Académique Documents
Professionnel Documents
Culture Documents
Page
Session 1
Session 2
: Accounting Information
4
20
35
Session 4
: Working Capital
57
Session 5
: Cash Management
72
Session 6
81
Page
Session 7
Page
101
Session 9
110
128
169
190
Page
ANNEX
Annex 1
Seminars
Annex 2
Recommended Reading
Annex 3
Annex 4
: Supporting Material
Page
1 MANAGEMENT
MANAGEMENT FOR FINANCE
SESSION
WHAT IS
Page
Planning
Organising
Directing, Leading & Motivating
Coordinating & Communicating
Controlling
Evaluating
Page
Decision making therefore is part of the managerial role, these may be ad-hoc, rational
or impartial depending upon the nature of the decision to be taken.
Page
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Step 11.
This is a generic process which could be applied to any management function, including
finance.
Page
Planning
Emphasis on
Type 1
Strategic
Decisions
Type 2
Tactical
Decisions
Control
Type 3
Operational
Decisions
Three decision types can be identified, namely Strategic, Tactical and Operational.
These may blend from time to time, particularly Type 2 and Type 3. The pyramid shows the
volume of decision types and how control increases at the operational level.
Page
Strategic Decisions are concerned with direction and purpose so to provide for a mission
to be accomplished over the longer term, whereas Tactical Decisions are narrow with
specific objectives to be achieved over the short to medium term.
Operational Decisions are specific, often routine with targets for performance monitored
over a short-term time horizon.
One important element in management decision-taking today is measurement.
Remember, if your decisions cannot be measured, they will be difficult to manage.
Financial Management Decisions at all three levels will be subjected to measurement for
reporting purposes as part of a financial information system.
Page
10
Control
Organisation
Communication
This is critical, because the management accountant has the pivotal role
to ensure that all policies, procedures & methods are communicated and
understood. Financial performance information must also be
communicated according to agreed time lines for organisational planning
purposes. One example, is the core role in budget reporting on a monthly
and quarterly basis.
Page
11
There are job functions within the accounting profession which should also be distinguished.
The Management Accounting role is concerned with the provision of information to people
within the organisation for management decision-taking.
The Financial Accounting role is concerned with the provision of information for external
reporting outside the organisation.
Cost Accounting is part of the Management Accounting function but mostly concerned with costs,
costing and cost behaviour to meet the requirements for internal and external reporting.
12
Company Law
External Accounting Rules (SSAPS)
International Accounting Standards (GAAPS)
Stock Exchange Rules for public companies
Page
13
14
Page
15
DIRECTORS
elect
account
review
report
SHAREHOLDERS
elect
AUDITORS
Page
16
The shareholders are the owners of the business, they elect the directors who are
accountable for business performance.
Auditors and appointed, by legal agreement, to agree to give a fair and accurate
independent report of business performance and behaviour with respect to accounting
processes and management, by checking the financial system through a process called
an audit .
The auditors will complete the annual audit to check that the accountancy function has
compiled with all regulations and procedures to draw up their internal financial
documents.
The audit would examine some documents such as invoices, cheque stubs, time cards
etc. The Books of Prime entry will be examined which covers a purchases daybook, a
cash book and wages records.
Page
17
The Ledger Accounts will be reviewed which covers the cash book, creditors &
debtors ledgers.
Finally the audit will obtain information to assemble the financial statements to show
the financial position through an income statement, a cash flow statement and a
balance sheet (all will be explained in detail in later sessions).
The auditors report will then be sent to the directors for review and adjustments as may
be needed and sent also to the shareholders before being signed off for publication.
Page
18
DISCUSSION QUESTIONS
1. WHY DOES FINANCE HAVE TO BE MANAGED ?
Page
19
2 MANAGEMENT
ACCOUNTING INFORMATION,
SESSION
WHAT IS
PRINCIPLES & TRANSACTIONS
WHO USES ACCOUNTING INFORMATION
WHAT INFORMATION MEANS
THE ACCOUNTING INFORMATION SYSTEM
MAJOR ACCOUNTING PRINCIPLES
THE SYSTEM FOR RECORDING TRANSACTIONS
THE MAIN FINANCIAL STATEMENTS
DISCUSSION QUESTIONS
Page
20
21
Investors
Company
Shareholders
Company
Directors
Company
Managers
Financial
Institutions
Existing &
Future
Customers
Business
Organisations
Lenders
Suppliers
Competitors
Trade
Associations
Employees
Unions
Government
Investment
Analysts
Tax Authority
The
Community
FIGURE 2.1
Page
22
23
Sources
Specifications
Applications
Information
Identification
Information
Recording
Information
Analysis
Information
Reporting
Information
Needs
Processing
Routines
Responsibility
Centres
24
The real value of accounting information will depend upon its end-use purpose, therefore
the value should be based on the cost of producing it in relation to the needs it satisfies.
Relevance
Reliability
Competencies
Comparability
Understandability
Cost / Benefit
Accessibility
Timeliness
Page
25
Going Concern
Accruals or
Matching
Consistency
Selecting the most appropriate method and stay with these for
comparative analysis overtime
Prudence
Objectivity
Historical Records
26
Materiality
Monetary
Measurement
Page
27
ACCOUNTING POLICIES
Policies are the rules which the company applies to select the best approach to achieve the needed
outputs of the accounting function.
One simple definition commonly adopted by the accounting profession is : -
Page
28
Page
29
Transactions
Prime Documents -
Ledger Accounts -
Classifies the transactions into separate books called ledger, for example
a creditor ledger, a debtors ledger and a general ledger.
Trial Balance
Adjustments
Financial
Statements
30
This system of DEBIT & CREDIT has been the basis upon which the key financial statements are
prepared.
[ There is no need for us on this programme to go into more detail about double entry bookkeeping. ]
Page
31
Page
32
Page
33
DISCUSSION QUESTIONS
Page
34
3 MANAGEMENT
THE MAJOR FINANCIAL STATEMENTS
SESSION
WHAT IS
THE BALANCE SHEET
------
Page
35
DISCUSSION QUESTIONS
Page
36
ASSETS
=
[what is owned] =
CAPITAL + LIABILITIES
[what is owed]
Page
37
The effect of trading will influence the Balance Sheet as shown : ASSETS =
ASSETS
These are items owned by a business which can be proved, have a monetary value, and that
the value can be objectively measured.
Page
38
Fixed Assets are normally recorded at historical cost, at the time their purchase was
originally transacted, for example :
Land
Manufacturing Plant
Machinery
Vehicles
Long-term Investments
Most of which are intended for the longer-term and are not intended for sale because most
are items concerned with the making of products which are to be sold at a profit.
Fixed assets are depreciated overtime, estimated over their useful life, in accordance with
agreed conventions relevant to the enterprise and the industry.
Page
39
Long term investments are stakes that the business may have taken in other companies.
Current Assets are those which are held for a short period traditionally less than one year which are
intended to convert back into cash for example.
All current assets are expected to work their way through the business cycle.
THE TOTAL ASSETS OF THE COMPANY IS THEREFORE FIXED ASSETS
CURRENT ASSETS.
Page
40
LIABILITIES
A liability is an amount owed by a business to a person or organisation who has provided funds to
finance the assets that are controlled by the business.
Liabilities therefore are classified into : -
LONG TERM
Equity Shareholders
Page
41
SHORT TERM
Overdraft that has been used from the facility granted by the
bank
These liabilities are the current obligation of the company to make payment.
Page
42
FIXED
ASSETS
CURRENT
ASSETS
CAPITAL &
RESERVES
LONG TERM
LIABILITIES
CURRENT
LIABILITIES
The balance sheet equation in vertical layout, which is commonly applied today :
FIXED
ASSETS
CURRENT
ASSETS
CURRENT
LIABILITIES
LONG TERM
LIABILITIES
CAPITAL &
RESERVES
Page
43
FIXED ASSETS
Land, Buildings, Vehicle, Plant (at cost)
Investment in Associated Company
xxx
xx
xxxx
2.
3.
TOTAL ASSETS
4.
5.
6.
xx
xx
x
x
xxxx
xx
x
x
xxx
xxx
OOOO
7.
8.
9.
xx
++++
xxxx
xxx
++++
Page
44
Current Liabilities
NOTE
It will take time to understand and digest this Balance Sheet format, it is
advised that examples of published accounts are referred to. This will
reinforce this essential learning component of the course.
Page
45
The Income Statement is designed to measure the transactions which have taken place between
two balance sheet dates (see Figure 3.1). It is normally a statement therefore, for the year
ended.. because it is a summary of all trading transactions which have taken place during the
period, not just to show the position at one point in time.
Page
46
BALANCE
SHEET
AS AT
31 DECEMBER
200X
TOTAL
REVENUE
LESS
TOTAL
COSTS
FOR THE
PERIOD
BALANCE
SHEET
AS AT
31 DECEMBER
200Y
Figure 3.1
Page
47
1. Sales Revenue
xxxx
Less
2. Cost of Sales
xx
Equals
3. Gross Profit
xxx
Less
4. Expenses
xx
Equals
5. Operating Profit
xx
6. Interest Charges
Less
7. Taxation
Equals
Page
48
This statement shows trading transactions, therefore the costs incurred are either the direct costs
(eg. labour + materials) of creating sales or indirect costs incurred to support sales (eg.
administration & distribution).
Therefore the Income Statement or Profit & Loss Account does not show Capital Transactions for
the purchase of fixed assets.
Capital Expenditure or CAPEX is the domain of the Balance Sheet and Operating Expenditure or
OPEX is the domain of the Profit & Loss statement.
Page
49
EXPENSES as understood in item 4 above (Pg. 49) also would include for example : Administration
Marketing & Distribution Costs
Wages & Salaries
Telephone Charges
Sales Administration
Sales Expenses
DEPRECIATION is also charged against the Gross Profit figure as a provision for replacing the
assets of the company.
Page
50
2.
3.
4.
Dividends
5.
Retained Earnings
Page
51
PLUS or MINUS
EQUALS
Page
52
340
(118)
(63)
1391
(11)
1539
Page
53
* To assess the Net Cash Inflows from Operating Activities, more details can be shown, for example : -
Plus
Plus
Plus or Minus
Plus or Minus
Plus or Minus
Less
Less
Less
Equals
Page
54
The purpose is to show the movement of funds through the business, the services from which this cash
was derived and the applications to which it has been deployed as a matter of public record to
supplement the published statements for the balanced sheet and income statement.
These 3 statements can be further analysed, using Ratio Analysis, to assess the financial position of any
business which has financial statements published and available in the public domain.
Page
55
DISCUSSION QUESTION
1. EXPLAIN THE PURPOSE AND CONTENT OF THE MAIN FINANCIAL
STATEMENTS THAT ARE PRODUCED FOR PUBLIC SCRUTINY.
Page
56
4 MANAGEMENT
SESSION
WHAT IS
WORKING CAPITAL
57
58
CASH AT BANK
SHORT TERM INVESTMENT CONVERTIBLE TO CASH
CURRENT AND FUTURE INCOME FROM DEBTORS
CASH CONVERTED FROM STOCK (INVENTORY)
59
Another term for the working capital ratio is the net current assets. Working capital therefore
is an important measure of the companys liquidity.
Working capital management is concerned with the management of the relationship between
current assets and current liabilities and the decisions pertaining to achieving the relevant
balance between both key areas of financing a business on a day-to-day basis.
Managing liquidity is part of the responsibility often referred to as cash management to
ensure that the company has enough cash when its obligations for cash payments are due.
Managing the cash cycle for the business becomes vital, this is why cash flow statements are
needed for cash management to protect the liability of the business.
Page
60
Working Capital Management involves the following key areas : CASH MANAGEMENT
DEBTOR MANAGEMENT
CREDITOR MANAGEMENT
INVENTORY MANAGEMENT
All of which are covered with the day to day management of working capital throughout the
business.
Page
61
CASH MANAGEMENT
Company income streams and regularity of them must be monitored in order to maintain a
positive cash flow position to reduce the need for short term borrowing through overdraft
facilities. Negative cash flow means a cash deficit, the cost of which impacts upon working
capital and also places pressure on relationships with suppliers should late payment to creditors
occur.
DEBTOR MANAGEMENT
The debtor days outstanding should be controlled carefully to ensure that money comes into the
business before it is paid out by ensuring that creditors days exceed debtor days otherwise the
cost of uncontrolled cash receivables will impact upon working capital.
The number of debtor days outstanding must be closely monitored because the cost of
extending credits to debtors is a cost to the company This cost cannot be overlooked.
Credit extended will increase the value of outstanding debtors and this has to be financed, often
from short term borrowing using overdraft facilities, so therefore the real cost of credit
extension must be known and must be managed carefully.
Page
62
CREDITOR MANAGEMENT
The key to creditor management is to take more credit from the companies creditors than are
extended by the company to its debtors. In simple terms the creditor days should be greater
than the debtor days so that money comes in before it is paid out. Often it is not possible, so
therefore an overdraft facility is used to bridge the gap between receipts and payments.
However, if this overdraft has a hard core element of sustained borrowing, this impacts
directly upon working capital balances.
The analysis of the creditor position must be managed so that the liquidity of the business is
monitored closely.
Page
63
INVENTORY MANAGEMENT
Inventory, or stocks is usually the least liquid of current assets and therefore it is vital that
inventory is managed efficiently.
Stock held must convert to cash, every effort must be made to ensure that optimum stockturn
is sustained in relation to the pattern of sales for the business otherwise working capital is
tied up needlessly. Stockheld is cash tied up. Inventory management has the main purpose of
converting stock to smooth flows of cash into the business.
Page
64
LIQUIDITY
Liquidity as mentioned earlier is the core theme of working capital management and is
defined as the short term ability of a business to meet its current short term liabilities.
An enterprise becomes illiquid when the liquid assets (cash, debtors & stock) as near cash
items are insufficient to cover the short term obligations to creditors.
DERIVATION
LIQUIDITY Deals with Short Term Liabilities Only
Is measured by the working capital balances in a company
Current Assets
(Minus)
Current Liabilities
(Minus)
65
LIQUID ASSETS
These will vary from industry to industry, but normally would include cash and debtors
and may be stocks if they are readily convertible to cash, so therefore ratios are used to
assess a companys liquidity :-
RATIOS
The Working Capital Ratio
(Or Current Ratio)
Equals
Current Assets
Current Liabilities
Liquid Assets (cash + near items)
Current Liabilities
66
67
SALES REVENUE
DEBTOR TURNOVER RATIO
COST OF SALES
CREDITOR TURNOVER RATIO =
Page
68
SAMPLE FIGURES
STOCK TURNOVER RATIO
3000
600
5000
400
3000
= 8 times per annum
375
Therefore to convert this to days based upon 365 days per annum.
STOCK PERIOD
365
5
73 days
DEBTORS PERIOD
(Customer Credit)
365
12.5
29.2 days
CREDITORS PERIOD =
(Supplier Credit)
365
8
45.6 days
This means it takes almost two months to convert business into cash and this is the number of days that
cash is tied up in working capital.
Page
69
70
DISCUSSION QUESTIONS
Page
71
SESSION
WHAT IS
5 MANAGEMENT
CASH MANAGEMENT
CASH
CASH FLOW
CASH BUDGETING
BUDGETED CASH FLOW STATEMENTS
DISCUSSION QUESTIONS
Page
72
CASH
Cash plays a pivotal role in any business, in fact it is the lifeblood of the business
whereby cash flows into the business to touch almost all parts of the business and also
flows our into the external business environment.
The difference between cash in flows and cash out flows will of course influence the
calculation of absolute profit
Page
73
EQUITY SHARE
CAPITAL
TAXATION
WAGES & SALARIES
FIXED ASSETS
LOAN CAPITAL
OVERDRAFT
OPERATING COSTS
CASH
GOVERNMENT
SOURCES
DEBTORS
In flows
Out flows
CREDITORS
LOAN REPAYMENTS
STOCKS
RAW MATERIALS
WORK IN PROGRESS
RESEARCH &
DEVELOPMENT
Figure 5.1
Page
74
Cash management is the management of liquidity to ensure there is sufficient cash to meet the
financial obligations to suppliers, employees, banks, the Inland Revenue and so on.
It makes sense to centralise the cash management of the business. The role of the finance
manager in this respect will be to forecast cash needs and monitor the utilisation of cash to
manage complete cash flow.
CASH FLOW
The Cash Flow Forecast or Cash Budget is the primary tool used for short term financial
planning. The key to managing cash is planning.
Cash budgeting is the term given to the projection of inflows and outflows of cash a specified
time periods which may be weekly or monthly for periods of up to one year ahead.
The objective of cash flow planning is to make an early assessment of the expected levels of
cash surpluses or deficits at future dates so that plans can be made to either hold or invest
surpluses or to arrange borrowing or even permanent financing where shortages are expected.
Page
75
2.
3.
Comparing forecasted inflows and outflows to determine the net cash flow for
each time period.
4.
Calculate the cumulative cash flow by adding the opening cash flow balance to
the net cash flow for the period.
By examining the forecasted movements in cash over several periods, cash flow can be
anticipated for cash planning. Action can be taken in advance, for future cash acquisitions and
utilisation.
The cash flow plan therefore is a forecasting tool to manage the cash flows between
debtors and creditors through the company as the trading intermediary.
Page
76
2) TOTAL INCOME
Step 2)
3) EXPENDITURE / PAYMENTS
Step 3)
Cash Payments
Creditor Payments
Wages & Salaries
Rent & Rates
Heating & Lighting
Interest Payments
Dividends
Loan Repayment
Taxation
Purchase of
Fixed Assets
Page
77
4) TOTAL EXPENDITURE
Step 4)
5) NET CASHFLOW (+ or -)
Step 5)
Step 6)
This format will then be set to determine the cash budget for a specified period. As a control
tool for financial management the actual cash movements can later be compared with those
that have been forecasted to determine a variance in cash movement for the each time period of
the budget.
A budgeted cash flow statement may have the appearance as shown in Figure 5.2.
Page
78
MONTH 2
MONTH N
TOTALS
minus 4 )
79
DISCUSSION QUESTIONS
1.
2.
Page
80
SESSION 6
81
VALUE ADDED
DEFINITION
EXPLANATION
KEY RATIOS
DISCUSSION QUESTIONS
Page
82
Managements responsibilities extend to : Shareholders, who expect a return on their investment commensurate with alternative
investment opportunities and the risk involved, and a growth in the value of their
shareholding.
Employees, whose security may depend on the continued existence of the company and
whose level of earnings may also depend on its prosperity.
Page
83
Page
84
ADEQUACY OF PROFIT
Profit is a common denominator for measuring how well a business utilises the resources
invested in it.
In the longer term, the profit earned by a business must be adequate to ensure its
continuity and fulfillment of the responsibilities referred to earlier. In particular, an
adequate profit is one which ensures that : Shareholders receive a dividend in line with going rates of return on alternative
investments
The real capital of the business is preserved during an inflationary period
Sufficient cash flow is generated to provide funds for expansion and for research and
development
Page
85
86
Page
87
The investment necessary for growth requires substantial and normally irregular flows
of cash. Unless proper financial arrangements are made, a rapidly growing company,
although profitable, may run into serious liquidity problems, which can be more
damaging to its survival than even a loss making situation.
It is important, therefore, that efforts to maximise profit through growth do not lead to
over-trading and a liquidity crisis. It is the duty of the Finance Manger to coordinate
the growth plans of various departments such as production and sales and to interpret
them in financial terms so as to ensure that adequate finance is available to sustain the
projected growth.
Page
88
Page
89
New capital introduces cash into the firm when isued but never appears in the
profit and loss account
Research and development affect the cash balance when paid for but may be
charged in the profit and loss account over several years.
NOTE
PROFIT IS A CONCEPT.
CASH AT BANK IS A FACT.
CASH IS KING ! ! !
Page
90
RETURN ON INVESTMENT
2. ROCE
3. ROSHF
4. ROA
RETURN ON ASSETS
Page
91
RETURN
Ratios 1 to 4 use the term return, the term simply means the profit figure generated
from the income statement. It is important to use the same measure of profitability to
be able to compare performance over time. In this way comparative reference can be
tracked and assessed.
Pre-tax profit can be used or profit before interest and tax are charged simply because it
gives a better reflection of the actual profit generated from trading as a business.
It is also common to use EBITDA which is Earnings before Interest, Tax Depreciation
and Amortisation as a measure of profitability and a basis for comparative analysis.
The most fundamental aspect of return is to ensure the basis to measure it over time is
consistent.
Page
92
MEASURES OF RETURN
1. ROI
2. ROCE
Page
93
3. ROSHF
This shows the return the company has achieved from the funds owned by its
shareholders. These include issued shares, capital reserves and revenue
reserves from accumulated profits.
Capital revenues may arise from revaluation of fixed assets, premiums on
shares issued at a price in excess of normal value.
Revenue reserves are mainly in the form of retained earnings that have
accumulated.
THIS COULD BE CONSIDERED AS THE MOST IMPORTANT
RATIO IN BUSINESS FINANCE.
4. ROA
Page
94
5. Gross Profit as a % of sales includes the margin of profit left after the direct costs of the
business have been charged, referred to as the cost of sales, therefore the Gross Profit
margin is determined by deducting the cost of sales from the revenue generated.
6. Pre tax Profit as a % of sales (also called net profit) is the profit made after deducting the
indirect costs of the business from the Gross Profit Figure. These indirect costs include items
of expense that must be paid from the revenue generated in order to produce the net profit
figure.
7. PBIT, a Profit Before Interest and Tax is charged is simply a variation on the Pre Tax
formula, but it deducts the amounts paid by the business on tax and interest actually paid
within the year.
8. EBITDA is yet a further development of the PBIT approach, but the measure of profit
ability (called earnings) is assessed after deducting amounts for interest, tax and depreciation
amortisation. Note E stands for Earnings, which is another term for profit.
Page
95
VALUE ADDED
DEFINITION
Value Added is the difference between the value of an enterprises outputs and the value of its
inputs.
EXPLANATION
By converting inputs into outputs the enterprise literally adds value to the materials and
services it buys through a series of conversion processes to make a saleable output.
This added value in the conversion process is in fact wealth generated by the company. A
key issue to take into account is how that wealth is distributed, ie. normally through
wages and salaries (the main component) taxes, interest payments, dividends
depreciation and in retained earnings.
Page
96
Labour is treated as a participant in the distribution of wealth rather than a charge in the
value added statement.
Page
97
x 100
VALUE ADDED
2.
showing the value added created by employees for each dollar spent on labour
Page
98
Similar to return on investment, but this shows the wealth created from the investment made.
VALUE ADDED
100
INVESTMENT
The enterprise must aim to maximise value added through increasing productivity and efficiency.
Page
99
DISCUSSION QUESTIONS
1. WHAT IS THE DIFFERENCE BETWEEN PROFIT AND PROFITABILITY?
2. WHAT ARE THE MAIN MEASURES OF PROFITABILITY USED BY THE
FINANCIAL ACCOUNTANT AND HOW ARE THEY DIFFERENT?
3. WHAT IS THE DIFFERENCE BETWEEN CASH AND PROFIT.
4. HOW IS PROFIT DIFFERENT FROM VALUE ADDED.
Page
100
SESSIONS
7, 8, 9
PROFITABILITY RATIOS
EFFICIENCY RATIOS
LIQUIDITY RATIOS
FINANCIAL GEARING RATIOS
INVESTMENT RATIOS
DISCUSSION QUESTIONS
Page
101
PROFITABILITY
EFFICIENCY
LIQUIDITY
FINANCIAL GEARING
INVESTMENT
Figures to calculate these ratios are mainly taken from the income statement and the balance
sheet.
Page
102
PROFITABILITY RATIOS
Name of Ratio
Formula
State result as
Gross profit
Sales
X 100
5. Net profit ratio (after tax and before Net profit after tax and before interest
Sales
interest)
6. Net profit ratio (after interest and
tax)
(1) NOTE
%
%
%
103
EFFICIENCY RATIOS
Name of Ratio
Formula
State result as
1. Inventory turnover
Cost of Sales
Average Stock
Debtors
Sales
X 100
Debtors
Sales
X 365
Days
Creditors X 100
Purchases
Creditors X 365
Sales
Days
Days
Sales revenue
Share capital + reserves + long term liabilities
Sales
Number of employees
Times
Page
104
9. Return on shareholders
funds
(1) Sales
Fixed assets
(2) Sales
Current assets
(3) Sales
Total assets
Times
Times
Times
(1) NOTE
(2) NOTE
105
LIQUIDITY RATIOS
Name of Ratio
Formula
State result as
1. Current ratio
Current assets
Current liabilities
Ratio
Ratio
3. Working capital
turnover
Sales
Working capital
Times
Page
106
Formula
State result as
1. Gearing ratio
These gearing ratios will also help to assess the solvency of the business.
Page
107
INVESTMENT RATIOS
Name of Ratio
Formula
State result as
DIVIDEND PAYOUT
RATIO
Dividends Announced
Profits for the year available for dividends
DIVIDEND YIELD
RATIO
EARNINGS PER
SHARE
PRICE / EARNINGS
RATIO (PIE)
Page
108
DISCUSSION QUESTIONS
1. ASSUME YOU ARE ONLY ALLOWED TO USE 10 RATIOS TO ASSESS THE
FINANCIAL POSITION OF A COMPANY, WHICH WOULD YOU USE AND
WHY?
Page
109
SESSION 10
110
Page
111
112
113
114
Whereby senior management will consider the future economic and industry
projections, then assess these in relation to the future corporate financial
ambition. An assessment of current resource availability and future resource
needs then allow top management to assess the demands of and provisions for
next years budget. This is all achieved with an annual budgetary cycle and
calendar.
BOTTOM UP
The Operational
Level
The process then is either top down or bottom up, but will of course involve both approaches
before the budget is approved and signed off.
Page
115
CLASSIFICATION OF BUDGETS
AT OPERATIONAL LEVEL
Functional and Departmental Budgets
Operating Budgets showing the income and expenditure for individual functions or
departments of an organisation in forms of Sales budget, Production budget, etc. These
may be allocated to cost centres or profit centres for managerial control at operational
level.
AT STRATEGIC LEVEL
The Master Budget
Financial Budgets showing the aggregate of functional and departmental budgets which
comprises of the Profit and Loss Account, Balance Sheet and Cash Budget.
Page
116
Page
117
Annual
Budgeting
Process
Figure 10.1
118
Objectives
Prepare budget
Confirm budgets
Implement plan
Budget Control
At Operational
Level
Figure 10.2
Page
119
120
121
SALES FORECAST
PRODUCTION BUDGET
Stock
Changes
SALES
BUDGET
Stock
Changes
PURCHASES BUDGET
Production, Purchasing, Marketing, Administration and R & D are analysed in physical and monetary
terms
and then allocated to responsibility centres for revenue and expenditure budgeting
PURCHASES BUDGET
SALES BUDGET
PRODUCTION COST
BUDGET
STOCK
DEBTORS
CAPITAL EXPENDITURE
BUDGETS
CREDITORS
CASH BUDGET
ESSENTIAL
FINANCIAL
STATEMENTS
MASTER BUDGET
FORECASTED PROFIT & LOSS A/C + BALANCE SHEET
THE BUDGETARY PLANNING PROCESS AND THE INTER RELATIONSHIPS BETWEEN BUDGETS
Page 122
Feb
Mar
April
May
June
(000)
(000)
(000)
(000)
(000)
(000)
60
52
55
55
60
55
10
10
10
10
10
10
30
30
31
26
35
31
(1) Income
Revenue forecasts
(2) Expenditure
Electricity
14
Other Overheads
Capital Purchase
___
___
11
___
___
___
42
42
68
38
47
52
18
10
(13)
17
13
12
30
40
27
44
57
30
40
27
44
57
60
NOTE : The budget anticipating a positive cash balance through the 6-Month period
Page
123
2. EXPENDITURE
3. TOTAL PAYMENTS
5. OPENING BALANCE
124
VARIANCE ANALYSIS
The purpose of budgeting is to determine a forecast for expected financial behaviour and
performance. In this sense a budget is a estimate only.
Against this estimate, actual performance must be compared as part of the management
control process. The difference between actual performance and budgeted performance is
referred to as a variance.
A favourable variance is where actual performance is better than that budgeted
An adverse variance is where the actual performance is worse than the budgeted
The relationships across all variances will influence profit in the following way : Budgeted profit (plus) All favourable variances (minus) All adverse variables =
Actual profit
Page
125
126
DISCUSSION QUESTIONS
1. WHY DO COMPANIES NEED BUDGETS?
2. WHAT IS THE
COMPONENTS?
TYPICAL
BUDGETING
PROCESS
USED
IN
MOST
Page
127
SESSION
11 & 12
128
Page
129
JOB COSTS
Page
130
CONTRACT
COSTING
This is form of job costing, but for large contracts, for example,
civil engineering contracts, where the costing exercise is
detailed with a profit motive to be embedded in the costing
exercise.
PROCESS COSTING
131
BATCH COSTING
Page
132
Estimate costs
Forecast any change to cost during the life of the costs incurred
Page
133
Direct costs
Direct Costs
Indirect Costs
are those that are specially incurred with the output of a product or service, for
example, the direct material used and the direct labour employed. These costs
are therefore the prime costs associated with, for example, production of a
specific product.
However to achieve this output, there are other costs involved to be able to convert the
materials and labour into the finished product, these are known as indirect costs.
Indirect costs
are all other costs incurred but which cannot be measured in respect of a
particular unit of output, hence the term indirect. These costs comprise the
overhead costs of the business, eg. Administration, marketing & selling
costs, which are a necessary expense to the business.
Page
134
These terms are important as they will be used to determine profit whereby : (1)
SALES REVENUE
(2) MINUS
DIRECT COSTS
(3) EQUALS
(4) LESS
INDIRECT COSTS
(5) EQUALS
The understanding of Direct and Indirect Costs is hence essential to determine Gross Margin of
Profit as well as the Net Operating Profit. The proportions between each will vary from industry
to industry.
The significance of these two types of costs is that : (1) They must be managed, monitored & controlled
(2) They should be contained within a budget for the purposes of (1) above.
Page
135
are those which do not change with output, they are incurred regardless of
sales or production. For example, premises rental if a business has no
sales, the rent still must be paid, therefore it is a fixed cost.
VARIABLE
COSTS
are those which will change with output and will therefore depend upon
output, for example the food costs in a restaurant will be influenced by the
number of restaurant guests ordering food.
TOTAL COSTS
Page
136
FIXED COSTS
DIRECT COSTS
INDIRECT COSTS
TOTALS
TOTALS
TOTAL
COST
Figure 11.1
The challenge is to achieve a fair basis to apportion the indirect costs to a particular job costing exercise.
Such a matrix maybe useful as a basis for managerial discussion on cost control, furthermore this could
apply at each stage in a manufacturing process.
Page
137
Direct
Materials
Direct
Labour
Direct
Costs
PROCESS
2
Machining
Dept
PROCESS
3
Finishing Dept
Further
Direct Costs
PROCESS
4
Finished
Goods Store
TOTALS
Further
Any Direct
Direct Costs Costs if at all
Accumulated
Indirect
TOTALS
A Proportion
of the
Business
Overheads
A Proportion
of the
Department
Overheads
A Share of
the Financial
Departments
Overheads
Allocation of
Share
Overheads
TOTAL
COSTS
Figure 11.2
Page
138
Historical Cost
Opportunity Cost
Replacement Cost
Fixed Cost
Variable Cost
Sunk Cost
139
Direct Cost
Indirect Cost
Overheads
Marginal Costs
Page
140
Cost Centre
Cost Variance
Page
141
Cost Behaviour
Standard Costs
Inflation
Page
142
Contribution
Cost Variance
Page
143
Specific orders
Job
Costing
Batch
Costing
Continuous operations
Contract
Costing
Process
Costing
Function /
Service Costing
Method of
Cost Control
Treatment of
Fixed Costs
Charging
Overheads
Figure 11.3
Page
144
From Figure 11.3, the overall cost control system for product costing will comprise : 1. Costs of Continuous Operations
2. Costs of Specific (Special) Orders
The costing methods applied to continuous operations will probably be based upon process
costing, whereas for the special orders costs will need to be applied to either :
The Job
The Batch
The Contract
To complete the costing exercise, decisions will have to be taken as how to change the fixed
and variable costs. This could be completed using :
145
Marginal Costing
146
Figure 11.4
FULL ABSORPTION
COSTING
AND
Direct Materials
Direct Labour
Direct Materials
Direct Labour
Variable Production Overhead
Variable Selling & Distribution Overhead
2. Contribution Margin
Selling Overhead
Distribution Overhead
Admin Expenses
R & D Costs
EQUALS
3. Total Cost
PLUS %
Mark Up
4. Margin
EQUALS
MARGINAL
COSTING
147
148
However the lunchtime menu could be a fixed price for a Business Lunch with a
fixed limited menu, or even a fixed price buffet lunch. This price will be lower than
that for the dinner menu because the price is based upon managerial costing principle
whereby as long as the lunch menu price exceeds the variable cost of food ingredients
and the staff employed, there will be a contribution to the fixed costs of the business
eg. the rental and electricity overheads.
Probably no absolute profit will be made. But overall the restaurant will be profitable
because the lunchtime business contributes to the business overheads as well as
covering the variable costs incurred.
Page
149
Page
150
Marketing
& Sales
Customer
Order
Processing
Credit
Control
Stock
Control
Invoicing
Process
Figure 11.5
Despatch
&
Delivery
After
Sales
Service
FIXED
COSTS
VARIABLE
COSTS
TOTAL
COSTS
151
The key to activity based costing (ABC) is activity based management and the
availability of data and information flows to accurately assess current and future
costs.
The realisation of the total cost per unit or for a total end to end process can
sometimes be alarming and then when this approach is used to set price, the level at
which price needs to be charged may make the product or service uncompetitive.
Page
152
Page
153
PROFIT VARIANCE
SELLING &
DISTRIBUTION COST
VARIABLES
Sales Price
Variance
Sales Volume
Variance
DIRECT
MATERIALS
VARIANCE
DIRECT
LABOUR COST
VARIANCE
VARIABLE
OVERHEAD COST
VARIANCE
FIXED
OVERHEAD
COST VARIANCE
Figure 11.6
Page
154
Page
155
FIXED COSTS
VARIABLE COSTS
These two types of costs will be applied to determine BREAK EVEN ANALYSIS.
Page
156
Figure 11.7
COST
()
FIXED
COST
LINE
0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)
NOTE
157
Figure 11.8
STEP 2
COST
()
0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)
NOTE : THE VARIABLE COST LINE STARTS AT THE AXIS OF THE CHART, THE STEEPNESS OF THE
LINE IS REFLECTED BY HOW VARIABLE COSTS CHANGE WITH THE VOLUME OF OUTPUT
Page
158
Figure 11.9
STEP 3
COST
()
F
Fixed
costs
0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)
NOTE
: THE TOTAL COST LINE IS A SUMMATION OF FIXED PLUS VARIABLE COSTS. THE TOTAL
COST LINE STARTS AT THE POINT AT WHICH FIXED COSTS HAVE BEEN PLOTTED
Page
159
Figure 11.10
STEP 4
REVENUE
& COST
()
Break Even
Point
Total Cost
Variable
costs
Loss
F
Loss
Fixed
costs
0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)
NOTE : THE BREAK-EVEN POINT IS WHERE TOTAL REVENUE EQUALS TOTAL COST. THE CHART
ALSO SHOWS PROFIT AND LOSS ESTIMATES FOR DIFFERENT LEVELS OF OUTPUT
Page
160
BREAKEVEN CHART
Figure 11.11
Sales Revenue
Total Costs
Profit
Breakeven
Sales
Variable Cost
Breakeven
Point
Loss
Fixed Costs
Breakeven Output
0
VOLUME (UNITS)
NOTE : From a management perspective, the relevant range of business activity can be forecasted and
then assessed against the breakeven point. In this way a margin of safety can be assessed, being
between the break even point and the forecasted (or actual) volume of output.
Page 161
Figure 11.12
To complement the breakeven chart, the profit volume chart can be used to examine, through the
chart, an estimate of profit or loss at different volumes of activity.
PROFIT
()
The PV Line
Total Sales Total Costs
Break Even
Point
Fixed cost
0
LOSS
VOLUME OF ACTIVITY
As $ Sales Revenue (or
% capacity)
LOSS
()
F
Page
162
To draw a PV Chart the following steps can be taken : 1. On the vertical axis, (the Y axis) the fixed costs are logged. This is the position where the
company has no sales.
2. The breakeven point is then plotted along the base axis (the X axis)
3. The line can be drawn by connecting the points on the X and Y axis.
NOTE
1.
2.
3.
4.
5.
Total Contribution
Unit Contribution
The PV Ratio
=
=
=
163
P.V. Ratio
Unit Contribution
Total Contribution
Unit Selling Price or Total Sales Revenue
Net Profit
164
Using the following data, ascertain the companys break even point.
Number of units produced
Sales Forecasted
Total Fixed Costs ( )
Variable Costs Per Unit ( )
Selling Price Per Unit ( )
40,000
36,000
201,600
14.00
20.00
The Directors of the company would like to know the number of units that need to be sold if they are
to recover 15% of the companys initial investment of 330,000.
Page
165
POINT (4)
POINT (5)
PROFIT FORECAST
20 x 36,000
= 14,400
720,000
= 0.02%
Page
166
Conclusion, Alexis cannot recover the initial investment on current sales forecasted and the
initial profit on sales of 720,000 is only 14,400. It is unwise to pursue this further without
careful assessment of the costs and market potential.
Page
167
DISCUSSION QUESTIONS
1. YOU HAVE BEEN ASKED TO ADVISE A USED CAR DEALER ON DIFFERENT
COSTING APPROACHES TO DECIDE PRICES TO BE CHARGED, BUT HAVE TO
TAKE INTO ACCOUNT THAT THE OWNERS OF THE BUSINESS MUST ACHIEVE AN
EFFICIENT INVENTORY TURNOVER TO AVOID TOO MUCH CAPITAL BEING TIED
UP.
Page
168
SESSION 13
169
170
Consider the preset value of 1 today with a financing cost of 20% and look at the value of
Pence
that 1 over a 10-year period and then realise how the preset value of that 1 diminishes.
100
90
80
70
60
50
40
30
20
10
0
10
If other concepts, such as inflation, opportunity cost, risk and even depreciation are
considered then the value is further diminished.
Page
171
172
To measure the economic worth and to provide a realistic estimation of return various common
methods are in use called capital investment appraisal methods.
Page
173
1.
2.
3.
4.
Page
174
1.
x 100%
Average Investment to earn that Profit
This is also referred to as the average return on investment and is a simple yardstick to compare
return against the cost of capital for the investment to determine if the accountancy rate of return
is sufficient in accordance with the companys objectives or investment practices.
Page
175
2.
PAYBACK
PERIOD (PP)
The 3 projects shown on the next page have different levels of initial investment
and different rates at which that investment is being repaid from net inflow of
cash.
Page
176
PROJECT
A
PROJECT
B
PROJECT
C
( m)
( m)
( m)
(10)
(15)
(20)
Year 1
(5)
Year 2
(2)
Year 3
(5)
Year 4
Year 5
15
15
3 Years
5 Years
Initial Investment
Net Cash Flows
Payback Period
Not Achieved
This method is simplistic, assumes a real ability to forecast future net cash flows and ignores the
future and/or residual value of the project, but it is a beginning.
Page
177
3.
The NET PRESENT VALUE method of Capital Investment Appraisal is more superior than the
payback period or the Accountancy Rate of Return because it considers :
1. The timing of the cash flows
2. All relevant cash flows
3. The real objectives of the business in relation to cost of capital
The NPV method uses Discounted Cash Flow (DCF) tables which represent the time value of
money as discussed earlier.
The DCF Tables will show the present value factors at different rates of interest so that the net
worth of money received in future years can be understood in terms of its present day value.
Page
178
INTEREST RATES
179
Page
Net Cash Flows are forecasted and present value factors applied
from the table of net present value factors
Page
180
Discount Factor*
@15%
Present Value
$m
1.0000
(10)
Year 1
.8696
.8696
Year 2
.7561
2.2683
Year 3
.6575
3.945
Year 4
.5718
2.859
Year 5
.4972
1.988
*
NPV
1.930
* See tables to confirm Present Value Factors at 15% for a 5-year period
* NPV = Net Present Value which is beyond the Cost of Capital at 15% Per Annum, so is therefore
favourable
Page
181
PROJECT B
The Net Present Value Factors are applied to the Forecasted Net
Cash Flows to determine present value
Page
182
(15)
Discount Factor*
@19%
Present Value
$m
1.000
(15)
Year 1
(5)
.8403
(4.215)
Year 2
(2)
.7062
1.412
Year 3
.5934
1.780
Year 4
.4987
4.488
Year 5
15
.4190
6.285
*
NPV
(8.074)
NEGATIVE, REJECT
* See tables to confirm Present Value Factors at 19% for a 5-year period
Page
183
CONCLUSION
Project A in Thailand has cost of capital at 15% but the NPV (Net Present Value) of this
Project is $1.930 million showing that the return from the project exceed the cost of capital
over the 5-years life of the project. Assuming the forecasts of Net Cash Flows have a good
level of tolerance, then the project should be accepted.
Project B in Vietnam has a higher cost of capital at 19% and yields after 5-years an NPV of
(S8.07 million). This negative NPV shows that the returns from the project are for less than
19% and therefore way below the cost of capital. Therefore the project should be rejected.
Page
184
Page
185
PROJECT ABCZ has an initial investment of 40,000, with positive net cash flows for 4years, which is the anticipated life of the project.
The company seeks to know what is the actual Internal Rate of Return in order to justify a
GO / NO GO decision.
To assess the position, two Discount Rates have been selected, 18% and 20% to determine
the actual return. From the example, it shows that at 18% the project has a positive NPV, so
therefore the actual IRR is greater than 18%. Using the simple formula for interpretation
between the two points of 18% and 20% the precise IRR can be calculated.
Page
186
FIGURE 13.1
PROJECT ABCZ
Year
Net Cash
Flow
Present
Value
18%
(40,000)
1.0000
16,000
Present
Value Value
Present
Present
Value
20%
(40,000)
1.0000
(40,000)
0.8475
13,560
0.8333
13,333
16,000
0.7182
11,491
0.6944
11,111
16,000
0.6086
9,738
0.5787
9,259
12,000
0.5158
6,189
0.4823
5,787
NPV
= 18% +
978
978
978 + 510
NPV
x 2%
(510)
= 19.31%
That is the base of 18* + An Adjustment to determine the actual IRR which is between 18% and 20%.
Here the IRR is 19.31%, which if it is beyond the cost of capital would be considered acceptable for
adoption.
Page
187
Businesses use more than One Method to assess each Investment Decision
There is an Increased Use of the Discounting Methods (NPV and IRR) Over Time
There remains a Continued Popularity of ARR and Payback Period owing to its
simplicity
So therefore in conclusion, there are a number of dimensions to capital investment
decisions, these appraisal techniques offer some insight into project viability from a
financial management perspective.
Page
188
DISCUSSION QUESTION
1.
2.
Page
189
SESSION 14
FINANCING A BUSINESS
SHARE ISSUES
FACTORING & INVOICE DISCOUNTING
Page
190
DISCUSSION QUESTIONS
Page
191
FINANCING A BUSINESS
Funding any business is an essential requirement, it is important to know when funds are
needed and to the level they are required.
Once this is determined, companies should be aware of how funds can be raised, this is
known as the source of funds .
Funds can be sourced from both internally and externally.
Page
192
SHORT TERM
--
--
--
--
--
--
--
Personal Loans
--
--
Invoice Factoring
Page
193
SHORT TERM
--
--
--
Debentures
--
--
Pension Funds
--
--
Bank Credit
Overdraft Facility
--
Invoice Discounting
--
Debt Factoring
--
194
ISSUES OF SHARES
The common methods of share issues to generate cash are : RIGHTS ISSUES
--
There are new shares offered to existing shareholders, easily the most
common method of raising equity capital for existing companies.
Shareholders are offered the right to subscribe for new shares in the
proportion to their existing shareholding, thus enabling them to retain
their current voting control.
--
195
PRIVATE PLACING
--
Page
196
In this way, the source is MATCHED to the application. Interest rates should be carefully
considered and the ability to repay the loan together with the flexibility allowed.
Page
197
OR
Assignment of Debts
(called factoring)
The purpose is simply to use the companys debtors as a means to raise finance for the business.
With invoice discounting, the risk of default by the debtor remains with the borrower.
With factoring, the factor bears the loss in the event of bad debt.
The common factoring process provides cash upfront of up to 80% of the value of invoices,
repayments are paid, together with the interest charged, from the cash collected by the factoring
agent from debtors.
Page
198
GOVERNMENT
ASSISTANCE
Page
199
DISCUSSION QUESTIONS
IMAGINE YOU ARE ABOUT TO START UP A NEW BUSINESS FOR THE FIRST
TIME. WHERE WOULD YOU SOURCE CAPITAL FOR YOUR NEW VENTURE ?
HOW WOULD YOU KEEP THIS BUSINESS FINANCIALLY STABLE ?
IF YOU WERE FACING DIFFICULTIES BECAUSE CUSTOMER DEMAND HAS
DROPPED AND YOU ARE ALSO FACING DIFFICULTIES IN COLLECTING
MONEY FROM DEBTORS . . . WHAT ACTIONS CAN BE TAKEN ?
Page
200
ANNEX 1
SEMINARS
Page
Page
ASSIGNMENT PREPARATION
2.
3.
4.
5.
6.
EXAMINATION BRIEFING
Page
Page
1. Students Are Required To Present The Plan For Their Financial Management
Assignment
2. Students Will Be Selected For Presentation Depending Upon Class Size
3. Group Feedback From Peers Will Be Obtained
4. Critique Given By Tutor
5. Tutor Explains How The Assignment Is Marked And The Criteria Used For
Assignment Evaluation
Page
TOPICS 1 TO 7
Page
TOPICS 8 TO 14
Page
Protocols
Examination Techniques
Tutor Expectations
Page
ANNEX 2
RECOMMENDED READING
Page
Atrill (2006) Financial Management for Decision Makers, 4th Ed, Financial Times Press
Brealey, R. A., Myers, S. C. & Allen, F. (2008), Principles of Corporate Finance, 9th
Edition, McGraw-Hill
Brooks, R. (2009), Financial Management : Core Concepts, 1st Ed, Pearson Education
Higgins, R. (2007), Analysis for Financial Management, ISE Edition, McGraw Hill
Education
Neale, B. & Pike, R. (2009), Corporate Finance and Investment Decisions & Strategies,
6th Ed, Prentice Hall
Titman, S., Martin, J. & Keown, A. (2010), Financial Management : Principles and
Applications : International Edition, 11th Ed, Pearson Education
Page
Websites
www.bloomberg.com
www.corporateinformation.com
www.hoovers.com
www.londonstockexchange.com
http://finance.yahoo.com/
www.hemscott.com
Page
ANNEX 3
Page
ANNEX 3
Page
Efficiency
Liquidity
Profitability
Financial Gearing
You are required to summarise the analysis with your key findings from this overview.
Page
2. Select any one area from the course on Financial Management and then prepare a
report outlining the following : 2.1
2.2
2.3
2.4
2.5
3. You have been asked to advise an international company in the textbook publishing
industry upon how to improve their book sales by considering all the relevant concepts
of financial management related to costs, costing and cost behaviour.
Page
3. What is Cash Management and how is this function normally achieved by the Finance
Manager.
Page
4. Explain the term Working Capital . How do we ensure that this type of capital is
working effectively.
5. Why do trading companies need profits ?
6. To assess the financial position of a business, a financial analyst would use a series of
financial ratios. Outline the main types of ratios and explain what they are intended to
achieve.
7. Explain the purpose of budgeting for any business organisation and outline what is
typically involved to achieve a system of budgetary control.
Page