Management Accounting Theory Flashcards
What are the objectives of a company listed on a stock exchange?
- Increase sales revenue
- Lower costs
- Increase share price
- Increase dividends
- Produce good quality products
- Have an extended & improved product range
- Good customer service & reputation
- Good relations with local community
- Behave in a socially & environmentally responsible manner
- Growth/defence of market share
- Expand into new geographical markets
What are the objectives of a company not listed on a stock exchange? (Shares owned by members of family)
- Provide high salaries
- Provide other forms of remuneration (cars, trips abroad) for family members that are directors or employed by company
- Employee welfare
- Good relations with local community
What is a budget?
Forward-looking formal plan that states what’s expected (or planned) to happen in the business over the next budget period
What are the main purposes of budgeting?
- Planning & anticipation for future eventualities to ensure organisation decisions align with its goals
- Communication btwn different parts of organistion and different levels of management & coordination of activities (e.g. production and sales department)
- Motivation as a target to work towards
- Authorisation of budgeted expenditure & responsibility to meet said budgets
- Evaluation & control of whether budgets are fulfilled
What are the limitations of budgets?
- Badly set budgets may result in dysfunctional behaviour
- Must assign resposbilities fairly
- Subject to error and revision is frequently required bc based on FUTURE expectations
- Takes time -> costly
- Doesn’t replace need for managerial decision-making
- Some important factors may not be quantifiable (e.g. customer relations) -> won’t be included in budget
What is a cash budget?
Forward-looking document that shows cash inflows & outflows and net cash position of business on weekly/monthly/quarterly basis
Why is a cash budget important?
Helps business identify any shortfalls of cash such that it can mitigate it by arranging additional finance (issuing shares, leasing/selling NCA, taking loans, bank overdraft)
Why is cash vital for business survival?
Because if a business lacks cash, it won’t be able to pay its employees, suppliers, tax & other government charges, loan repayments or loan interests
What is the limiting factor for a business?
Usually sales -> sets level of all other business activities
Cash Payment for Purchases
If Gross Profit Margin given: x%
COS: remainder of x% x Sales Budget
What is working capital?
Inventory, receivables and payables
If cash is invested in working capital -> can’t be used to invest in new business projects or pay employees, finance providers or tax authorities
Benefits: (1) hold sufficient inventory supply to avoid unexpected shortages, (2) maintain good relations with customers and suppliers
What does working capital represent?
Cash tied up in day-to-day business operations
Cash operating cycle (Working capital investment)
Period it takes to recover cash tied up in working capital
Cash Operating Cycle:
Inventory Holding Period + Receivables Collection Period - Payables Payment Period
Shorter Cash Operating Cycle implies
Less money tied up in working capital
What can firms do to keep investment in working capital to a minimum?
- Hold only bare minimum level of inventory to meet expected short-term needs -> but may be impossible to get inventory at short notice in case of sudden business opportunities/spoilage -> customers go elsewhere -> loss in sales & customer goodwill damage
- Offer short credit terms to customers or only make sales for cash -> customers can buy from other stores that sell on credit and more favourable terms
- Delay payment to suppliers as long as possible -> supplier can refuse to sell business more goods or insist on immediate cash payment
Investment in working capital example
Sales: 60,000 @ $6.50 = $390,000
Receivables: 3 months
Receivables outstanding: 390k x 3/12 = $97,500
GPM: 40%
COS: 60% x 390k = $234,000
Inventory holding: 2 months
Average inventory holding: 234k x 2/12 = $39,000
Payables: 1.5 months
Average payables outstanding: 234k x 1.5/12 = $29,250
Working Capital Investment: Receivables Outstanding + Payables Outstanding - Inventory Held
$97,500 + $39,000 - $29,250 = $107,250
What is credit control?
Way to manage receivables by (1) checking creditworthiness of prospective customers to mitigate bad and doubtful debts, (2) regularly checking if there are overdue debts and (3) contacting customers via telephone or mailing to remind them to pay
If customers continuously fail to pay -> business should stop selling to tem and take legal action against them using up-to-date and accurate records of customer transactions
Credit discount example
Allow 3 months credit to customers. Bank charges overdraft at 1.25% per month. Should firm offer 2.5% discount for payment within 2 months?
= assume $100 sale. If discount applies: $97.50 after 2 months vs $100 after 3 months
Effect: 100-97.5 = 2.5 ‘interest’. Interest from borrowing $100 from bnk: $1.25
2.5 > 1.25 -> costlier to offer discount than wait another month and incur bank overdraft interest charges
What should firms do if they anticipate cash deficit?
- Negotiate to collect money from customers earlier (using discounts as incentive)
- Negotiate paying suppliers later
- Renegotiate loan repayment
- Buy new inventory later (if it won’t cause any issues)
- Lease/Sell NCA to other companies
