Finance

Financial Management Higher Business Management

Role and importance of Financial Management
Efficient management of finance is crucial to an
organisation’s success. They have to:
Ensure adequate funds are available for resources needed to help achieve organisational objectives
Ensure costs are controlled
Ensure adequate cash flow
Establish and control profitability levels

Duties of Finance
Maintain financial records
Payment of bills and expenses
Collection of accounts due
Monitoring of funds
Payment of wages and salaries
The main role Finance provides information for managers and decision-makers within business

Annual Accounts
There are four main financial statements used (called Final Accounts):
Trading account
Profit and loss account
Balance sheet
Cash flow statement

Trading, Profit & Loss Account
The trading account records how much money is made from selling goods against how much it costs to make. The gross profit is calculated in the trading account.
The profit and loss account shows the businesses incomes and expenditures. The net profit is calculated in the profit and loss account.

Trading Account Format
£ £
Turnover (or sales) 180,000
Cost of sales
Opening Stock 40,000
Purchases 95,000
135,000
Less: Closing Stock (45,000) 90,000
GROSS PROFIT 90,000

Profit and Loss Account Format
£ £
Gross Profit 90,000
Other income
Interest received 11,000
101,000
Expenses
Rent and rates 25,000
Wages and salaries 45,000
Insurance 2,000 72,000
NET PROFIT 29,000

Profit and Loss Account Key Terms
Trading account – provides summary of business’s trading activity during financial year
Sales – monies received through selling goods/services
Cost of sales – cost of sales to a business before a profit margin is added
Opening stock – value of stock at start of the financial period
Closing stock – value of stock at end of the financial period

Purchases – cost of goods business has bought for resale to customers
Purchase returns – value of goods purchased but returned to supplier
Sales returns – value of goods bought by customer but returned to the firm
Expenses – any expenses incurred by the business in the course of normal operation
Profit and Loss Account Key Terms

Interpretation of Trading, Profit & Loss Accounts
Was this year’s trading result good or bad, compared with last year or with a rival company?
Has the Gross Profit improved this year, compared with last year?
Are we making efficient use of our stock?
Does our Net Profit figure compare favourably with those of other organisations in the same industry?

Balance Sheet
The profit and loss account shows the history of the business activity throughout the financial year.
The balance sheet shows a snapshot of a particular date in time.
CAPITAL = ASSETS - LIABILITIES

Balance Sheet Assets Liabilities & Capital Balance

Assets
Assets – are what a business owns
Fixed assets – have a lifespan of more than one year, eg machinery, motor vehicles
Current Assets – are constantly changing eg stock, debtors, bank, cash

Liabilities
Liabilities – what is owed by the business
Current Liabilities – eg trade creditors (suppliers of goods on credit), bank overdraft, short-term loans (less than 1 year)
Long-term liabilities – normally longer than 1 year – eg mortgage, bank loan

Capital
Capital – provided by the owner of the business and treated as being owned to the owner of the business
Profits – may increase capital
Drawings – may decrease capital
Reserves – monies retained by business

Liquidity
Liquidity shows us whether a business has enough assets to cover its debts.
Turning assets into cash to pay off debts is what normally happens.
Stock is the hardest to turn into cash. Why?

Working Capital
Working Capital is:
Current Assets – Current Liabilities
If a business has too much working capital then they are not using their resources properly.
If too little, then they may not be able to pay off short term debts.

Interpretation of Balance Sheet
Do we have enough working capital to avoid cash flow problems?
Are we making enough use of available trade credit?
Is our level of debtors comparable with that of our industry competitors?

What are Ratios?
Ratios are a way of comparing different figures.
Ratios should only be used when comparing like with like (ie same size of business; same industry)
Ratios can compare results with previous years or rival firms
Ratios, however are historic, and do not take into account of other factors such as quality of workers, inflation, economic situation

Uses of Ratio Analysis
Compare current performance with previous years
Compare performance against similar organisations
Identify changes in performance to aid future actions
Identify trends over time

Limitations of Ratio Analysis
Information is historic
Comparisons must only be made with similar organisations (size, industry)
No account of external factors (PEST)
No account of NPD or declining products
No account of human factors (staff morale, staff turnover)

Ratios
Profitability
Gross Profit percentage
Net Profit percentage
Return on Capital Employed (ROCE)
Liquidity
Current Ratio
Acid Test Ratio
Asset Usage
Rate of Stock Turnover

Gross Profit Percentage
Gross Profit
Sales Revenue
Measures profit made from buying and selling stock
For every £1 of sales, how much profit is made?
Increase = more sales generated or cost of materials have fallen
Decrease = cost of materials may have went up
X 100%

Net Profit Percentage
Net Profit
Sales Revenue
For every £1 of sales, how much profit after expenses is made?
Increase = handling expenses better
Decrease = expenses may have went up
X 100%

Return on Capital Employed (ROCE)
Net Profit
Capital Employed
If you invest £100 in a firm how much will you get back?
ROCE should be measured against interest rates. Since your savings can make money in a high interest bank account
X 100%

Current Ratio
Current Ratio = Current Assets:Current Liabilities
Looks at how business can pay off its debts
A ratio of 2:1 is considered prudent, but does not take into account stock being held.
Higher than 2:1 means money may not being invested in the business properly
Having less than 2:1 may mean the firm is in danger of not being able to pay off debts (too much money tied up in stock?)

Acid Test Ratio
Acid Test =
Current assets – stock: current liabilities
This is a tougher ratio than the current ratio because it excludes stock, since stock is the hardest asset to transform into cash.
This ratio should be around 1:1.

Rate of Stock Turnover
Stock turnover =
Cost of Sales Average Stock Stock hanging around is bad for the firm. Stock’s can go off, out of fashion or out of date. This ratio works out how many times stock is used up. Note: Average Stock is calculated by adding Closing and Opening Stock and then dividing by 2

Budgets
Budgets are statements of anticipated future expenditure covering a specific time period
Cash Budgets – show expected receipts & payments on a monthly basis to help assess potential cash flow problems

Uses of Budgets
To monitor & control
Gain information
To set targets
To delegate authority

How budgets help managers
Make them accountable for decisions
Help check income & expenditure
Can highlight need for corrective action
Help develop long term plans
Assists with decision making
A means of comparison with actual results

Cash Flow Statements
Cash Budgets/Cash Flow Statements contain estimated figures of cash position of an organisation over a period of time.
Remember the closing balance is cash and not profit!
Cash Budgets are used to highlight potential shortages or surpluses of cash resources

Cash Budget

Cash Budgets and Role of Manager Giving financial control may empower individuals Motivate Budgets spent by Dept. Mgrs. Delegate Measure performance Control Departmental reports Coordinate Departmental budgets Command Bulk buying? Trade discounts? Organise Borrow or not? Plan

Cash Flow Management
Liquidity – as mentioned, to check either shortages or surpluses of cash resources.
Decision-making – the role of the manager can be aided by cash budgets.
Projection – different variables and scenarios can be used (on a spreadsheet) to see what can affect the cash position of the organisation.

Users of Financial Information
Shareholders – can assess Board’s performance and decide about investment or disinvestment
Potential Shareholders – decide whether firm is a worthwhile risk
Short term creditors – should credit be granted to the firm?
Long term creditors – should money be lended to the firm? Will it be paid back?

Users of Financial Information
Government and local authorities – look to directors’ report and business plan. Do these plans affect local area?
Competitors – compare themselves with rivals to work out market share and if plans conflict with their own
Employees – can the firm pay better wages? Is the future sound?
Management – use info to evaluate past performance and used to plan for future
Customers – is firm likely to still be around? Other concerns, eg environment

Sources of Finance

Internal Sources of Finance
Retained Profits – profit kept by company for future activities
Selling Assets – money raised by selling off an asset no longer needed
Both are Short-term

External Sources of Finance
Long Term (10 years +)
Issuing Shares – capital raised by selling shares
Debentures – a fixed interest long term loan
Loans – borrowing money, repaid over a time period with interest
Mortgages – a loan secured for property

Medium Term (1-10 years)
Leasing – renting equipment or premises
Hire Purchase – acquiring an asset on credit followed by fixed payments. After last instalment purchaser owns asset.
Loans

Short Term (up to 1 year)
Overdraft – borrowing more money than is available in bank account
Trade Credit – businesses receive goods first, then pay later
Factoring – a specialist business collecting unpaid debts for a fee

Additional Sources of Finance
LEC – Scottish Enterprise Renfrewshire
Local authorities – East Renfrewshire Council
Government Partnerships – Business Gateway
Grants and allowances – Repayable Grants, Soft Loans, Subsidies
EU grants – Regional Development Fund & Social Fund

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Finance

by Marcus9000 on Oct 15, 2007

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Finance — Presentation Transcript