Question

Assume that you recently graduated and have just reported to work as an investment advisor at the brokerage firm of Edmund PVT Ltd. One of the firm’s clients is Michelle Torre, a professional swimmer who has just come to the Australia from Canada. Michelle is a highly ranked swimmer who would like to start a company to produce and market apparel that she designs. She also expects to invest substantial amount of money. Michelle is very bright, and, therefore, she would like to understand in general terms what will happen to her money. Your manager has developed the following set of questions that you might ask and answer to explain the Australian business finance set up to Michelle.

Required

1. Explain three main areas of concern in business finance.                                      

2. The financial manager has one particular goal in mind.                                                        

1. What is this goal and why adopt it as the focal point for financial management?
2. What are some of the difficulties in achieving this goal?

3. What is time value of money? Explain.                                                                                     

4. How can firms improve their competitive position and so make projects potentially more attractive?                                                                                                                                     

Answer 1

Business finance or corporate finance is the life of any business. It relates directly to how a business will have enough money to deal with day to day issues, plan for the future and even deal with the funds that are already available.

(a)The three major areas of concern in business finance are:-

(a) Capital Raising

(b) Working Capital

(c) Capital Budget

Capital Raising:- For any business to flourish they need to invest in themselves. The level and type of investment will depend on the business.Whatever the goal it requires funds and the business will need to raise these funds.

Working Capital :- Working capital is simply the money that is used on a day to day basis.Tracking the incomings and outgoings of your business allows you to see how much working capital you have. It will also enable you to plan for purchases by knowing what funds are left over.

Capital Budget:- Capital budget is simply the process of understanding what the business is likely to need in the future. This is different from capital raising, where you actually need the funds.It is used to  assess the direction the firm is moving in and what expenditure is likely, this is a theoretical exercise which should cover all the different possibilities.

(b) The main goal of the financial manager is to help the company maximize profits.In order to do that, a financial manager needs to focus on smaller, more specific goals of financial management: planning, cost containment, cash flow management and legal compliance.To maximize the firm’s value, the financial manager has to consider both short- and long-term consequences of the firm’s actions.The stronger the financial management the greater the opportunity to have  to maximise the  profits in the short term and to grow capital value in the long term. The stronger the  financial management the easier it is to raise finance, and probably at a lower cost.Profit maximization is based on profits and profits are a must for survival of any business.Without profits, the business losses its primary objective and therefore has a direct risk to its survival. The profit maximization objective indirectly caters to social welfare. In a business, profits prove efficient utilization and allocation of resources. Resource allocation and payments for land, labor, capital, and organization takes care of social and economic welfare.

(c) Difficulties in acieving profit maximization are:-

(1) Long term Sustainable goals

   While profit maximization in financial management has the potential to bring in extra money in the short-term, long-term earning could be drastically diminished.Lowering production quality for the sake of increased profits will hurt the  brand, upset customers, and allow competitors to steal business.

(2) Product Quality

  Earning higher profits might be one of the goals of financial management but cutting corners, using lower quality materials, and sacrificing company values to earn a higher profit will affect the reputation of the company and potentially lose customers.

(3) Employee Training

A great way to reach profit maximization in financial management is to cut employee training or the research and development budget. While this will reduce operating expenses, and maximize short-term profits, it will not help the company reach any long-term sustainable goals and could even potentially cause employees harm.

Time Value of Money

Time value of money is a financial concept. A certain amount now is worth more than the same amount in the future. This is because we can invest now and earn a return, resulting in more money in the future.We can also refer to the concept as the Net Present Value (NPV) of money.We should always look at The Time Value of Money considering inflation and the resulting adjustment to purchasing power.

There are five (5) variables that we need to know:

1. Present value (PV) - This is our  current starting amount. It is the money that we have in our hand at the present time, our initial investment for our future.
2. Future value (FV) - This is our ending amount at a point in time in the future. It should be worth more than the present value, provided it is earning interest and growing over time.
3. The number of periods (N) - This is the timeline for our  investment (or debts). It is usually measured in years, but it could be any scale of time such as quarterly, monthly, or even daily.
4. Interest rate (I) - This is the growth rate of our money over the lifetime of the investment. It is stated in a percentage value.
5. Payment amount (PMT) - These are a series of equal, evenly-spaced cash flows.

Firms can improve their competitive position and so make projects potentially more attractive by :-

(1) People

People are the driving force behind most competitive advantage.If the people working in the firm are more creative and are better at innovating , producing and establishing relationships , then it helps in improving the competitive position.

(2) Organisational structure and culture

Organisational culture is the shared habits, behavior, beliefs, mission, norms and symbols of your organization.An effective culture focuses the energies and abilities of people on producing meaningful results.

(3) Cost leadership

In a cost leadership approach, a business will generally mass produce to drive prices really low, gaining an advantage in pricing.

(4)Differentiate the company

The first thing to do to improve competitive positioning is to view business from four different axes—supply chain, R&D and innovation, manufacturing, and marketing and sales.

(5) Customer Relationship

Upgrade customer relationship System.

(6) R&D and innovation

• Continually improve technological know-how
• Develop new research-intensive products
• Be on the lookout for new trends
• Protect and patent your technology

(7)

Marketing and sales

• Develop company  branding
• Increase product-related services
• Improve distribution network
• Develop and enhance the capabilities of sales force
• Explore new markets