role of financial management

● strategic role of financial management

○ Financial management: the planning and monitoring of a business’ financial

resources
○ Strategic role includes:
➢ Setting financial objectives so that overall goals can be achieved,
objectives based on the stage of the business life cycle
➢ Sourcing finance, preparing financial statements and forecasting
revenue, profits, debt and costs to determine liquidity and solvency
➢ Maintaining sufficient cash flow

● objectives of financial management

𑁋 profitability, liquidity, efficiency, growth, solvency

PROFITABILITY ○ Net return on invested capital expressed as a percentage of the

initial investment
○ Maximised through simultaneously increasing sales and
decreasing costs
○ Measures success → compare profits to those of competitors

LIQUIDITY ○ How quickly an asset can be converted into cash to fulfil short
term debts
○ Current assets are more liquid e.g cash and accounts receivable
○ Liquidity helps financial managers determine if a business can
quickly convert an asset into cash so that debts are repaid

EFFICIENCY ○ The act of increasing profit whilst simultaneously decreasing

costs
○ Ability to manage assets so that debts are minimised and profits
are maximised

GROWTH ○ Measurement of how profitability increases over consecutive

periods
○ Increased outputs and therefore revenue and profit may mean
that businesses need expand to meet demand and ensure long
term sustainability:
➢ Expand location or plant size
➢ Increase the value and quantity of assets
➢ Incorporation
➢ Horizontal integration
➢ Merging or acquisition
➢ Diversifying product mix

SOLVENCY ○ Ability to pay long term liabilities by the due date

 ○ Main determination of a business’ financial stability
○ Gearing is the percentage of debt and equity finance that is used
to fund the business → these figures are compared
○ The negative gearing of a business reduces as debt is repaid and
revenue is generated from assets

𑁋 short-term and long-term

SHORT-TERM ○ Tactical goals

○ 1-2 years
○ Regularly reviewed
○ Increased efficiency and profitability

LONG-TERM ○ Strategic goals

○ 5+ years
○ Broad goals can be met with assistance from short term goals
○ Intention for growth and increased net valuation

● interdependence with other key business functions

Marketing ○ Effective marketing generates revenue and may be profitable in the

long term
○ Capital invested into marketing and designing new products
○ Financial goals and use of capital determines the price of products

Operations ○ Budgets and financial statements show the capital allocation to

operations
○ Value and liquidity of assets which fund business activities
○ Reducing operational costs whilst also maximising profitability so that
efficiency is attained

Human ○ Businesses must take into account the cost of wages, staff acquisition
resources and training
○ Redundancy of employees to reduce labour costs through outsourcing
or automation

influences

● internal sources of finance 𑁋 retained profits

○ Group of funds known collectively known as equity
○ E.g profits, owner’s contributions, shareholders

Retained profits ○ Profits that businesses do not distribute as dividends

 ○ For as long as profits are sustained, retained profits are the
cheapest and most accessible source of finance
○ Businesses may accumulate interest on these profits or invest
them towards technology and capital equipment

● external sources of finance

𑁋 debt 𑁋 short-term borrowing (overdraft, commercial bills, factoring),

long-term borrowing (mortgages, debentures, unsecured notes, leasing)
○ Debt refers to monetary contributions that are externally sourced to
fund the business
○ Businesses must repay the amount borrowed in addition to interest

SHORT-TERM BORROWING (UNDER 12 MONTHS)

Overdraft ○ Borrowing made on a business’ cheque account or credit card that is

limited to a predetermined amount
○ Business has a short period of time to generate cash flow and therefore
repay overdraft
○ Business should not use overdraft more than once or twice a year

Commercial ○ Short term loan from the bank

bills ○ Repaid within 30 to 180 days
○ Guranteed and paid immediately
○ Used to fund current assets e.g suppliers, wholesale
○ Cheapest form of short term finance

Factoring ○ When a business sells its accounts receivables to a third party

○ Ensures that business immediately retain cash rather than waiting for the
consumer to repay it
○ Accounts receivable usually sold at a smaller price than the amount to be
repaid → loss of margins

LONG-TERM BORROWING (12 MONTHS OR LONGER)

Mortgage ○ Floating charge is charged against an asset

○ 25-30 year term
○ If repayments are unable to be made, the asset can be repossessed and
resold by the bank
Debentures ○ Issued by debenture holder companies
○ Fixed interest rate and term
○ Secured by the company’s assets
○ Loan matures as company repays it

Unsecured ○ Issued by finance companies

notes ○ Lender does not have the security of a floating charge over assets
○ Higher interest rate as there is an increased risk for the lender

Leasing ○ When the owner of an asset temporarily lends it to a lessee

○ Payments are tax deductible
○ Finance lease: buying an asset and paying it off - essentially owning it when
the lease period is over
○ Operating lease: asset is returned at the end of the lease period

𑁋 equity 𑁋 ordinary shares (new issues, rights issues, placements, share

purchase plans), private equity

EQUITY

Ordinary ○ New issues: new prospectus issued, first time sale of shares with revenue
shares used to fund business activities e.g R&D, growth; ownership diluted

○ Rights issues: existing shareholders are invited to buy new shares at a

reduced price so the company can generate funds, not an obligation

○ Placements:
➢ Investors who own more than $2.5m in assets or make $250k over 2 years
are offered money by the business to invest in more shares
➢ Aim is to raise additional funds
➢ Allows shareholders to quickly dilute and obtain ownership

○ Share purchase plans: is when existing shareholders are offered to buy more
shares without a brokerage fee, each shareholder can purchase up to $30 000
worth of shares

Private ○ Direct investment into a company

equity ○ Private individuals/businesses invest in businesses that they think will
generate a high return
○ Look for innovative projects and opportunities for growth
○ Business ownership comprises of majority shareholders → shareholders then
obtain control of what is occurring within the business

● financial institutions 𑁋 banks, investment banks, finance companies, life

insurance companies, superannuation funds, unit trusts and the Australian
Securities Exchange
 Banks ○ In return for deposits, a bank will lend a business money
○ They expect to be repaid the money including interest
○ Provide credit and debit cards, overdraft facilities, mortgage

Investment banks ○ Provide investments and loans to the business sector

○ Loan types are personalised to meet specific business needs
○ Provide advice on and manage capital, finance for expansion,
property funds, mergers/acquisition

Finance ○ Immediate access to short and medium term loans

companies ○ Higher interest
○ Raise money through debentures
○ Have the right to administrate a business if they go into liquidation

Life insurance ○ Life insurance companies lend these premiums to businesses

companies ○ Receipts from premiums provide businesses with capital that can be
reinvested

Superannuation ○ The money paid by members of the fund is invested by the super
funds company into businesses, properties, etc
○ The superannuation fund expects a high return on investment so its
members can also generate a ROI

Unit trusts ○ Large number of unit holders invest in a mutual fund

○ This fund is then invested into businesses and property
○ Each unit holder receives a return on investment based on how
much they invested
○ E.g three individuals invest $1000 each and invest it in a business
→ the return on investment is given back to the individuals

Australian ○ Hosts and monitors the trading of shares within the Australian stock
Securities market
Exchange (ASX) ○ Reviews/monitors stock market conditions, legal compliance of
companies and stockbrokers, permissibility for incorporation,
property investments
○ Primary market - distribution of new shares
○ Secondary market - purchase and sale of pre-existing shares

● influence of government 𑁋 Australian Securities and Investments Commission,

company taxation

Australian Securities ○ Independent statutory commission who is accountable to the

and Investments Commonwealth Parliament
Commission ○ ASIC’s objective is to reduce fraud and unfair practices in financial
markets
○ Collects the financial information of companies that is disclosed in
their financial reports by law
 ○ Investigates and penalises businesses who fail to disclose financial
information

Company taxation ○ Incorporated businesses

○ 30% of net profits
○ Interest payments are tax deductible → availability of funds at end
of FY
○ Impacts profitability
➢ Increases the price of g/s so that businesses can still attain
their desired margins
➢ Impacts competitiveness, particularly against unincorporated
business

● global market influences 𑁋 economic outlook, availability of funds, interest rates

Economic ○ Projected fluctuations in the global economy

outlook ○ Positive (boom) or negative (recession)
○ Inflation → suppliers are overseas, cartage costs, global outsourcing,
decreased spending from consumers across the global market
○ Interest rates in other countries → make borrowing funds offshore
either cheaper or more expensive

Availability of ○ The deregulation of Australian financial markets has enabled business

funds to borrow and invest offshore
○ Business can take advantage of lower interest rates in other domestic
economies
○ When borrowing offshore, creditors will consider the domestic
economic outlook, industry + business supply and demand and level of
risk
○ Businesses must consider the currency exchange rate → if another
foreign currency increases against the AUS dollar, finance will not be
cheaper and vice versa

Interest rates ○ Since interest rates in other countries are more favourable than
Australia’s, businesses may borrow overseas to take advantage of
lower interest rates
○ May impact cost of suppliers, cartage, outsourcing, borrowing and
consumer spending
 processes

● planning and implementing 𑁋 financial needs, budgets, record systems, financial

risks, financial controls

Financial needs ○ Identifying and planning for the needs of a business based off its
current position
○ Business size, access to sources of finance, location, workforce size,
amount of time in the market
○ Instruments such as financial statements can assist a business in
planning so that they can meet their financial needs

Financial risks ○ The risk that a business cannot fulfil its financial obligations
○ Reliance on negative gearing, high interest rates and negative cash
flow may pose the risk of insolvency

Financial controls ○ Creation and allocation of a financial plan that will maximise
financial security and meet objectives
○ Most important in protecting assets
○ Examples include clear employee responsibilities, rotational duties,
credit procedures, budgets

Budgets ○ Forecasted allocation of funds to specific key business functions

○ Aid a business in planning when and how capital will be used to
ensure the achievement of objectives
○ Three types include operating, project and financial budgets

Record systems ○ Instruments that collate and store business data

○ Reliability and accuracy of reports determines how useful they are to
a business
○ To maximise accuracy, business should enter their data twice by
different employees to identify errors

𑁋 debt and equity financing 𑁋 advantages and disadvantages of each

○ Debt: short and long term acquisition of funds from external sources
ADVANTAGES DISADVANTAGES

○ Funds are readily available ○ Interest payments, particularly for

○ Can be obtained at short notice short term finance
○ Interest repayments are tax ○ Risk of fluctuations in the
deductible currency exchange rate if acquired
○ Will not dilute the current offshore
ownership of the business ○ If regular repayments are not
made, a business may become
insolvent
○ Lenders can claim a business
 bankrupt if repayments can not be
met
○ Increase gearing

○ Equity: funds acquired within the business e.g profit

ADVANTAGES DISADVANTAGES

○ Cheaper as there are no interest ○ Funds are not readily available

repayments ○ Payments not tax deductible
○ Owners who have contributed ○ Lower profits and returns for owners
have full control over finances ○ Less control as shareholders obtain
○ Decreases gearing more ownership
○ Unfavourable dividend repayments
if the business is not generating a
high ROI → may detract
shareholders

𑁋 matching the terms and source of finance to business purpose

Decisions surrounding which source of finance to acquire will be dependent

on:
○ Type of business (incorporated or unincorporated)
➢ Smaller businesses may find it difficult to acquire debt finance
as there is an increased risk for the lender
○ Gearing ratio
➢ Businesses who have a greater amount of equity will be able to
access debt finance more easily due to greater security
○ Term of finance and its purpose
➢ Long-term finance should be used to fund non-current assets →
if not, businesses will not be able to generate revenue from the
assets to repay the loan
➢ Short-term finance should be used to fund current assets e.g
overdraft to fund inventory → if not, businesses will still be
repaying debt after the asset has been resolved, decreasing
profitability and liquidity

● monitoring and controlling 𑁋 cash flow statement, income statement, balance

sheet

Cash flow ○ Cash inflows and outflows

statement ○ Helps businesses determine whether they can meet their
financial obligations as they fall due
 ○ Whether they are operating on positive or negative gearing
→ positive or negative closing cash balance
○ Cash inflows and outflows categorised into operating
activities, investing activities and financing activities

Income statement ○ Shows operating income and expenses incurred over a period
○ Informs a business whether they are operating at a profit or
loss
○ Statement shows:
➢ Income
➢ Expenses
➢ COGS (opening stock + purchases - closing stock)
➢ Gross profit (revenue - COGS)
➢ Net profit (gross profit - expenses)

Balance sheets ○ Business’ assets, liabilities and total owner’s equity

○ Division of assets and liabilities into current and non-current
○ Called a balance sheet as the value of the business’ total
assets and total liabilities + owner’s equity needs to be equal
○ Shows whether a business can meet its financial obligations,
assets are generating profit, and the owners’ ROI (increasing
value of owners’ equity)

● financial ratios

LIQUIDITY

Current ratio (working Current assets ÷ current ○ Determines whether a business can convert its
capital) liabilities assets into cash to meet short term financial
obligations
○ Higher current ratio = better because you have
more assets than liabilities
○ Business wants a ratio at 2:1 or above so that
they have double the amount of assets than
liabilities
○ Ratio below 2:1 means that they are at risk of
having negative working capital

EXAMPLES 300 000 ÷ 200 000 ○ For every $1 of liabilities, the business has
= 1.5 $1.50 of assets
∴ ratio = 1.5:1 ○ Therefore, the business could improve its
liquidity as it is below the favourable ratio of
2:1

EXAMPLES 550 000 ÷ 600 000 ○ For every $1 of liabilities, the business has
= 0.92 $0.92 of assets
∴ ratio = 0.92:1 ○ Therefore the business is operating on negative
working capital, meaning they cannot meet short
term financial obligations
 GEARING

Debt to equity Total liabilities ÷ total equity ○ Determines the solvency of a business
ratio ○ Ratio of 0.5 - 0.7:1 is considered low gearing and
therefore more desirable
○ Ratio over 0.7:1 means increased risk
○ Higher the gearing
➢ More debt than equity
➢ Low level of solvency
➢ Greater financial risk
➢ Less attractive to investors
Strategies:
○ Factoring
○ Sell inventory → retain profits and be more
attractive to shareholders
○ Issue shares
○ Renegotiate loans, outsourcing and supplier
contracts
○ Sale and leaseback
○ Sell assets that are depreciating in value and not
generating revenue

EXAMPLES 75 000 ÷ 125 000 ○ Business has $0.60 of liabilities for every $1 of
= 0.6 equity
∴ ratio = 0.6:1 ○ Therefore, the business has positive gearing as
they are more reliant on debt finance than equity
finance

EXAMPLES 12 000 ÷ 7000 ○ Business has $1.70 of liabilities for every $1 of

= 1.7 equity
∴ ratio = 1.7:1 ○ Although the debt ratio is higher, it is not
problematic if the business can generate enough
cash flow to fulfil liabilities
○ However, if the business is heavily reliant on
higher gearing, it will result in insolvency

PROFITABILITY

Gross profit Gross profit ÷ sales x ○ Higher percentage/ratio

ratio 100 ➢ Will have more net profit
➢ Less expenses incurred
➢ Effective marketing strategy
➢ Effective financial management
○ Lower percentage/ratio
➢ Business needs to change product or marketing mix
to distinguish itself from competitors
➢ Have liabilities refinanced
Net profit Net profit ÷ sales x 100 ○ 18% considered high
ratio ○ Below 10% considered low
○ Higher ratio/percentage
➢ Business aims for this number to be as high as
possible
➢ Shows that the amount of expenses incurred are
feasible in ensuring that net profit is generated
○ Lower ratio/percentage
➢ Business may need to cut more expenses or refinance
loans so that the owners can receive more profit

Return on Net profit ÷ total equity ○ 18% considered high

equity ratio x 100 ○ Below 10% considered low
○ Determines whether the owners are receiving a higher return
on their investment in the business
○ The higher the ratio = more desirable return for the owner
○ Allows owners to consider whether they would seek a higher
return on other investments e.g shares, bank savings

EFFICIENCY

Expense ratio Total expenses ÷ ○ Indicate the efficiency of a business by determining if the
sales x 100 business can simulatenously reduce expenses, maximise
profitability and increase output
○ Business should aim to keep the expense ratio as low as
possible
○ If the expense ratio is too high, it indicates poor efficiency
➢ Corrective action toward financial management
strategies e.g budgeting
➢ Need to reduce costs e.g change suppliers, move
warehouses to reduce cartage costs, outsourcing,
automation, cut wages through redundancy and
training of employees

Accounts Sales ÷ accounts ○ Desired turnover ratio is 30 days

receivable receivable ○ Higher turnover ratio
turnover ratio = ϴ ➢ Collect debts quickly
= 365/ϴ
= no. of days

𑁋 comparative ratio analysis

○ Used to compare ratios over different time periods against industry
standards, competitors and the business’ previous figures
○ Figures collated over a number of years can provide a useful snapshot
of performance trends
 ○ Comparing forecasted figures and actual figures over a short time
frame; useful instrument for departments within the business

● limitations of financial reports 𑁋 normalised earnings, capitalising expenses,

valuing assets, timing issues, debt repayments, notes to financial statements

Normalised earnings ○ If a business generates more revenue than usual, they would
“normalise” their earnings by representing what they would
usually earn during the year
○ Provides investors with an understanding of how much
revenue and profit the business usually generates so they are
not misled to think that the business has high profitability

Capitalising expenses ○ When a business puts something that is actually an expense as

an asset
○ Makes profitability seem higher
○ E.g when a business buys a non-current asset, they can spread
out the costs of the asset over a number of years (under the cost
of depreciation)

Valuing assets ○ Businesses will usually represent assets with its original
market value on balance sheets
○ Assets depreciate over time and intangibles are impossible to
value accurately
○ Does not accurately encapsulate the valuation of the business

Timing issues ○ Adjusting the timing of transactions to provide a false

representation of costs, revenue and profit
○ If a business does not generate favourable revenue, they will
add revenue or take away costs that were incurred during
previous financial periods

Debt repayments ○ Balance sheet does not state when debts are due
○ E.g an investor might see that a business has $50 000 in debt
and may think that if the business is profitable, they will be
able to meet it as it falls due. However, the debt is actually due
next week but the investor does not know this

Notes to financial ○ Financial statements can be subjective as it only provides an

statements outlook of the business that is favourable for the owner
○ Therefore, investors are misled

● ethical issues related to financial reports

Audits ○ Independent investigation into a business’ financial records to

ensure that they are not falsified
○ Reduces fraud, embezzlement, theft and resource inefficiency
○ Required by law to have an external audit under the
 Corporations Act 2001
➢ Internal audit: employees assess accounting and
accuracy of records
➢ External audit: conducted by external and authorised
accountants who issues a report to confirm the
business’ compliance

Record keeping ○ All transactions made in cash must still be recorded

○ If not, it provides a false impression of revenue and
profitability
○ The ATO monitors business operators to ensure that all
businesses are paying the correct amount of tax

Taxation ○ All business are required to comply with the payment of GST
○ Must accurately report net profits to ensure that they pay the
right amount of tax
○ If not, businesses will be penalised by the ATO

Strategies

● cash flow management

𑁋 cash flow statements

Cash flow ○ Cash inflows and outflows

statement ○ Helps businesses determine whether they can meet their
financial obligations as they fall due
○ Businesses can pinpoint which assets and liabilities they need
to control to improve liquidity and solvency

𑁋 distribution of payments, discounts for early repayment, factoring

Distribution of ○ Use budgets and record systems to decide when payments

payments will be made and how much
○ Ensures liquidity so the businesses have enough cash to pay
debts as they fall due

Discounts for early ○ A business may offer discounts to debtors who repay the
repayment money they owe to the business before it falls due
○ Improves accounts receivables turnover ratio

Factoring ○ If a business needs to urgently access cash, they can sell

their accounts receivables to a factoring company
 ○ They will receive back 90% of the initial valuation of
receivables
○ Although they incur a loss, they are provided immediate
access to cash

● working capital management

𑁋 control of current assets 𑁋 cash, receivables, inventories

Cash ○ Prepare a budget to determine how and when cash will be used
○ Will reduce the risk of cash shortages and excess so that short
term financial obligations can be met

Receivables ○ Factoring
○ Businesses might need to adapt the term of the credit or how
much credit they provide to customers
○ Checking the credit rating of prospective consumers in
conjunction with the ATO
○ Following up accounts that are not repaid when they fall due
○ Implement more strict policies for collecting overdue receivables
○ Offering early discounts for those who repay money on time
○ Penalties for those who repay credit late
○ More clear and accessible communication systems to remind
consumers of the need to repay e.g automated email responses,
telephone calls to establish relationships

Inventories ○ If inventory that is ordered is not sold, the business may need to
purchase less stock
○ Will reduce inventory and transport costs
○ Inventory will not depreciate in value over time, ensuring that no
losses are incurred
○ Alleviated wastage and therefore loss of revenue

𑁋 control of current liabilities 𑁋 payables, loans, overdrafts

Payables ○ Regularly review and change suppliers if needed → take

advantage of interest free periods, discounts and extended loan
terms
○ Pay accounts payable by the due date to avoid late fees
○ Could acquire a supplier who is located closer to the business to
reduce cartage costs

Loans ○ Minimise use of short term loans as they incur higher interest
○ Use long term loans as they reduce short term cash outflow and
incur lower interest → business will have more capital to meet
other short term obligations
Overdrafts ○ Businesses must monitor how reliant they become on overdraft
○ Consider the interest rate, account keeping and establishment fees
of an overdraft account

𑁋 strategies 𑁋 leasing, sale and lease-back

Leasing ○ Temporarily borrowing an asset from an individual/business who

owns that asset
○ Increases the availability of funds, providing opportunity for
revenue and profit
○ Tax deductible

Sale and ○ Selling an asset and leasing it back from the buyer
leaseback ○ Increase liquidity as funds from the sale of the asset are now
readily available working capital
○ Tax deductible

● profitability management

𑁋 cost controls - fixed and variable, cost centres, expense minimisation

Fixed and variable ○ Businesses can search or negotiate for cheaper fixed costs
e.g smaller plant for rent, new insurance policy
○ Minimise variable costs through reducing energy
consumption, changing suppliers
○ Compare fixed and variable costs on budgets and income
statements

Cost centres ○ Different business departments where costs are allocated

○ Number of costs incurred by these departments
○ Help management understand the costs incurred from each
department and how these can be reduced

Expense ○ Relocate to a property that is smaller or not in a ‘prime’

minimisation location for cheaper rent
○ Change suppliers, energy, telephone and internet providers
○ Renegotiate insurance
○ Renegotiate outsourcing contracts
○ Minimise energy consumption e.g get solar, efficient water
sources
○ Casualisation
○ Locate closer to suppliers to reduce cartage costs and lead
times
 𑁋 revenue controls - marketing objectives

Marketing objectives ○ Compare marketing mix, revenue and profits to that of

competitors and take corrective action
○ Mark ups should cover both fixed and variable costs
whilst providing a profit margin
○ Break-even analysis can be conducted to forecast how
many units need to be sold to become profitable
○ Will increase profitability and return on investment,
making the business more attractive to shareholders

● global financial management

Exchange rates ○ The fluctuation of exchange rates makes it difficult

for businesses to plan
○ Makes borrowing funds, global sourcing and
suppliers more or less expensive
○ When the Australian dollar appreciates, the price of
goods from Australian business increases, impinging
competitiveness in the global market

Interest rates ○ Since interest rates in other countries are more

favourable than Australia’s, businesses may borrow
overseas to take advantage of lower interest rates
○ May impact cost of suppliers, cartage, outsourcing,
borrowing and consumer spending

Methods of international ○ Payment in advance:

payments ➢ When credit is transferred to the seller’s bank
account before the goods are delivered
➢ Increased risk for the buyer

○ Letter of credit:
➢ Buyer’s bank guarantees that the agreed
amount will be paid immediately when the
goods arrive
➢ Fees charged by the bank for this process
must be considered
➢ Reduced risk for the seller
 ○ Bill of exchange
➢ Document that requires the importer to pay
for goods by a certain date
➢ Reduced risk for both parties
➢ Cost extra as it involves the bank
➢ Document called ‘bill of lading’ is sent from
the exporter to the bank that outlines:
➢ Where the goods are being shipped to
➢ Legal ownership of the goods

○ Clean payment
➢ Way to avoid bank charges incurred from
letters of credit
➢ Buyer and seller handle all shipping
documentation, bank merely pays the money
➢ Cheaper and more efficient if paperwork is
handle internally by shipping agents
➢ Reduced risk for both parties

Hedging ○ Hedging is the process of minimising the risk of

exchange currency fluctuations (credit risk)
○ Ways to minimise risk:
➢ Establish offshore subsidiaries → rather than
converting currency from AUD to another
dollar, the business just establishes a
subsidiary in that country
➢ Arranging for imports and exports to be done
in the same currency

Derivatives ○ Financial mechanisms employed to reduce the

exporting risks associated with currency fluctuations
○ Forward exchange contract
➢ Australian goes into a deal with a bank to
exchange USD with a bank at an agreed
exchange rate
➢ Protects them from losing money and thus
profitability from exchange rate fluctuations
➢ Usually reversed after 1 financial year
➢ Cannot take advantage of positive changes in
currency exchange rates (depreciation of
AUSD)
○ Currency swaps
➢ When two business swap currencies now and
agree to reverse their transaction at a later
date to take advantage of currency exchange
rates and lower interest at their own banks
➢ E.g an Australian business wants to expand
into England
➢ Rather than being charged high interest rates
 due to high risk in England, the Australia
borrows money from an Australian bank for
lower interest
➢ The English business does the same and they
swap the amount of money they each
borrowed
➢ Then conduct a forward exchange contract so
that they are not impacted by fluctuating
interest rates
➢ Then generate revenue in their new countries
to pay off interest to the other