Week 2.2 Flashcards
Fundamental accounting equation
Assets = liabilities + equity
Borrowing money increases your liability
Selling shares increases your equity
Double-entry bookkeeping
Enter each transaction twice
Once as a credit
Once as a debit
Bookkeeping and Company Accounts
Companies must maintain accurate accounts
Poor bookkeeping can result in unpaid taxes, fines etc
Can be delegated to specialist firms (for small firms)
Larger companies tend to employ their own staff
Financial Accounting
External
Annual reports of the company’s situation
Published to shareholders and the public
Must be audited
Used by investors to make investment decisions
Management Accounting
Internal
More up to date information
Typically has company confidential information
Used to monitor and measure performance
Supports decision making
Financial reports should contain
Balance sheet (assets, liability and equity at defined moment)
Equity statement (retained earnings)
Cashflow statement (operating costs, investing & finances)
Financial review/Management discussion
Profit & loss report (income and expenses)
Financial reports assumption
Company is a “going concern”
They can pay their debts
Shareholders have lower priority than loan providers in case of insolvency
Assets have lower value if they have to be liquidated quickly
IFRS
International Financial Reporting Standard
Financial information should be relevant and faithfully represent the company
Enhancing qualitative characteristics (comparability, verifiability, timeliness, understandability)
4 metrics to consider before investing in a company
Market capitalisation
Earnings per share
Price earnings ratio
Beta
Consider how metrics have changed over time and compare to those of competitors
Market Capitalisation
Share price x number of shares
Earnings per share (EPS)
Profit / number of shares
Price Earnings (PE)
Profit / Market cap
Beta
Measure of volatility compared with the rest of the market
Management accounting definition
Analysing information to advise business strategy and drive sustainable business success
Focusses on present and future cf financial accounting
Rely on predictive models. Nowadays, data is available on demand via dashboards
Finer grained than financial reports (Analysis of costs, profitability, optimisations, risk management et al.
Planning and control involves
Objectives -> Strategic decisions -> Operating decisions
Three methods of budgeting
Top-down approach (Senior managers tell lower levels what is expected) Strategy over operations
Participatory approach (Budget is negotiated between different units) Compromise
Bottom-up approach (Lower levels tell senior managers what they need) Operations over strategy
5 reasons for budgeting
Promotes forward thinking
Motivates managers to perform better
Provides a basis for a system of control
Helps co-ordinate parts of the business
Provides a system of authorisation
Avoidable costs (relevant)
Costs an organisation could eliminate by choosing an alternative
Unavoidable costs
Sunk (They’re, in-effect, already incurred, no matter what a manager does)
Cost centre
Identifiable part of an organisation to which costs can be assigned and aggregated.
Can be a group of individuals, machines, departments, a single factory
Aggregate costs by element, nature, function or behaviour
Identified where many costs can be allocated to specific parts of an organisation where someone has responsibility for that part of the organisation
Total costs equation
Total Cost = Fixed Cost + Variable Cost
Important to measure cost because it helps determine the selling price of a product, helps plan production, maintain management control and supports management decision making
4 types of cost
FIxed
Variable (proportional to activity)
Semi-fixed (or stepped cost)
Semi-variable
π = pq - (F + wq)
For a business that sells only one product
π is profit
p is sales price
F is fixed costs
w is variable costs per unit sold
q is quantity sold
Break even point vs net (positive) profit
p = w + (F/q)
p > w + (F/q)
Balanced scorecard (Kaplan and Norton)
Uses internal measures of performance such that companies “keep looking, and moving forward”
Financial, internal business, innovation & learning and customer perspectives
Neglects social, ethical and environmental aspects
Using external measures of performance often tempts companies to “shift the goalposts” such that they match expectations
Taxes
Traditionally companies pay tax based on their profits
Used by governments to reduce or correct social and environmental damage
Global multinational companies transfer profits between countries so they can be more tax efficient
Resolving international tax transfer issue
Standardised accounting via IFRS
OECD (Organisation for Economic Cooperation and Development) also has a proporsal with 136 countries which will tax companies in the country where profit has been earned
Overheads
Costs required to run a business which cannot be directly attributed to any business activity, product or service
Issues with basic profit formula
Very simplistic
Doesn’t account for sharing overheads
Can be solved using TCS or ABC
Cost accounting
Key part of both types of accounting
Financial statements include closing inventory as current assets using the minimum of the cost of production and net realisable value
Used in a variety of management decisions
Determining the minimum price of a product
Support cost engineering
Make decisions about out-sourcing
Construct an appropriate portfolio of products or services
TCS
Traditional Costing Solution
Easy and cheap solution
Calculate the total overheads and share this figure proportionally
May misallocate costs to higher volume, but cheaper products
ABC
Activity Based Costing
More accurate than TCS but not as easy
Applied to both financial and commercial activities
Supports “Activity Based Management”
Identify a series of cost drivers (Total cost and the number of activity drivers)
Activity rate (Total cost / number of drivers)
Multiply activity rate by number of drivers consumed by each product
Techniques for identifying activities
Unit level
Product level
Organisation sustaining
Customer level
Batch level
Activity Based Management
Decide on what products you should focus on and improve
Means of analysing your strengths by looking at each aspect of your business
Process view (Cost drivers) ->
Cost assignment view (Resources -> Activities -> Cost objects)
Activities -> Performance measures
Continuous improvement process (Activity analysis, cost driver analysis, performance analysis)
Cost engineering
Ensures efficiency improves and manages costs (“How do I do x but cheaper?”)
Reducing wastage of raw materials
Simplifying production processes
Sharing common components between products
Adopting JIT to avoid storing overheads
Cost engineering can be applied regularly, not just at the start (annual targets or can benchmark against competition)
Manufacturing and experience
Manufacturing tends to improve with experience
e.g. Labour efficiency is improved through repetition and better equipment becoming available
Efficiency gains in one area may also be applied elsewhere
Curtiss-Wright Law (Aircraft production)
Cn = C1 n ** (-a)
Efficiency gain is typically in the range 10-25% for each doubling of manufacturing volume
Value chain (Porter)
Sequence of activities that together make a product
Inward logistics (Receiving, storing and distributing “inputs”)
Operations (Manufacturing)
Marketing and Sales
Distribution
Follow-up services
Support activities (infrastructure, H/R, development, procurement)
Core competency
Harmonized combination of multiple resources and skills that distinguish a firm in the marketplace
Prahalad & Hamel
Have an impact on the perceived customer benefit of using your product
Should be difficult to imitate; can give access to new markets
Drucker Business Enterprise 2 main functions
Marketing and innovation
Supply chain decisions consideration
Driven by ethics or profit
Human rights, labour conditions, health and safety, the environment
Should someone interfere in the actions ot the suppliers/subcontractors
Supply chain decisions
Driven by ethics or profit
Human rights, labour conditions, health and safety, the environment
Should someone interfere in the actions of their suppliers/subcontractors?
Production overheads
Machine setup, maintenance, storage and handling of goods, wasted materials, testing, faulty items
General business overheads
Accounting fees, advertising insurance, interest, legal fees, labor burden, rent, repairs, supplies, taxes, telephone bills, travel expenditures, utilities
Cost allocations and cost tracing
Direct costs -> Cost tracing -> Cost objects
Indirect costs -> Cost allocations -> TCS/ABC systems -> Cost objects
Outsourcing decisions
Only outsource to companies who have a competitive advantage
Importance of core competencies
Monitor outsourcing decisions continuously
Capital Budget Decision
Financial managers must decide what long-term investments a business takes on
Involves Capital Investment Appraisal
Financial managers must find investments where the return exceeds the cost of capital (should offer greater return than safe assets such as government bonds), else they should return funds to their shareholders
Six stages involved in capital building
Identification
Search for alternatives
Information acquisition
Selection
Financing
Implementation and control
Find investments that meet strategic decisions, find alternatives, consider the benefits/drawbacks, then select a project to implement, obtain the financing and then start them/monitor them
Payback method
Calculating the number of years until cumulative cash flow equals or exceeds the initial outlay.
Accept an investment if it falls below a threshold number of years/periods (for non-uniform cash flows)
Simple, appropriate for risky investments, good initial method, appropriate where liquidity constraints exist and a fast payback method is required
Neglects inflation, doesn’t consider any cash flow after the payback period
Accounting Rate of Return
Accept if the ARR is >= a threshold
Still doesn’t account for inflation
ARR = Average accounting profit / average investment
Frequently used to evaluate manager’s performance, simple to calculate
Ignores inflation
Future values and present values
Future values: Amount an investment is expected to grow after earning interest
Present value: Value today of some expected future cash flow
Future value of £n in y years time with inflation rate r is n x (1+ (r/100))y
Future sum of £n is at present worth n/(1+(r/100))y
DCF methods
Discounted Cash Flow methods measure all expected future cash inflows and outflows as if they occurred at a single point of time
Considering profitability over whole project lifetime and inflation
Use required rate of return (minimum acceptable annual rate of return) (discount rate, hurdle rate, cost of capital, opportunity cost of capital)
Net Present Value method
(can’t find this on slides 2022)
Calculates the expected gain/loss by discounting all future cash flows to the present point in time
Discount cash flow from each year to their present value
Sum results
Compare to required rate of return
Only projects with a 0 or positive NPV are acceptable
IRR
(not on 2023 slides)
Internal rate of return is an alternative DCF method which equates the NPV of all cash flows to zero
Harder to understand, so usually use NPV
Drucker purpose of business
(can’t find on 2023 slides)
“The purpose of a business is to create and keep a customer”
Boston consulting group product portfolio matrix
(Can’t find on 2023 slides)
Describes how to prioritise your investments
Maps market share against growth
Question marks (Select a few to grow)
Stars (Invest)
Dog
Cash cow (Keep cash cows going)
Pareto optimal solution
(not in 2023 slides)
No adjustment is possible without making at least one criterion worse
Decision recording (not in 2023 slides)
Decisions usually made by a committee
Record of decisions made with a decision matrix
Can weight criterion and take a weighted average
Formally recording decisions is useful to defend against later accusations of negligence and liability
Note voting impossibility theorems of arrow, gibbard and satterthwaite
Investment fables
There is no such thing as a perpetual bond (One that pays interest forever)
The risk of losing big and going bankrupt wipes out any expected gain
Hindsight is priceless. It is hard to “beat the market”. Leads to stock market bubbles, provide evidence of group think
Returns from owning shares comes from
Dividends
Increase in share price
