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Steve Pollard Associate Lecturer Business Institute
Steve Pollard Tel: 07843 449928 Fax: 028 9036 6831 E-mail:firstname.lastname@example.org
• 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
• Introduce you to financial planning
• Develop skills in the preparation of financial statements for the purpose of business planning.
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.
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.
“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
• Efficiency • Effectiveness
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.”
Financial Accounting “Not everything that can be counted counts, and not everything that counts can be counted.”
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.
Triple Bottom Line
Profit Social Environmental
All About You
Key Trends in your sector?
Planned growth / Maintain / contraction? Business / Financial Plans in place? Where in 3 Years time?
Organisational Controls Exercise
Please list as many financial / administrative controls that you can think of which are used within your business.
Key Organisational Controls
• 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 Expenditure
– – – – – – – – – – Authorisation limits Double signatures Tendering process Budgets Cost centres Audit Security Asset management Payroll check Double entry.
• Controls over Incoming Funds
– Banking procedures – No cash
Exercise Where Are You At?
Financial Reporting - The Traditional Accounting Control Model
“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
• How financial and physical asset resources are reported • 3 main accounting statements….
– balance sheet – profit & loss /income & expenditure statement – cash flow statement.
The Balance Sheet
A statement of the assets and liabilities of a business at a particular date – It has two parts: 1. A statement of Fixed Assets, Current Assets & Current liabilities – Total Assets 2. A statement of how net assets have been financed
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.
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
A Balance Sheet
Community Day Care Centre Example Balance Sheet
A balance sheet can be analysed to reveal how the enterprise is performing in terms of its:
Liquidity Solvency Stability Efficiency
Suggested Ratios Liquidity (Quick or acid test ratio) Current assets – stock Current liabilities
Suggested Ratios Current or Working Capital Ratio
Current Assets Current Liabilities
Profitability (Profit Ratio)
Gross Profit Sales x100
Net Profit Sales
Efficiency (Stock Turnover Ratio) Cost of Sales Average Stock
Profit and Loss (Income and Expenditure) Reporting
Revenue (Income/Turnover/Sales) Less: Costs = Profit or Loss (Surplus or Deficit)
Profit and Loss Account
Cost of Sales Gross Profit Operating Costs (inc depreciation): Equipment Depreciation (estimate) Fred Salary Rent Operating Profit
(10) 10 (1) (3) (2) 4
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.
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.
Glossary of Terms
Where sales revenue plus other income (such as rent received) exceeds the sum of cost of goods sold plus overheads
Profit and Loss Account
£’000 Revenues, Sales, Income or Turnover Cost of Sales 1,200 (600)
Operating Costs (inc depreciation) Operating Profit Interest Payable less Interest Receivable
(300) 300 (25)
Profit before Tax
Tax Profit after Tax Dividend Retained Profit
(75) 200 (50) 150
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
Product 1 £’000
Product 2 £’000
Product 3 £’000
Product 1 Sales Direct Costs Contribution 600 (280) 320 Product 2 300 (160) 140 Product 3 100 (80) 20 Total 1,000 (520) 480
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.
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.
Accurately Identifying Costs
•Start-Up •Direct •Overheads •Capital (See Handout: Costs Table)
Costs in Year One for a New Start Community Day Care Centre
Review Handout Community day Care Centre
When Sales Revenues = Costs Point at which enterprise is making neither a profit or loss
Break-Even •Indicates the point at which all costs are covered by sales revenue •Prompt you to reassess the price if breakeven appears unachievable •Helps calculate the level of sales required to cover any additional fixed costs such as new premises, equipment or staff
Calculating Break-Even One Product or Service
Overheads__________________ Price of unit – direct costs of unit = No. Units
Community Day Care Centre Example £111,767 £100 - £10 = 1,242 weeks per year
Open 50 weeks p.a. then 1,242 / 50 = 25 Children
Break Even Analysis
• • • •
Marginal Costing Absorption Costing Activity Based Costing Standard Costing
• A useful way of emphasising the marginal costs of production and services. This information is of great assistance when making pricing decisions.
• 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.
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.
• 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.
• 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.
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.”
• A system for identifying predetermined or target unit costs that should be achieved under efficient operations.
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.
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
Cashflow Statement Template
Making Capital Investment Decisions Appraisal Techniques
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).
Investment Appraisal Methods
Please refer to Investment Appraisal Methods Handout
• Simple measure of the period of time taken for the savings made to equal proposed capital expenditure.
• 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?
• 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.
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
Return on Investment (Accounting Rate of Return)
• 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 (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
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
r is the discount rate/interest rate t is the time period of the cash flow.
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?
Discounted Cash Flow (NPV): Solution
Machine A Expenditure Now £ 100,000 Less Year 1 Savings (discounted) £ 54,540 £ 45,460 Less Year 2 Savings (discounted) £ 45,430 Savings at Net Present Value (£ 30) Conclusion: Machinery B the better option Machine B £90,000 £49,995 £40,005 £45,430 £ 5,425
The Use of Appraisal Methods in Practice
Capital Investment Evaluation Methods in 100 large US Firms: Frequency of Use
Firms Using Payback ARR IRR NPV
Total % 94 50 81 74
Always % 62 21 54 33
Mostly % 14 5 7 14
Often % 12 13 13 16
Rarely % 6 17 7 11
Source: Pike & Neale, Corporate Finance and Investment
Financial Planning and Monitoring
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
How Book-Keeping records Budgets Cashflow
Budgets •Estimate of Income / Expenditure for a set period •Most likely to be used for: Preparation of Cashflow Forecasts Preparation of P&L Forecasts
Budgets Many types but 4 Main Ones are: •Sales Budget •Materials / Direct Costs Budget •Overheads Budget •Capital Expenditure Budget
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
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 ??
Budgeting Key Issues: Top Down or Bottom Up? Is Top Down always Possible? Does Bottom-Up stretch the Workforce?
Budgeting – Key Requirements
Responsibility through Cost Centres?
No vagueness about who is responsible for costs or revenues?
Review your Budgetary Practice Against Druckers Checklist
• • • •
Performance Management Operational Planning Recognising & Identifying Problems Reflection
Performance management is about monitoring performance against targets, identifying opportunities for improvement and delivering change
Aims/ Objectives Evaluation
Planning and Organisation Implementation Monitoring and Control
• Productivity • Performance • Quality • Costs • Budgets You need: • Information • Views • Agreement that the problem needs resolution • Agreed aims and objectives
Key indicators of problems
Evaluation & Close
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