Business Studies 2016 Hsc Paper 5a2i38

Finance – Section 4 – Profitability and GFM Strategies Evaluate the financial management strategies a business can use to achieve its financial goals.

Step 1: Assess: define

Step 2: Brainstorm: identify the financial management strategies you could use in this response. Then identify three to five strategies that you can use that best fits the case study and answering this question.

 cash flow management – cash flow statements – distribution of payments, discounts for early payment, factoring  working capital management – control of current assets – cash, receivables, inventories – control of current liabilities – payables, loans, overdrafts – strategies – leasing, sale and lease back  profitability management – cost controls – fixed and variable, cost centres, expense minimisation – revenue controls – marketing objectives  global financial management – exchange rates

– interest rates – methods of international payment – payment in advance, letter of credit, clean payment, bill of exchange – hedging – derivatives

Step 3: Financial goals identification:

1.0 Executive Summary The purpose of this report is to make a judgement based on value of the profitability management strategies that a business can utilise to achieve its financial goals. Furthermore this report will make a judgement based on value of the global financial management strategies a business can use to achieve its financial goals. This report will make reference to the case study of Apple Inc. 1.1 Corporate Descriptor (Optional) Apple Inc. is a leading consumer electronics company that operates on an international scale. Its headquarters is located in California, but it operates in 15 countries, employing more than 90,000 employees. 2.0 Profitability Management Strategies Profitability strategies are defined as the strategies used to generate a profit, and refer to cost controls – fixed and variable, cost centres, expense minimization and revenue controls – marketing objectives.

2.1 Cost Controls Cost controls are the expense minimization method of carefully analysing the expenses of a business and whether those expenses are needed for a businesses continued operations. (context) 2.1.1 Cost Centres Cost centres are particular areas, departments or sections of a business to which costs can be directly attributed. This strategy is recommended as it enables the incurred direct and indirect cost to be specifically placed on a part of the business . This process places ownership on costs as these are recorded, measured and monitored. Inevitably, this strategy places responsibility on employees and ensures there is no excess expenditure. This would substantially reduce costs and hence improve profitability. (define) By identifying areas of costs to budget allocated, a business is able to minimise expenses of overrun and look for opportunities to minimise fixed and variables costs. It is this management and monitoring that enables for increased profitability. This strategy is of high value to a business since it allows for the minimisation of expenses and increased efficiency. Profit and efficiency are two key financial goals that the utilisation of cost centres can effectively achieve. (expand) Apple utilises the cost centres as a strategy to achieve its financial goals of profit and efficiency. By grouping its costs into division, department and geographic locations for ing and management purposes (Retail, Americas, Europe), Apple has consistently recorded expense figures that exceed industry averages. In 2014, Apple recorded an expense ratio of 16%, which exceeds the industry average of 20%. By using costs centres, Apple tracks expenditure and strategies to drive costs down in their business. For example, Apples tracks the amount of materials being used in the manufacture of their partners such as Foxconn and Pegatron in order to ensure that wastage do not reach over 21% of incoming and out coming products. Apple has been able to balance its expenses across the business effectively, and as a result, the business’s profitability has benefitted as well. In 2014, Apple recorded $39 billion dollars (a record) indicating the effectiveness of cost centres in achieving financial goals. (example) NO LINK 2.1.2 Expense Minimisation

This involves a business focusing on the reduction of costs throughout the entirety of the business; this is regardless of the proportionality with which expenses are incurred, across different departments. (define). If a business is able to successfully implement this strategy, it can effectively improve its efficiency, through the overall lowering of expenses. This strategy can include the use of supplier rationalisation policies, dual suppliers to create competitive tension, buying in bulk, sourcing direct, from low cost country sourcing and volume aggregations. By dealing with one or a smaller number of suppliers it also takes a level of complexity out of the supply chain allowing the business to focus on its core business functions. In addition by taking up this strategy individuals will also be able to achieve economies of scale by producing large qualities through smaller number of supplier allowing for a decrease the cost per unit. This can result in the maximisation of profitability and growth, since a business will have access to a larger portion of funds that can be used to invest into expansion overseas, research and development. (expand)

Apple has consistently aimed to utilise expense minimisation, which has contributed to their significant successes in achieving profit, efficiency and growth. For example, Apple buys its entire component parts in bulk (committing to more than 150 days’ worth of supply) this ensures the lowest price per unit and prepays for these component parts to receive a discount for early payment. Apple utilises outsourcing to countries with a competitive advantage such as countries will a low wages and abundance in resources which both can be achieved for a low price. Outsourcing materials such as lead and tin which is essential for the inner components of the iPhone and labour is outsourced to China due to their low wages which allows Apple to significantly lower expenses. Ipad manufacturing in the US costs Apple $338 whereas an Ipad made in China cost $38 saving $300 which in 2013 71 million were sold. Apple enjoys one of the highest GP and NP in the industry – 41% GP (7% more than Samsung) and 23% NP. As a result of their successful efficiency and profitability, Apple has undertaken several effective expansions overseas, indicating the effectiveness of expense minimisation in achieving growth. In China, Apple has 50% market share in the smartphone market. (example) NO LINK 2.1.3 Fixed and variable costs NO DEFINITION. Fixed costs do not change with the level of activity of a business. These costs must be paid regardless example, wages, salaries, insurance and lease. Fixed costs are better in improving cash flow problems as due to fluctuations in variable costs they will severely affect how liquid the business will be. Variable costs are those that change proportionately with the level of operating activity in a business for example materials and labour used in the production process. Variable costs are better suited to solving profitability issues as during positive periods of growth the variable costs will decrease and as a result increase the profits of the

business as the derived demand for labour and materials drives down prices for those costs and thus profits increases as a whole. (expand) Apple is well regarded as having the best cost controls in the industry. Apple can pressure prices of their component parts (variable costs) by knowing supplier’s margins, and order in large quantities. Apple uses air freight which is generally expensive however Apple buys in bulk which decreases prices down as a whole. Subsequently the cost of sourcing, which is variable is minimised. Therefore, Apple enjoys significant cost saving efficiencies by reducing variable costs. Apple records the highest GP in comparison to Samsung and other technology companies – 7% more GP. (example) NO LINK

2.2 Revenue Controls NO CONTEXT PARAGRAPH 2.2.1 Marketing Objectives NO DEFINITION. (eg. marketing objectives are defined as the objectives and goals set by the business to control its revenue by changing the direction of marketing.) The achievement of marketing objectives, such as market share, growth and customer service, is heavily linked with a business’s ability to achieve its financial goals. Through the display of high quality customer service, for example, it is likely that a business will be able to incur increasing amounts of revenue – this is due to the customer loyalty that can be obtained as a result of having knowledgeable staff that provide positive attitudes towards consumers. This can contribute to increased profitability and growth, via the impact of increasing revenue. Similarly, the achievement of market share is vital to a business’s growth. (expand)

Apple has been significantly successful in achieving the various marketing objectives – as a result, the business has also been successful in achieving the financial goals of profit and growth. Apple is ranked in the top 50 companies in the world, in its quality of customer service. This, combined with Apple’s increasing market share worldwide, allowed the business to record revenue of $180 billion in 2014. This contributed to Apple’s high profitability, recording $39 billion net profit in 2014. Also, Apple’s growth as a result of this financial performance is indicated in the business’s 50% market share of the Australian tablet market. These factors indicate the effectiveness of revenue controls in the achievement of financial goals. (example) 3.0 Global Financial Management Strategies

NO CONTEXT PARAGRAPH 3.1 Interest Rates NO DEFINITION. The utilization of overseas interest rates is a strategy a business can use in order to achieve its financial goals, specifically liquidity and solvency. By only taking out loans in countries with lower relative interest rates, businesses will have significantly less interest to pay on these loans, hence freeing up surplus funds for the business, and improving its liquidity and solvency. Since the business is not obliged to put a certain portion of funds into interest payments, they contribute this money to the liquid funding of the business. Similarly, a business can also aim to only deposit funds into banks within economies with higher relative interest rates, in order to receive higher interest payments from these banks. (expand)

Apple has the advantage of being able to borrow in the economy of its headquarters, the US, due to the relatively low 2% interest rates its banks provide. This has allowed Apple to borrow funds at a low rate, which has resulted in the business’s interest payments being less heavy than if it was to borrow from another economy. As a result of this, Apple’s liquidity and solvency has been boosted significantly as well, through the effective use of interest rates in borrowing practices. Apple’s current ratio in 2013 was 1.68:1, indicating strong liquidity. Also, Apple’s gearing ratio in 2013 was 1.64:1, indicating the business’s high solvency. The achievement of these financial goals has come as a result of Apple’s effective use of interest rates as a global financial management strategy. NO LINK 3.2 Hedging Hedging is a risk minimisation strategy that businesses are able to utilise in order to protect against fluctuations in foreign currencies during international exchanges. (define) It involves both parties involved in the exchange agreeing to make an immediate transaction, or a ‘spot exchange’, so that neither party is weakened during the transaction due to changes in currency value. If hedging is used, a business will likely maintain a stronger position, in of solvency and liquidity, than if it were to not use hedging, and expose it to currency changes. This is because a business may lose some liquid funds during the process of transaction, due to its own currency being weakened. By using hedging, the business ensures these liquid funds are safe. (expand)

Apple often employs hedging as a strategy to ensure its funds are protected during international transactions. Since Apple’s international sales represent 60% of their

revenue, this means that Apple is a net receiver of foreign currencies and as such is at risk of fluctuations in exchange rates. If foreign exchange rates are stronger than the US $, then this have a positive impact on Apple’s revenue line. By using hedging, this has protected the business against any possible negative fluctuations in the US dollar, which would weaken Apple’s purchasing power in the global market. Hence, Apple has been able to undergo spot exchanges, at times of the business’s choosing, to make transactions with overseas parties. As a result, the business has protected significant amounts of its surplus funds, contributing to its strong liquidity and solvency positions. (this paragraph can also be used for exchange rates – case study) (example) NO LINK 4.0 Conclusion This report, overall, has made judgments, based on value, of the profitability strategies, and the global financial management strategies that businesses can use to achieve their financial goals.