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• Module overview
• 1. Introduction to budgets
  • 1.1 Introduction to the Budget Process
  • 1.2 Budget types
    • 1.2.1 The Budget Guidelines
    • 1.2.2 The Sales Budget
    • 1.2.3 Budget for Operating Expenses
    • 1.2.4 Profit Budget
    • 1.2.5 Cash-Flow Budget
    • 1.2.6 The Financial Position Budget
    • 1.2.7 Additional Types of Budgets
    • 1.2.8 Additional Budgeting Techniques
  • 1.3 The budget process and its objectives
  • 1.4 Budgets for performance management
    • 1.4.1 Master budget

• 2. Planning the budget

  • 2.1 Planning the Budget
    • 2.1.1 Business income
    • 2.1.2 Visual representation of sales and budgets
    • 2.1.3 The break-even point
    • 2.1.4 Contribution margin

• 3. Controlling the budget

  • 3.1 Controlling budgets
    • 3.1.1 Variance analysis
    • 3.1.2 Taking action to achieve the objectives of the budget
    • 3.1.3 Resource acquisition and usage

• 4. Introduction to Financial Management

  • 4.1 Business Objectives
    • 4.1.1 Maximising profit
    • 4.1.2 Maximising wealth
  • 4.2 Ethics and conflicts in business
    • 4.2.1 The dilemma of ethics in finance, investment and accounting
  • 4.3 Financial Managers
    • 4.3.1 Financial information and objectives
    • 4.3.2 Accounting, the financial information system
  • 4.4 The finance function
    • 4.4.1 Business and financial calculations

• 5. Elements of Business and Financial Management

  • 5.1 Business Structures
    • 5.1.1 Sole proprietors
    • 5.1.2 Partnerships
    • 5.1.3 Corporations and companies
  • 5.2 Reporting financial data and information
  • 5.3 Financial reports
    • 5.3.1 Statement of financial performance (profit and loss statement)
  • 5.4 Capital Markets
    • 5.4.1 Capital Markets
  • 5.5 Regulation and financial institutions
    • 5.5.1 Interest rates, supply and demand and market efficiency
  • 5.6 An overview of taxation implications

• 6. Obtaining Funds: Sources of Long Term and Short Term Finance

  • 6.1 Finance from external sources
    • 6.1.1 Equity finance
  • 6.2 Debt
  • 6.3 Long-term debt
    • 6.3.1 Debentures and unsecured notes (bonds)
    • 6.3.2 Mortgage loans
  • 6.4 Hybrids of debt and equity
  • 6.5 Leasing
    • 6.5.1 Operating Lease
    • 6.5.2 Financial Lease
    • 6.5.3 Distinguishing between an operating lease and a financial lease
    • 6.5.4 Sale and Leaseback
    • 6.5.5 The issue of gearing
  • 6.6 Short-term debt
    • 6.6.1 Bank Overdrafts
    • 6.6.2 Fully drawn advance
  • 6.7 Retained Earnings, internal funds and depreciation

• 7. Managing Working Capital

  • 7.1 Managing current assets and current liabilities
    • 7.1.1 Appropriate level of working capital
  • 7.2 Managing inventories
    • 7.2.1 Reasons for holding inventories
    • 7.2.2 The economic order quantity (EOQ)
    • 7.2.3 Re-order point (ROP)
    • 7.3.4 Safety stock (SS)
    • 7.2.5 Quantity discounts
  • 7.3 Managing trade debtors (accounts receivable)
    • 7.3.1 Credit policies
    • 7.3.2 Collection period
    • 7.3.3 Managing cash and near-cash assets
    • 7.3.4 Managing trade creditors (accounts payable)

• 8. Job Costing

  • 8.1 Accounting information about product, service and project costs
    • 8.1.1 Full costing
    • 8.1.2 Single product/service line
    • 8.1.3 Multi product/service
    • 8.1.4 Direct and indirect costs
  • 8.2 How costs behave
    • 8.2.1 Allocating Overheads
  • 8.4 Cost drivers
    • 8.4.1 ABC and the service industry
  • 8.5 Conclusion

5.5.1 Interest rates, supply and demand and market efficiency

Money is a commodity. Some people/organizations buy it and others sell it. As a very simple example we 'buy' the use of money when we take out a mortgage for a house (we commonly call this borrowing), and 'sell' when we have savings that generate interest (we call this lending). Like any commodity money has a price determined by the intersection of its demand and supply curves (as shown on a graph). Interest rates represent the price of borrowed or loaned funds.

As interest rates fall, demand for loans increases until demand exceeds supply, at which point interest rates will rise until a point is reached where demand for money decreases. The next reading discusses the elements that affect interest rates.

Reading 2

De Lucia, R.D., & Peters, J., 1998. 'Factors affecting interest rates'. In Commercial Bank Management . 4th edition. LBC Information Services, Sydney . Pages 94-102.

Reasons for different interest rates

Interest rates differ for a number of reasons apart from demand and supply. Some of these are:

Risk	Higher risk borrowers generally pay higher rates on their borrowings to compensate lenders for the risks associated with the loan.
Profits on re-lending	Financial institutions make their profit on the interest differential between borrowing and lending.
Size of loan	Deposits above a certain amount with a financial institution may attract a higher interest than smaller deposits.
Duration of loan	Long-term loans usually earn a higher interest rate than short-term loans

 

Nominal and real rates of interest

Nominal Interest rates are the actual rates charged or payable on securities and real rates are the nominal rates less the inflation rate. The real rate measures the increase in real wealth measured in terms of the purchasing power of the investor or lender. An example is:

Nominal rate 10%

- inflation rate 3%

= Real rate of interest 7%

Interest rates are determined by the risk free rate of interest plus a risk premium. Government securities, for example, are deemed as risk free and as a result the interest rates paid on them are also deemed to be risk free.

All ot her borrowings carry higher interest rates that include a risk prem ium. The risk premium is applied because of:

• the possibility that the borrower won't pay
• the credit rating of the borrowing and lending institution
• expected short, medium and long term interest rate fluctuations

Efficiency of markets

The capital market is an intermediary between investors and borrowers and its efficiency is measured by how well it satisfies both investors and borrowers.

Companies use a number of financial instruments (pieces of paper!), such as shares, debentures and convertible notes to raise funds. These funds are used for potentially profitable projects and activities that would be abandoned if the funds are not found.

The combination of appropriate markets and a wide range of financial instruments allow surplus funds to be allocated efficiently.

The idea of an 'efficient market' implies that the market prices for all the securities marketed or traded reflect all available information and so the market is able to determine the price of financial assets (shares and securities) quickly and fairly. It also means that no single individual or company can dominate the market and that the cost of trading in financial securities is not too high. If these conditions don't exist the market will be inefficient.

Securities markets regulations

Securities are regulated in two ways. The Reserve Bank and Treasury implement government regulations that reflect economic and monetary policies, and the Australian Securities and Investment Commission (ASIC) administer Corporations Law and related regulations.

The government influences the supply of loan funds and their cost in the capital market. To stimulate the economy the government makes funds available at an interest rate that encourages investment and consumption. To dampen the economy, it restricts funds, creating tight liquidity, and interest rates are raised to discourage investment and consumption. In Australia the Reserve bank and Treasury implement these strategies.

Corporations, legislation and regulation

In Australia ASIC is solely responsible for the administration and regulation of companies and reports to the Commonwealth Attorney General and the Commonwealth Parliament. The Corporations Law includes provisions that:

• require annual statutory returns and financial statements designed to inform potential investors and shareholders about companies and their management
• guarantee that audits are conducted on the financial records of public companies
• ensure the following in respect of takeovers
• an informed and competitive market
• the market is kept supplied with information about both the target company and acquiring company to enable assessments of the worth of the takeover offer
• reduce the opportunity for market manipulation in target share prices
• provide for the registration and regulation of stock exchanges and futures exchanges
• prohibit stock market manipulation, false trading and other misleading practices
• licence and control investment advisers

As you can see, the market is tightly regulated to make it work smoothly and efficiently.

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