Financial management strategies - 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, hedging, derivatives

What this dot point is asking

NESA wants you to know two clusters of financial-management strategies: profitability management (cost controls and revenue controls) and global financial management (the exchange-rate, interest-rate and payment risks Australian businesses face when operating internationally, and the tools used to manage those risks). Section II questions on these topics are typically 4 to 6 marks; Section IV extended responses often ask you to evaluate financial strategy in a chosen business, especially during a stress period (Covid, 2022 inflation, 2023-2024 interest-rate cycle).

The answer

Profitability management

Cost controls

Cost controls limit and reduce the cost base. The framework splits into fixed and variable costs and into cost-centre management.

Fixed costs are costs that do not vary with output volume - rent, depreciation, base salaries, insurance, software subscriptions. Fixed-cost control involves:

• Capacity management. Matching capacity to demand. Closing underutilised stores (the Wesfarmers closure of underperforming Kmart and Target stores in regional locations); consolidating distribution centres; downsizing head office.
• Capital efficiency. Sale and leaseback of property to convert a fixed asset into cash. Coles and Woolworths have both used sale and leaseback on distribution-centre and store-property portfolios in recent years.
• Restructuring. Periodic restructuring programmes to remove duplication after acquisitions or to delayer management.

Variable costs vary with output - raw materials, packaging, freight, casual labour, payment processing. Variable-cost control involves:

• Supplier negotiation. Volume-based pricing; multi-year contracts in exchange for price commitments.
• Process efficiency. Lean methods to reduce per-unit input. Toyota's TPS reduced per-vehicle labour minutes by orders of magnitude over decades.
• Substitution. Replacing expensive inputs with cheaper alternatives where quality permits.

Cost-centre management splits the business into accountable units with their own budgets. The general manager of each cost centre is accountable for cost performance. Used extensively in:

• Decentralised businesses (Wesfarmers's portfolio structure, where Bunnings, Kmart, Officeworks each operate as a separate division with its own P&L).
• Hospital management (each department has a cost centre).
• Universities (each faculty is a cost centre).

Expense minimisation v efficiency

"Expense minimisation" is a phrase that can be misleading. Cutting expenses always feels possible until you cut what was actually generating revenue (sales staff, marketing, R&D). The mature approach is efficiency - more output for the same expense, or the same output for less expense.

Revenue controls

Revenue controls increase and stabilise revenue.

Marketing-objective alignment

Marketing budgets tied to specific revenue objectives (new customer acquisition, conversion rate, average basket size, customer-lifetime value). Marketing ROI is measured and the budget is moved toward channels and campaigns that work.

Pricing discipline

Avoiding unnecessary discounting; segmenting pricing to capture willingness to pay. Qantas's frequent-flyer programme is a segmentation tool - business travellers pay full-fare premium; leisure travellers pay sale fares. Both segments contribute revenue without cannibalising each other.

Customer-mix management

Shifting customer mix toward higher-margin products and segments. Coles and Woolworths have both expanded Own Brand ranges, which have higher gross margin than equivalent name-brand SKUs.

Loyalty programmes

Everyday Rewards (Woolworths), Flybuys (Coles, Wesfarmers), Qantas Frequent Flyer. Loyalty programmes lift purchase frequency and basket size in exchange for points cost. Well-designed programmes are profitability-positive; poorly-designed ones are a cost without revenue lift.

Cross-sell

Selling additional products to existing customers. Banks cross-sell (mortgage customers offered insurance, credit cards, super); telcos cross-sell (mobile customers offered home internet); supermarkets cross-sell (food customers offered insurance, mobile, fuel discounts via partnerships).

A worked Australian profitability example: Qantas FY24

Qantas reported FY24 (year ending 30 June 2024) underlying profit before tax in a high-single-digit billion-dollar range (the actual number subject to public reporting; here the discussion is illustrative of mechanisms rather than precise figures).

• Cost controls. Network optimisation (cutting unprofitable routes), aircraft-fleet renewal (newer aircraft are 15-25 percent more fuel-efficient), labour cost restructuring, supplier renegotiation. The post-Covid restructure saw approximately 1,700 ground-handling positions outsourced (the High Court ruled this unlawful in 2023, with subsequent settlement around $120 million).
• Revenue controls. Loyalty-programme expansion (Qantas Frequent Flyer has become an increasingly large profit contributor in its own right), business-class capacity restoration, freight strength, ancillary-revenue growth (seat selection, baggage, lounge passes).

Profitability is the net of cost and revenue management. Qantas's post-Covid recovery to record profitability reflects both sides.

Global financial management

Australian businesses operating internationally face three types of financial risk: exchange-rate, interest-rate and counterparty/payment risk.

Exchange-rate risk

The AUD floats against major trading currencies (USD, EUR, CNY, JPY, GBP). A USD-earning Australian exporter benefits when the AUD weakens (more AUD per USD); a USD-cost Australian importer benefits when the AUD strengthens (fewer AUD per USD).

The AUD/USD has moved in a wide range in recent years - broadly between 0.60 and 0.75 - reflecting commodity prices, interest-rate differentials and risk sentiment.

Examples.

• BHP earns the vast majority of its revenue in USD (iron-ore, copper, met coal are priced in USD globally) but a significant share of costs is in AUD (wages, royalties, Australian-built equipment). A weaker AUD boosts AUD-reported earnings.
• Cochlear earns most revenue in USD, EUR and GBP but headquartered cost is in AUD. AUD strength erodes reported earnings.
• CSL is similar - global revenue in USD and EUR; Australian-headquartered cost base; significant US-based manufacturing reduces the AUD exposure relative to a purely export-based business.
• Woolworths mostly transacts in AUD but imports significantly (private-label apparel from Asia, fresh produce from Asia and the Americas, packaged goods from Europe). A weaker AUD raises input cost.

Interest-rate risk

The Reserve Bank of Australia sets the cash rate. The benchmark target rate moved sharply higher through 2022-2023, peaking around 4.35 percent, with the cycle plateauing into 2024-2026. Higher rates raise borrowing costs for businesses and consumers.

International businesses face the additional complexity of cross-currency interest-rate differences. A business with USD revenue and AUD debt has a mismatched exposure that can be hedged.

Methods of international payment

Australian businesses use several international payment methods, each with different risk-and-cost trade-offs.

• Telegraphic transfer (TT) / wire transfer. Direct bank-to-bank payment. Fast, simple, but the buyer pays in advance (high seller protection, low buyer protection) or the seller is paid after shipment (low seller protection).
• Documentary letter of credit (LC). A bank guarantees payment to the seller on presentation of specified shipping documents. Balances risk between buyer and seller; widely used in commodity trade and emerging-market trade.
• Documentary collection (D/P or D/A). Bank handles shipping documents on the buyer's behalf, releasing them on payment (D/P) or against acceptance of a bill of exchange (D/A).
• Open account. Goods shipped before payment; relies on relationship and trust. Common in long-established B2B relationships and within multinational groups.
• Trade-finance facilities. Banks provide working-capital finance secured against trade receivables or inventory.

The choice depends on the established trust between buyer and seller, the country risk, the trade volume and the cost.

Hedging instruments and derivatives

Forward contracts

Agreement to buy or sell currency (or a commodity) at a fixed rate at a future date. Eliminates uncertainty in either direction.

Options

Right (not obligation) to transact at a fixed rate. Preserves upside while protecting downside, in exchange for an option premium.

Swaps

Exchange of cash flows. Currency swaps exchange payments in different currencies. Interest-rate swaps exchange fixed-rate for floating-rate payments. Used by corporations with mismatched currency or rate exposures.

Futures

Standardised exchange-traded contracts. Common for commodities (oil, copper, gold) and equity indices.

Worked example: Qantas fuel hedging

Jet fuel is 25-30 percent of an airline's operating cost. Qantas runs a structured hedging programme using a combination of forwards and options to lock in some fraction of fuel cost up to 12-18 months ahead. The 2022 oil-price spike (Brent crude above USD 100 in places, after the Russia-Ukraine invasion) was partly cushioned by Qantas's hedged barrels. Hedging cost (option premiums and forward-curve dynamics) is a real expense; the benefit is reduced earnings volatility and improved budgeting.

Worked example: BHP currency exposure

BHP earns USD revenue and incurs largely AUD cost. The business does not aggressively hedge AUD/USD because its long-term shareholders are global (USD-thinking) and the natural exposure to USD is part of the investment proposition. Compared with a purely-Australian-cost business, BHP's earnings already include the currency tailwind or headwind, and shareholders prefer the transparency to a hedged programme.

This is an important lesson - hedging is not always desirable. Some businesses choose not to hedge because shareholders prefer the natural exposure.

Country risk

Beyond price hedging, businesses operating globally face country risk - political risk (expropriation, capital controls, regulatory change), legal risk (contract enforceability), and operational risk (infrastructure, labour, security).

Tools to manage country risk include:

• Political-risk insurance.
• Local-currency financing (debt matches revenue currency).
• Joint ventures with local partners.
• Diversification across countries.

Putting profitability and global management together

For an Australian business operating globally, the financial-management challenge is to:

1. Manage the cost base (fixed and variable) in each country.
2. Optimise revenue (pricing, mix, loyalty) in each market.
3. Hedge currency, rate and commodity exposures as appropriate.
4. Choose the right international payment methods.
5. Manage country risk through structure and insurance.

The CFO function has become more strategic over time as the financial-engineering tools (derivatives, structured trade finance, intra-group financing) have proliferated.