and financial institutions for interest on loans or overdrafts, and leasing
payments.

Financial Management Strategies#1. Cash Flow Management

Strategies to control Cash Flow include:
Distribution of Payments:
Distributing payments throughout the month or year so expenses aren’t due at the
same time.
To ensure there are no large cash outflows at any given time
Provide enough time for business to generate cash inflows
If it is for a purchase of Non-Current Assets, it can consider to pay it by
instalments
—> pay small sums of money at regular intervals over a period of time, rather than
paying the whole amount at once.

Think about you want to review BS, you will separate the whole topic into different
chapters and review them weekly instead of at once.

Financial Management Strategies#1. Cash Flow Management

Strategies to control Cash Flow include:
B. Discounts for customers who pay early.
To encourages those who owe to the company to pay as soon as possible. This can
improve the cash flow position by collecting debts faster (i.e. reduce the number
of days in Account Receivable).
For example, company is waiting a payment from its customers which is due in 30
days. —> Account receivable
Company provides 10% off to customers if they can pay right now.
—> Faster to collect money from customers —> cash flow improved.
However, the profit margin decreases since offering discount.--> affect
profitability

Financial Management Strategies#1. Cash Flow Management

Strategies to control Cash Flow include:
C. Factoring: Selling AR at a discounted price to a factoring company. The business
does not have to follow up and receive the cash, i.e. improving Cash Flow. Those
who owe the debt have to repay to the factoring company directly.

If customers fail to make the payment to the factoring company, the business need
to be responsible for.

Financial Management Strategies#1. Cash Flow Management

The nature of the business and the industry will affect Cash Flow Management.
E.g.
Retail industry around Christmas times expect huge increase in Cash Receipts.
Children programs expect high Cash Inflow during the term breaks.
Engineering & construction companies can expect high Cash Outflow at the end of a
project.
Financial Management Strategies#2. Working Capital Management#
The amount of cash a business has access to, or its ability to generate cash is
called liquidity. An alternate term for liquidity is working capital. Working
Capital refers to funds that are available for short term financial commitments.
Working capital management refers to ensuring that current assets cover current
liabilities in meeting the objectives of the business.

Net Working Capital = Current Assets – Current Liabilities.

Why working capital management is important?

Revision about CA & CL

Generally a 2:1 ratio indicates a sound financial position.

Financial Management Strategies#2. Working Capital Management#

2023#($m)
2022#($m)
Bank
2.6
3.7
Accounts Receivable
5.1
3.2
Inventory
3.4
1.8

Overdraft
2.1
1.3
Accounts Payable
4.9
2.8
Short Term Loans
1.2
3.5

Net Working Capital

??
??
Current Ratio
??
??
Comment & Analyse the Current Ratio & Working Capital

Financial Management Strategies#2. Working Capital Management#

Strategies on Working Capital Management can include:
Control of Current Assets
Control of Current Liabilities
Strategies on leasing, sale & lease back.

2.1 Control of current assets

Current assets belong to which financial statements?

Examples of Current assets.

2.1 Control of current assets

a) Cash: Management must plan for the time of cash receipts, cash payments and
asset purchases to avoid the situation of cash shortage or excess cash.
Cash is the most liquid asset → it can be used instantly to pay debts such as loans
and cover any expected expenses.
Cash also can be used to take advantage of investment opportunities.
For example, the business might have the opportunity to purchase extra stock at a
discounted priced for a limited time only.--> expense reduces, profits increases
once stock has been sold.
Business need to hold an appropriate reserve of cash→ however, not too much cash
since it can be lost through theft, fraud and mismanagement.
Sufficient cash for operations and able to repay debts as they fall due. Reserves
might be useful for unexpected events. However, excessive cash can lead to
resources not efficiently utilised.

2.1 Control of current assets

b) Accounts Receivables (AR): businesses must ensure the timing of accounts
receivable allows the business to maintain adequate cash
→ increase the number of times in AR
→ or reduce the number of days in AR.
This can be done by:
Check customer’s credit rating before granting sales
Sending customers’ statements monthly so they know when to expect accounts
Follow up if customers have not paid by the due date
Offering discounts if pay early
Check policies on debt collections, such as using a debt collection agency for bad
debts.

2.1 Control of current assets

c) Inventories: Management must consider how much inventory to keep at any given
time.
Levels of inventory must be carefully monitored so that excess or insufficient
levels of stock do not occur.
→ Too much inventory can lead to cash shortages, and becomes a costs if stock
remain unsold + increase storage costs and insurance.
→ Too little inventory can lead to loss of sales since the business can’t provide
G&S when customers needed.
Too much inventory or slow-moving inventory will lead to excess cost, wastage
(outdated) and cash shortages (storage, insurance).
Insufficient inventory of quick-selling items may also lead to loss of customers,
and hence lost sales.

2.1 Control of current assets

c) Inventories: Management must consider how much inventory to keep at any given
time.
Business must consider their rate of inventory turnover → how fast the stock be
sold.
For example, supermarket: high and quick turnover.
Car dealership: slow turnover.
Some businesses use an inventory system called Just In Time (JIT).
→ To ensure the correct material arrive just as they needed for production
→ So that the business will not overproduce and reduce storage costs and reduce the
risk of waste occurring in storage

2.1 Control of current liabilities

Current liabilities belong to which financial statements?

Examples of Current Liabilities.

2.2 Control of current liabilities

a) Accounts Payable (AP):
A business must monitor its APs and ensure the timing of their payments allow the
business to maintain adequate cash resources.

The business must be aware of the due date of Account Payable.

→ If all AP due at the same month, it will lead to a cash shortage and the risk of
some accounts go unpaid.

Strategy 1: Distributing payments throughout the month allows the business to avoid
cash shortfalls.

2.2 Control of current liabilities

a) Accounts Payable (AP):
Strategy 2: Planning ahead allows the business to take advantage of discounts for
early payments → directly reduce costs each month.
Also, Net working capital = CA - CL → Net working capital increases.

Strategy 3: Holding back payment until the final date of interest-free credit
period
→ Allows business to use available cash for other purpose and generate more cash
inflow.
→ however, the business needs to pay high late fee if cash is not available for due
date.

2.2 Control of current liabilities

a) Accounts Payable (AP):
Strategy 4: Consignment: payment is not required until inventory is sold (e.g.
cars.)
Consignment means goods are left in the possession of a third party to sell.
Example: The car company wants to sell its cars but has no place to showcase its
cars for prospective buyers. The car company consignits its cars to a car yard to
sell on its behalf. The car yard does not charge the car company a fee for the room
displace but will charge a sale commission for any cars sold.

2.2 Control of current liabilities

b) Loans : Managers need to utilise them effectively and aim to minimise costs
where possible.
Strategy 1: Investigate alternative sources of funds from different banks and
financial institutions.
Strategy 2: Negotiate lowest interest rates.
Strategy 3: Search suitable repayment schedule, loan amount and administration
costs.

2.2 Control of current liabilities

c) Overdrafts: Overdrawing bank account to an agreed amount to overcome temporary
cash shortage.
While overdrafts are a cheap and convenient source of funds, managers must be aware
of :
Account-keeping fees: the business need to pay fee if deposit is lower than
agreeable amount.
Administration fees
Variable Interest fees: the faster the loan is repaid, the less interest fees.

https://www.commbank.com.au/support.banking.explain-account-overdraw.html

2.3 Strategies for managing working capital

Strategies for working capital management include:
Leasing
Sale and Lease-back

2.3 Strategies for managing working capital

Leasing: hire an assets from another company who has purchased and own the assets
(often Non-Current Assets). E.g. Machinery,Vehicles, Factory.
Benefits include:
Improve working capital: less cash outflow compare with the actual purchase, and
consistent cash outflow.
Tax Deductible
Strategies to improve current ratio
Business with a ratio lower than 2:1 should consider the following 2 strategies:

2.3 Strategies for managing working capital

2. Sale & Lease Back: selling an existing asset (often Non-Current Assets) and then
lease it for continue usage of the asset with fixed payments.
→ the business lose ownerships of the asset, but it retain use of it.
This can improve liquidity due to cash inflow from the sale of the asset and
consistent cash payment. However, it affect long-term profitability as the business
incurs leasing expenses indefinitely.

Exercise Questions:
Identify TWO methods of cash inflows and cash outflows.
Define factoring.
Explain how discounts for early payments and evenly distribution of payments can
improve cash flow.
Distinguish working capital and liquidity ratio.
Explain how a high liquidity ratio (greater than 3:1) will not benefit the
business.

Exercise Questions (cont.):

Comment on the working capital for the following business:
Recommend TWO controls of current assets.
Recommend TWO controls of current liabilities.
Identify TWO strategies for managing working capital.
Discuss TWO benefits of the TWO strategies mentioned above.

3. Profitability management
Role:
To maximise profit by maximising revenue and minimising costs.

How to achieve:
Cost controls
Revenue management

3.1 Profitability Control - Cost Control

Minimise costs and avoid unnecessary spending!
Fixed Costs (costs that do not fluctuate based on the level of production).
→ No matter how much does the company produce, the cost doesn’t change.
E.g. Rent, utilities, depreciation.
Control can be done by renting a new premises. → select a physical location that is
cost-effective

3.1 Profitability Control - Cost Control

Variable Costs (costs that fluctuate based on the level of production).

→ Costs increase or decrease in proportion to production.
E.g. raw materials and labour.
Control can be improved method of productions. For example, find more affordable
inputs, negotiate a discount for bulk buying

3.1 Profitability Control - Cost Control

Cost Centres: costs attributed to a particular department (e.g. IT department,

production department ).
Control can be done by outsourcing → third party completed some works for the
business.
It can have direct costs and indirect costs.
→ direct costs: incurred by one particular product or activity within a cost
center, department or region. For example, depreciation of a machine used to
produce a single product.
→ indirect costs: incurred by more than one product or activity within multiple
cost centres, departments or regions. For example, administration costs.

3.1 Profitability Control - Cost Control

Minimise Expenses: reduce unnecessary expenses.
E.g. Rent supplies.
Control can be done by establishing guidelines and policies to encourage staff to
minimise expenses.
Or undertake expense budgets to make expense patterns within a business visible.

3.2 Profitability Control - Revenue Control

Revenue:
Establish marketing objectives ensures a business engage with customers, makes
sales and earns revenue.
Control can be done by:
→ Sales Forecasts: must be set a level that will generate enough revenue to cover
costs and result in profit, which means break-even point,
→ Sales Mix: 4Ps must be constantly reassessed to ensure they reflect the needs and
wants of consumers as well as appeal directly to target market.
For example, Effective advertising campaign

Maximise Revenue !

3.2 Profitability Control - Revenue Control

(Cont)
→ Diversify product ranges (maximise profit & market share) & ceasing particular
production lines (not profitable).
→ Monitor & control optimal price level. If over priced, hard to attract customers.
If significantly under priced, profit might not be generated. Hence, have to
consider the following factors:
Costs
Competitor’s price
Image of the product (if it is too cheap, it can turn customers away)
Government Policies
Business goals.

4. Global Financial Management

Due to globalisation, businesses have access to more opportunities to trade with
other countries, hence increase profit. However, globalisation exposes businesses
to more uncontrollable risks.

The following areas are strategies of Global Financial Management:

Exchange Rates
Interest Rates
Methods of International Payments
Hedging
Derivatives

4.1 Global Financial Management - Exchange rate

Exchange Rates: The value of 1 currency relative to another currency. When
importing goods/services, payment method is often the currency of that particular
country (or USD).
Foreign Exchange Market (Forex, fx): determines the price of one currency relative
to another.
Currently AUD $1= USD $0.65
Go to: https://www.xe.com/

4.1 Global Financial Management - Exchange rate

Appreciation: there is a rise in the value or purchasing power of AUD(AUD is worth
more when converted to other currencies) i.e. each AUD can buy more of the other
currency.
E.g AUD $1= USD $0.67 to AUD $1= USD $0.76.

Imports US G&S
Original: AUD$100 only can buy USD$67 G&S
Now: AUD$100 can buy USD$76 G&S
Can purchase more!
Cheaper!
Purchasing Power Increases!
Demand increase
In short term: Increase income (value of AUD increases), imports cheaper, reduce
imports expenses which increase the demands of imports (Australian domestic
businesses meet risks)

4.1 Global Financial Management - Exchange rate

Appreciation: there is a rise in the value or purchasing power of AUD(AUD is worth
more when converted to other currencies) i.e. each AUD can buy more of the other
currency.
E.g AUD $1= USD $0.67 to AUD $1= USD $0.76.

Exports AUD$100 G&S

Original: Pay USD$67
Now: Pay USD$76
More expensive. Demand of Australian G&S decrease
In long term : An appreciation of the AUD reduces the international competitiveness
of Australian businesses who are selling products internationally (losing export
volume).

4.1 Global Financial Management - Exchange rate

Depreciation: there is a drop in the value or purchasing power of AUD (AUD is worth
less when converted to other currencies), i.e. each AUD can buy less of the other
currency. E.g AUD $1= USD $0.67 to AUD $1= USD $0.56.

Imports US G&S
Original: AUD$100 can buy USD$67 G&S
Now: AUD$100 only can buy USD$56 G&S
Buy Less!
More expensive!
Purchasing Power decrease.
Demand decrease
In Short term: decrease income (AUD worths less), imports more expensive, reduce
the demands of imports (internationally products), Australian domestic businesses
increase competitivness.

4.1 Global Financial Management - Exchange rate

Depreciation: there is a drop in the value or purchasing power of AUD (AUD is worth
less when converted to other currencies), i.e. each AUD can buy less of the other
currency. E.g AUD $1= USD $0.67 to AUD $1= USD $0.56.
Exports AUD$100 G&S
Original: Pay USD$67
Now: Pay USD$56
Cheaper! Demand of Australian G&S increase
In long term: An depreciation of the AUD increases the international
competitiveness of Australian Export Business(rising export volume), more
international customers.

4.2 Global Financial Management - Interest rate

Interest Rates: The cost of borrowing money. The higher level of risk involved in
lending to a business, the higher the interest rate.
Changing interest rates can have an impact on the interest expenses of the
businesses and hence, impact of the level of profit.

Changes in Interest Rates

Changes in Interest Expenses
Changes in Net Profit
↑
↑
↓
↓
↓
↑

Payments to overseas companies can be complicated. There may be no guarantee that

the importer will pay. Similarly, there is no guarantee that the exporter will send
the products.
To solve this problem, a method of payment using a third party, who both parties
trust is required.
Therefore, businesses must select a method of payment that both parties are aware
of and can agree on.
4.3 Global Financial Management - International payment methods

Four basic methods of international payments (from lowest risk to the highest risk
for the exporter)
· Payment in advance
· Letter of credit
· Bill of exchange
· Clean payment
4.3 Global Financial Management - International payment methods
Lowest risk to exporters (Sellers)
Highest risk to exporters (Sellers)

International Payment methods

Description
1) Payment in Advance
Exporters (sellers) received payment first, then export the goods. No risks to
exporters, but importers (buyers) bear the risk of no guarantee that they will
receive the goods. Also, importers (buyers)are unable to inspect the product before
paying

International Payment methods

Description
2) Letter of Credit
A letter from the importer’s bank to the exporters (sellers)that payments will be
processed once conditions of the goods have been met (e.g. delivered in fine
conditions).
Liability is on the bank, if importers (buyers) don’t pay, the bank will cover the
cost.
Some bank will ask importers (buyers) to pay deposit or to prove they have enough
money to pay.

International Payment methods

Description
3) Bills of Exchange
Document set by exporter’s (seller’s) bank demanding payment at a specified time.
a) Bill against payment: the bill is sent to the importer’s (buyers) bank (with a
set of documents) where the goods will be released to the importers (buyers) after
payment.
b) Bill against acceptance: the bill is sent to the importer’s bank (with a set of
documents), but the importer may collect the goods before payment. Importers only
need to sign the bills where specify when payment is due.

International Payment methods

Description
4) Clean Payment
Exporter (seller) ships the goods directly to the importer (buyers) before payment
is received. No risks to importers, but exporters bear the risk of no guarantee
that payments will be received. Payments are normally sent according to the credit
terms of the invoice (e.g. 30, 60, 90 days).
No banks are involved.
Only used by the exporter if they are confident that the importer will pay by the
agreed time.

4.3 Global Financial Management - Hedging

Spot exchange rate: is the value of one currency in another currency on a
particular day.

Due to fluctuations, spot exchange rates do not last, i.e. the value of one
currency in term of another currency is changing.
→ affect the profitability of the business.
However, it is possible for businesses to minimise the risk of currency
fluctuations—- hedging

4.3 Global Financial Management - Hedging

Hedging: it is the process of minimise risk of currency fluctuations.

Strategies can include:

Establish offshore subsidiaries (Opening a branch in a foreign country, removing
the need for exchanging currencies.)
Import payments & export receipts to be denominated in the same currency. For
example, using US dollars for all international transactions.
Insist of both import & export contracts to be the same currency.
For example, customers must pay in the exporter’s (seller)currency.
Hedging can be applied to currency, oil, inventory.

4.3 Global Financial Management - Derivatives

Derivatives: financial instruments to reduce the risks of currency fluctuations.
These can be:
Forward Exchange Contract: a contract to exchange currency at a future date and a
fixed exchange rate.
For example, an Australian business sells $50,000 worth of products to a Japanese
customer, which the invoice payable in 30 days. Forward exchange rates will allow
them to lock in the value of that sale by selling Japanese yen and buying
Australian dollars for a fixed rate.
This saves the business from the risk of an unfavourable exchange rate when they
convert their overseas revenue back into domestic currency.

4.3 Global Financial Management - Derivatives

2. Options Contract: is a contract that the buyer has the right but not the
obligation to exchange foreign currency at a set price before a specified date.
This can be a Call Option (right to buy) or Put (sell) Option.

4.3 Global Financial Management - Derivatives

For example, a call option provides an Australian business to purchase 100 USD with
a fixed exchange rate is 1 AUD = 1 USD and this exchange rate will be expired in a
month (the business can use this fixed rate to purchase USD any day within this
month).
In this month, AUD and USD may be appreciated or depreciated, no one knows. At the
expired date, the real exchange rate is 1 AUD = 0.5 USD, but the Australian company
used the fixed exchange rate to purchase $100 USD.
The company is making a profit or a loss?

Profit ! (Save $100 AUD)

4.3 Global Financial Management - Derivatives

For example, a put option provides an Australian business to sell 100AUD with a
fixed exchange rate is 1 AUD = 1 USD and this exchange rate will be expired in a
month (the business can use this fixed rate to sell AUD any day within this month).
In this month, AUD and USD may be appreciated or depreciated, no one knows. At the
expired date, the real exchange rate is 1 AUD = 2 USD, but the Australian company
used the fixed exchange rate to sell $100 AUD.
The company is making a profit or a loss?

Loss ! (Loss $100 AUD)

4.3 Global Financial Management - Derivatives

2. Options Contract: is a contract that the buyer has the right but not the
obligation to exchange foreign currency at a set price before a specified date.
This can be a Call Option (right to buy) or Put (sell) Option.

Businesses can hold revenue in foreign currency until exchange rates are
favourable, which allows businesses to potentially increase profits.

4.3 Global Financial Management - Derivatives

3. Currency Swap Contract: agreement to exchange foreign currency in the spot
market (value of one currency to another at a particular time) and agree to reverse
the transactions in the future.

4.3 Global Financial Management - Derivatives

For example, a medium-sized Australian business may need Japanese yen, but even
though it is a reputable business and has a good credit rating, it may not be well
known in Japan.

If it can find, or if a bank can team it with, a Japanese business that wants
Australian dollars, the swap would work as follows.

The Australian business would borrow Australian dollars in Australia, where it is

well known and can arrange a loan at cheaper interest rates; the Japanese business
would borrow yen in Japan for the same reason. They would then agree to swap the
currencies and repay each other’s loan; that is, the Japanese business would repay
the Australian dollar loan, while the Australian business would repay the Japanese
yen loan.

Exercise Questions:
Outline why businesses need to monitor the amount of fixed and variable costs.
Recommend ONE method of expense minimisation.
Explain how effective marketing campaigns can improve profitability.
Explain how the fluctuation of currency can affect financial performance.
Describe the impact of an increase in interest rates to financial performance.
Describe the FOUR methods of international payment.
Identify which international payment will benefit exporters and importers.
Outline how derivatives can minimise risks.