The document provides an overview of a module on financial planning and management. It introduces various financial concepts that will be covered, including financial planning, financial statements, costing techniques, budgeting, and investment appraisal methods. The module aims to develop skills in financial planning and reporting to help businesses achieve sustainability through tight financial controls.

1. Steve Pollard Associate Lecturer Business Institute A&B Financial Planning

2. Steve Pollard Tel: 07843 449928 Fax: 028 9036 6831 E- mail: [email_address]

3. RATIONALE Financial planning is of critical importance to business – The majority of whom fail within the first 3-5 Years. The focus of this module is therefore achieving sustainability through tight financial planning and management

4. Aims Introduce you to financial planning Develop skills in the preparation of financial statements for the purpose of business planning.

5. Areas Covered Financial Planning Key Financial Controls/Processes Financial Reporting Income and Expenditure (Profit and Loss) Statement Balance Sheet Cash Flow Forecasting Introduction to Costing. Option Appraisal Methods Introduction to Budgeting.

6. Intended Learning Outcomes Identify and evaluate the attainment of financial objectives List the key financial controls/processes Describe the purpose of the Balance Sheet CFF and the Profit and Loss Account (P&L) List the key costing techniques Use costing information to determine how cost structures can influence profitability Understand the importance of Budgeting Utilise different option appraisal techniques to evaluate options, future potential courses of action.

7. Financial Management “ Financial management is all about getting the most appropriate manpower, materials or equipment at the best price (economy), making sure that the resources are used in the most productive way (efficiency) to meet the organisation’s objectives (effectiveness).” Chartered Institute of Management Accountants

8. Three Es Economy Efficiency Effectiveness

9. Cadbury Schweppes Plc “ Our primary objective is to grow the value of the business for our shareowners. This objective is quantified in terms of three financial targets: To increase our earnings per share by at least 10% every year To generate £150m of free cash flow every year To double the value of our shareowners’ investment within four years.”

10. Financial Accounting “ Not everything that can be counted counts, and not everything that counts can be counted.” Albert Einstein

11. All About You... 1. The name of your business (and brief description) 2. Your company’s: key financial objectives attitude to surpluses & profitability 3. Your company’s’s annual turnover no of employees net worth (if you know it) key products and/or services 4. Your role 5. Financial reports that you contribute towards the preparation of are required to present interpret to help with decision making.

12. Triple Bottom Line Profit Social Environmental

13. All About You Key Trends in your sector? Planned growth / Maintain / contraction? Business / Financial Plans in place? Where in 3 Years time?

14. Financial Controls

15. Organisational Controls Exercise Please list as many financial / administrative controls that you can think of which are used within your business.

16. Basic Internal Controls Financial reporting Budgetary planning Other planning Financial policy and procedures in Place Employee behaviour Segregation of duties Qualification of staff and advisers Controls over Incoming Funds Banking procedures No cash Key Organisational Controls Controls over Expenditure Authorisation limits Double signatures Tendering process Budgets Cost centres Audit Security Asset management Payroll check Double entry.

17. Exercise Where Are You At?

18. Financial Reporting - The Traditional Accounting Control Model

19. Financial Reporting “ An individual without information cannot take responsibility; an individual who is given information cannot help but take responsibility.” Peters, T (1988) “ Thriving on Chaos – Handbook for a Management Revolution” Harper Collins, New York

20. Financial Statements How financial and physical asset resources are reported 3 main accounting statements…. balance sheet profit & loss /income & expenditure statement cash flow statement.

21. The Balance Sheet A statement of the assets and liabilities of a business at a particular date – It has two parts: A statement of Fixed Assets, Current Assets & Current liabilities – Total Assets A statement of how net assets have been financed

22. Glossary of terms Fixed Assets – Held by the enterprise rather than for sale or conversion to cash e.g. Buildings, machinery, equipment, fixtures & fittings. Current Assets – Cash and anything that is expected to be converted into cash within one year e.g. stock, debtors, cash, bank balance.

23. Glossary of Terms Current Liabilities – Liabilities to be paid within a year e.g overdraft, trade creditors, short-term loans, accrued expenses, tax. Long-term Liabilities – More than a year Total (Net) Assets – Fixed + Current less current liabilities and long-term liabilities

24. A Balance Sheet Community Day Care Centre Example Balance Sheet

25. A balance sheet can be analysed to reveal how the enterprise is performing in terms of its: Liquidity Solvency Stability Efficiency

26. Suggested Ratios Liquidity (Quick or acid test ratio) Current assets – stock Current liabilities

27. Suggested Ratios Current or Working Capital Ratio Current Assets Current Liabilities

28. Suggested Ratios Profitability (Profit Ratio) Gross Profit x100 Sales Net Profit x100 Sales

29. Suggested Ratios Efficiency (Stock Turnover Ratio) Cost of Sales Average Stock

30. Profit and Loss (Income and Expenditure) Reporting

31. Revenue (Income/Turnover/Sales) Less: Costs = Profit or Loss (Surplus or Deficit)

32. Profit and Loss Account £’000 Revenue 20 Cost of Sales (10) Gross Profit 10 Operating Costs (inc depreciation): Equipment Depreciation (estimate) (1) Fred Salary (3) Rent (2) Operating Profit 4

33. Glossary of Terms Cost of Goods Sold – The directly attributable costs of products or services sold e.g. materials, direct labour, production costs. Gross Profit – Where sales revenue (turnover) exceeds the cost of goods sold.

34. Glossary of Terms Overheads (Indirect Costs or Fixed) Costs that do not vary with changing sales or production volumes e.g. rent, rates, administration, depreciation, telephones, heat, light & power, insurance, professional fees, stationery etc.

35. Glossary of Terms Net Profit Where sales revenue plus other income (such as rent received) exceeds the sum of cost of goods sold plus overheads

36. Profit and Loss Account £’000 Revenues, Sales, Income or Turnover 1,200 Cost of Sales (600) Gross Profit 600 Operating Costs (inc depreciation) (300) Operating Profit 300 Interest Payable less Interest Receivable (25) Profit before Tax 275 Tax (75) Profit after Tax 200 Dividend (50) Retained Profit 150

37. Costing

38. Costing: The Value of Costing: An Example Consider a company with 3 products Accounts show sales of £1,000,000, costs of £700k, profit of £300k

39. Product 1 Product 2 Product 3 Total £’000 £’000 £’000 £’000 Revenue 600 300 100 1,000 Costs (350) (220) (130) (700) Profit/ (Loss) 250 80 (30) 300

40. BUT! Product 1 Product 2 Product 3 Total Sales 600 300 100 1,000 Direct Costs (280) (160) (80) (520) Contribution 320 140 20 480 Indirect Costs (70) (60) (50) (180) Profit/(Loss) 250 80 (30) 300 Total Costs 350 220 130 700

41. Costing Terminology Direct Costs Costs that can be specifically linked to a product, department, function or business unit. Indirect Costs Those costs that cannot be linked, specifically to a product, department, function or business.

42. Costing Terminology Fixed Costs Costs which in the short term remain unchanged regardless of the level of activity. Variable Costs Costs that change as the level of activity changes.

43. Accurately Identifying Costs Start-Up Direct Overheads Capital (See Handout: Costs Table)

44. Exercise Costs in Year One for a New Start Community Day Care Centre

45. Review Handout Community day Care Centre

46. Break-Even When Sales Revenues = Costs Point at which enterprise is making neither a profit or loss

47. Break-Even Indicates the point at which all costs are covered by sales revenue Prompt you to reassess the price if break-even appears unachievable Helps calculate the level of sales required to cover any additional fixed costs such as new premises, equipment or staff

48. Calculating Break-Even One Product or Service Overheads__________________ Price of unit – direct costs of unit = No. Units

49. Community Day Care Centre Example £111,767 = 1,242 weeks per year £100 - £10 Open 50 weeks p.a. then 1,242 / 50 = 25 Children

50. Break Even Analysis 20,000 40,000 60,000 20 40 Units £’000 C F E D B A

51. Costing Techniques Marginal Costing Absorption Costing Activity Based Costing Standard Costing

52. Marginal Costing A useful way of emphasising the marginal costs of production and services. This information is of great assistance when making pricing decisions.

53. Marginal Costing If the selling price < variable cost, the loss will increase as more units are sold This will be acceptable only in limited circumstances Example? Supermarket loss leaders.

54. Marginal Costing If selling price > variable cost, then the margin will absorb part of the fixed costs After a certain point, profits will be made MC explains why some goods are sold off very cheaply Example? Airline tickets.

55. Absorption Costing Takes into account all costs Allocates them to individual products or cost centres Some are directly attributable to a distinct activity Examples: materials, dedicated employees wages.

56. Absorption Costing Others are not directly attributable Allocation required as costs must be absorbed by each product No single correct method of overhead allocation Aim is to achieve fairness in each individual situation Examples: finance, personnel, IT.

57. Activity Based Costing Takes total cost allocation one step further More accurate cost management methodology than traditional cost accounting Focuses on indirect costs (overheads) Traces rather than allocates each expense category to the cost driver Effectively makes “indirect” expenses “direct.”

58. Standard Costing A system for identifying predetermined or target unit costs that should be achieved under efficient operations.

59. Uses of Cost Accounting Cost Control Promoting Responsibility Aid Business Decision Making Aid Pricing Decisions Understanding the nature of your costs, and what drives them, is vital for effective management decision making.

60. Cashflow Concerned with the flow of cash in and out of the business Provides a guide as to whether sufficient cash will come in to cover cash going out May have to Manage e.g. Overdrafts

61. Cashflow Statement Template See Handout

62. Making Capital Investment Decisions Appraisal Techniques

63. Investment Decision Techniques Payback Return on Investment (RoI) or Accounting Rate of Return (ARR) Discounted Cash Flow Net Present Value (NPV) Internal Rate of Return (IRR).

64. Investment Appraisal Methods Please refer to Investment Appraisal Methods Handout

65. Payback Simple measure of the period of time taken for the savings made to equal proposed capital expenditure.

66. Payback: Example A new machine will cost £100,000. It will save £40,000 running expenses in the first year and £30,000 per year thereafter Can you calculate the payback period?

67. Payback: Solution A new machine will cost £100,000. It will save £40,000 running expenses in the first year and £30,000 per year thereafter Payback period is 3 years.

68. Return on Investment (Accounting Rate of Return) Takes the average of the money saved over the life of the asset and expresses it as percentage of the original sum invested

69. A new machine will cost £100,000. It will save £40,000 running expenses in the first year and £30,000 per year in each of the remaining 7 years Can you calculate the return on investment or accounting rate of return? Return on Investment (Accounting Rate of Return)

70. Return on Investment (ARR): Example A new machine will cost £100,000. It will save £40,000 running expenses in the first year and £30,000 per year in each of the remaining 7 years The RoI is 250,000x100 = 31.25% p.a. 100000 x 8

71. Discounted Cash Flow (Net Present Value) Does take account of the time value of money Therefore considered best method More difficult to understand! Discount factor = 1 (1+r)t r is the discount rate/interest rate t is the time period of the cash flow.

72. Discounted Cash Flow (Net Present Value) Question The purchase of 2 competing piece of machinery are under consideration Machine A costs £100k and will save £60k in year 1 and £55k in year 2 Machine B costs £90k and will save £55k in both years 1 and 2 Savings occur at the end of each year with bank interest at 10% Can you calculate the NPV of the two projects?

73. Discounted Cash Flow (NPV): Solution Machine A Machine B Expenditure Now £ 100,000 £90,000 Less Year 1 Savings (discounted) £ 54,540 £49,995 £ 45,460 £40,005 Less Year 2 Savings (discounted) £ 45,430 £45,430 Savings at Net Present Value ( £ 30) £ 5,425 Conclusion: Machinery B the better option

74. The Use of Appraisal Methods in Practice Capital Investment Evaluation Methods in 100 large US Firms: Frequency of Use Firms Using Total Always Mostly Often Rarely % % % % % Payback 94 62 14 12 6 ARR 50 21 5 13 17 IRR 81 54 7 13 7 NPV 74 33 14 16 11 Source: Pike & Neale, Corporate Finance and Investment

75. Financial Planning and Monitoring

76. Monitoring Performance Required by law to exercise control Need effective systems for monitoring financial performance in place Need to gather and understand financial information needed to make decisions

77. How?

78. How Book-Keeping records Budgets Cashflow P&L Statements Balance Sheet

79. Budgets Estimate of Income / Expenditure for a set period Most likely to be used for: Preparation of Cashflow Forecasts Preparation of P&L Forecasts

80. Budgets Many types but 4 Main Ones are: Sales Budget Materials / Direct Costs Budget Overheads Budget Capital Expenditure Budget

81. Budgeting Annual Operating Plans Budgets for each part of the business every month / week Medium Term – Quarterly for next 3 years Long-Term – Annual Budgets for next three years

82. Budgeting Need for continual Re-Forecasting Still have budget but also a re-forecast Need to constantly compare actual with forecast Compare the reforecast with the previous reforecast ??

83. Budgeting Key Issues: Top Down or Bottom Up? Is Top Down always Possible? Does Bottom-Up stretch the Workforce?

84. Budgeting – Key Requirements Responsibility through Cost Centres? No vagueness about who is responsible for costs or revenues?

85. Drucker Checklist Exercise: Review your Budgetary Practice Against Druckers Checklist

86. Leadership Performance Management Operational Planning Recognising & Identifying Problems Reflection

87. Performance Management Performance management is about monitoring performance against targets, identifying opportunities for improvement and delivering change

88. Operational Planning Business/Personal Aims/ Objectives Planning and Organisation Implementation Monitoring and Control Evaluation

89. Key indicators of problems Productivity Performance Quality Costs Budgets You need: Information Views Agreement that the problem needs resolution Agreed aims and objectives

90. Reflection

91. Evaluation & Close Thank You