Week 2: Management Accounting and Finance Flashcards
What is the equation to workout assets?
Assets = Liability + Equity
How is the equation for assets maintained?
It is maintained by double entry bookkeeping - each transaction is entered at least twice, once as a credit and once as a debit, depending on the type of account. These must balance, ensuring the new values satisfy the equation.
Why must companies maintain accurate accounts?
To manage their cash flow, keep track of assets, equities and liabilities
What does poor bookkeeping lead to?
Unpaid tax, fines and can encourage fraud.
What may small firms do with accounting?
Delegate it to a specialist firm by providing bills, invoices and bank statements.
Name some popular accounting packages that can be used to enter data yourself
Intuit Quickbooks, Sage Accounting, Zoho Books, Freshbooks, …
What may a company do with accounting as it grows?
It usually employs its own specialist staff - an accounting/finance team that are responsible for accounts, payroll, financial statements, tax and compliance
What are the two main branches of accounting?
Financial accounting and Management accounting
What does financial accounting involve?
Annual reports of the company’s situation that are published to shareholders and the public. These must be audited for correctness and are used by investors to decide whether to buy/hold/sell
What does management accounting include?
It provides additional and more up to date information, typically confidential company data. It is used to monitor and measure performance, and used to support management decision making.
What are some financial reports?
Balance sheets - show assets, liability and equity at a defined point.
Profit and loss report - shows income and expenses
Equity statement - shows retained earnings
Cash flow statements - report operating costs, investing and finances
Besides balance sheets, profit and loss reports, equity statements and cash flow statements, what typically takes place when it comes to financial reports?
A financial review or management discussion
What does a financial report usually assume?
The company is a ‘going concern’, meaning they can pay their debts as they fall due, in case of insolvency, shareholders have lower priority than loan providers and assets will have a lower value if they need to be liquidated in a hurry
What does the IFRS stand for?
International Financial Reporting Standard
What are fundamental qualitative characteristics of financial information?
Relevance and faithful representation
What are enhancing qualitative characteristics of financial information?
Comparability, verifiability, timeliness and understandability
Where are IFRS standards required or permitted?
In over 140 jurisdictions, including the UK.
What do the US apply instead of the IFRS?
Their own Generally Agreed Accounting Principles (GAAP)
Can graphs be included in financial reports?
Yes, they may be easier to read but can sometimes be less precise or misleading.
Before investing in a company, what is it wise to do?
Analyse their financial data
What are some key financial metrics?
Market Capitalisation (market cap)
Earnings Per Share (EPS)
Price Earnings (PE) Ratio
Beta (measure of volatility compared with rest of market)
What is the equation for market cap?
Share price x number of shares
What is the equation for Earnings Per Share (EPS)?
Profit / Number of shares
What is the equation for the price earnings ratio (PE)?
Profit / Market Cap
What does CIMA say about management accounting?
It is defined as analysing information to advise business strategy and drive sustainable business success
What time period does management accounting focus on?
The present and the future
Where can financial data be found?
On dashboards, and can be found on demand rather than monthly etc
Which type of accounting claims to create more value than other types of accounting?
Management Accounting
What does management accounting require for its analysis of costs, profitability and optimisation?
Reporting at finer grains (Individual products, divisions…)
What are the key areas of planning and control?
Objectives (goals and problems) Strategic Decisions (how do we achieve the goals?) Operating Decisions (how do we apply the strategy, budgets?)
What approaches are there for budgeting?
Top-down approach
Bottom-up approach
Participatory approach
What is the top-down budgeting approach?
Senior managers tell lower levels what is expected and leave them to work out details, emphasis on strategy over operations.
What is the bottom-up budgeting approach?
Lower levels tell senior managers what they can achieve, what resources they need. Emphasis on operations over strategy
What is the participatory approach to budgeting?
The budget is negotiated between different levels in the organisation, this may lead to compromises.
What are the 5 main benefits of budgeting to business?
Promote forward thinking and identification of short-term problems
Motivate managers to better performance
Provide a basis for a system of control
Provide a system of authorisation
Help co-ordinate the various sections of the business
What are avoidable costs?
These are costs that can be eliminated by choosing one alternative over another - relevant in account terminology
What are unavoidable costs?
These are a cost that has been incurred and cannot be avoided regardless of what a manager does - never relevant
What is a cost centre?
An identifiable part of an organisation where costs can be assigned or aggregated
In a manufacturing setting, give an example of a cost centre
A single factory
A department or activity
A machine or group of machines
An individual or group of them
How can cost centres be identified?
Many costs can be allocated to specific parts of the organisation
Someone has responsibility for that part of the organisation
Why measure cost?
Help determine selling price
Help production planning
Maintain management control
Support management decision making
How can costs be aggregated?
By element (material, labour) By nature (direct, indirect) By function (production, non-production) By behaviour (fixed, variable)
How can costs be classified?
Fixed, variable, semi-variable, semi-fixed
What is the model of profit for a business?
π = pq – (F + wq) where: π is profit p is sales price F is fixed costs w is variable costs per unit sold q is quantity sold
Using the business profit model equation, when is profit positive and when is it equal?
Profit if p > w + (F / q)
Break-even if p = w + (F / q)
What is the Balanced Scorecard and who introduced it?
Kaplan and Norton introduced it, and it includes measures that drive performance. You can list goals and measures about different categories
What are the 4 categories on the balanced scorecard?
Financial perspective
Internal Business Perspective
Innovation and Learning Perspective
Customer Perspective
What does the balanced scorecard do?
Keeps companies looking and moving forward instead of backward
What does the balanced scorecard omit?
Social, environmental and ethical aspects
What should also be taken into account when making decisions and company strategy?
The ethics and externalities
What is the OECDs proposal for tax?
A scheme where companies with an income above €20B will be taxed 15 percent in the country where a quarter of profit above 10 percent is earned.
What are overheads?
Overheads are costs required to run a business but cannot be directly attributed to any specific business activity, product or service.
What types of overheads are there?
Production overheads (machine setup, maintenance, storage and handling of goods...) General business overheads (accounting fees, advertising, insurance, interest, legal fees...)
What is overhead allocation, absorption or conversion?
This is where overheads are shared across multiple products or services.
What are the names of the cost systems?
Traditional Cost System (TCS)
Activity Based Costing (ABC)
How does Traditional Cost System (TCS) work?
You calculate the total overheads and share the figure proportionally.
If Product A consumes 100k hours/year, and Product B consumes 200k hours/year, if overheads are £900K, what are the overheads for the two products using TCS?
Product A - £300K
Product B - £600K
What is an issue with TCS?
It may misallocate costs to higher volume but cheaper products, for example, a product consumes less hours/year but is more expensive to handle/store.
How does Activity Based Costing work (ABC)?
First you identify cost drivers for a product. You the determine a metric for each of these to use as a cost driver, such as total for the whole production system or service. Identify the amounts that are associated with each cost driver and add them up.
If Product A uses 100K labour hours and 200K machine hours, and Product B uses 200K labour hours and 150K machine hours, with labour costs at £20 per hour and machine costs at £30 per hour, calculate the total cost of each using ABC, and state which is better.
Product A - 2M labour cost, 6M machine cost, total is £8M
Product B - 4M labour cost, 4.5M machine cost, total is £8.5M
Product A is therefore cheaper
Give a suitable cost driver for each of the activities:
- Workers assemble a product
- Products are designed by engineers
- Equipment is set up
- Materials are moved to production line
- Number of workers
- Number of designers/engineers
- Number of set up hours
- Number of production runs
Where is cost accounting used?
It is used to determine the minimum price of a product, to support cost engineering, to make correct decisions about out-sourcing and to construct the appropriate portfolio of products or services.
What type of costing supports Activity Based Management?
Activity Based Costing (ABC)
What is cost engineering?
It is a way of ensuring manufacturing efficiency improves and managing costs by reducing waste, reducing faulty items produced, cutting components required, simplifying processes.
When can cost engineering be applied?
It can be applied regularly, not just at the start.
What is the manufacturing learning curve?
Manufacturing improves with experience, you get more efficient at things, parts and processes become more specialised and therefore more efficient. Equipment becomes better, gains in one area may apply to others…
What did Curtiss-Wright (1936) identify?
Identified the manufacturing learning curve effect in aircraft production. Efficiency improved by 20 percent with each doubling of manufacturing volumne.
What did Henderson from Boston Consulting Group publish in 1973?
The law: C (subscript) n = C (subscript) 1 x n^-a
What is Porters Value Chain (1985)?
A sequence of activities which together create a product or service Inward Logistics Operations Marketing and Sales Distribution Follow-up Services
What should be done throughout the value chain?
Value should be added to the product or service. Costs of activities should be identified to understand if they add value. Find if cost reductions are possible. See if anything can be outsourced
Who should you outsource activities to?
Companies that have a competitive advantage
What are Core Competencies (Prahalad & Hamel 1990)?
Core competency is defined as a harmonised combination of multiple resources and skills that distinguish a firm in the marketplace.
It should make a significant contribution to perceived customer benefits.
Should be difficult to imitate, can give access to new markets
What does Drucker claim about businesses?
They have two functions: Marketing and Innovation
What are some ethical issues with supply chains?
Questions should be asked whether companies have a moral responsibility with respect to its supply chain (human rights, labour conditions, health and safety, environmental)
What is the Capital Budget Decision?
It is a question that financial managers are required to answer, that asks “what long term investments should the business take on?”
What else is capital budgeting known as?
Capital Investment Appraisal
What is the objective of the Capital Budget Decision?
To find investments where the returns exceed the cost of capital.
If a firm has the funds available to invest in new projects, when should they invest within the firm, or return the money to shareholders?
They should return the funds to shareholders when the firm cannot provide greater returns than safer financial assets such as government bonds.
What are the 6 stages in capital budgeting?
Identification Stage Search Stage Information Acquisition Stage Selection Stage Financing Stage Implementation and Control Stage
What are the methods for evaluating investment proposals?
Payback method
Accounting Rate of Return (ARR)
Net Present Value (NPV)
Internal Rate of Return (IRR)
What are the methods for evaluating investment proposals?
Payback method
Accounting Rate of Return (ARR)
Net Present Value (NPV)
Internal Rate of Return (IRR)
Which investment evaluation methods ignore the time value of money?
Payback method
Accounting Rate of Return (ARR)
Which investment evaluation methods take into account the time value of money?
Net Present Value (NPV)
Internal Rate of Return (IRR)
What is the payback method?
It counts the number of years before cumulative cash flow equals initial outlay or exceeds it, the shorter the better.
What are the advantages of the payback method?
Widely used, simple to understand, appropriate where liquidity constraints exist and fast payback is required. Appropriate for risky investments in uncertain markets, used for initial screening
What are the limitations of the payback method?
Ignores the time value of money
Ignores cash flows that occur after the payback period
What is the formula for the accounting rate of return (ARR)
ARR = (Average Accounting Profit) / (Average Investment)
When do you accept a product with ARR?
If its ARR is greater than or equal to the required accounting rate of return - with mutually exclusive products, accept the one with the higher ARR.
How do you work out the future value of money?
(100 + r) / 100
where r is the inflation rate as a percentage
What is the formula for the value of £n in y years time?
n x (1 + r/100)^y
How do you work out the present value of money?
(100 + r) / 100
How do you work out what a future sum of £n is worth at present (discounting)?
n / (1 + r/100)^y
What is the Discounted Cash Flow method?
It is a method that measures all future cash inflow and outflow method as if they occurred at a single time, typically the present
What do DCF methods use?
The Required Rate of Return (RRR), which is the minimum acceptable annual rate of return on an investment.
What is the NPV method?
This calculates the expected monetary gain or loss from a project by discounting all future inflows and outflows at the present using RRR.
How do you calculate the value of a project using the NPV method?
Construct a table of inflows and outflows, convert inflows and outflows to present, sum the present value figures
What is the IRR?
The Internal Rate of Return, it represents the discount rate that equates the present value of initial outlay to the present value of the expected cash inflows - broadly equivalent to NPV so NPV is preferred as it is easier
What is the Boston Consulting Group Product Portfolio Matrix?
A matrix of investments High Growth, Low Market Share - ? Low Growth, Low Market Share - Dog High Growth, High Market Share - Star Low Growth, High Market Share - Cash Cow
What is Multiple Criteria Decision Making/Evaluation?
It is a way of making a decision against a list of criteria. Alternatives will have a range of attributes or criteria, the cheapest may not be the best in all aspects. It is a problem that is well known in research. A pareto solution is desirable where possible - no adjustment possible without something getting worse
What is a Pareto optimal solution?
No adjustment possible without making something worse?
What is Evidence Based Decision Making?
It is where a decision is made based on some research. You cannot research forever, at some point you have to stop and make a decision.
Why is a formal record kept of decisions and rationale?
Helps to defend against accusations of negligence or legal action.
What did Pugh introduce for comparing alternatives when making a business decision?
A matrix where you can count positive and negative features - a weighted one can also be used
What does Peter Drucker say is at the centre of costs and results?
Serving the customer
What does Drucker say is the best way to improve an organisations performance?
To measure the results of capital appropriations against the promises and expectations that led to their authroisation.
