4.1 Finance operations (level 4) Flashcards
Finance operations consist of the following, often inter-related, components: (pg 89)
- Financial reporting
- Management accounting
- Treasury management
- Internal audit
Financial (corporate reporting) is concerned with:
- the production of financial information for external users in accordance with relevant accounting standards and legislation
- this info will be useful for decision making and assessing the management of the bus
The financial info may include:
- financial statements ( eg used by investors and creditors)
- tax reporting (HM Revenue and Customs in UK)
- regulatory reporting (regulatory bodies exist for different industries and they specify a set of laws, regulations and reporting requirements that must be adhered to)
There are three main FS produced each year:
- Statement of Profit or Loss (SOPL) for the year which details the income and costs incurred and indicates whether the bus has made a profit or a loss
Statement of Financial Position (SOFP) at the year end which shows the assets and liabilities and shareholders equity (stake owners have in bus) - Statement of Cash Flows for the year which summarises the cash receipts and payments for the year. This shows whether the bus is solvent and where the cash has been spent
The normal sequence of steps in the accounting function is:
- Transactions
- Day books
- Ledger accounts
- Financial statements
The main reason to produce FS is to:
satisfy stakeholders who have an interest in the financial performance of the bus:
- Investors / potential investors - interested in how profitable the bus is and how well it is being run
- Managers - interested in the bus financial situation so they can plan effectively for the future
- Banks - to see whether the bus can afford repayments on loans / overdraft
- Employees - interested in financial position of the bus and the impact on their jobs and wages
- Suppliers and customers - to check the financial stability of the bus to see if they will be able to make payments / supply goods as needed
- Government - to check the bus is obeying relevant laws on reporting and taxation
Management accounting is the
- provision of info to help managers and other internal users in their activities of decision making, performance measurement and control
- management accounts will source data for their work from financial accounting records and other sources of internal and external data
The several key management reports that are common:
- Cost schedules
- Budgets
- Variance reports
A cost schedule lists:
- the various expenses involved in manufacturing a unit of each type of product
- aka standard cost card
A cost schedule can help a bus to make several key decisions:
- Pricing decisions - how much to sell products for to make a profit
- Break-even analysis - which profits are profitable, can enough units be sold to cover costs
- Key factor analysis - should products be made inhouse or outsourced (cheaper)
- Investment appraisal - should a new machine be bought or should a new profit be started
Budgets show:
- the total planned revenues and costs for the coming period
- based on cost schedules
Budgets are useful for several reasons:
CRUMPET
- Coordination - provides guidance for managers and ensures everyone is working together for good of bus
- Responsibility - authorizes managers to make expenditure, hire staff and generally follow the plans laid out
- Utilization - helps managers to get the best out of their resources in coming period
- Motivation - useful to influence the behavior of managers and motivate them to perform in line with objectives
- Planning - force managers to look ahead and helps them to identify opportunities and threats and take effective action in advance
- Evaluation - used as basis for management appraisal
- Telling (communication) - ensures all members of the bus understand what is expected of them during coming period
Drawback of budgets:
- only estimates of what will happen in coming period
- in reality not all targets will be met
- therefore a variance report will be needed
Variance reports compare
- the budget to actual results achieved for the budget period and identifies any significant differences between the two
- for control purposes management may need to identify why there is a difference
- and then can decide if any control measures are needed (assist and interact with other functions to find solutions)
Control measures might be appropriate to:
- prevent adverse variances occurring in future
- repeat a favourable variance in the future
- bring actual results back on track to achieve budgeted targets
Treasury management is the
management of funds of the bus, such as cash and other working capital items, plus long-term investments, short-term and long-term debt and equity finance
The key roles of the treasury function include:
- Working capital management - monitor cash balance and working capital to make sure bus doesn’t run out of money
- Cash management - preparation of cash budgets and arrangement of overdrafts if necessary
- Financing - monitor investments and borrowings to make sure they gain as much investment income and incur as little interest expense as possible
- Foreign currency - monitor foreign exchange rates and manage affairs so that it minimises losses due to changes in exchange rates
- Tax - manage affairs to legally avoid as much tax as possible
Working capital is the
- is the capital available to fund the day to day operations
- calculated as excess of current assets (inventory, trade receivables, cash) over current liabilities (trade payables) (pg 96)
- the treasury function is responsible for deciding on an appropriate level of investment in working capital for the bus
- management must decide on appropriate balance for each component of working capital
Advantages of a large balance of components of working capital:
- Inventory - customers are happy since they can immediately receive goods
- Trade receivables - customers are happy since they like credit
- Cash - creditors are happy since bills are paid promptly
- Trade payables - preserves own cash
Advantages of a small balance of components of working capital:
- Inventory - Low holding costs and less risk of obsolescence costs
- Trade receivables - less risk of irrecoverable debt and better cash flow
- Cash - more can be invested elsewhere to earn profit
- Trade payables - suppliers are happy and may offer discounts
Financing
- the org may need additional funding to allow it to grow and invest in new projects
- may need to raise finance from external sources
- treasury and FF will weigh up which source of finance best suits the circumstances of the bus
Two main sources of internal financing:
- Debt - borrowing cash from a third party and promising to pay them back at a later date normally with interest (sources: bank loans / overdrafts, venture capitalists and selling bonds)
- Equity - involves selling a stake in the bus in order to raise cash (selling shares to new or existing shareholders)
The main advantages of raising cash through debt financing:
- interest payments are allowable against tax (dividend payments to shareholders are not)
- does not change the ownership of org
- tends to be cheaper to service than equity, as it is often secured against assets of bus and takes priority over equity in event of liquidation
The main advantages of equity financing:
- there is no minimum level of dividend that must be paid to shareholders so can be suspended if profits are low whereas interest payments must be paid each year
- it does not require security - bus may lack quality assets and bank will normally require security on assets before granting a loan
Foreign currency
- The org may have borrowings in foreign currencies or may have customers / suppliers who will pay / expect to be paid in foreign currencies
- The treasury dep will try to manage affairs to minimise the bus’s exposure to foreign exchange losses
Tax
- one of the roles of the finance and treasury function is to calculate the tax liability of the org and lawfully mitigate or reduce that liability as far as possible
External auditors:
- Company directors have a legal requirement to produce true and fair AFS
- to help ensure this they are required to have their published FS audited by an external team of experts
What is internal audit:
- it is an independent activity established by management to examine and evaluate the org risk management processes and systems of control and to make recommendation for the achievement of company objectives
- the benefits should exceed the costs
- reported to non-executive directors (larger orgs)
The purpose of internal audit:
- Directors also need assurances on other financial matters mostly for their own internal use
- it is one of the methods used by management to ensure the efficient and orderly running of the bus as a whole and is part of the overall control environment
The role of internal audit often includes:
- helping to set corporate objectives
- helping to design and monitor performance measures for these objectives
Internal audit staff are typically expected to carry out a variety of tasks:
- review internal controls and financial reports
- review risk management systems
- carry out special assignments
- conduct operational reviews
The purpose of internal audit can be summarised according to:
- Role - to advise management on whether there are sound systems of internal controls to protect the bus from losses
- Legal basis - Generally not a legal requirement but the UK Corporate Governance Code recommends that if a listed org does not have an internal audit dep it should annually assess the need for one
- Scope of work - determined by management, covers all areas of the org, operational and financial
- Approach - Increasingly risk-based. Assess risks. Evaluate systems of control. Test operations of systems. Make recommendations for improvement.
- Responsibility - to advise and make recommendations on internal control and corp governance
Limitations of internal audit:
- internal auditors have an unavoidable independence problem. They are employed by management and yet are expected to give an objective opinion on matters for which management are responsible.
- in order to overcome this the internal audit could be separate from the FF however resource constraints would prevent this in smaller org.
- internal audit will only succeed if is is given the proper staff and resources
- if they identify fraud they may be reluctant to report it for fear of repercussions (losing their job)
These limitations can be reduced if an audit committee:
- sets the work agenda for internal audit
- receives internal audit reports
- is able to ensure the internal audit gets the proper resources
- has a voice at main board level
Recent changes in finance operations:
- shared service centres (SSC) have taken over many of the rules based finance operations
- SSC’s work has expanded to handle all the processes from end to end
- the quality of service or level of expertise and the value they can contribute has become more important than being low cost
