Role (Finance)

• Strategic Role of Financial Management

  
  

  The process of determining and managing the financial resources required to achieve both short-term and long-term objectives which include Profitability, Efficiency, Growth, Solvency and Liquidity
• Key areas of the strategic role of financial management:

  
  

  • Appropriate sourcing of finance
  • Budgeting and maintaining sufficient cash flow
  • Preparation of audited financial statements
• Mismanagement of the strategic role of the financial management can lead to:

  • Insufficient funds to pay suppliers
  • Inadequate capital for expansion
  • Too many assets that are non-productive
  • Overstocking of materials
• Other key business functions (KBFs) are often interdependent on Finance to achieve their objectives
• Apple case study on the 'strategic role of financial management':

  
  

  CFO of Apple - Luca Maestri

  • Responsible for helping and setting achievement of Apple’s strategic direction

  2023 Data

  • Sales revenue - $383b
  • R&D - $30b
  • Net profit - $97b

  Objective

  • Apple holds the objective to not only be profitable, but to be the most innovative competitor in the market
• Objectives of financial management:

  
  

  1. Profitability
  2. Efficiency
  3. Growth
  4. Solvency
  5. Liquidity

  ‘PEGSL’
• Profitability:

  
  

  Define: The money a business makes from its operations after all expenses have been accounted for

  
  

  How - Maximising Profitability Can Be Done Through:

  • Increasing revenue → through changing marketing or pricing policies
  • Reducing expenses → cost cutting in KBFs
• Profitability case study:

  2022 → 2023

  • Revenue: $394b → $383b
  • Net Profit: $100b → $97b
  • Gross Profit: $171b → $169b
  • Gross Profit Ratio: 43% → 44% (2% improved)
  • Net Profit Ratio: 25% → 25%
  • Return on Equity Ratio: 175% → 172% (2% deterioration)
• Efficiency:

  Define: The ability of an organisation to maximise returns from its assets with minimal costs / the amount of revenue that is spent on expenses

  How - Businesses Can Improve Efficiency Through:

  • Minimising expenses → businesses can implement operation processes to avoid wasting any resources
  • Maximising output → businesses may also achieve lower per-unit cost through maximising output from their labour or machinery 
  • It also relates to how effective the business is at collecting payment for invoices from customers (accounts receivable)
• Efficiency Case Study:

  2022 → 2023

  • Expense Ratio: 13% → 14% (10% deterioration)
  • While higher than 2022, the expense ratio is still very efficient → expense minimisation strategies 
  • Accounts Receivable Turnover Ratio (times): 6.5 → 6.3
  • Accounts Receivable Turnover Ratio (days): 56 days → 58 days (3% deterioration)
  • Considerable amount in accounts receivable ($61b (2023)) due to third-party relationships (e.g. telecommunications providers)
• Growth:

  
  

  Define: The ability of a business to expand its activities

  
  

  How - Businesses Can Improve Growth Through:

  
  

  Organic growth (internal)

  • Increased production
  • Higher sales
  • Expanded product range
  • Expansion overseas
  • Increasing market share

  Mergers and acquisitions
• Growth Case Study PART 1:

  Organic Growth

  • Services (App Store, iTunes, Apple Music and mobile payments) are a key platform for Apple’s growth strategy, representing 22% of all sales and is the ONLY sector to experience growth in sales (9%) ($78b (2022) → $85b (2023)) during Apple’s difficult 2023 financial year
  • Wearable sales increased by 25% (to 10% of total sales in 2023)

  Mergers and Acquisitions

  • Beats acquisition ($3.6b) - commercial music products
• Growth case study PART 2:

  Key Markets

  • China continues to represent growth opportunities for Apple
  • Achieved double digit growth in emerging markets such as China (2022) sales of $74b, investing in high-growth markets like Japan and shifting focus onto India
  • India market potential → Apple investing manufacturing capability to target this market which is growing at 7%

  Retail Store Growth

  • 463 stores (2015) → 526 stores (2022)
  • Approx. half of the retail stores are located in the US
  • 50 stores in China
• Solvency:

  Define: The extent to which the business can meet its financial commitments in the long-term (>12 months)

  • It is an indication of the risk to the shareholder’s investment
  • Businesses that rely upon debt finance compared to equity finance are considered ‘highly geared’, which we state they have ‘reduced’ solvency
• Solvency case study:

  2022 → 2023

  • Gearing Ratio: 5.9:1 → 4.57:1 (change of 23%)
  • Apple has been increasing their reliance on debt (since like 2002 - make up a number, e.g. 80ish%) which is considered ‘cost-effective’ in funding growth due to low average interest rates on their loans 
  • Total liabilities/debt: $302b → $290b
• Liquidity:

  Define: Ensuring the business has enough cash to fund its day-to-day activities and pay its short-term debts (<12 months)

  • The quicker an asset can be turned into cash, then it is considered more ‘liquid’
  • Cash in a bank account is considered most liquid
  • However, too much cash sitting there can mean missed business opportunities
• Liquidity case study:

  2022 → 2023

  • Current Ratio: 0.88:1 → 0.99:1 (13% improved) 
  • Total assets: $353b → $353b
  • Current assets: $135b → $144b
• Short and long-term

  Short-Term Objectives: Tend to include 1-2 years, reviewed regularly to ensure achievement → Tactical (1-2 years) + Operational (day-to-day)

  Long-Term Objectives: Generally cover more than 5 years in time, broader goals, reviewed annually → Strategic (5+ years)

  • Broad goals that are supported by short-term goals to assist in achievement

  
  

  • Profitability → ST and LT
  • Efficiency → ST and LT
  • Growth → LT
  • Solvency → LT
  • Liquidity → ST
• Short and long-term objectives conflicts PART 1:

  1. Short-Term Profitability vs Growth 
  2. Growth objectives incur significant costs in the short-term (e.g. R&D investment and market research) → increase in expenses → decrease profitability in the short-term but will positively impact growth objective in the long-term
• Short and long-term objectives conflicts PART 2:

  1. Solvency vs Growth 
  2. Businesses may borrow funds (increasing debt - e.g. mortgages) to expand operations → helps achieve growth objective → however, increasing reliance of debt will negatively impact solvency 
  3. Liquidity (ST) vs Profitability (LT)
  4. Liquidity → offering discounts for early payments 
  5. Profitability → will reduce profit margins
• Short-term and long-term objectives case study:

  Short-Term

  • Focus is on liquidity and profitability 

  Long-Term

  • Apple are currently heavily invested in R&D to develop their AI division in order to catch up to main competitors Google (Home) and Amazon (Alexa)
  • In 2023, Apple spent approx. $30b on R&D
  • Highlights the focus on services to create more diversity within Apple products (currently heavily reliant on the success of the iPhone)
  • Focus is on growth and solvency
• Interdependence with other KBFs:

  Key Point to Consider: HR, Operations and Marketing rely upon Finance to provide appropriate funding and financial information to perform their roles effectively. In return, these KBFs can generate the business more profit, giving more funds to Finance
• Role Syllabus