Managing Finance and Budgets

Lecture 1

Managing Finance and Budgets - Aims

To enable you to understand the role of finance and budgets in relation to SMEs, VCOs* and large organisations

To provide you with the knowledge and understanding of theory and practice required to enable the student to determine and evaluate the choices available to SMEs, VCOs and large organisations in using resources and to critically analyse available methods.

To enable you to develop a range of transferable skills useful for undergraduate study and for working in UK SMEs, VCOs and large organisations

*SMEs = Small and Medium-sized Enterprises VCOs = Voluntary and Charitable Organisations

Managing Finance and Budgets - Key Topics

Introductory Background Financial Statements Costing Pricing Techniques Investment Decisions Sources of Finance Budgets Ethical Issues

Managing Finance and Budgets - Methods of Learning

Reading - Compulsory and supporting texts Self-assessment exercises Notes, case studies Module Communication Centre Lectures - theory Seminars - application of theory Assessment - case study

The Required Text Book

You will need to purchase:

McLaney & Atrill 1999 Accounting: An Introduction Pearson Education London

Each week you will be set chapters from this text as reading (see the programme in the handbook), and the seminar material will draw on exercises from this text.

How the Module will be Taught

Within each week: There will be an introductory one-hour lecture. It will be

useful if you have already read the chapter in the set text beforehand (see the handbook for details).

You will be given certain directed tasks. These will be followed up within the seminars a few days later. In order to maximise learning you will be allocated to a seminar group, and a study group of about three or four students. During each seminar your group may or may not be called on to report on the tasks. You should come prepared to report.

At the end of the seminar, the tutor will review the main learning issues of the week, and will answer questions.

Session 1 - Introduction and Background

Learning outcomes: Explain the role and limitations of the finance function

particularly in relation to SMEs, VCOs and large organisations

Key concepts:The role of finance & budgets in the

organisationThe differing requirements of stakeholdersDifferent branches of accountingLegal and regulatory frameworksThe Different types of Financial Statement.

The Role of Finance and Budgets

There are four separate, but linked functions: Planning

working out what we should do Controlling

making sure we are doing it Reporting

proving we are doing it Decision-Making

working out how to do it better

The Role of Finance and Budgets

PLANNING Producing forecasts and budgets Ensuring that the organisation will have enough cash

to survive Allocating money in line with the mission and

objectives of the organisation Setting targets for the organisation and for each

department in the organisation Providing each department with the money it needs

to operate

The Role of Finance and Budgets

CONTROLLING Monitoring income - checking that each department

achieves its targets Monitoring expenditure - checking that departments

do not over-spend Monitoring the overall position - checking that the

overall organisation is profitable and does not run out of cash

The Role of Finance and Budgets

REPORTING Classification of transactions into different categories Summarising for different users Reporting on performance - internally - who brought

in how much income, who spent what, how is the organisation performing

Reporting externally - to shareholders, tax office, VAT office, Companies House, non-executive Directors

The Role of Finance and Budgets

DECISION-MAKING Helping the company to achieve its financial

objectives - e.g. increasing wealth of owners Helping the company and its staff to make decisions

about which projects to invest in Helping the company to determine where to get its

money from Helping the company to decide what to do with its

money

Stakeholders and their Needs

SHAREHOLDERS Organisational performanceValue of sharesManagement performanceReturn v risk

EMPLOYEES Job securityRemuneration comparison

CUSTOMERS Continuity of supplySUPPLIERS Credit riskGOVERNMENT PAYE, Corporation Tax,

VATStatutory legislation

Stakeholders and their Needs

LENDERS Security

Credit risk

Financial structure

COMMUNITY Environment

Contributions

Jobs

MANAGERS Performance

Plans

Objectives

Activity One

Discuss the following: Why should a non-accountant study accounting? What sources of information other than accounts

might users employ to gain an impression of the financial position and performance of a business?

Activity One: A Possible Solution (1)

Why should a non-accountant study accounting?

For a stakeholder in a business, its financial performance is a very important indicator of its health as an organisation.

A crucial way in which a business reports its success or failure is through the language of accountancy.

Managers, shareholders, employees and customers all have stakes in the continued running of an organisation. In order to safeguard their interests, they need to interpret accounts, and to be able to judge to what extent their investment (career, capital etc.) is being safeguarded.

Activity One: A Possible Solution (2)

• What sources of information other than accounts can be used to find out about the performance of a business?

• Meetings with managers or employees• Publications or announcements concerning the

business• Media reports• Industry watchdogs/reports• FTSE or other performance indicators

The Different Types of Accounting

There are two main types of accounting• Financial Accounting

• This is the main ‘public’ or external financial scrutiny undergone by an organisation in order to demonstrate its effectiveness.

• Management Accounting• This is the internal financial scrutiny used to steer

the organisation towards the achievement of its mission.

Financial Accounting & Management Accounting

Financial Accounting Seeks to meet needs of

other stakeholders General purpose, summary

reports with little detail Subject to regulations and

standardised format Tends to be annual or six-

monthly, backward-looking Audited, objective

measurement of financial position

May be certified by auditor

Management Accounting Seeks to meet needs of

managers Detailed and focused on

specific needs Does not require a specific

or standardised format Produced as frequently as

required, with forecasts May incorporate information

which is less objective or verifiable

Key Topics

Financial Accounting Statutory requirements Financial statements Cash-flow statements Accounting standards Interpretation of accounts Annual reports

Management Accounting Costing Cost-volume-profit analysis Pricing Budgeting Investment Analysis Sources of finance

Other Branches of Accounting

Auditing - checking accounts to ensure there is a true and fair view - may be a legal requirement

External auditing - answering to shareholders Internal auditing - answering to management Book-keeping - collecting basic financial data and

producing financial statements (usually through a double-entry book-keeping system)

Cost accounting - focusing on costs in greater detail Taxation - specialised, technical advice

Activity Two

Which of the following is the most useful to an organisation and why? - Financial Accounting, Management Accounting, Book-keeping, Auditing, Cost-Accounting or Taxation.

Activity Two: Possible Solution

Which of the following is the most useful: - Financial Accounting, Management Accounting, Book-keeping,

Auditing, Cost-Accounting or Taxation. Each of these have their uses to particular groups of people,

and for an organisation to survive it needs all of them. However, some are merely ‘external measures’ designed to

address the issues of accountability - ( Financial Accounting, Auditing, Taxation)

Others are ‘internal measures’ designed to help management improve performance - ( Management Accounting, Book-keeping, Cost-Accounting)

It could be argued that while the first group is necessary, it is the second group which is actually useful to the organisation itself.

Financial Statements

There are three different types of financial statement which are used by an organisation:

The Cash-flow Statement is designed to answer the question “What happened to all the money?”

The Profit & Loss Account is designed to answer the question “How much money did we make (or lose)?”

The Balance Sheet is designed to answer the question “Do the books balance?”.

Financial Statements - Example

You decide to run a soft drinks stand at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each.

Produce a Cash-flow Statement, Profit & Loss Account and Balance Sheet for the one day of operation.

Example Cash-flow Statement

Opening Balance: £ 0

Loan: £ 50+

Goods purchased: £ 40- (200 x 20p)

Entry Fee: £ 5-

Cash received: £ 75+ (150 x 50p)

Closing Balance: £ 80

“What happened to all the money?”

Example Profit & Loss Account

Sales: £ 75 (150 x 50p)

Cost of Sales: £ 30 (150 x 20p)

Gross Profit: £ 45

Entry Fee: £ 5

Net Profit: £ 40

“How much money did we gain (or lose)?”

Example Balance Sheet

Assets: Cash: £ 80

Stock: £ 10 (50 x 20p)Total: £ 90Liabilities:Loan outstanding: £ 50Retained profits: £ 40Total: £ 90

“Do the books balance?”

Types of Organisation

Sole Trader Partnership Limited Company (Ltd) Public Limited Company (PLC) Voluntary organisations Central and local government Quasi-governmental bodies

“Sole Trader”

Owned and controlled by one person (though more may work in it)

Advantages: Simple, flexible, full control and full retention of profits

Disadvantages: Unlimited liability, Difficult to raise capital, limits growth

Requirements: Licence (if appropriate), VAT registration (if appropriate) Accounts (for tax reasons) Health & Safety regulations Employment regulations

“Partnership”

Similar to Sole Trader but for more than one person Governed by formal or informal partnership

agreement (“Deed of partnership”) or subject to Partnership Act 1890

Shared responsibilities Shared finance and profits “Jointly and severally liable” Liability of “sleeping partners” can be limited

Limited Company (Ltd)

Set up to encourage enterprise Therefore subject to stricter regulatory framework Owned by shareholders, run by Directors Separate legal entity to those who own it or run it Limited liability (may be limited by guarantee) Pays Corporation Tax on profits Profits distributed to shareholders through dividends Registers with Companies House Governed by Articles/Memorandum of Association

Limited Company (Ltd)

Advantages: Protection of limited liability

Continuity through separate identity

Easier to raise finance

Credibility

£100 to start up

Disadvantages: Legal formalities & costs

Lack of privacy of accounts

Accountability to shareholders

Conflict between owners & directors

Public Limited Company (PLC)

Similar to Limited Company but shares traded publicly through Stock Exchange

Must adhere to specific legislation (e.g. 6 monthly accounts, qualified accountant as Company Secretary)

Method of raising finance (e.g. through sale of shares)

Original owners can realise some of the value of their shares

Statutory Requirements for Incorporated Companies

Annual report including:

Annual return

Profit and Loss Account, Balance Sheet &

Cash-flow Statement

Notes to Accounts

Directors report

Auditors’ report (if appropriate) Information required is dependent on size of the

Company (small, medium, or large)

Voluntary Organisation - Unincorporated

Collection of individuals with common aim May have a membership structure and constitution No separate legal status - cannot incur debts or be

sued Individuals may therefore be jointly liable (but may

take out liability insurance) A trust may be suitable for organisations with

charitable aims A trust is normally governed by a trust deed -

trustees manage the assets for the benefit of a specific purpose

Voluntary Organisation - Incorporated

Company limited by guarantee or Industrial and provident society

Can hold property, enter into contracts and employ staff in own name

Limits personal liability (to the guarantee) assuming no breaches of trust

Has to comply with law and legislation and will incur additional costs

Charitable Status

A group MAY register as a charity if its aims and objectives are “charitable” according to the Charity Commissioners’ definition - i.e. they fall into one of the 4 “heads of charity”: - relief of the poor, the handicapped & the aged - the advancement of religion - the advancement of education - other purposes beneficial to the community

Trustees may not benefit from the organisation and beneficiaries cannot be those who give (i.e. self-help groups are not charitable)

Charitable Status

A group MUST register if its aims and objectives are “charitable” according to the Charity Commissioners’ definition AND:

Its income exceeds £1,000

It uses or occupies land or buildings

It has a permanent endowment There is NO sanction for not registering Charity Commission decides if aims are charitable

Charitable Status

Advantages Financial - including

exemption from most forms of direct taxation

Status/credibility of charity registration number

Disadvantages Political and campaigning

activities are limited Trading activities are limited Must comply with charity law

- submitting annual accounts; stating charitable status of official documents

Monitored by Charity Commission

Application process (though now simplified including model governing documents)

Activity Three

Discuss the following: What are the main advantages and disadvantages

which should be considered when deciding between becoming a sole trader or a partnership business?

What are the main advantages and disadvantages which should be considered when whether or not to become a limited liability company?

What are the main advantages and disadvantages when deciding whether or not to apply for charitable status?

Activity Three: Possible Solutions

Advantages and disadvantages of being a sole trader or partnership

Advantages: Sole Trader: full control and full retention of profits Partnership: Shared responsibilities, shared financeDisadvantages: Sole Trader: Unlimited liability, difficult to raise capital Partnership: “Jointly and severally liable”. Shared

profits.

Activity Three: Possible Solutions

Advantages and disadvantages of becoming a limited liability company

• Advantages: Protection of limited liability, easier to raise finance

• Disadvantages: Legal formalities & costs, accountability to shareholders

Activity Three: Possible Solutions

Advantages and disadvantages of applying for charitable status:

• Advantages: Financial - exemption from most forms of direct taxation, Status/credibility of charity registration number

Disadvantages: Trading activities are limited, must submit annual accounts

Seminar One - Activities

During this seminar we will: Agree working groups Review Chapter 1 of the set book Revise key concepts from this week’s work Discuss Case Study 1 Discuss Case Study 2

Case Study 1

Clare Wong spends a lot of her time working for a large charity. The charity has grown enormously in recent years, and the trustees have been advised to overhaul their accounting procedures. This would involve its workers (most of whom are voluntary) in more book-keeping, and there is a great deal of resistance to this move. The staff have said that they are there to help the needy, and not to get involved in book-keeping

Prepare some notes that you could use in speaking to the voluntary workers in order to try to persuade them to accept the

new proposals.Dyson (1997) - Accounting for non-Accounting Students.

Case Study 2

You are a personnel officer in a manufacturing company, and one of your employees, a young engineering manager has been chosen to attend the local Business School to study for a diploma in management. He is reluctant to sign up for the course because it includes a subject called “Financial Management”. As an engineer, he thinks it will be a waste of time to study such a subject.

Prepare some notes that you could use in speaking to the engineering manager in order to show him the benefits to him of studying financial

management.Dyson (1997) - Accounting for non-Accounting Students.

Seminar One - Preparation

Read Chapter 1 - McLaney & Atrill Revise key concepts:

The role of finance & budgets in the organisation

The differing requirements of stakeholdersDifferent branches of accountingLegal and regulatory frameworks

Prepare Case Study 1 and 2 individually N.B. During the seminar, you will be allocated to

groups of three or four people and be asked to work on each case study, presenting your solutions to the group.