Finance

Finance is about a quarter of the HSC course. It is the topic most likely to include calculations: expect ratio questions in Section I and Section II, and financial data in the business report. The syllabus focus is the role of interpreting financial information in the planning and management of a business.

• Role of financial management: strategic role, objectives (profitability, growth, efficiency, liquidity, solvency; short-term and long-term), interdependence with other key business functions.
• Influences: internal and external sources of finance, financial institutions, government (ASIC, company taxation) and global market influences.
• Processes: planning and implementing, debt and equity financing, matching the terms and source of finance to the purpose, monitoring and controlling (the financial reports and ratios), comparative ratio analysis, limitations of financial reports, ethical issues.
• Strategies: cash flow management, working capital management, profitability management, global financial management.

Financial management is planning and monitoring a business's financial resources so it can achieve its goals. Its strategic role is to make sure the business has the funds it needs and uses them efficiently.

Objectives

• Profitability: earning a satisfactory return on sales and on owners' funds.
• Growth: increasing the size of the business (sales, assets, market share).
• Efficiency: using resources (such as assets and expenses) as productively as possible.
• Liquidity: being able to pay short-term debts as they fall due.
• Solvency: being able to meet long-term debts; closely linked to how much the business borrows (gearing).

Short-term objectives cover the next year (for example, keeping enough cash for monthly bills); long-term objectives cover several years (for example, reaching a target return on equity). Objectives can conflict: holding lots of cash improves liquidity but earns little, reducing profitability.

Interdependence

Finance provides the funds that operations, marketing and HR spend, and sets their budgets. In turn their decisions drive revenue and costs.

Sources of finance

Internal: retained profits, profits kept in the business instead of being paid out to owners. Cheap and keeps control, but limited in size.

External, debt (borrowing):

External, equity (ownership):

• Ordinary shares: a new issue (such as an initial public offering on the ASX), a rights issue (existing shareholders may buy new shares in proportion to their holdings), a placement (new shares sold directly to selected investors such as institutions) and a share purchase plan (existing shareholders may buy up to a set dollar amount of new shares).
• Private equity: investment by private funds in businesses not listed on the stock exchange, usually taking a large stake.

Financial institutions

Banks, investment banks, finance and life insurance companies, superannuation funds, unit trusts and the Australian Securities Exchange (ASX), where companies raise equity and investors trade shares.

Government and global influences

• ASIC (Australian Securities and Investments Commission) enforces company and financial services law, including financial reporting requirements under the Corporations Act 2001.
• Company taxation: companies pay tax on profit. The general rate is 30%; base rate entities (aggregated turnover under $50 million and mostly active income) pay 25% (rates as at 2026–27).
• Global market influences: the global economic outlook, the availability of funds, and interest rates. During a global downturn funds become harder and dearer to raise.

Planning and implementing

Determine financial needs, prepare budgets (operating, project and financial budgets), keep record systems, identify financial risks, and set up financial controls (policies such as separating duties, protecting assets and checking credit).

Debt or equity?

• Debt: owners keep control; interest is tax-deductible; funds are available quickly. But it must be repaid with interest whatever happens to profit, often needs security, and raises gearing and risk.
• Equity: no repayments or interest; lowers risk. But ownership and profits are shared, and issuing shares takes time and money.

Matching principle: match the term of the finance to the life of the asset. Short-term finance for short-term needs (stock, a seasonal cash gap); long-term finance for long-term assets (buildings, major equipment).

Monitoring and controlling: the financial reports

• Cash flow statement: cash in and out from operating, investing and financing activities over a period.
• Income statement: revenue, cost of goods sold, gross profit, expenses and net profit over a period.
• Balance sheet: assets, liabilities and owners' equity at a point in time, where $\text{assets}=\text{liabilities}+\text{owners’ equity}$

Financial ratios

For accounts receivable, $365÷\text{turnover ratio}$ gives the average number of days taken to collect debts. A current ratio around 1.5 to 2 : 1 is often treated as comfortable, and a debt to equity ratio well above 1 as high, but always compare with the industry.

Worked example. Tidewater Tiles has sales of $500,000, cost of goods sold of $300,000, expenses of $150,000, current assets of $180,000, current liabilities of $120,000, total liabilities of $200,000 and owners' equity of $250,000.

Note that gross profit ratio minus expense ratio equals net profit ratio ($40\%-30\%=10\%$), a quick check on your working.

Comparative ratio analysis

A ratio on its own means little. Compare it over different time periods (is it improving?), against standards (such as targets or common benchmarks) and with similar businesses (industry averages).

Limitations of financial reports

• Normalised earnings: profits adjusted to remove one-off items, which can hide real performance.
• Capitalising expenses: recording an expense as an asset, which overstates profit and assets.
• Valuing assets: assets may be shown at historical cost or estimates that differ from their real value; intangibles are hard to value.
• Timing issues: reports show one point or period, and can be made to look better around balance date.
• Debt repayments: the reports do not show clearly when debts must be repaid or whether the business can meet them.
• Notes to the financial statements: important detail is often in the notes, which many readers skip.

Ethical issues

Financial reports must be honest. Audited accounts (independent checking) are required for public and large companies; good record keeping and reporting practices are needed for tax and legal purposes. Unethical practices include inflating profits, hiding debts and misleading investors, which can lead to ASIC action.

Cash flow management

• Cash flow statements and forecasts show when shortages are likely.
• Distribution of payments: spreading bills evenly through the year so outflows don't all come at once.
• Discounts for early payment: encouraging customers to pay sooner.
• Factoring: selling receivables for immediate cash.

Working capital management

Working capital $=$ current assets $-$ current liabilities. Managing it means balancing liquidity against profitability.

• Control of current assets: cash (enough to pay bills, not idle), receivables (credit checks, collection policies, early-payment discounts), inventories (avoid overstocking, JIT).
• Control of current liabilities: payables (use credit terms fully without paying late), loans and overdrafts (keep costs low).
• Leasing: using assets without tying up cash in buying them.
• Sale and lease back: selling an owned asset and leasing it back, freeing cash while keeping use of the asset.

Profitability management

• Cost controls: managing fixed costs (which don't change with output, such as rent) and variable costs (which do, such as materials); cost centres (areas such as a department or store whose costs are tracked separately); expense minimisation (cutting unnecessary spending).
• Revenue controls: setting marketing objectives and pricing so revenue covers costs and earns a profit, and reviewing the sales mix.

Global financial management

• Exchange rates: an appreciation of the Australian dollar makes exports dearer for foreign buyers and reduces the AUD value of foreign-currency receipts; a depreciation does the opposite and makes imports dearer.
• Interest rates: businesses may borrow overseas at lower rates but take on currency risk.
• Methods of international payment (from most to least secure for the exporter): payment in advance, letter of credit (the importer's bank guarantees payment once shipping documents are presented), bill of exchange (a document requiring the importer to pay, now or at a set date, usually handled through banks) and clean payment (goods are sent and the importer pays later, on open account).
• Hedging: reducing exchange rate risk.
• Derivatives: contracts used to hedge: forward exchange contracts (lock in a rate now for a future date), options (the right but not the obligation to exchange at a set rate, for a fee) and swaps (exchanging currencies or interest payments).

Worked example. An importer must pay €50,000 in three months. Today A$1 = €0.60, so the cost is $50000÷0.60\approx \$83,333$ If the dollar falls to €0.55, the cost rises to $50000÷0.55\approx \$90,909$ A forward contract at about €0.60 would protect the importer against that rise.

• Dividing ratios the wrong way round (current liabilities ÷ current assets).
• Confusing liquidity (short-term) with solvency (long-term).
• Using short-term finance for long-term assets, or saying this is fine.
• Treating profit and cash as the same: a profitable business can still run out of cash.
• Getting the exchange rate direction wrong: exporters paid in foreign currency lose when the Australian dollar rises.
• Stating a ratio without interpreting it against a benchmark.

• Show your working in calculations; marks are often awarded for the method.
• When interpreting a ratio, use three steps: state the figure, compare it with a benchmark, explain what it means for the business and what could be done.
• In the business report, use the financial data to diagnose causes (look for links between the numbers and the additional information), then recommend specific strategies such as refinancing, cash flow management and cost controls.
• An extended response on finance should evaluate strategies or ratio analysis, using a real business (for example a listed company's annual report) as evidence.

• Operations: inventory management, cost control, investment in technology.
• Marketing: pricing, credit terms and their effect on cash flow, sales forecasts.
• Human resources: wages as a major cost, the cost of staff turnover, superannuation obligations.