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FFM Summary Notes Free Version 2013
FFM Summary Notes Free Version 2013
PAPER FFM
[Financial Management]
Text Book Summary
Please read through the text book. Do depend on this summary as errors & omissions
may occur.
Done By
Tariq Suhail Al Shaibani
http://hct-cat.webs.com/
Part A: Chapter 1
Working Capital is the capital available for conducting the day-to-day operations of an
organization.
Current Assets Current Liabilities A business may be
i.
ii.
A company is said to be overtrading when its sales are expanding to o quickly for it to finance
them.
Costs associated with running out of raw material:
Sales will be lost, therefore you will lose any contribution made from each lost sale
If emergency deliveries are required, there will be an additional cost for these
If production ceases altogether and staff and machines sit idle, there will be costs of lost
production
Loss of customer goodwill will arise if orders cannot be met. This may lead to loss of sales
to this customer in the future
Working capital Cycle (cash operating cycle) is the period between the suppliers
being paid and the cash being received from the customers.
The Cash Capital Cycle in a manufacturing business equals:
The working capital cycle in a manufacturing business equals:
The average time that raw material remain in inventory
Less the period of credit taken from suppliers
Plus the time taken to produce the goods
Plus the time finished goods remain in inventory after production is completed
Plus the time taken by customers to pay for the goods
You can use the ratios below to calculate the cash operating cycle.
Liquidity Ratio:
Current ratio =
Quick ratio or acid test ratio =
x 365days
x 365days
x 365days
Inventory Turnover =
x 365days
*Its another measure of how vigorusly a bussiness is trading. A lenthing turnover period indicates: a slow
down in trading or a build-up in inventory levels
Accounts payable payment period =
paying
Symptoms of overtrading:
iii.
Revenue
iv.
Current/ non-current assets
v.
Inventory/receivables > sales
vi.
Current and quick ratios
vii.
Current liabilities > current assets
viii.
Assets financed by credit and not proprietors capital
Other causes of over-trading: when a business repays a long without replacing it ;
and in the period of inflation the profits may be insufficient to replace non-current
assets and inventories
Chapter 2:
EOQ =
Bank overdraft
x.
xi.
*Trade credit will have a cost, whenever a company is offered discount for early payments,
but opts instead to take longer credit.
4
is the reduction in the payment period in days which would be necessary to obtain
the early payment discount\
Direct Debit
Receiver initiates each payment
The amount varies
All changes in Direct Debit amounts must be notified to the payers 14 days in advance
Indemnity: the originator (payee) must provide an indemnity to guarantee a refund of
incorrect debts.
Type of payment
Telegraphic Transfer (TT) or cable payment
order
Details
Instructions for the payment are sent from the
payers bank to the payees bank by cable
(over the telecommunications system).
Mail Transfer (MT) or mail payment order
Instructions are sent by mail
*For payments within the UK, TTs are more common
Bankers Automated Clearing Services (BACS) is a company owned by the major retail banks
which operates the electronic transfer of funds between accounts within the banking system.
*It reduces paperwork
*Is widely used to pay salaries
5
3.
4.
5.
6.
Exceptional items
Unexpected payments
Net cash flow is the total change in a companys cash balances over a period of time
Operational cash flow is the net cash flow arising over a period from trading operations
Priority cash flows do not relate to trade, but are vital to keep the company
afloat (interest and tax payments)
Discretionary cash flows are cash payments/receipt that do not have to be made
(investments, capital expenditures, ordinary and preference dividend)
Financial cash flows arise from variations in long-term capital (issue of shares,
loans, payment of a long-term loan)
-Cost of Sales
- Cash out
Notes
Cash in = Sales + Opening receivables closing
receivables
Cash out = Purchases + Opening payable closing
payable
Purchases = COGS + Closing inventory opening
inventory
Profit
Reducing receivables
Reducing Inventories, or
*If a company is making loses, it could try to maintain a positive operational cash flow by
taking more credit (Increase payables; will reduce working capital)
The three main focuses of cash and credit management:
1) Profitability
2) Liquidity
3) Security/Safety
Cash budgets are prepared on the cash basis; not accruals concept.
Revision Kit Pg137 Question 29
the purpose of a cash budget
1) To have sufficient cash to meet its payment obligations
2) Whether the business will have a cash surplus or deficit
3) For control purposes
7
Cash budget:
Receipts
Less payments
Net cash flow in month
X
(X)
X
X or (X)
X or (X)
X
Control reports could be prepared for operational cash flows. The purpose of the report should
be either:
Making Losses
Inflation
Growth
xvii.
xviii.
Seasonal business
One-off items of expenditure
*A typical question on cash forecasts might ask you to prepare a budget, and then require you to
explain how the organization might deal with the shortfall predicted.
A constant monthly amount (unchanged figures) of receipts and payments will often
indicate a sloppy cash forecasting practice (weak forecasting system)
Inflation usually effects costs before revenues.
When prices are increased trade receivables will become higher, and the working capital of the
business will increase.
Chapter 6:
A growth rate can be estimated from an analysis of the growth in (ex. Over the past years)
n
b=
a=
The line of best fit that is derived represents the regression of Y upon X (X = a + bY)
*Regression can be used to find a trend line
***Pg 102: Remember when you are using years a X, the first year will be 0!
10
Trend they are three types: upwards, downward and no clear movement
seasonal variations are short-term fluctuations in recording values
cyclical variations are medium-term changes
random variations
The Actual Time Series, Y = T + S + C + R
Where
C = cyclical component
R = random component
Part C: Chapter 7:
Key Principles on which a business cash management policy should be based on:
Profitability
Liquidity
Safety
11
ie Q =
S = the amount of cash to be used each time
F = the fixed cost of obtaining new funds (cost per sale/purchase of securities)
i = the interest cost of holding cash or near cash equivalents
Q = the total amount to be raised to provide for S
Treasury managements is the corporate handling of all financial matters, the generation of
external and internal funds for business, the management of currencies and cash flows, and
the complex strategies, policies and procedures of corporate finance.
12
*Read advg and disadvg of centralized and decentralized cash management systems.
*Read Anser of Question 36
Advantages of a centralized treasury department:
- Foreign currency management becomes easier
- Higher interest rates may be attainable on investment because the department has larger
amount of cash available for investment
- The treasury department may be a profit center in its own right
- Lower interest rates may be sought for borrowing
- The level of cash held for precautionary purposes can be minimized
- Experts can be employed
Chapter 8:
A financial intermediary brings together providers and users of finance, either as broker (an
agent handling a transaction on behalf of others) as a principal (eg holding money balances
of lenders for lending to borrowers)
Banks are intermediaries; they borrow money at an interest in order to lend it at a
higher interest.
Other financial intermediaries:
xxii.
xxiii.
xxiv.
Building societies
Finance houses
Insurance companies
xxv.
xxvi.
xxvii.
Pensions funds
Unit trusts
Investment trust companies
*EXAM FOCUS POINT: In the exam you may be asked to give examples financial
intermediaries and explain how financial intermediation benefits the economy
Two categories of banks in the UK:
Primary banks (commercial, retail or clearing banks) are the banks which operate the
payments mechanism.
Retail banking is the activity of the traditional high street bank, dealing with
relatively small deposits and small loans to customers.
Secondary banks consist of investment banks, and foreign banks un the UK. They
do not themselves carry out cheques clearing, although retail banks may do the
clearing for them.
Wholesale banking involves small numbers of customers with larger deposits or
requiring larger loans. (Due to the large sums involved, customers expect banks to
trip their profit margins by reducing loan rates or increasing deposit rates)
In banks the gross profit is the difference between the interest paid to depositors and
interest received by the lenders. Net profit is the gross profit less operating expenses.
A central bank is an institution which typically has the role of controlling the monetary
systems of a country, acting as a banker to the banks, and acting as a lender of last resort.
*the degree of independences varies between countries.
Building societies are regulated by the Financial Services Authority.
The money makers are markets just like any other with buyers, sellers and traders. The
commodity that is traded is money that lent and borrowed in wholesale amounts. The term
money refers to the short duration of the loans or deposit
The traders or participations in the money markets are:
Financial intermediaries
Government
Local authorities
Brokers, marker makers
Firms and individuals
14
Deposits they are simple deposits of money in bank accounts (both current & deposit
accounts)
Bills means that you will pay the specified amount in at a future date. You may get
a bank bill assuring your supplier that you will pay an amount at a specific date.
Commercial paper this represents short-term IOUs issued by large companies which
can be held until maturity or sold to others
Certificate of deposits (CDs) is available for customer who deposit 50,000 or more
with a bank for a fixed term. If a customer wishes to withdraw the amount before the
term ends, a CD is created, which can be sold to others so they can redeem the
amount + interest.
Repo is short for sale and repurchase agreement of securities (bonds and bills).
The seller promises to buy it at a future date at a higher price.
b) To use the market to borrow funds in its own name and lend funds to a
less well established bank at a higher rate of interest
c) To sound out the market for the likely future trends in rates
Certificates of deposit Market
Disintermediation refers to the bypassing of financial intermediaries in order to
arrange lending and borrowing directly from the ultimate parties to the transaction.
Ex. Commercial paper but a bank acts a go-between, arranging transaction for the
corporate borrower and investors.
A Eurocurrency is a deposit of funds with a bank outside the currencys country of origin.
*Read Answer 37, Nature of instruments!
A bond (In UK called gilts) is a long-term debt security. A bon usually offers a fixed rate
interest known as a coupon rate.
Treasury bills are issued at a discount to face value, and the interest rate is implicit in
the difference between the issue price at a discount and the redemption price at par.
Gilts and Treasury bills together are called government stocks
15
The foreign exchange market is the market for buying and selling a currency in exchange of
another currency
Stock exchange is the main market. Alternative Investment Market (AIM) is more
loosely regulated (not at full listing) market for small and emerging businesses.
Stock market serves two main purposes:
xxviii.
xxix.
*In UK FT-SE 100 or Footise 100 index covers the 100 largest companies
*EXAM FOCUS POINT: you may be asked in the exam to decide whether or not a stock
exchange listing is suitable for a particular company
Disadvantages of a stock market listing:
xxx.
xxxi.
xxxii.
+ x 100
16
The interest yield (also known as the flat yield or running yield) is the interest or coupon
rate expressed as a percentage of the market price
Interest yield =
Accrued interest : the time when it is resold and the time remaining for the interest
to be given
xxxiv.
Cum div (int) and Ex div (int): due to administration purposes the issuer of
securities must close their books some time before the due date for the payment
of interest/dividend (if you buy it after that, you will not receive the interest, the
last holder will)
If yield is relatively low it can be concluded that the price is relatively high and that the
demand is also high
The redemption yield is the interest yield plus/minus the yield on the gain or loss if
held redemption
The security of a local authority stock is not considered as good as the enteral government
The market in the local authority stock is thinner (not many transactions) than glits, ince
the amounts involved is smaller and held by few investors
Certificate of deposit (CDs) are issued by an institution (bank or building society). A CD
offers an attractive rate of interest and can be easily sold.
A bill of exchange is a unconditional order in writing from one person or company to
another requiring the person or company to whom it is addressed to pay a specified sum of
money on demand (sigh bill) or at a future date (term bill).
17
18
Cumulative the unpaid fixed rate dividend is cumulated (carried forward) until the
company is profitable and the directors recommend dividend to be paid
Participation the owner has the right to choose the fixed preference shares dividend
or the ordinary dividend share being paid, whichever is higher
Redeemable the company will buy it back at some time in the future
Convertible the owner will have the right in the future to convert his shares into
ordinary shares
Loan notes (or loan stock) are long-term debt capital raised by a company for which is interest
is paid.
Debenture is a form of loan notes. It is usually secured with the interest plus capital.
A debenture trust deed would empower a trustee (such a bank) to intervene on behalf of
debenture holders if the condition of the borrowing is unfulfilled.
Deep discount bonds are loan notes issued at a price which at a large discount to their nominal
value.
Zero coupon bonds are bonds that are issued at a discount to their redemption value, but no
interest is paid on them.
*Check the redemption date of current loans in the SOFP to establish the new finance the
company would likely need.
Interest charges on Debt capital reduce the profits chargeable to corporation tax.
Implications of a fall in interest rates for a typical company
(i)
The cost of floating rate borrowing will fall
(ii)
The value of the companys shares will rise
(iii)
The higher share value results in a lower cost of share capital
(iv)
Consumer will have more disposal income
Convertible securities are fixed return securities that may be converted, on predetermined dates and at the option of the holder, into ordinary shares.
A warrant is a right given by a company to an investor, allowing him to subscribe for new
shares at a future date at a fixed, pre-determined price (the exercise price)
Warrants usually are issued as part of a package with unsecured loan notes; and are detachable.
19
Profitability
Liquidity
Safety
Seasonal factors may lead to a cash surplus but this will be used to cover the shortfalls later.
Reasons of why a business needs cash: economist JM eynes
Transactions motive: for regular commitments, day to day transactions
Speculative motive: in hope that interest may rise; though most business do not
hold cash for a speculative motive
*Remember Profit/net assets will tell you if the buss. Is running effectively.
**The higher the return, the higher the risk
An investment that is highly liquid will generally attract a lower return.
Authorities are restricted to invest in government securities, high-street bank and building
societies.
Diversification is the process of reducing risk by increasing the number of separate investment
in a portfolio.
Market or systematic risk is risk that cannot be diversified away.
Non-systematic or unsystematic risk applies to a single investment or class of investment, and
can be reduced by diversification
An investment portfolio will either be systematic or unsystematic.
20
The need for a real return: after inflation have been taken out
Inflation
Uncertainty about future rates of inflation
Changes in the level of government borrowing
Higher demand for borrowing from individuals
The balance of payments
Monetary policy
Interest rates abroad
*The interest rate is the price of money and so increasing the price should reduce the
demand for money
A Public Sector Borrowing Requirement (PSBR) is an excess of public sector spending over
revenue. The bigger the PSBR, the bigger increase in the money supply
A Public Sector Repayment (PSDR) is when public sector revenue is greater than public
sector expenditure.
21
Inflation refers to a sustained increase in the general level of prices over time.
A Retail Prices Index (RPI) measures the percentage changes month by month in the average
level of prices of the commodities and services including housing costs purchased by the great
house holds in the UK.
*Inflation leads to a restitution of income and wealth.
In time of inflation those with economic power tend to gain at the expense of others,
particularly those on on fixed incomes
Nominal rates of interest are rates of interest expressed in money terms
Real r
Real rates of interest are the rates of return that investors get from their investment,
adjusted for the rate of inflation
Fisher Equation:
(1 + i) = ( 1 + r ) (1 + h)
Where h
r
i
= Rate of inflation
= Real rate of interest
= Nominal (money) rate of interest
The pricing policy of an organization should take in consideration the effects of inflation.
However, the competitive position in which a firm finds itself in will be more important.
EXAM FOCUS POINT: in the exam you may be given the details of a specific bussiness, and be
asked how inflation might affect that bussiness.
Chapter 12:
A Comparing of an overdraft and loan financing will be very important for exam purposes.
Term loan: the customer borrows a fixed amount and pays it back with interest over a period or
at the end of it
Debtor/creditor
Bailor/Bailee safe deposit
Principal/agent when a bank arranges insurance; cheques
Mortgagor /mortgagee customer is mortgagor, bank is mortgagee
Fiduciary relationship means that the bank the superior party and is expected to act in
good faith.
xxviii.
xxxix.
xl.
xli.
xlii.
xliii.
xliv.
xlv.
xlvi.
xlvii.
xlviii.
xlix.
l.
li.
lii.
Customers duties:
liii.
liv.
Duty of care
Advice of forgery
*A customer has no duty to check his or her bank statement for any incorrect entries.
*With credit scoring, the CAMPARI approach to
credit assessment is not relevant and not used.
*EXAM FOCUS POINT:
You may be required to apply your knowledge of
lending criteria to a particular scenario.
Discretionary rates is when the bank decide on the return which it requires from
lending depending on the nature of the risky venture (ex. New business)
23
to increase total current assets (receivables, inventory level or overall sales turnover)
Or to reduce other current liabilities
Bullet the borrower does not repay any of the loan principal until the end of the loan
period
Balloon principal is repaid during the term of the loan
Amortising or straight repayment loan at regular intervals (principal + interest)
Loan covenants:
Types of leasing
Finance leases are lease agreement between the user of the leased asset (the lessee)
and a provider of finance (the lessor) for most or all of the expected useful life.
The equipment is usually provided by a third party. The lessee is responsible for
the servicing and maintaining
Sales and leaseback when a business already owns an asset agrees to sell it to a
financial institution and to lease it back.
*A major advantage of the operating lease is that the leased equipment does not have to be
shown in the lessees published SOFP!! Therefore; no increase in gearing ratio.
Hire purchase is a form of installment credit
a) Lender credit occurs when the buyer borrows money and uses the money to
purchase goods outright.
b) Vendor credit occurs when the buyers obtains goods on credit and agrees to pay
the vendor by installments. Hire purchase is an example of vendor credit.
Chapter 13:
Equity share capital is a key method of financing for companies of all sizes.
The optimal mix of finance will determine how much a company should be geared.
Source of funds:
25
Primary markets enable organizations to raise new finance, by issuing new shares or
new debentures.
Secondary markets enable existing investors to sell their investment.
*check out page 220 point b for a takeover!
Individuals invest in the stock market, but the most important participations are the
institutions such as pension funds, insurance companies and unit trusts.
Providers of capital are investors:
a) Pension funds are separate legal entities which consist of a pool of assets
b) Insurance companies invest premium paid on insurance policies
c) Investment trusts they trade in investment
d) Unit trusts offers the holder an opportunity to diversify their investment. The
trust creates a large number of small units of low nominal value.
e) Venture capital specialize in raising funds for new business ventures
Equity means simply the ordinary shares of a company
Securities is commonly used to mean any sort of investment that can be bought and sold in
the financial markets. (will be used as term in the exam, pg 221)
Loan stock or debentures are amounts loan to a company.
Bonds are very large loans which normally (but not necessarily) have a fixed rate of interest
Eurobonds are bonds that bought and sold on an international basis.
A large public company is usually in a better position to raise capital than smaller companies.
A public company is one that can invite the general public to subscribe shares
A private company is prohibited from offering its shares to the general public.
**The main source of new lending to companies both long term and short-term is the banks.
Factors in the choice of financing method
-
Purpose
Amount
Repayment
Term
Cost
- Security
- Restrictive covenants
- Control of the business
- Effects on gearing
Gearings: Irredeemable preferences share are not classed as debt and do not increase a
companys gearing ratio
26
When using retained earning you must put in mind the opportunity cost involved.
Capital structure refers to the way in which an organization is financed, by a combination of
equity and non-current liabilities and current liabilities.
A company would finance current assets partly with current liabilities and partly with longterm funding.
Equity finance is generally more expensive than debt because equity investors take a greater
risk. Additionally, interest payment on debt are tax deductible unlike dividend payment which
payable after tax.
A highly geared company indicates that the company will less likely to be able to pay dividend.
Therefore, gearing affects the market value of shares.
The level of gearing which the market will allow will therefore depend on the nature of the
company and the industry in which it is engaged:
a) A company which in a cyclical business, where profits are subject to period up
and downs, should have relatively low gearing
b) A company which profits are stable should be able to raise a larger amount of debt
Gearing is a measure for comparing how much of the long-term capital of a business
is provided by capita Equity and creditors.
Debt/equity ratio =
(i)
(ii)
Basic Earning per share is calculated by dividing the net profit or loss for the period attributable
to ordinary shareholder by the weight average number of ordinary shares outstanding during
the period.
*chck calculation page 227
27
Chapter 14:
Small and medium-zed enterprises (SMEs) often have difficulty raising finance.
Characteristics of SMEs:
a) Firms are likely to be unquoted
b) Ownership is restricted to a few individuals, typically a family group
c) They are not micro business that are normally regarded as those very small businesses
that act as a medium for self-employment to the owners
*If market conditions do change, small business may be more adaptable. However, a significant
portion will not survive the first few years.
Finance may be difficult to obtain because of the risks faced by SMEs.
Government policy will have a major influence on the level of funds available:
a) Tax policy
b) Interest rate policy
The main issue that face in accessing funds for SMEs is the problem of uncertainty.
A common problem is often that banks will be unwilling to increase loan funding without an
increase in security given or an increase in equity funding.
Possible sources of finance for SMEs include:
Owner financing
Overdraft financing
Banks loans
Trade credit
Equity finance
Equity gap is a when a business has few tangible asset will probably have difficulty obtaining
equity finance when they are formed.
A funding gap is the difference between the amount of funds that is available or obtainable for
a business and the amount of funds that it needs for developments and growth
A maturity gap for a small company is the difference between the maturity of its assets and the
maturity of its liabilities
A major problem with obtaining equity finance can be the inability of the small firm to offer
an easy exit route for investors.
28
Business angel are wealthy individuals or groups of individuals who invest direct in
small business. It is informal in terms of a market and can be difficult to set up.
Venture capital is risk capital, normally provided in return for an equity stake.
The type of venture that might attract investment are:
a) Businesses start-ups
b) Businesses development
c) Management buyouts the purchase of the all or part of a business from its owner by
its managers
d) When one of the owners wants to realize all or part of his investment
Venture capital trusts are a special type of funding giving investors tax reliefs.
Venture Capital Funding: is the provision of risk bearing capital, to companies with a high
growth potential. Providers of finance will usually require a seat on the board and will be
looking an ex exit route from the company via for example flotation.
Significant influences on the capital structure of small firms are:
Government aid for SMEs which is usually in the form of grants include Enterprise Finance
Guarantee, Enterprise Initiates, Development agencies and Enterprise Investment Scheme.
*EXAM FOCUS POINT: you may use relevant examples from you country should you wish to do
so.
***Equity finance is not offered by the bank!!
29
Avoidable costs
Differential Costs is the difference in relevant cost between to alternatives
Opportunity costs (take the most profitable)
Directly attributable costs they are fixed cost that are affected like more supervisors
if activity increases
Non-relevant costs
A notional cost or imputed cost is a hypothetical accounting cost to reflect the use of a benefit
for which no actual cash expense is incurred.
The total relevant cost of a scarce resource consists of the following:
Chapter 16:
A capital expenditure results in the acquisition of non-current assets or an improvement in
their earning capacity.
Revenue expenditure is expenditure which is incurred for the purpose of the trade of the
business or to maintain the existing earning capacity of non-current assets.
Capital income is the proceeds from the sale of non-trading assets
Revenue income is derived from the sale of trading assets or interest and dividends
received from investments held by the business
Purchase of inventories is a revenue expenditure.
Revenue expenditure from purchasing inventories may either be charged as an expense or shown
as a current asset (closing inventory) and not yet charged in the I/S
An asset register is a listing of all non-current assets owned by the organization.
30
Addition and disposals over a certain amount must be authorized on a capital expenditure
authorization form and a disposal authorization form respectively.
Discrepancies between the asset register and the actual non-current assets present and
between the assets register and the nominal ledger must be investigated.
Recurring and minor non-current asset purchases may be covered by an annual allowance
provided for in the capital expenditure budget.
A capital expenditure budget is essentially a non-current assets purchase budget.
Chapter 17:
Check Question 82
The steps involved in project appraisal are:
Initial investigation
Detailed evaluation
Authorization
Implementation
Project monitoring
Post-completion audit
APR =
31
Compound interest is when the interest earned also earns interested itself in later
periods
S=P(1+r)n
Note: S is the future value of investment and P is the amount invested now
Discounting
PV = S (x (1 + r)-n
Remember: (1 + r)-n and
IRR = A % + *
+%
*The negative sign NPVa NPVb become (+) . The answer should be
somewhere between the two rates.
A
a
B
b
*Remember you can use the IRR to determine the upper the higher % and take two thirds of it for
the lower % Pg288
EXAM FOCUS POINT:
Internal rate of return is an extrapolation based on cash flow analysis. It takes account of
the time value of money.
33
*Some markets are risker than other, which is why export credit insurance premiums are
higher for some countries than others.
A credit utilization report (pg 303) can indicate the extent to which total limits are being
utilized.
Reviewed in aggregate (total), it can reveal the following:
*EXAM FOCUS POINT: Know the distinction between overdue receivables and
34
Where
d
t
=
=
*A customer may assume a charge for late payment might give the customer the authority to
pay late
The credit control department is responsible for those stages in the collection cycle
dealing with the offer of credit, and the collection of debts (pursuing overdue debts as well)
The credit cycle consist of the order cycle (From customer order to invoice dispatch) and
the collection cycle (from invoice dispatch to the receipt of cash)
Roles of the credit controller:
Keeping the receivables ledger up-to-date
Pursuing overdue debts
Dealing with customer queries
Reporting to sales staff about new enquiries
Giving reference to third parties (Eg credit reference agencies)
Checking out customers creditworthiness
Advising on payment terms
35
e) Penalties for late payer (interest charge should accrue when debts become overdue
to discourage late payment)
A contract is an agreement which legally binds the parties.
a) The parties intend to create legal relations
b) There is an offer and acceptance
c) It is a bargain for which something is offered for consideration
Essential elements of contract
Form
For a sale or purchases of land and consumer credit agreements must be in writting
Legal intention
Offer
is a firm proposal to give or do something or to be bound on specific terms
Acceptance
is the unconditional and unqualified agreement to all the terms of the offer
Consideration
is what a person (the promise) must give in exchange for what has been promised to
him.
Damages
Termination
Quantum meruit : is when a contract is terminated half way, and one part has already
performed part of his obligations (ex. Part of construction work), he is entitled to claim
reasonable amount for the work done
Specific performance
36
Lien. Any goods which have not been paid for can be retained by the seller at the sellers
premises providing the buyers has not lawfully obtained possession.
Chapter 19:
*Read the article written by the examiner on Credit Policy in the October 2010 edition of
Student accountant
Credit risk means that there is a possibility that debt will go bad.
***DRAW LEVEL OF RISK***
Many firms make profits from high risk customer, by demanding slightly higher returns and by
managing them carefully. Higher risk customers need not to be shunned simply because they
are higher risk.
A credit assessment is a judgment about the creditworthiness of a customer
Credit reference: Sources of information
a) Externally generated information
This is information produced by third parties such as banks about their customers which
they make available to third parties on request
Banks owe a duty of care to their customers, so their credit status will be
precisely worded.
The quick ratio measures liquidity more precisely than current ratio
The payables payment period indicates the average length of time a company takes to
pay its debts. Together with receivables turnover and inventory turnover it gives some idea
as to the operations cycle
Gearing ratios put payables in the context of the firms overall borrowing: they
are frequently unsecured
ROCE =
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The value of P/E ratio refelects the markets appraisal of the shares future prospects. The
market price of a share and its earning capacity.
Changes in EPS: the P/E ratio and the share price
a) The relationship between the EPS and the share price is measured by the P/E ratio
b) The P/E ratio does not vary much over time normally
c) So if the EPS goes up or down, the share price should be expected to move up or down
too, and the new share price will be the new EPS multiplied by the constant P/E ratio
*CHECK Answer 69: Effect of grearing EPS
If the inventory turnover period gets longer or if the debt collection period gets longer,
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the total amount of inventories or of receivables will increase. These suggest rowing
liquidity problems in the potential customer.
*Remember if the customer is able to borrow substantial funds at short notice: these can
be used to repay suppliers
If a company has a working capital less than 1. This means that to some extent,
current liabilities (ex. creditors, you the supplier) are helping to finance the non-current
assets.
A prudent current ratio said to be 2:1. In other words, current assets should be twice the size
of current liabilities.
*Read pg 335
Debt/equity ratio =
Interest cover is a measure of financial risk which is designed to show the risk in terms
of profit rather in terms of capital values
=
*The answer will be times. It means how many times the company can pay its interest
=
=
Item
Net operational cash flow
Priority payments
Cash for discretionary spending
Investment spending
Cash after investment spending
Comments
should be positive
Should be normally positive
If negative, the company must obtain
money from non-trading sources, perhaps
by borrowing
Visits to the customers premises can provide useful information. The credit controller can
get a feel for the business and those running it. He can also discuss any queries.
In-house credit rating is when the company have its own credit rating for its customers, etc.
The UK Data Protection Act 1998 cover data about individuals not data about
corporate bodies
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Major Key accounts customer will receive a special treatment in the sales effort. The
more valued the customer, the higher rank of the staff member will deal with them.
Credit insurance can be obtained against some bad debts. They usually are available for up to
75% of a companys potential bad debt loss. The company will bare the 25% so it will not
become slack with credit control and involve in overtrading.
Premium on a whole turnover policy are usually 1% of the insured sales.
Under an annual aggregate excess of loss policy, the insurer pays 100% of debts above an
agreed limit. (Like car insurance, you have to pay the first $150 musahama)
Export credit insurance:
(a) Buyer risks also known as commercial risks. In international sales, credit period
is longer and suing someone overseas is harder and longer, and more expensive.
(b) Country risks also known as market risks or political risks. (cancelation or non-renewal
of an export license; or a third country through which payment must be made)
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Administration
Credit protection
Advance of collection the debts
assigned to the factor, and the clients customer will only become aware of the arrangement
if he does not pay his debt to the client.
More personal intervention should be:
Lower value -------------------------------------------------------------------------------- Higher Value
Letter E-mail Fax Telephone (expensive) Personal Visit (time consuming)
*A valued supplier may threat to refuse to sell any goods until the debt is cleared.
Credit control necessarily involves as an expense to the business.
A doubtful debt is a debt which there is some uncertainty as to whether it will be paid
(provision).
A bad (irrecoverable) debt is a debt which will not be paid
Even if a doubtful debt is eventually paid, additional expenses will occur:
(i)
(ii)
Some of the accounting ratio calculated may be contradictory. For example, the company may
post an increase in sales whereas in fact is overtrading and running out cash.
Z-scoring is a technique where a solvency model is developed and chosen ratios are input to
it to give the company a Z-score: the higher the score, the safer the company.
A-scoring is more subjective, but is based on three main pillars:
1) Defects: before a collapse a company will have many defects such as the company
is dominated by a single individual, poor accounting systems, etc.
2) Mistakes borrows too much, overtrading, depends on the success of big projects
3) Symptoms Financial ratios, z-scoring are in decline, sudden changes of accounting
policies, non-financial signs (eg fall in market share)
*The sale department needs to know if a customer is failing to pay his debt, so no further
sales (loses) are made to him.
Monitoring irrecoverable debts: bad debts/ revenue ratios pg376
a) Bad debts recognized refers to the time when the debt went bad
b) Bad debts originated refers to the date when the sale was initially made
Debt collection agencies (credit collection agencies) are the most effective way of pursuing
debts.
Most debt collection offers a no collection, no fee basis. Some agencies require an advance
subscription fee.
*Abritration page 379
Bankruptcy is where an individuals property is sold for the creditors benefit.
Insolvency is when the assets of a company are taken over by a third party appointed
by creditors.. The company is run until the debts are paid, or maybe be wound up.
A company is insolvent when it is unable to pay its debts. Pg 380 compelte
Questions ANSWER inCLUDE
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