MANUAL CONTENTS

Page
Session 1

: What is Management About

Session 2

: Accounting Information

4
20

Accounting Principles & Transactions

Session 3

: Major Financial Statements

35

Session 4

: Working Capital

57

Session 5

: Cash Management

72

Session 6

: Profit, Profitability and Value Added

81

Page

Session 7

: Assessing The Financial Position

Page
101

Analysing & Interpreting Financial Statements (1)

Session 8

: Analysing & Interpreting Financial Statements (2)

Session 9

: Analysing & Interpreting Financial Statements (3)

Session 10 : Budgets and Budgetary Control

110

Session 11 : Costs, Costing & Cost Behaviour (1)

128

Session 12 : Costs, Costing & Cost Behaviour (2)

Session 13 : Time Value of Money & Capital Investment Appraisal

169

Session 14 : Financing A Business

190
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ANNEX

Annex 1

Seminars

Annex 2

Recommended Reading

Annex 3

: Sample Assignments & Sample Examination Papers

Annex 4

: Supporting Material

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1 MANAGEMENT
MANAGEMENT FOR FINANCE
SESSION
WHAT IS

RATIONAL DECISION-MAKING FOR PLANNING & CONTROL

THE MANAGEMENT DECISION PYRAMID
THE ROLE OF THE MANAGEMENT ACCOUNTANT AND THE
MANAGEMENT PROCESS
THE FINANCIAL MARKET RELATIONSHIP BETWEEN
SHAREHOLDERS, DIRECTORS & AUDITORS
DISCUSSION QUESTIONS

Page

WHAT IS MANAGEMENT ABOUT ?

The primary functions of Management are :

Planning
Organising
Directing, Leading & Motivating
Coordinating & Communicating
Controlling
Evaluating

Management in any function will involve these activities in order to be effective.

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Types of Management Decisions :

Routine day-to-day operational decisions

Short-term problem resolution
Medium term decisions at managerial level
Strategic, longer term decisions
Control Decisions

All requiring three basic qualities in management :

Technical Skills related to the scope of work

Interpersonal Skills to get the job done
The ability to see The BIG Picture, often called Strategic Level Thinking

Decision making therefore is part of the managerial role, these may be ad-hoc, rational
or impartial depending upon the nature of the decision to be taken.
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RATIONAL DECISION MAKING FOR PLANNING & CONTROL

Step
Step
Step
Step
Step
Step
Step
Step
Step
Step

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Step 11.

Identify Business Objectives and Timelines for Achievement

Review the Environment within which achievement is to occur
Consider Options
Select Criteria to assess the Options & assess Resources
Select the most Viable Option
Prepare Management Plans as appropriate
Prepare Operational Plans for Short-term Implementation
Implement
Collect Information for Monitoring Performance
Review and Evaluate to determine Divergence from the plan to achieve
control
Revise Plans as needed.

This is a generic process which could be applied to any management function, including
finance.
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THE MANAGEMENT DECISION PYRAMID

Planning

Emphasis on

Type 1
Strategic
Decisions
Type 2
Tactical
Decisions

Control

Type 3
Operational
Decisions

Three decision types can be identified, namely Strategic, Tactical and Operational.
These may blend from time to time, particularly Type 2 and Type 3. The pyramid shows the
volume of decision types and how control increases at the operational level.
Page

Strategic Decisions are concerned with direction and purpose so to provide for a mission
to be accomplished over the longer term, whereas Tactical Decisions are narrow with
specific objectives to be achieved over the short to medium term.
Operational Decisions are specific, often routine with targets for performance monitored
over a short-term time horizon.
One important element in management decision-taking today is measurement.
Remember, if your decisions cannot be measured, they will be difficult to manage.
Financial Management Decisions at all three levels will be subjected to measurement for
reporting purposes as part of a financial information system.

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THE ROLE OF THE MANAGEMENT ACCOUNTANT AND THE

MANAGEMENT PROCESS
Planning

The management accountant helps to formulate business plans by

providing information to assist product and selling decisions in selected
markets at the optimum price and in addition evaluates proposals for
capital expenditure. These may be longer term planning inputs. In the
shorter term, the management accountants role is critical to budgetary
processes to plan income, expenditure and profit.
Information is produced by the management accountant on past
performance, much needed to plan for the future.
The management accountant establishes budget processes & procedures
to ensure these harmonise with each other across the organisation and are
aggregated into a master budget for the plans to create forecasted major
financial statements, all of which require top management approval.
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10

 Control

The management accountant produces performance reports periodically

to assess actual outcome with those planned and budgeted for, for each
responsibility centre of the organisation. Such centres are normally
departments with designated management control.

Organisation

The internal department organisation is essential to ensure that the

management processes are efficient. This is central to the role of the
management accountant. Efficient organisation is important for the
distribution of relevant and timely information flows.

Communication

This is critical, because the management accountant has the pivotal role
to ensure that all policies, procedures & methods are communicated and
understood. Financial performance information must also be
communicated according to agreed time lines for organisational planning
purposes. One example, is the core role in budget reporting on a monthly
and quarterly basis.
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11

The communication role in itself provides a basis for motivating the

entire organisation and can be the basis for employee recognition and
reward. Communication extends to four main stakeholder groups ;
employees, customers, shareholders and the government.

There are job functions within the accounting profession which should also be distinguished.
The Management Accounting role is concerned with the provision of information to people
within the organisation for management decision-taking.
The Financial Accounting role is concerned with the provision of information for external
reporting outside the organisation.
Cost Accounting is part of the Management Accounting function but mostly concerned with costs,
costing and cost behaviour to meet the requirements for internal and external reporting.

Financial Management is A GENERIC TERM covering all of the above.

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12

MANAGEMENT AND ACCOUNTABILITY

Management for the Finance function must be fully aware of the regulations which govern
companies whether they are
PRIVATE COMPANIES, called limited companies AND
PUBLIC COMPANIES quoted on the stock exchange.
There are requirements for both private listed company and public operated companies to publish
audited financial statements for each reporting year, the details will be outlined later in this
manual.
The regulations covering the publication of these functional statements are attached to

Company Law
External Accounting Rules (SSAPS)
International Accounting Standards (GAAPS)
Stock Exchange Rules for public companies
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13

Management responsibility for the preparation of financial statements therefore extends

to : Disclosure
Accountability
Fairness

which are the anchors of Financial Corporate Governance related to financial

management, which this manual will not extend to, but just to give an example of the
combined code.
Every listed company should have a board of directors
There should be a clear division of responsibilities between the chairman and the chief
executive officer
There should be a balance between executive and non-executive directors
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14

 The board should receive timely information

Appointments to the board should be subject to rigorous, formal and transparent
procedures
Boards should use the annual general meeting to communicate with private investors
Internal controls should be in place to protect the shareholders wealth
The board should set up an audit committee of non-executive directors to oversee the
internal controls and financial reporting

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15

THE FINANCIAL MANAGEMENT RELATIONSHIP BETWEEN

SHAREHOLDERS, DIRECTORS AND AUDITORS
Figure 1.1 Outlines the dimensions of the relationships which must be managed effectively

DIRECTORS

elect

account

review
report

SHAREHOLDERS

elect

AUDITORS

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16

The shareholders are the owners of the business, they elect the directors who are
accountable for business performance.
Auditors and appointed, by legal agreement, to agree to give a fair and accurate
independent report of business performance and behaviour with respect to accounting
processes and management, by checking the financial system through a process called
an audit .
The auditors will complete the annual audit to check that the accountancy function has
compiled with all regulations and procedures to draw up their internal financial
documents.
The audit would examine some documents such as invoices, cheque stubs, time cards
etc. The Books of Prime entry will be examined which covers a purchases daybook, a
cash book and wages records.
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17

The Ledger Accounts will be reviewed which covers the cash book, creditors &
debtors ledgers.
Finally the audit will obtain information to assemble the financial statements to show
the financial position through an income statement, a cash flow statement and a
balance sheet (all will be explained in detail in later sessions).
The auditors report will then be sent to the directors for review and adjustments as may
be needed and sent also to the shareholders before being signed off for publication.

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18

DISCUSSION QUESTIONS
1. WHY DOES FINANCE HAVE TO BE MANAGED ?

2. WHO ARE THE STAKEHOLDERS WHO BENEFIT FROM FINANCIAL

MANAGEMENT ?

3. WHAT ARE THE TYPICAL MANAGEMENT DECISIONS THAT ARE

TAKEN BY FINANCIAL MANAGEMENT ?

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19

2 MANAGEMENT
ACCOUNTING INFORMATION,
SESSION
WHAT IS
PRINCIPLES & TRANSACTIONS
WHO USES ACCOUNTING INFORMATION
WHAT INFORMATION MEANS
THE ACCOUNTING INFORMATION SYSTEM
MAJOR ACCOUNTING PRINCIPLES
THE SYSTEM FOR RECORDING TRANSACTIONS
THE MAIN FINANCIAL STATEMENTS
DISCUSSION QUESTIONS
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20

WHO USES ACCOUNTING INFORMATION ?

Financial Managements require information for decision-making, whereas shareholders
require information on the value of their investment and the dividend income to be received
from their shareholding.
Employees need to know the companys ability to pay salaries & wages. Creditors must know
if the firm can meet its financial obligations. Government Agencies collect accounting
information on company performance. The Inland Revenue need to know the profit level for
tax collection. In fact, there are many stakeholders requiring information who are both
internal to the organisation and external.
Management Accounting provides this internal information and the financial accounting
provides external information.
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21

KEY STAKEHOLDERS REQUIRING FINANCIAL INFORMATION

Investors

Company
Shareholders

Company
Directors

Company
Managers

Financial
Institutions

Existing &
Future
Customers

Business
Organisations

Lenders

Suppliers

Competitors

Trade
Associations

Employees

Unions

Government
Investment
Analysts

Tax Authority

The
Community

FIGURE 2.1
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22

The fundamental role of accounting is the process of identifying, measuring and

communicating relevant economic information about the firm.
Data and Information are not the same.
Data are facts and figures, Information is the interpretation of data within the context of
environment, achieved through observation, discussion and different forms of
communication.
The importance of information is the relevant new messages it delivers to different levels
of management and to the wider group of stakeholders (see Figure 2.1).
In accounting, many of these messages are based on different types of measurement called
metrics and a measurement system to capture the relevant data and information. Hence the
need for an accounting information system and the management of that system (see
Figure 2.2).
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23

THE ACCOUNTING INFORMATION SYSTEM

Sources

Specifications

Applications

Information
Identification

Information
Recording

Information
Analysis

Information
Reporting

Information
Needs

Processing

Routines

Responsibility
Centres

INFORMATION COMMUNICATIONS TECHNOLOGY

FIGURE 2.2
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24

The real value of accounting information will depend upon its end-use purpose, therefore
the value should be based on the cost of producing it in relation to the needs it satisfies.

There is a tendency for information overload. The main management information

challenge is to produce just the optimal amount of information required.
This is the essence of the design of the Accounting Information System.
What influences the usefulness of Accounting Information ?

Relevance
Reliability
Competencies
Comparability

Understandability
Cost / Benefit
Accessibility
Timeliness

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25

MAJOR ACCOUNTING PRINCIPLES

Stewardship

Reporting events performance and financial position periodically

Going Concern

- The Business will continue to operate year to year, unless being

closed to wind up the business.

Accruals or
Matching

Matching effort to accomplishment, ie. the cost of resources used

against the benefit received

Consistency

Selecting the most appropriate method and stay with these for
comparative analysis overtime

Prudence

Conservatism in valuation and in reporting

Objectivity

Avoiding personal bias when compiling accounting statements

Historical Records

Avoiding personal bias when compiling accounting statements

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26

Materiality

Concern only with matters that are significant

Monetary
Measurement

- All accounting statements are expressed in monetary terms to use

money as the common denominator for measurement

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27

ACCOUNTING POLICIES
Policies are the rules which the company applies to select the best approach to achieve the needed
outputs of the accounting function.
One simple definition commonly adopted by the accounting profession is : -

specific accounting methods selected and consistently followed by a business as

being, in the opinion of management, appropriate to its circumstances and best
suited to present fairly its results and financial position

(SSAP2 Statements of Standard Accounting Practice)

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28

THE SYSTEM FOR RECORDING TRANSACTIONS

All transactions must be recorded for disclosure so that a true and fair view can be reported in the
financial statements which the company are required by law to produce.
The sequence in which transactions are recorded and reported is as follows : -

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29

Transactions

- The economic events of the company involving money, recorded as invoices

for credit sales, cash sales and payments made in cash, cheques or electronic
transfers.

Prime Documents -

Provides Evidence of these transactions and summarises them, normally in a

Day Book. There maybe a sales daybook, a purchases daybook and a cash
book, all of which are Books of Prime Entry.

Ledger Accounts -

Classifies the transactions into separate books called ledger, for example
a creditor ledger, a debtors ledger and a general ledger.

Trial Balance

To balance the books at the end of an accounting period.

Adjustments

Financial
Statements

To adjust the ledger balance in the case of pre-payments or partial

payments (accruals)
To enter the ledger balances into the financial statements (profit & loss/
income statement, cash flow statement and Balance Sheet)
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30

PRINCIPLES OF RECORDING TRANSACTIONS

DEBIT AND CREDIT
For every transaction, there is a dual effect on the business and therefore it should be recorded twice
to realise this effect.
This system is referred to as double-entry book-keeping. The rule is simple --- FOR EVERY DEBIT,
THERE MUST BE A CREDIT.
This tradition has been upheld since the middle ages whereby all debits must equal all credits.

This system of DEBIT & CREDIT has been the basis upon which the key financial statements are
prepared.
[ There is no need for us on this programme to go into more detail about double entry bookkeeping. ]
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31

THE MAIN FINANCIAL STATEMENTS

The corporate report published by a company comprises a number of documents for external
reporting of information about the companies financial position. These documents are :

THE BALANCE SHEET

THE PROFIT & LOSS ACCOUNT OR INCOME STATEMENT

THE CASH FLOW STATEMENT

STATEMENT OF ACCOUNTING POLICIES

THE DIRECTORS REPORT

NOTES TO THE ACCOUNTS

THE AUDITORS CERTIFICATE

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32

THE BALANCE SHEET

shows the financial position at one particular

moment in time which sets the assets of a
business against the liabilities if the liabilities. If
the liabilities are subtracted from the assets, this
will disclose the shareholders investment in the
business.

THE PROFIT & LOSS

ACCOUNT OR INCOME
STATEMENT

shows a summary of transactions for the same

period. It shows income that has been generated
against which costs are charged to determine a
profit or loss for the period.

THE CASH FLOW

STATEMENT

analyses the sources from which cost has flowed

into the business and the way in which this cash
has been spent

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33

DISCUSSION QUESTIONS

1. IT IS SAID THAT INFORMATION IS THE GLUE THAT HOLDS ANY

ORGANISATION TOGETHER. HOW DOES FINANCIAL INFORMATION
ACHIEVE THIS ?
2. WHAT ARE THE KEY CRITERIA TO USE TO ASSESS THE REAL ECONOMIC
VALUE OF ACCOUNTING DATA & INFORMATION ?
3. WHAT ARE THE MAJOR PRINCIPLES UPON WHICH THE ACCOUNTING
FUNCTION IN A BUSINESS IS BASED ?

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34

3 MANAGEMENT
THE MAJOR FINANCIAL STATEMENTS
SESSION
WHAT IS
THE BALANCE SHEET
------

The Balance Sheet Equation

Assets
Liabilities
Horizontal & Vertical Layout in outline
Vertical Layout Essentials

THE PROFIT & LOSS OR INCOME STATEMENT

-- Simple Presentation Format
-- The Profit Cascade

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35

 THE CASH FLOW STATEMENT

-- Typical Formats

DISCUSSION QUESTIONS

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36

THE BALANCE SHEET

The Balance Sheet is a statement that balances what the company owns against what the
company owes.

The Balance Sheet Equation therefore is : -

ASSETS
=
[what is owned] =

CAPITAL + LIABILITIES
[what is owed]

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37

The effect of trading will influence the Balance Sheet as shown : ASSETS =

CAPITAL [ + or - PROFIT LOSS ] + LIABILITIES

ASSETS
These are items owned by a business which can be proved, have a monetary value, and that
the value can be objectively measured.

Assets can be classified into : * Fixed Assets

* Current Assets

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38

Fixed Assets are normally recorded at historical cost, at the time their purchase was
originally transacted, for example :

Land
Manufacturing Plant
Machinery
Vehicles
Long-term Investments

Most of which are intended for the longer-term and are not intended for sale because most
are items concerned with the making of products which are to be sold at a profit.

Fixed assets are depreciated overtime, estimated over their useful life, in accordance with
agreed conventions relevant to the enterprise and the industry.

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39

Long term investments are stakes that the business may have taken in other companies.
Current Assets are those which are held for a short period traditionally less than one year which are
intended to convert back into cash for example.

Stock (Inventory of finished goods & raw materials)

Debtors (The Customers who owe the company money)
Cash in hand and Cast at bank
Short term Investments

All current assets are expected to work their way through the business cycle.
THE TOTAL ASSETS OF THE COMPANY IS THEREFORE FIXED ASSETS
CURRENT ASSETS.
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40

LIABILITIES
A liability is an amount owed by a business to a person or organisation who has provided funds to
finance the assets that are controlled by the business.
Liabilities therefore are classified into : -

LONG TERM

Equity Shareholders

Reserves of the business from past profits owing to the equity

shareholders (often called retained earnings)

Long Term Loans

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41

SHORT TERM

Short term liabilities are referred to as current liabilities as these are

amounts lent for a period of up to one year, these comprise : -

Trade Creditors who have supplied Goods and Services and

who are waiting to receive payment

Short Term Loans from the bank

Overdraft that has been used from the facility granted by the
bank

Tax Provisions for payment on a due date

Dividends yet to be paid

These liabilities are the current obligation of the company to make payment.
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42

THE PRESENTATION FORM OF THE BALANCE SHEET

The balancing equation for the horizontal layout which today is somewhat outdated :

FIXED
ASSETS

CURRENT
ASSETS

CAPITAL &
RESERVES

LONG TERM
LIABILITIES

CURRENT
LIABILITIES

The balance sheet equation in vertical layout, which is commonly applied today :

FIXED
ASSETS

CURRENT
ASSETS

CURRENT
LIABILITIES

LONG TERM
LIABILITIES

CAPITAL &
RESERVES

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43

BALANCE SHEET -- SIMPLIFIED VERTICAL LAYOUT ESSENTIALS

1.

FIXED ASSETS
Land, Buildings, Vehicle, Plant (at cost)
Investment in Associated Company

xxx
xx

xxxx
2.

CURRENT ASSETS (CA)

Stock
Debtors
Investment
Cash

3.

TOTAL ASSETS

4.

LESS CURRENT LIABILITIES (CL)

Creditors
Short Term Loans
Taxation & Dividends Payable
NET CURRENT ASSETS (CA CL)
TOTAL ASSETS CURRENT LIABILITIES

5.
6.

xx
xx
x
x
xxxx
xx
x
x
xxx
xxx
OOOO

7.
8.
9.

ADD LONG TERM LIABILITIES

Long Term Loans
NET ASSETS (Net Worth)
FINANCED BY
Share Capital
Reserves

xx

++++
xxxx
xxx

++++
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44

The vertical layout shows

Fixed Assets + Current Assets = Total Assets

Current Liabilities

Net Current Assets

Current Assets - Current Liabilities

To show the Working Capital of the company

NOTE

Total Assets - Current Liabilities

Minus Any Long Term Liabilities

This Balancing Figure has then to be supported and confirmed by

financing from share capital + reserves

It will take time to understand and digest this Balance Sheet format, it is
advised that examples of published accounts are referred to. This will
reinforce this essential learning component of the course.
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45

THE PROFIT & LOSS ACCOUNT OR INCOME STATEMENT

The Profit & Loss account or what is know also as the INCOME STATEMENT reports the
revenue earned in a period. Other terms used for revenue are turnover and sales.
The accountant then changes the costs of earning that revenue to reveal a surplus or deficit known
as profit or loss.

The Income Statement is designed to measure the transactions which have taken place between
two balance sheet dates (see Figure 3.1). It is normally a statement therefore, for the year
ended.. because it is a summary of all trading transactions which have taken place during the
period, not just to show the position at one point in time.

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46

PROFIT & LOSS ACCOUNT FOR THE PERIOD

ENDED 31ST DECEMBER 200X

BALANCE
SHEET
AS AT
31 DECEMBER
200X

TOTAL
REVENUE
LESS
TOTAL
COSTS
FOR THE
PERIOD

BALANCE
SHEET
AS AT
31 DECEMBER
200Y

Figure 3.1
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47

THE SIMPLE PRESENTATION FORMAT FOR THE INCOME STATEMENT

1. Sales Revenue

xxxx

Less

2. Cost of Sales

xx

Equals

3. Gross Profit

xxx

Less

4. Expenses

xx

Equals

5. Operating Profit

xx

6. Interest Charges

Less

7. Taxation

Equals

8. Net Operating Profit

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48

This statement shows trading transactions, therefore the costs incurred are either the direct costs
(eg. labour + materials) of creating sales or indirect costs incurred to support sales (eg.
administration & distribution).

Therefore the Income Statement or Profit & Loss Account does not show Capital Transactions for
the purchase of fixed assets.

Capital Expenditure or CAPEX is the domain of the Balance Sheet and Operating Expenditure or
OPEX is the domain of the Profit & Loss statement.

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49

EXPENSES as understood in item 4 above (Pg. 49) also would include for example : Administration
Marketing & Distribution Costs
Wages & Salaries
Telephone Charges
Sales Administration
Sales Expenses

DEPRECIATION is also charged against the Gross Profit figure as a provision for replacing the
assets of the company.

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50

THE PROFIT CASCADE

There are different measurements taken for profit depending upon the purposes for which this
information is required and as a basis for achieving the comparative analysis of performance.
1.

Profit Before Interest & Tax

2.

Profit Before Tax

3.

Profit After Tax

4.

Dividends

5.

Retained Earnings

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51

THE CASH FLOW STATEMENT

The cash flow statement shows the flow of funds through a business between the two reporting
periods for the balance sheet, in the same way the Income Statement is derived across two points
in time.
In simple terms the standard layout for the cash flow statement is : -

1. CASH FLOW FROM OPERATING ACTIVITIES

PLUS or MINUS

2. CASH FLOW FROM INVESTING ACTIVITIES

PLUS or MINUS

3. CASH FLOW FROM FINANCING ACTIVITIES

EQUALS

4. A NET INCREASE (OR DECREASE) IN CASH OVER

THE TIME PERIOD FOR THE STATEMENT

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52

A TYPICAL CASH FLOW STATEMENT

* NET CASH INFLOW FROM OPERATING ACTIVITIES

340

NET OUTLOW FROM INVESTING ACTIVITIES

(118)

NET CASH (OUTFLOW) INFLOW FROM OPERATING ACTIVITIES

INCREASE IN CASH AND CASH EQUIVALENTS
FORECAST EXCHANGE LOSSES

CASH FLOW AT THE PERIOD ENDED

(63)
1391
(11)

1539

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53

* To assess the Net Cash Inflows from Operating Activities, more details can be shown, for example : -

Net profit before taxation

Depreciation expense
Interest expense
Increase (minus) or decrease (plus) in inventories (stock)
Increase (minus) or decrease (plus) in debtors
Increase (plus) or decrease (minus) in creditors
Interest paid
Corporation tax paid
Dividend paid
Net cash flows from operating activities

Plus
Plus
Plus or Minus
Plus or Minus
Plus or Minus
Less
Less
Less
Equals
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54

The purpose is to show the movement of funds through the business, the services from which this cash
was derived and the applications to which it has been deployed as a matter of public record to
supplement the published statements for the balanced sheet and income statement.

These 3 statements can be further analysed, using Ratio Analysis, to assess the financial position of any
business which has financial statements published and available in the public domain.

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55

DISCUSSION QUESTION
1. EXPLAIN THE PURPOSE AND CONTENT OF THE MAIN FINANCIAL
STATEMENTS THAT ARE PRODUCED FOR PUBLIC SCRUTINY.

* THE PROFIT & LOSS OR INCOME STATEMENTS

* THE CASH FLOW STATEMENT
* THE BALANCE SHEET

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56

4 MANAGEMENT
SESSION
WHAT IS

WORKING CAPITAL

WORKING CAPITAL DEFINITION

WORKING CAPITAL RATIO
SOURCES OF WORKING CAPITAL
WOKING CAPITAL MANAGEMENT
LIQUIDITY
THE CASH OPERATING CYCLE
WORKING CAPITAL POLICY
DISCUSSION QUESTIONS
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57

DEFINITION OF WORKING CAPITAL

Working capital is the money needed for a business to fund its day to day operations.
Without working capital, a company cannot continue to trade. The working capital
calculation is derived from the balance sheet values for current assets and current liabilities.
The working capital is thus the difference between what the company owns, currently, in
stock, debtors, cash and short term investments minus what the company owes currently to
the creditors.

WORKING CAPITAL RATIO

CURRENT ASSETS --- CURRENT LIABILITIES
It is expressed as a proportion eg. 2 :1; 1.5 : 1, 3 : 1 to demonstrate the level of COVER the
company has from its current assets to pay current liabilities. The GOLDEN RULE is 2 : 1,
but this will depend upon the industry, stockturn behaviour, general market conditions and
financial control.
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58

SOURCES OF WORKING CAPITAL

From Current Assets

CASH AT BANK
SHORT TERM INVESTMENT CONVERTIBLE TO CASH
CURRENT AND FUTURE INCOME FROM DEBTORS
CASH CONVERTED FROM STOCK (INVENTORY)

From Current Liabilities

CREDIT TAKEN FROM SUPPLIERS
SHORT TERM LOANS
OVERDRAFT FACILITIES
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Another term for the working capital ratio is the net current assets. Working capital therefore
is an important measure of the companys liquidity.
Working capital management is concerned with the management of the relationship between
current assets and current liabilities and the decisions pertaining to achieving the relevant
balance between both key areas of financing a business on a day-to-day basis.
Managing liquidity is part of the responsibility often referred to as cash management to
ensure that the company has enough cash when its obligations for cash payments are due.
Managing the cash cycle for the business becomes vital, this is why cash flow statements are
needed for cash management to protect the liability of the business.

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60

Working Capital Management involves the following key areas : CASH MANAGEMENT
DEBTOR MANAGEMENT
CREDITOR MANAGEMENT
INVENTORY MANAGEMENT
All of which are covered with the day to day management of working capital throughout the
business.

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61

CASH MANAGEMENT
Company income streams and regularity of them must be monitored in order to maintain a
positive cash flow position to reduce the need for short term borrowing through overdraft
facilities. Negative cash flow means a cash deficit, the cost of which impacts upon working
capital and also places pressure on relationships with suppliers should late payment to creditors
occur.

DEBTOR MANAGEMENT
The debtor days outstanding should be controlled carefully to ensure that money comes into the
business before it is paid out by ensuring that creditors days exceed debtor days otherwise the
cost of uncontrolled cash receivables will impact upon working capital.
The number of debtor days outstanding must be closely monitored because the cost of
extending credits to debtors is a cost to the company This cost cannot be overlooked.
Credit extended will increase the value of outstanding debtors and this has to be financed, often
from short term borrowing using overdraft facilities, so therefore the real cost of credit
extension must be known and must be managed carefully.
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62

CREDITOR MANAGEMENT
The key to creditor management is to take more credit from the companies creditors than are
extended by the company to its debtors. In simple terms the creditor days should be greater
than the debtor days so that money comes in before it is paid out. Often it is not possible, so
therefore an overdraft facility is used to bridge the gap between receipts and payments.
However, if this overdraft has a hard core element of sustained borrowing, this impacts
directly upon working capital balances.
The analysis of the creditor position must be managed so that the liquidity of the business is
monitored closely.

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INVENTORY MANAGEMENT
Inventory, or stocks is usually the least liquid of current assets and therefore it is vital that
inventory is managed efficiently.

Stock held must convert to cash, every effort must be made to ensure that optimum stockturn
is sustained in relation to the pattern of sales for the business otherwise working capital is
tied up needlessly. Stockheld is cash tied up. Inventory management has the main purpose of
converting stock to smooth flows of cash into the business.

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64

LIQUIDITY
Liquidity as mentioned earlier is the core theme of working capital management and is
defined as the short term ability of a business to meet its current short term liabilities.
An enterprise becomes illiquid when the liquid assets (cash, debtors & stock) as near cash
items are insufficient to cover the short term obligations to creditors.

DERIVATION
LIQUIDITY Deals with Short Term Liabilities Only
Is measured by the working capital balances in a company
Current Assets

(Minus)

Current Liabilities

What is currently owned

(Minus)

What is currently owed

e.g. Stock, Debtors,

Cash at Bank

e.g. Trade Creditors, Short Term

Loans and Overdrafts
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65

LIQUID ASSETS
These will vary from industry to industry, but normally would include cash and debtors
and may be stocks if they are readily convertible to cash, so therefore ratios are used to
assess a companys liquidity :-

RATIOS
The Working Capital Ratio
(Or Current Ratio)

Equals

The Acid Test

Equals

Current Assets
Current Liabilities
Liquid Assets (cash + near items)
Current Liabilities

This is to provide an assessment of adequate cash cover to meet to companys short-term

financial obligations. Ideally a 2:1 cash cover would be expected for the current ratio and
1:1 for the Acid Test.
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THE CASH OPERATING CYCLE

The cash operating cycle is the length of time elapsing between the companys cash
payments for purchases of materials and labour in relation to cash received from the sale of
goods and services.
The Cash Operating Cycle = Stock Period plus Customer Credit Period minus
Supplier Credit Period

To assess this, the following ratios should be calculated :

STOCK TURNOVER
DEBTORS TURNOVER
CREDITOR TURNOVER
And then convert these turnover ratios into the days in which cash is tied up in working
capital.
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AN EXAMPLE TO DETERMINE THE CASH OPERATING CYCLE

COST OF SALES
STOCK TURNOVER RATIO

VALUE OF STOCK HELD

SALES REVENUE
DEBTOR TURNOVER RATIO

AVERAGE DEBTOR VALUE

COST OF SALES
CREDITOR TURNOVER RATIO =

AVERAGE CREDITOR VALUE

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68

SAMPLE FIGURES
STOCK TURNOVER RATIO

3000
600

DEBTORS TURNOVER RATIO

5000
400

CREDITORS TURNOVER RATIO

= 5 times per annum

= 12.5 times per annum

3000
= 8 times per annum
375

Therefore to convert this to days based upon 365 days per annum.
STOCK PERIOD

365
5

73 days

DEBTORS PERIOD
(Customer Credit)

365
12.5

29.2 days

CREDITORS PERIOD =
(Supplier Credit)

365
8

45.6 days

The Cash Operating Cycle is therefore

73 + 29.2 - 45.6 days

This means it takes almost two months to convert business into cash and this is the number of days that
cash is tied up in working capital.
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WORKING CAPITAL POLICY

Policy relates to the rules which govern decisions, therefore the financial management of the
company must lay down policies to govern working capital management.
Key questions must be asked to lay down such policies : How should the working capital of the company be financed
Is an overdraft facility required and to what level
What is the level of cash that should be tied up in current assets, and for each type of current
asset
What rules must be applied to extending credit to customers, and what are our credit
collection in policies
How do we build relationships with suppliers to attain extended credit for our business
What level of risk can we take to achieve a threshold level for working capital cover to
prevent a liquidity crisis
How do we preserve the financial health of the company from a working capital perspective
How do we guard against being under-capitalised to avoid over trading, which could be fatal
for the company
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70

DISCUSSION QUESTIONS

1. EXPLAIN THE TERM WORKING CAPITAL AND DISCUSS THE CHALLENGES

THAT THE FINANCIAL ACCOUNTANT WILL HAVE IN DISCHARGING THE
MANAGERIAL ROLE IN THIS AREA.

2. WHY IS LIQUIDITY SO IMPORTANT TO ANY BUSINESS? HOW CAN LIQUIDITY

BE PROTECTED TO AVOID THE BUSINESS HAVING TO FACE A LIQUIDITY
CRISIS

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71

SESSION
WHAT IS
5 MANAGEMENT

CASH MANAGEMENT

CASH
CASH FLOW
CASH BUDGETING
BUDGETED CASH FLOW STATEMENTS
DISCUSSION QUESTIONS

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72

CASH
Cash plays a pivotal role in any business, in fact it is the lifeblood of the business
whereby cash flows into the business to touch almost all parts of the business and also
flows our into the external business environment.
The difference between cash in flows and cash out flows will of course influence the
calculation of absolute profit

This is shown in Figure 5.1.

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73

EQUITY SHARE
CAPITAL

TAXATION
WAGES & SALARIES
FIXED ASSETS

LOAN CAPITAL
OVERDRAFT

OPERATING COSTS

CASH

GOVERNMENT
SOURCES
DEBTORS

In flows
Out flows

CREDITORS
LOAN REPAYMENTS
STOCKS
RAW MATERIALS
WORK IN PROGRESS
RESEARCH &
DEVELOPMENT

Figure 5.1

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74

Cash management is the management of liquidity to ensure there is sufficient cash to meet the
financial obligations to suppliers, employees, banks, the Inland Revenue and so on.
It makes sense to centralise the cash management of the business. The role of the finance
manager in this respect will be to forecast cash needs and monitor the utilisation of cash to
manage complete cash flow.
CASH FLOW
The Cash Flow Forecast or Cash Budget is the primary tool used for short term financial
planning. The key to managing cash is planning.
Cash budgeting is the term given to the projection of inflows and outflows of cash a specified
time periods which may be weekly or monthly for periods of up to one year ahead.
The objective of cash flow planning is to make an early assessment of the expected levels of
cash surpluses or deficits at future dates so that plans can be made to either hold or invest
surpluses or to arrange borrowing or even permanent financing where shortages are expected.

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75

Preparation of the Cash Budget -- Four Distinct Steps.

1.

Forecasting future cash inflows

2.

Forecasting future cash outflows

3.

Comparing forecasted inflows and outflows to determine the net cash flow for
each time period.

4.

Calculate the cumulative cash flow by adding the opening cash flow balance to
the net cash flow for the period.

By examining the forecasted movements in cash over several periods, cash flow can be
anticipated for cash planning. Action can be taken in advance, for future cash acquisitions and
utilisation.
The cash flow plan therefore is a forecasting tool to manage the cash flows between
debtors and creditors through the company as the trading intermediary.
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PLANNING CASH FLOW FOR ANY SPECIFIED TIME PERIOD

1) INCOME / CASH RECEIPTS
Cash Sales
Debtor Payments
Sale of Fixed Assets
New Share Issue / Capital
New Loans
Realised Investments

Step 1) Forecast the source of future cash

inflows.

2) TOTAL INCOME

Step 2)

Calculate total cash inflows

3) EXPENDITURE / PAYMENTS

Step 3)

Forecast future cash outflows

Cash Payments
Creditor Payments
Wages & Salaries
Rent & Rates
Heating & Lighting
Interest Payments
Dividends

Loan Repayment
Taxation
Purchase of
Fixed Assets

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77

4) TOTAL EXPENDITURE

Step 4)

Calculate total cash outflows

5) NET CASHFLOW (+ or -)

Step 5)

Determine net cash flow

6) OPENING CASH BALANCE (b/f)

CLOSING CASH BALANCE (c/f)

Step 6)

Calculate cumulative cash flow

This format will then be set to determine the cash budget for a specified period. As a control
tool for financial management the actual cash movements can later be compared with those
that have been forecasted to determine a variance in cash movement for the each time period of
the budget.
A budgeted cash flow statement may have the appearance as shown in Figure 5.2.

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BUDGETED CASH FLOW STATEMENT FORMAT

MONTH 1

MONTH 2

MONTH N

TOTALS

1. INCOME / CASH RECEIPTS

___________
___________
___________
2. TOTAL INCOME
3. EXPENDITURE / PAYMENTS
___________
___________
___________
4. TOTAL EXPENDITURE
5. NET CASH FLOW ( 2

minus 4 )

6. OPENING CASH BALANCE (B/F)

CLOSING CASH BALANCE (C/F)
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79

DISCUSSION QUESTIONS

1.

EXPLAIN HOW CASH IS MANAGED IN A SUCCESSFUL BUSINESS

ORGANISATION.

2.

WHAT IS THE REAL PURPOSE OF PREPARING A CASH BUDGET ?

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80

SESSION 6

PROFIT, PROFITABILITY & VALUE ADDED

PROFIT AND PROFITABILITY

NEED FOR PROFIT
ADEQUACY OF PROFIT
REALITY AND NATURE OF PROFIT
THE CONFLICT BETWEEN PROFITABILITY AND LIQUIDITY
PROFIT AND CASH
KEY RATIOS FOR MEASURING PROFITABILITY
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81

VALUE ADDED
DEFINITION
EXPLANATION
KEY RATIOS

DISCUSSION QUESTIONS

Page

82

NEED FOR PROFIT

It is recognised that the management has responsibilities for the well-being of the
employees and the community as a whole, as well as to companys shareholders. In
carrying out these responsibilities, the manager must always be aware of the impact of
decisions on the companys profit. Though short term decisions may reduce or
eliminate profit, in the longer term, a company must earn profits in order to survive.
The main criterion for assessing the efficiency of a business is its reported profits.

Managements responsibilities extend to : Shareholders, who expect a return on their investment commensurate with alternative
investment opportunities and the risk involved, and a growth in the value of their
shareholding.
Employees, whose security may depend on the continued existence of the company and
whose level of earnings may also depend on its prosperity.
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83

 The Community. It is becoming increasingly recognised that industry and

commerce have responsibility to the community in which they operate. This can
extend to environmental aspects such as the prevention of pollution and the
provision and support of local amenities.
Government, by making a contribution through taxes to the national exchequer
which go towards social services, defense and public investment.

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ADEQUACY OF PROFIT
Profit is a common denominator for measuring how well a business utilises the resources
invested in it.
In the longer term, the profit earned by a business must be adequate to ensure its
continuity and fulfillment of the responsibilities referred to earlier. In particular, an
adequate profit is one which ensures that : Shareholders receive a dividend in line with going rates of return on alternative
investments
The real capital of the business is preserved during an inflationary period
Sufficient cash flow is generated to provide funds for expansion and for research and
development
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85

REALITY AND NATURE OF PROFIT

In spite of recent developments in accountancy principles and concepts the stated
profit figures are best only estimates in any situation. Some of the areas affecting the
stated profit which are not always capable of exact determination include :

Provisional for depreciation or amortisation of fixed assets

Valuation of finished goods and work in progress
Credit taken for profit on partly completed long term contracts
The matching of expenses with income, especially where there is an element of
deferred revenue expenditure
Adjustments for changes in the value of money, especially foreign exchange
The treatment of exceptional gains or losses (including unrealised losses) whether
of a capital or revenue nature
In all but the simplest of business, the profit is an approximate figure very much
dependent on the conventions which have been applied.
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THE CONFLICT BETWEEN PROFITABILITY AND LIQUIDITY

Recognising the need for profit for the long term survival of the firm, and the use of
profitability as an index for measuring managerial performance, it is natural that most
company management should consider maximising return on investment to be their
prime objective.
Improved profitability can be achieved by application of cost reduction techniques such
as inventory control, value analysis, work study, etc., but in many cases the most
important source is from increased volume and the development of new products.

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87

The investment necessary for growth requires substantial and normally irregular flows
of cash. Unless proper financial arrangements are made, a rapidly growing company,
although profitable, may run into serious liquidity problems, which can be more
damaging to its survival than even a loss making situation.

It is important, therefore, that efforts to maximise profit through growth do not lead to
over-trading and a liquidity crisis. It is the duty of the Finance Manger to coordinate
the growth plans of various departments such as production and sales and to interpret
them in financial terms so as to ensure that adequate finance is available to sustain the
projected growth.

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SOME REASONS WHY PROFIT AND CASH ARE DIFFERENT

Depreciation is charged in the profit and loss account as an expense but does not
affect the cash balance
Stock is created by cash payments for material, labour, etc. Stock is not charged as an
expense in the profit and loss account until it is sold
Debtors and creditors. Invoiced sales appear in the profit and loss account as
turnover. Incurred expenses appear in the profit and loss account as costs. It may be
several months before cash changes hands
Stock valuation may be arrived at in many different ways. The valuation will affect
the reported profit but not he cash balance

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89

 New capital introduces cash into the firm when isued but never appears in the
profit and loss account
Research and development affect the cash balance when paid for but may be
charged in the profit and loss account over several years.

NOTE

PROFIT IS A CONCEPT.
CASH AT BANK IS A FACT.
CASH IS KING ! ! !

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90

MAIN RATIOS USED TO ASSESS PROFIT PERFORMANCE (PROFITABILITY)

1. ROI

RETURN ON INVESTMENT

2. ROCE

RETURN ON CAPITAL EMPLOYED

3. ROSHF

RETURN ON SHAREHOLDERS FUNDS

4. ROA

RETURN ON ASSETS

5. GROSS PROFIT AS A % OF SALES

6. PRE TAX PROFIT AS A % OF SALES
7. PROFIT BEFORE INTEREST & TAX AS A % OF SALES (PBIT)
8. EBITDA

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91

RETURN
Ratios 1 to 4 use the term return, the term simply means the profit figure generated
from the income statement. It is important to use the same measure of profitability to
be able to compare performance over time. In this way comparative reference can be
tracked and assessed.
Pre-tax profit can be used or profit before interest and tax are charged simply because it
gives a better reflection of the actual profit generated from trading as a business.
It is also common to use EBITDA which is Earnings before Interest, Tax Depreciation
and Amortisation as a measure of profitability and a basis for comparative analysis.
The most fundamental aspect of return is to ensure the basis to measure it over time is
consistent.

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92

MEASURES OF RETURN
1. ROI

This measures the return from investment made or to be made. For

example for projects to the company has or will embark upon. Hence the
important aspect is to ensure that the return is greater than the cost of
capital and that the best of opportunity has been taken in comparison with
other investment options. This term is used quite widely and can relate to
the business as a whole as well as to projects.

2. ROCE

The total capital employed in a business again has to have a consistent

approach to its calculation as there are different approaches used. ROCE
is the profit derived from all the capital the company has used in running
the business. This will include its stakeholders funds and long term loans
as one approach to determine capital employed OR by using total assets
minus current liabilities.

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93

3. ROSHF

This shows the return the company has achieved from the funds owned by its
shareholders. These include issued shares, capital reserves and revenue
reserves from accumulated profits.
Capital revenues may arise from revaluation of fixed assets, premiums on
shares issued at a price in excess of normal value.
Revenue reserves are mainly in the form of retained earnings that have
accumulated.
THIS COULD BE CONSIDERED AS THE MOST IMPORTANT
RATIO IN BUSINESS FINANCE.

4. ROA

Return on Assets as a measure of profitability is important because it shows

how the financial management of the company is using the Total assets to
make profit.
It shows how efficiently the assets are being deployed in the business.
Shareholders funds will have been invested in the assets in the assets of the
business, the shareholders as owners of the business will need to know how
their assets are being used to make a sustainable return on their funds.

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94

5. Gross Profit as a % of sales includes the margin of profit left after the direct costs of the
business have been charged, referred to as the cost of sales, therefore the Gross Profit
margin is determined by deducting the cost of sales from the revenue generated.

6. Pre tax Profit as a % of sales (also called net profit) is the profit made after deducting the
indirect costs of the business from the Gross Profit Figure. These indirect costs include items
of expense that must be paid from the revenue generated in order to produce the net profit
figure.
7. PBIT, a Profit Before Interest and Tax is charged is simply a variation on the Pre Tax
formula, but it deducts the amounts paid by the business on tax and interest actually paid
within the year.
8. EBITDA is yet a further development of the PBIT approach, but the measure of profit
ability (called earnings) is assessed after deducting amounts for interest, tax and depreciation
amortisation. Note E stands for Earnings, which is another term for profit.
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95

VALUE ADDED
DEFINITION
Value Added is the difference between the value of an enterprises outputs and the value of its
inputs.

EXPLANATION
By converting inputs into outputs the enterprise literally adds value to the materials and
services it buys through a series of conversion processes to make a saleable output.
This added value in the conversion process is in fact wealth generated by the company. A
key issue to take into account is how that wealth is distributed, ie. normally through
wages and salaries (the main component) taxes, interest payments, dividends
depreciation and in retained earnings.
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96

Value added essentially is the result of trading to sell products as a result of a

transformation process achieved from the inputs of raw materials and components,
utilities, fees for professional services, advertising and promotion, hiring and leasing
charges and the cost of financing.

Labour is treated as a participant in the distribution of wealth rather than a charge in the
value added statement.

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97

PERFORMANCE INDICATORS / RATIOS

VALUE ADDED
SALES TO CUSTOMERS less BROUGHT IN GOODS & SERVICES = VALUE ADDED
PAYROLL TO VALUE ADDED RATIOS
1.

TOTAL PAYROLL COSTS

x 100

VALUE ADDED

showing the % of wealth returned to employees

2.

TOTAL VALUE ADDED

TOTAL PAYROLL

showing the value added created by employees for each dollar spent on labour
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98

3. VALUE ADDED TO INVESTMENT RATIO

Similar to return on investment, but this shows the wealth created from the investment made.

VALUE ADDED

100

INVESTMENT

The enterprise must aim to maximise value added through increasing productivity and efficiency.

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99

DISCUSSION QUESTIONS
1. WHAT IS THE DIFFERENCE BETWEEN PROFIT AND PROFITABILITY?
2. WHAT ARE THE MAIN MEASURES OF PROFITABILITY USED BY THE
FINANCIAL ACCOUNTANT AND HOW ARE THEY DIFFERENT?
3. WHAT IS THE DIFFERENCE BETWEEN CASH AND PROFIT.
4. HOW IS PROFIT DIFFERENT FROM VALUE ADDED.

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100

SESSIONS
7, 8, 9

ASSESSING THE FINANCIAL POSITION,

ANALYSING & INTERPRETING FINANCIAL
STATEMENTS

PROFITABILITY RATIOS
EFFICIENCY RATIOS
LIQUIDITY RATIOS
FINANCIAL GEARING RATIOS
INVESTMENT RATIOS
DISCUSSION QUESTIONS
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101

ANALYSING & INTERPRETING FINANCIAL STATEMENTS

The classical approach to this subject is commonly referred to as ratio analysis. Ratios are
used in a consistent format to compare financial performance over time in order to determine
the current financial position of a company so that its financial health can be established.
The categories of ratios are as follow :

PROFITABILITY
EFFICIENCY
LIQUIDITY
FINANCIAL GEARING
INVESTMENT

Figures to calculate these ratios are mainly taken from the income statement and the balance
sheet.
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102

PROFITABILITY RATIOS
Name of Ratio

Formula

State result as

1. Return on investment (after interest

and tax)

Net profit after tax

Total net assets (1)

2. Return on investment (after tax

before interest)

Net profit after tax but before interest

Total net assets

3. Gross profit ratio

Gross profit
Sales

4. Net profit ratio (before interest and

taxation)

Net profit before interest and tax

Sales

X 100

5. Net profit ratio (after tax and before Net profit after tax and before interest
Sales
interest)
6. Net profit ratio (after interest and
tax)
(1) NOTE

Net profit after interest and tax

Sales

%
%
%

Total Net Assets

= Total Assets Less Current Liabilities
This Is The Net Worth Of The Business
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103

EFFICIENCY RATIOS
Name of Ratio

Formula

State result as

1. Inventory turnover

Cost of Sales
Average Stock

2. Debtors to sales ratio

Debtors
Sales

X 100

3. Debtor days (collection

period)

Debtors
Sales

X 365

Days

4. Creditors turnover ratio

Creditors X 100
Purchases

5. Creditor days (payment

period)

Creditors X 365
Sales

Days

6. Cash conversion cycle

Inventory days Creditor days +

Debtor days
=
Cash conversion days

Days

7. Sales to capital employed

Sales revenue
Share capital + reserves + long term liabilities

8. Sales per employee

Sales
Number of employees

Times

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104

9. Return on shareholders
funds

Net profit after tax and dividends

Ordinary share + reserves

10. Return on capital

employed

Net profit before interest and taxation

Share capital + reserves + long term loans (2)

11. Asset utilisation ratios

(1) Sales
Fixed assets
(2) Sales
Current assets
(3) Sales
Total assets

Times
Times
Times

(1) NOTE

: Ordinary Shareholder + Reserves = Ownership Capital, these are the

Shareholders Funds

(2) NOTE

: Long Term Loans = Debt Capital

Therefore The Total Capital Employed = Ownership Capital + Debt Capital
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105

LIQUIDITY RATIOS
Name of Ratio

Formula

State result as

1. Current ratio

Current assets
Current liabilities

Ratio

2. Acid test ratio

Monetary current assets

Current liabilities

Ratio

3. Working capital
turnover

Sales
Working capital

Times

(1) NOTE : Working Capital = Current Assets Less Current Liabilities

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106

FINANCIAL GEARING RATIOS

GEARING
Gearing refers to the proportion of fixed interest (Debt), capital in relation to the equity capital
held by the shareholders as owners of the firm. If this proportion is high, then the company is
considered to be taking a high risk position.
New business development plans which require loan financing will increase the gearing of the
enterprise.
Gearing refers to the proportion of debt a company has in its capital structure.
Name of Ratio

Formula

State result as

1. Gearing ratio

Long term liabilities

Share capital + reserves + long term liabilities

2. Debt & Equity ratio

Long term liabilities

Equity share capital

3. Interest Cover ratio

Profit before interest and tax

Interest payable

These gearing ratios will also help to assess the solvency of the business.
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107

INVESTMENT RATIOS
Name of Ratio

Formula

State result as

DIVIDEND PAYOUT
RATIO

Dividends Announced
Profits for the year available for dividends

DIVIDEND YIELD
RATIO

Dividend per share

Market value per share

EARNINGS PER
SHARE

Earnings (profit) available to ordinary shareholders

Number of ordinary share issued

PRICE / EARNINGS
RATIO (PIE)

Market value per share

Earnings per share

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108

DISCUSSION QUESTIONS
1. ASSUME YOU ARE ONLY ALLOWED TO USE 10 RATIOS TO ASSESS THE
FINANCIAL POSITION OF A COMPANY, WHICH WOULD YOU USE AND
WHY?

2. IF YOU WERE REQUIRED TO ASSESS THE FINANCIAL POSITION OF 3

MAJOR COMPETITORS IN A MATURE INDUSTRY FROM THEIR COMPANY
FINANCIAL REPORTS, WOULD YOU CONSIDER COMPARATIVE RATIO
ANALYSIS TO BE AN EFFECTIVE TOOL ?

WHAT ARE THE STRENGTHS AND WEAKNESSES OF THIS APPROACH ?

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109

SESSION 10

BUDGETS AND BUDGETARY CONTROL

BUDGETS AND BUDGETARY CONTROL

BUDGETING THE PURPOSE & BENEFITS
BUDGETING AS AN APPROACH TO MANAGEMENT
TOP DOWN AND BOTTOM UP BUDGETING
CLASSIFICATION OF BUDGETS AT STRATEGIC AND
OPERATIONAL LEVELS
THE PLANNING PROCESS
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110

 STAGES IN THE ANNUAL BUDGET PREPARATION

THE INTERRELATIONSHIPS BETWEEN BUDGETS
VARIANCE ANALYSIS
MAKING BUDGETARY CONTROL EFFECTIVE
DISCUSSION QUESTIONS

Page

111

BUDGETS AND BUDGETARY CONTROL

Budget
- A qualitative statement, for a defined period of time, which may include planned
revenues, expenses, assets, liabilities and cash flows. A budget provides a focus for the
organisation, aids the co-ordination of activities, and facilitates control. Planning is
achieved by means of a fixed master budget, whereas control is generally exercised
through the comparison of actual costs with a flexible budget.
Budgetary Control
- The establishment of budgets relating the responsibility of executives to the
requirements of a policy, and the continuous comparison of actual with budgeted results,
either to secure by individual action the objectives of that policy, or to provide a basis for
its revision.
Chartered Institute of Management Accountants
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112

BUDGETING THE PURPOSE & BENEFITS

To aid the planning of annual operations
To coordinate the activities of the business
To provide a system for authorisation
To communicate future intentions
To motivate achievement of objectives and improve performance
To control the business as a whole
To evaluate the performance of managers through their budget management
To promote forward thinking and identify short term problems
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113

BUDGETING AS AN APPROACH TO MANAGEMENT

The management approach to budgeting is common across most organisations which use
any form of budgetary control.
Stating assumptions about the environment of the budget
Setting objectives to prescribed time lines
Establishing detailed financial estimates (eg. costs and revenue)
Delegating specific responsibilities for authorisation
Monitoring performance
Reviewing variances between budgeted performance and achieved performances
Reacting to exceptions through management decisions and actions
Effective budget management is often applied as a measure of managerial performance,
hence these processes outlined above are a core component of the managerial role in any
area of business.
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114

TOP DOWN AND BOTTOM UP BUDGETING

Budgeting is often achieved through a two stage process.
TOP DOWN
The Strategic
Level

Whereby senior management will consider the future economic and industry
projections, then assess these in relation to the future corporate financial
ambition. An assessment of current resource availability and future resource
needs then allow top management to assess the demands of and provisions for
next years budget. This is all achieved with an annual budgetary cycle and
calendar.

BOTTOM UP
The Operational
Level

Middle management and people down the organisation are involved at an

operational level. Preparing the budget must align with operational plans for the
future within the domain of each department (or budget centre). Information is
drawn from the internal and external business environment to assist in budget
preparation (eg. resource constraints, resource needs, competition and the
dynamics of the market).

The process then is either top down or bottom up, but will of course involve both approaches
before the budget is approved and signed off.
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115

CLASSIFICATION OF BUDGETS
AT OPERATIONAL LEVEL
Functional and Departmental Budgets
Operating Budgets showing the income and expenditure for individual functions or
departments of an organisation in forms of Sales budget, Production budget, etc. These
may be allocated to cost centres or profit centres for managerial control at operational
level.
AT STRATEGIC LEVEL
The Master Budget
Financial Budgets showing the aggregate of functional and departmental budgets which
comprises of the Profit and Loss Account, Balance Sheet and Cash Budget.

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116

THE PLANNING PROCESS

These are four key elements in achieving the budget planning & control process.
Long Term Planning
Annual Budgeting
The Annual Budget Cycle
Budgetary Control
The key elements are shown in Figure 10.1.

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117

PLANNING & THE ANNUAL BUDGET

Confirm mission, vision
Analyse the business environment & set objectives
Medium & Long
Term Planning
Process At
Strategic Level

Identify strategy options

Evaluate alternative strategic options
Prepare strategic plan for the business with timelines

Annual
Budgeting
Process

Figure 10.1

Implement the long-term plan in the form of the

annual master budget
Monitor actual results
Respond to divergences from plan
Page

118

SIMPLE BUDGETING PLANNING AND CONTROL CYCLE

Assumptions
Annual Budget
Cycle At
Operational
Level

Objectives
Prepare budget
Confirm budgets
Implement plan

Budget Control
At Operational
Level

Monitor plan monthly & quarterly

Correct problems
Adjust budget

Figure 10.2

Then re-enter the cycle

Page

119

STAGES IN THE ANNUAL BUDGET PREPARATION

Stages in budget preparation
1. Budget assumptions and guidelines

These are crucial underlying assumptions of

economic indicators such as inflation and
exchange rates, together with anticipated growth
rates for relevant industrial sectors and market
conditions.

2. Determine the factors that restrict

output

An audit of production, human and other resources

should be carried out to determine the limits on
production and other constraints.

3. Preparation of the sales budget

This is the single most important budget. It is a

function of the size of the market, the units share
of that market and the selling price obtained in a
competitive market context.
Page

120

4. Initial preparation of other

functional budgets

Once sales volume is known, the production and

overhead departments can start putting together the
budgets for their specific areas.

5. Negotiation of budgets with

superiors (Bottom up)

It is human nature to want to have some slack in the

system, whether this is a generous expenses budget
of having plenty of stock to feed production.

6. Coordination and review of

budgets

It is usually the responsibility of financial

management to make sure the budget is consistent,
e.g. that production is not making more than
marketing say they can sell.

7. Final acceptance of budgets (Top

down)

General managers of individual units may be asked

to present and commit to their budgets at divisional
and group levels before agreement.

8. Ongoing review of budgets

This is part of managerial control.

Page

121

BASIC ASSUMPTIONS + COMPANY OBJECTIVES FOR GROWTH, PROFIT

AND FINANCIAL POSITION FOR THE PERIOD.

SALES FORECAST

PRODUCTION BUDGET

Stock
Changes

SALES
BUDGET

Stock
Changes

PURCHASES BUDGET

Production, Purchasing, Marketing, Administration and R & D are analysed in physical and monetary
terms
and then allocated to responsibility centres for revenue and expenditure budgeting

PURCHASES BUDGET

SALES BUDGET

PRODUCTION COST
BUDGET

MARKETING COST BUDGET

R & D COST BUDGET

BUDGETS SUBMITTED BY RESPONSIBILITY CENTRES

WORKING CAPITAL BUDGETS

STOCK

DEBTORS

CAPITAL EXPENDITURE
BUDGETS

CREDITORS
CASH BUDGET

ESSENTIAL
FINANCIAL
STATEMENTS

MASTER BUDGET
FORECASTED PROFIT & LOSS A/C + BALANCE SHEET

THE BUDGETARY PLANNING PROCESS AND THE INTER RELATIONSHIPS BETWEEN BUDGETS

Page 122

AN EXAMPLE OF A BUDGET A SIMPLE 6-MONTH CASH BUDGET

Jan

Feb

Mar

April

May

June

(000)

(000)

(000)

(000)

(000)

(000)

60

52

55

55

60

55

Marketing & Distribution

10

10

10

10

10

10

Salaries & Wages

30

30

31

26

35

31

(1) Income
Revenue forecasts
(2) Expenditure

Electricity

14

Other Overheads

Capital Purchase

___

___

11

___

___

___

(3) Total Payments

42

42

68

38

47

52

(4) Cash Surplus (Deficit)

18

10

(13)

17

13

(5) Opening Balance

12

30

40

27

44

57

(6) Cash balance (Closing)

30

40

27

44

57

60

NOTE : The budget anticipating a positive cash balance through the 6-Month period
Page

123

SIMPLE EXPLANATION OF TERMS

1. INCOME

- Cash to be received from trading

2. EXPENDITURE

- Cash paid out for operating expenses

3. TOTAL PAYMENTS

- Equals total expenditure

4. CASH SURPLUS (DEFICIT)

- Is the net cash flow derived from income minus

expenditure. Note this could be a deficit!

5. OPENING BALANCE

- The balance at the beginning of the month which

includes the amount brought forward from the
previous month.

6. CLOSING CASH BALANCE

- The closing figure at the end of the month reflects

the balance of income & expenditure.
Page

124

VARIANCE ANALYSIS
The purpose of budgeting is to determine a forecast for expected financial behaviour and
performance. In this sense a budget is a estimate only.
Against this estimate, actual performance must be compared as part of the management
control process. The difference between actual performance and budgeted performance is
referred to as a variance.
A favourable variance is where actual performance is better than that budgeted
An adverse variance is where the actual performance is worse than the budgeted
The relationships across all variances will influence profit in the following way : Budgeted profit (plus) All favourable variances (minus) All adverse variables =
Actual profit
Page

125

MAKING BUDGETARY CONTROL EFFECTIVE

A serious attitude must be taken to the budgeting system by all levels of management,
but often there is no choice
Clear demarcation between areas of managerial responsibility for each budget domain
Budget targets being reasonable and attainable
Established data collection, analysis and routines for communication
Fairly short reporting periods, normally monthly
Variance reports being produced shortly after the end of the reporting period for
monitoring performance
Action being taken to get operations back under control
Page

126

DISCUSSION QUESTIONS
1. WHY DO COMPANIES NEED BUDGETS?
2. WHAT IS THE
COMPONENTS?

TYPICAL

BUDGETING

PROCESS

USED

IN

MOST

3. WHAT IS THE PURPOSE ACHIEVED BY VARIANCE ANALYSIS ?

4. HOW COULD A BUSINESS FUNCTION WITHOUT A BUDGETARY CONTROL
SYSTEM AND HOW WOULD THIS INFLUENCE FINANCIAL DECISION
TAKING ?

Page

127

SESSION
11 & 12

COSTS, COSTING & COST BEHAVIOUR

COSTING -- DIFFERENT TYPES

DIRECT AND INDIRECT COSTS
FIXED AND VARIABLE COSTS
BASIC COSTING TERMS DEFINED
FULL ABSORPTION AND MARGINAL COSTING
ACTIVITY BASED COSTING
COSTING AND VARIANCE ANALYSIS
Page

128

 COST VOLUME PROFIT ANALYSIS

DISCUSSION QUESTIONS

Page

129

COSTING -- DIFFERENT TYPES

The management accounting function, among other roles, will be required to perform the
task of assessing costs for different types for costing purpose, for example : STANDARD COSTS

When a product uses the same components & same time to

complete a process. This is typical in manufacturing industries,
whereby there maybe a standard labour cost and a set of
standard materials costs which form part of the costing exercise.

JOB COSTS

This is often made up of standard costs, but if costing is

required for a unique job then the unique features of the
design, content and processing may be costed on a
dedicated job cost basis.

Page

130

CONTRACT
COSTING

This is form of job costing, but for large contracts, for example,
civil engineering contracts, where the costing exercise is
detailed with a profit motive to be embedded in the costing
exercise.

PROCESS COSTING

This type of costing applies normally with large quantities

of product output, where products may be at different stages
of completion. Each stage is therefore a production process
which requires separate costing for managerial control purposes.
Process costs are mostly concerned with material costs, labour
costs and overhead costs. The processed food manufacturing
industry, the agricultural chemicals industry, furniture
manufacturing, ball bearing manufacturing are such examples.
Page

131

BATCH COSTING

This applies where there is a definite quantity of output within a

single production run. Typically in the Brewing Industry, the
Contract Food Industry, the Pharmaceutical Industry.

Page

132

Within each of these types of costing, the task is to :

Determine the cost structure ad types of costs

Estimate costs

Know how cost, if at all, varies with output

Forecast any change to cost during the life of the costs incurred

Determine a total cost to then be given to a centre of responsibility for

management

Page

133

DIRECT AND INDIRECT COSTS

Costs, in simple terms can be classified as :

Direct costs

Direct Costs

Indirect Costs

are those that are specially incurred with the output of a product or service, for
example, the direct material used and the direct labour employed. These costs
are therefore the prime costs associated with, for example, production of a
specific product.

However to achieve this output, there are other costs involved to be able to convert the
materials and labour into the finished product, these are known as indirect costs.
Indirect costs

are all other costs incurred but which cannot be measured in respect of a
particular unit of output, hence the term indirect. These costs comprise the
overhead costs of the business, eg. Administration, marketing & selling
costs, which are a necessary expense to the business.
Page

134

These terms are important as they will be used to determine profit whereby : (1)

SALES REVENUE

(2) MINUS

DIRECT COSTS

(3) EQUALS

GROSS MARGIN OF PROFIT

(4) LESS

INDIRECT COSTS

(5) EQUALS

NET OPERATING PROFIT OR LESS

The understanding of Direct and Indirect Costs is hence essential to determine Gross Margin of
Profit as well as the Net Operating Profit. The proportions between each will vary from industry
to industry.
The significance of these two types of costs is that : (1) They must be managed, monitored & controlled
(2) They should be contained within a budget for the purposes of (1) above.

Page

135

FIXED AND VARIABLE COSTS

FIXED COSTS

are those which do not change with output, they are incurred regardless of
sales or production. For example, premises rental if a business has no
sales, the rent still must be paid, therefore it is a fixed cost.

VARIABLE
COSTS

are those which will change with output and will therefore depend upon
output, for example the food costs in a restaurant will be influenced by the
number of restaurant guests ordering food.

TOTAL COSTS

equal fixed costs plus variable costs.

Page

136

THE RELATIONSHIP BETWEEN DIRECT, INDIRECT, FIXED & VARIABLE COSTS

There could be a relationship between these 4 Cost Categories and it may be helpful when completing a
cost exercise for a particular job.
VARIABLE
COSTS

FIXED COSTS

DIRECT COSTS

INDIRECT COSTS

TOTALS

TOTALS

TOTAL
COST
Figure 11.1

The challenge is to achieve a fair basis to apportion the indirect costs to a particular job costing exercise.
Such a matrix maybe useful as a basis for managerial discussion on cost control, furthermore this could
apply at each stage in a manufacturing process.
Page

137

COSTS INCURRED DURING A MANUFACTURING PROCESS TO BE USED TO

ESTIMATE THE FUTURE COST OUTPUT
PROCESS
1
Production
Dept

Direct
Materials

Direct
Labour

Direct

Costs

PROCESS
2
Machining
Dept

PROCESS
3
Finishing Dept

Further

Direct Costs

PROCESS
4
Finished
Goods Store

TOTALS

Further
Any Direct
Direct Costs Costs if at all

Accumulated
Indirect

TOTALS

A Proportion
of the
Business
Overheads

A Proportion
of the
Department
Overheads

A Share of
the Financial
Departments
Overheads

Allocation of
Share
Overheads

TOTAL
COSTS

Figure 11.2
Page

138

BASIC COSTING TERMS DEFINED

Before we continue further, the following are simple definitions of key costing terms : DEFINITIONS

Historical Cost

Cost at Date of Purchase

Opportunity Cost

The Cost of the Alternative Forgone

Replacement Cost

Present Day Cost of Replacement

Fixed Cost

Those Which Do Not Change with Output

Variable Cost

Those Which Do Change with Output

Sunk Cost

Those Already Paid and Cannot Be Changed

Page

139

 Direct Cost

Those Directly Attributable to Output

eg. Direct Labour, Direct Materials, Direct Expenses

Indirect Cost

Incurred in Business Operations but not Directly

Attributable eg. Rent rates, Insurance, Admin
Expenses

Overheads

Indirect Costs and not Directly Chargeable to

Output, Staff Salaries, Vehicle Leasing, Rent
Maintenance

Marginal Costs

The Cost of One EXTRA Unit of Output

which is the Incremental Cost Incurred

Page

140

 Cost Centre

A Location where costs can be Sensibly Attached

eg. A Department such as Personnel or to a Function
such as Maintenance
Overheads may be Charged to a Cost Centre or
Apportioned between Cost Centres using an
Appropriate Method of Overhead Absorption (eg.
Rental Charge to the Square Feet Occupied by the
Cost Centre). Often such methods of Allocation
Costs are Arbitrary as in the Case of Selling and
Distribution Costs

Cost Variance

The Amount of Difference Between the Actual Costs

Incurred and the Budgeted Cost (or Standard Cost)

Page

141

 Cost Behaviour

A Historical Review of How Costs are Incurred

and Changed with the Rate of Output Overtime,
Assessed by Cost Variance Analysis and used for
Future Budget Determination

Standard Costs

Cost Estimates Applied in Forecasting Future

Budgets, Where the Budgeted Costs becomes
known as a Standard Cost eg. for Labour
& Materials

Inflation

Costs Incurred which are usually uncontrollable

and must Be Considered in the Budgeting Process
and in Contingency Cost Control

Page

142

 Contribution

The amount derived from Sales Revenue less only

the variable costs incurred. The amount remaining is
called the contribution in fact to fixed costs and profit)
of the enterprise

The difference between the cost estimated and the

cost actually incurred

Cost Variance

Page

143

ELEMENTS OF A PRODUCT COSTING SYSTEM

Overall Cost Control System
Product Costing
System
Costing
Method

Specific orders
Job
Costing

Batch
Costing

Continuous operations
Contract
Costing

Process
Costing

Function /
Service Costing

Method of
Cost Control

Standard Cash or Actual Costs Or Activity Based Costs

Treatment of
Fixed Costs

Fully Absorbed Or Apply Marginal Costing

Charging
Overheads

A Rate for Absorption Using Marginal Costing

Figure 11.3
Page

144

From Figure 11.3, the overall cost control system for product costing will comprise : 1. Costs of Continuous Operations
2. Costs of Specific (Special) Orders
The costing methods applied to continuous operations will probably be based upon process
costing, whereas for the special orders costs will need to be applied to either :

The Job
The Batch
The Contract

To complete the costing exercise, decisions will have to be taken as how to change the fixed
and variable costs. This could be completed using :

Full Absorption Costing

Marginal Costing OR
Activity Based Costing
Page

145

FULL ABSORPTION AND MARGINAL COSTING

Full Absorption Costing

means that all costs, both fixed and viable will be

charged to obtain a full absorption cost for the product,
assuming that the market can accept thefinal price after
a profit margin has been numbered up on the total cost
estimate.

Marginal Costing

means that the variable costs only is considered as a

means to determine the marginal cost of output and
therefore the basis for setting price. The selling price
determined minus the managerial costs, is referred to as
the contribution. This in fact is a contribution to fixed
cost and profit.

The two alternative approaches to costing are shown in Figure 11.4.

Page

146

Figure 11.4

FULL ABSORPTION
COSTING

AND

1. Total Direct Costs

1. Total Variable Costs

Direct Materials
Direct Labour

Direct Materials
Direct Labour
Variable Production Overhead
Variable Selling & Distribution Overhead

Total Production Overhead

PLUS

2. Total Indirect Costs

2. Contribution Margin

Selling Overhead
Distribution Overhead
Admin Expenses
R & D Costs
EQUALS

3. Total Cost

PLUS %
Mark Up

4. Margin

EQUALS

5. Total Selling Price

NOTE SELLING PRICE TOTAL COSTS = NET PROFIT

BEFORE TAX

MARGINAL
COSTING

Proposed Selling Price Minus The Total

Variable Cost
LESS
EQUALS

3. Less Fixed Costs

4. Less Profit (or Loss)

NOTE MARGINAL COSTING IS BASED UPON THE

CONCEPT OF A CONTRIBUTION MARGIN
Page

147

Why are these two approaches important ?

They are used to set Price in order to gain sales and profit.
The Marginal Approach argues that as long as variable costs are covered, that there will be a
contribution to fixed costs and profit. This is provided the contribution margin is large
enough.
The Full Absorption Costing approach is more conventional because it ensures all elements
of cost are built into the pricing decision. Furthermore it helps to estimate profit in more
absolute terms.
In practice, the two approaches may be used side by side in order to achieve desired
business volumes and the overall profitability of the enterprise.
For example, a restaurant may have a lunch and dinner menu. The dinner menus may
change menu prices for individual dishes all based upon full absorption costing. The
restaurant is then positioned in the competitive market place according to the price
positioning relative to others.
Page

148

However the lunchtime menu could be a fixed price for a Business Lunch with a
fixed limited menu, or even a fixed price buffet lunch. This price will be lower than
that for the dinner menu because the price is based upon managerial costing principle
whereby as long as the lunch menu price exceeds the variable cost of food ingredients
and the staff employed, there will be a contribution to the fixed costs of the business
eg. the rental and electricity overheads.
Probably no absolute profit will be made. But overall the restaurant will be profitable
because the lunchtime business contributes to the business overheads as well as
covering the variable costs incurred.

Page

149

ACTIVITY BASED COSTING

This approach to costing is based upon a different philosophy, rather than using
Direct and Indirect Costs as a basis to determine actual cost, the approach uses the
defined separate activities which together deliver value for the business. The
conversion process is separated into domains which normally are independently
managed but nevertheless coordinated in terms of fixed & variable costs incurred and
then aggregate these into a total cost estimate. Each domain will then cost its
activities. It is very challenging to be applied in practice, but is widely applied.

Examples are shown in Figure 11.5.

Page

150

ACTIVITY BASED VALUE CHAIN

Product WareDevelop- housing

ment

Marketing
& Sales

Customer
Order
Processing

Credit
Control

Stock
Control

Invoicing
Process

Figure 11.5

Despatch
&
Delivery

After
Sales
Service

FIXED
COSTS

VARIABLE
COSTS

TOTAL
COSTS

TOTAL ACTIVITY BASED

COST
END TO END
Page

151

The key to activity based costing (ABC) is activity based management and the
availability of data and information flows to accurately assess current and future
costs.

The realisation of the total cost per unit or for a total end to end process can
sometimes be alarming and then when this approach is used to set price, the level at
which price needs to be charged may make the product or service uncompetitive.

Page

152

COSTING AND VARIANCE ANALYSIS

Costing and total cost estimates are forecasts made upon assumptions about
environmental conditions and the behaviour of costs. Sometimes, uncontrollable variables
will have an unanticipated impact upon cost, rendering the cost estimates invalid to some
extent.
The difference between the cost estimates and the actual cost incurred is referred to as a
cost variance. This variance may be positive of the cost was actually less than planned or
adverse if costs are greater than estimated.
The analysis of variance can be considered through the following hierarchy in Figure
11.6.

Page

153

PROFIT VARIANCE

TOTAL SALES MARGIN

VARIANCE

SELLING &
DISTRIBUTION COST
VARIABLES

Sales Price
Variance

Sales Volume
Variance

TOTAL PRODUCTION COST

VARIANCE

DIRECT
MATERIALS
VARIANCE

DIRECT
LABOUR COST
VARIANCE

VARIABLE
OVERHEAD COST
VARIANCE

FIXED
OVERHEAD
COST VARIANCE

Figure 11.6
Page

154

COST VOLUME PROFIT ANALYSIS

One key area of financial management is cost-volume-profit analysis, which is intended to
assess the levels of potential or actual profits for varying levels of output. Key concepts to
be applied are : COSTS FIXED & VARIABLE
CONTRIBUTION
BREAKEVEN ANALYSIS
MARGIN OF SAFETY
THE PROFIT VOLUME CONCEPT
RATIOS

Page

155

THE BEHAVIOUR OF FIXED AND VARIABLE COSTS

Costs may be broadly be classified as we have seen into :

FIXED COSTS

- These stay fixed as long as the business stays in business

VARIABLE COSTS

- These change as the business activity level changes

These two types of costs will be applied to determine BREAK EVEN ANALYSIS.

Page

156

BREAK EVEN ANALYSIS

STEP 1

Figure 11.7

GRAPH OF FIXED COST(S) AGAINST THE VOLUME OF ACTIVITY

COST
()

FIXED
COST
LINE

0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)

NOTE

THE FIXED COST IS HORIZONTAL TO THE BASELINE BECAUSE COST IS FIXED

REGARDLESS OF OUTPUT
Page

157

Figure 11.8
STEP 2

GRAPH OF VARIABLE COSTS AGAINST THE VOLUME OF ACTIVITY

COST
()

0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)
NOTE : THE VARIABLE COST LINE STARTS AT THE AXIS OF THE CHART, THE STEEPNESS OF THE
LINE IS REFLECTED BY HOW VARIABLE COSTS CHANGE WITH THE VOLUME OF OUTPUT
Page

158

Figure 11.9
STEP 3

GRAPH OF TOTAL COST AGAINST THE VOLUME OF ACTIVITY

COST
()

Total Cost Line

TC
Variable
costs

F
Fixed
costs
0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)
NOTE

: THE TOTAL COST LINE IS A SUMMATION OF FIXED PLUS VARIABLE COSTS. THE TOTAL
COST LINE STARTS AT THE POINT AT WHICH FIXED COSTS HAVE BEEN PLOTTED
Page

159

Figure 11.10
STEP 4

GRAPH SHOWING TOTAL REVENUE TO ASSESS BREAK-EVEN

Total Sales
Revenue

REVENUE
& COST
()

Break Even
Point
Total Cost
Variable
costs
Loss

F
Loss

Fixed
costs

0
VOLUME OF ACTIVITY (UNITS OF OUTPUT)
NOTE : THE BREAK-EVEN POINT IS WHERE TOTAL REVENUE EQUALS TOTAL COST. THE CHART
ALSO SHOWS PROFIT AND LOSS ESTIMATES FOR DIFFERENT LEVELS OF OUTPUT
Page

160

BREAKEVEN CHART

Figure 11.11
Sales Revenue

Relevant Range Of Business

Activity
REVENUE
& COST
()

Total Costs
Profit

Breakeven
Sales

Variable Cost
Breakeven
Point

Loss

< Margin of Safety >

Fixed Costs
Breakeven Output

0
VOLUME (UNITS)

NOTE : From a management perspective, the relevant range of business activity can be forecasted and
then assessed against the breakeven point. In this way a margin of safety can be assessed, being
between the break even point and the forecasted (or actual) volume of output.
Page 161

Figure 11.12

THE PROFIT VOLUME CHART

To complement the breakeven chart, the profit volume chart can be used to examine, through the
chart, an estimate of profit or loss at different volumes of activity.
PROFIT
()

The PV Line
Total Sales Total Costs
Break Even
Point

Fixed cost

0
LOSS

VOLUME OF ACTIVITY
As $ Sales Revenue (or
% capacity)

LOSS
()

F
Page

162

To draw a PV Chart the following steps can be taken : 1. On the vertical axis, (the Y axis) the fixed costs are logged. This is the position where the
company has no sales.
2. The breakeven point is then plotted along the base axis (the X axis)
3. The line can be drawn by connecting the points on the X and Y axis.
NOTE

1.
2.
3.
4.
5.

With no sales, a company has losses equivalent to fixed costs

When sales occur, variable costs are incurred
Sales generate contribution to recover fixed costs
When total contribution equals fixed costs, a breakeven point is achieved
Beyond the breakeven point, total contribution exceeds fixed costs and a profit is generated.

Total Contribution
Unit Contribution
The PV Ratio

=
=
=

Total Sales Total Variable Costs

Unit Sales Unit Variable Costs
Total Contribution or Unit Contribution
Total Sales
Unit Selling Price
Page

163

KEY RATIOS FOR COST VOLUME - PROFIT ANALYSIS

Unit Break Even Point

Total Fixed Costs

Unit Selling Price - Unit Variable Costs
(ie. The Unit Contribution)

Break Even Sales Revenue

Total Fixed Costs

x Total Sales
Total Fixed Costs + Net Profit
Revenue

P.V. Ratio

Unit Contribution
Total Contribution
Unit Selling Price or Total Sales Revenue

Unit Margin of Safety

Total Sales in Units The Break Even Point

Revenue Margin of Safety

Total Sales Revenue The Break Even Point

Net Profit

PV Ratio x Margin of Safety

Page

164

SIMPLE EXAMPLE -- DISCUSSION QUESTION

ALEXIS LTD
Alexis Ltd is a small company manufacturing industrial measuring devices for the surveying industry.
They have a future investment ambition to take on a new product for the household market.

Using the following data, ascertain the companys break even point.
Number of units produced
Sales Forecasted
Total Fixed Costs ( )
Variable Costs Per Unit ( )
Selling Price Per Unit ( )

40,000
36,000
201,600
14.00
20.00

The Directors of the company would like to know the number of units that need to be sold if they are
to recover 15% of the companys initial investment of 330,000.

Page

165

ALEXIS LTD -- SOLUTION

POINT (1) UNIT CONTRIBUTION

POINT (4)

Contribution Per Unit

= Sale Price less Variable Costs
= 20.00 - 14.00
= 6.00

Profit on Selling 36,000 units

Sales x Price (36,000 x 20) = 720,000
Less Cost of Sales (36,000 x 14) = 504,000
Equals
Contribution
216,000
Less Fixed Costs
201,600
Equals
Profit
14,400

POINT (2) BREAK EVEN VOLUME

Break Even Units
= Fixed Costs divided by Contribution (per unit)
= 201,600 / 6.00
= 33,600 units

POINT (3) THE OBJECTIVE FOR 15%

RECOVERY
15% of 330,000 = 49,500
New Break Even Units
= Fixed Costs Plus Target Profit divided by
Contribution (per unit)
= (201,600 + 49,500)
6
= 41,850 units to be sold

POINT (5)

PROFIT FORECAST

= PROFIT SELLING PRICE

x UNIT SALES FORECAST

Profit / Sales = 14,400

20 x 36,000

= 14,400
720,000
= 0.02%

Page

166

Conclusion, Alexis cannot recover the initial investment on current sales forecasted and the
initial profit on sales of 720,000 is only 14,400. It is unwise to pursue this further without
careful assessment of the costs and market potential.

Page

167

DISCUSSION QUESTIONS
1. YOU HAVE BEEN ASKED TO ADVISE A USED CAR DEALER ON DIFFERENT
COSTING APPROACHES TO DECIDE PRICES TO BE CHARGED, BUT HAVE TO
TAKE INTO ACCOUNT THAT THE OWNERS OF THE BUSINESS MUST ACHIEVE AN
EFFICIENT INVENTORY TURNOVER TO AVOID TOO MUCH CAPITAL BEING TIED
UP.

2. A NEW RESTAURANT HAS BEEN PLANNED IN YOUR RESIDENTIAL AREA, IT HAS

BOTH TAKE AWAY AND IN-DINING AVAILABLE, BUT NEEDS TO USE THE
PRINCIPLES OF COST, COSTING AND COST BEHAVIOUR TO DECIDE HOW TO SET
PRICES AT A LEVEL TO ACHIEVE PROFIT ABOVE THEIR COST OF CAPITAL. HOW
WOULD YOU ADVISE THEM.

Page

168

SESSION 13

THE TIME VALUE OF MONEY & CAPITAL

INVESTMENT APPRAISAL DECISIONS

THE TIME VALUE OF MONEY

CAPITAL INVESTMENT DECISIONS
CAPITAL INVESTMENT APPRAISAL METHODS
-----

Accounting Rate of Return

Payback Period
Net Present Value
The Internal Rate of Return

INVESTMENT APPRAISAL IN PRACTICE

DISCUSSION QUESTIONS
Page

169

THE TIME VALUE OF MONEY

This concept considers the future value of money as it travels forward in time. Therefore
consider the following question : Is a or a $ today worth more than tomorrow or less than tomorrow ?
If tomorrow was one years time what would be your answer !
So therefore, if you give a friend a loan of 100 today, how much would you expect
back in 12 months time ?
If a bank lends you of 20,000 today to buy a car and gives you the loan for 5
years, how much will they expect back in 5 years time ?
This is the CONCEPT of the TIME VALUE OF MONEY.
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170

Consider the preset value of 1 today with a financing cost of 20% and look at the value of
Pence

that 1 over a 10-year period and then realise how the preset value of that 1 diminishes.
100
90

80
70
60
50
40
30
20
10
0

10

Years into the future

If other concepts, such as inflation, opportunity cost, risk and even depreciation are
considered then the value is further diminished.
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171

CAPITAL INVESTMENT DECISIONS

The profitability of the enterprise is a function of its ability to generate projects or
investments which provide greater returns than the cost of funds.
Capital investment decisions form part of a capital budgeting procedure which involves :
1. A creative search for investment opportunities. This may involve new projects expansion
of existing facilities, replacement of existing facilities, research & development etc.
2. Long range plans and projections of the companies future direction and development.
3. A yardstick to measure economic growth.
4. Forecasting the results of development projects.
5. Expenditure controls of outlays prior to and during a project life.
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172

6. Time plans for income and expenditure streams.

7. Investment analysis for returns and value of the project at disposal.

To measure the economic worth and to provide a realistic estimation of return various common
methods are in use called capital investment appraisal methods.

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173

CAPITAL INVESTMENT APPRAISAL METHODS

1.

ACCOUNTING RATE OF RETURN (ARR)

2.

PAYBACK PERIOD (PP)

3.

NET PRESENT VALUE (NPV)

4.

INTERNAL RATE OF RETURN (IRR)

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174

1.

ACCOUNTING RATE OF RETURN (ARR)

Average Annual Profit

ARR =

x 100%
Average Investment to earn that Profit

This is also referred to as the average return on investment and is a simple yardstick to compare
return against the cost of capital for the investment to determine if the accountancy rate of return
is sufficient in accordance with the companys objectives or investment practices.

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175

2.

PAYBACK PERIOD (PP)

PAYBACK
PERIOD (PP)

The payback period is the length of time it takes

for the initial investment to be repaid out of the net
cash inflows from the project.

The 3 projects shown on the next page have different levels of initial investment
and different rates at which that investment is being repaid from net inflow of
cash.

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176

PROJECT
A

PROJECT
B

PROJECT
C

( m)

( m)

( m)

(10)

(15)

(20)

Year 1

(5)

Year 2

(2)

Year 3

(5)

Year 4

Year 5

15

15

3 Years

5 Years

Initial Investment
Net Cash Flows

Payback Period

Not Achieved

This method is simplistic, assumes a real ability to forecast future net cash flows and ignores the
future and/or residual value of the project, but it is a beginning.
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177

3.

NET PRESENT VALUE (NPV)

The NET PRESENT VALUE method of Capital Investment Appraisal is more superior than the
payback period or the Accountancy Rate of Return because it considers :
1. The timing of the cash flows
2. All relevant cash flows
3. The real objectives of the business in relation to cost of capital

The NPV method uses Discounted Cash Flow (DCF) tables which represent the time value of
money as discussed earlier.
The DCF Tables will show the present value factors at different rates of interest so that the net
worth of money received in future years can be understood in terms of its present day value.

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178

INTEREST RATES

179
Page

EXAMPLE OF TWO ALTERNATIVE PROJECTS

PROJECT A

Construction Project in Thailand with an initial $10 million

investment

Using Discounted cash flow at 15% per annum

Net Cash Flows are forecasted and present value factors applied
from the table of net present value factors

The Total Cash Flow exceeds the assumed Rate of Return of

15% and on this criteria the project could be accepted

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180

PROJECT A (COST OF CAPITAL 15%) THAILAND

$m
Net Cash Flow
(10)

Year (0) Investment

Discount Factor*
@15%

Present Value
$m

1.0000

(10)

Year 1

.8696

.8696

Year 2

.7561

2.2683

Year 3

.6575

3.945

Year 4

.5718

2.859

Year 5

.4972

1.988
*
NPV

1.930

* See tables to confirm Present Value Factors at 15% for a 5-year period
* NPV = Net Present Value which is beyond the Cost of Capital at 15% Per Annum, so is therefore
favourable
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181

PROJECT B

Real Estate Investment in Vietnam

Using Discount Rate at 19%

Net Cash Flows both Positive and Negative

The Net Present Value Factors are applied to the Forecasted Net
Cash Flows to determine present value

The value of these aggregated Cash Flow is still negative, even

after 5-years

The Project should be rejected based on these criteria

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182

PROJECT B (COST OF CAPITAL 19%) VIETNAM

$m
Net Cash Flow
Year (0) Investment

(15)

Discount Factor*
@19%

Present Value
$m

1.000

(15)

Year 1

(5)

.8403

(4.215)

Year 2

(2)

.7062

1.412

Year 3

.5934

1.780

Year 4

.4987

4.488

Year 5

15

.4190

6.285
*
NPV

(8.074)

NEGATIVE, REJECT
* See tables to confirm Present Value Factors at 19% for a 5-year period
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183

CONCLUSION
Project A in Thailand has cost of capital at 15% but the NPV (Net Present Value) of this
Project is $1.930 million showing that the return from the project exceed the cost of capital
over the 5-years life of the project. Assuming the forecasts of Net Cash Flows have a good
level of tolerance, then the project should be accepted.

Project B in Vietnam has a higher cost of capital at 19% and yields after 5-years an NPV of
(S8.07 million). This negative NPV shows that the returns from the project are for less than
19% and therefore way below the cost of capital. Therefore the project should be rejected.

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184

THE INTERNAL RATE OF RETURN (IRR)

The NPV method shows if the returns from a capital investment project exceed the cost of
capital, but to calculate the ACTUAL return, then the IRR method is used.
The Internal Rate of Return is the discount rate, which when applied to Future Cash Flow of a
project produces a Net Present Value of zero.
This is the exact point at which the percentage return is determined.
The Actual Internal Rate of Return is calculated by a method called interpolation, by first
finding a rate giving a positive return and another rate giving a negative return and finding
the rate in between these two points as shown in the example in (Figure 13.1).

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185

PROJECT ABCZ has an initial investment of 40,000, with positive net cash flows for 4years, which is the anticipated life of the project.
The company seeks to know what is the actual Internal Rate of Return in order to justify a
GO / NO GO decision.
To assess the position, two Discount Rates have been selected, 18% and 20% to determine
the actual return. From the example, it shows that at 18% the project has a positive NPV, so
therefore the actual IRR is greater than 18%. Using the simple formula for interpretation
between the two points of 18% and 20% the precise IRR can be calculated.

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186

FIGURE 13.1

PROJECT ABCZ
Year

Net Cash
Flow

Present
Value
18%

(40,000)

1.0000

16,000

Present
Value Value

Present

Present
Value

20%

(40,000)

1.0000

(40,000)

0.8475

13,560

0.8333

13,333

16,000

0.7182

11,491

0.6944

11,111

16,000

0.6086

9,738

0.5787

9,259

12,000

0.5158

6,189

0.4823

5,787

NPV

Internal Rate of Return

IRR

= 18% +

978
978
978 + 510

NPV

x 2%

(510)

= 19.31%

That is the base of 18* + An Adjustment to determine the actual IRR which is between 18% and 20%.
Here the IRR is 19.31%, which if it is beyond the cost of capital would be considered acceptable for
adoption.
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187

INVESTMENT APPRAISAL IN PRACTICE

Businesses use more than One Method to assess each Investment Decision
There is an Increased Use of the Discounting Methods (NPV and IRR) Over Time
There remains a Continued Popularity of ARR and Payback Period owing to its
simplicity
So therefore in conclusion, there are a number of dimensions to capital investment
decisions, these appraisal techniques offer some insight into project viability from a
financial management perspective.

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188

DISCUSSION QUESTION
1.

WHY DO FINANCIAL ANALYSTS CONSIDER THAT THE TIME VALUE OF

MONEY IS IMPORTANT ?

2.

COMPARE AND CONTRAST THE 4 MAIN METHODS OF CAPITAL

INVESTMENT APPRAISAL NAMELY : -- ACCOUNTING RATE OF RETURN
-- PAYBACK
-- NET PRESENT VALUE
-- INTERNAL RATE OF RETURN

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189

SESSION 14

FINANCING A BUSINESS

SOURCES OF INTERNAL FUNDS

-- Long Term
-- Short Term

SOURCES OF EXTERNAL FUNDS

-- Long Term
-- Short Term

SHARE ISSUES
FACTORING & INVOICE DISCOUNTING
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190

 LONG AND SHORT TERM BORROWING

OTHER SOURCES OF FINANCE

DISCUSSION QUESTIONS

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191

FINANCING A BUSINESS
Funding any business is an essential requirement, it is important to know when funds are
needed and to the level they are required.
Once this is determined, companies should be aware of how funds can be raised, this is
known as the source of funds .
Funds can be sourced from both internally and externally.

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192

THE MAJOR SOURCES OF INTERNAL FUNDS

LONG TERM

SHORT TERM

--

From Retained Profits held in the business

--

Sale of Fixed Assets

--

Loans from Directors

--

Tighter Credit Control

--

Delayed Payments to Creditors

--

Reduced Stock Levels

--

Personal Loans

--

Cash Held at Banks

--

Invoice Factoring

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193

THE MAJOR SOURCES OF EXTERNAL FUNDS

LONG TERM

SHORT TERM

--

Issue of Ordinary and/or Preference Shares

--

Long Term Bank Loans

--

Debentures

--

Government Loans / Grants

--

Pension Funds

--

Trade Credit Taken

--

Bank Credit
Overdraft Facility

--

Invoice Discounting

--

Debt Factoring

--

Short Term Loans

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194

ISSUES OF SHARES
The common methods of share issues to generate cash are : RIGHTS ISSUES

--

There are new shares offered to existing shareholders, easily the most
common method of raising equity capital for existing companies.
Shareholders are offered the right to subscribe for new shares in the
proportion to their existing shareholding, thus enabling them to retain
their current voting control.

This is a cheaper form of raising a public share issue and the

method namely fails.

OFFERS FOR SALE

AND PUBLIC
ISSUANCE

--

Larger amounts of new capital can be sorted by a public listing

through the stock exchange to the general public. This is also called
Going Public. The most common ways is an offer for sale to an
issuing house who then in turn offers the shares for sale to the general
public. This is desirable as the issuing house underwrites the value of
the shares and thereby reduces the risk to the offering company.
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195

 PRIVATE PLACING

--

Private companies usually depend upon individual owners as the

main source of equity finance. Additional equity is raised by
widening the ownership, without going to the general public.
Hence it is called a private placing normally organised through
stock broking companies.

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196

LONG TERM AND SHORT TERM BORROWING

In general terms for accounting purposes, short-term refers to a period of up to one year ie. the
current trading year for example. Therefore long-term borrowing would be loan finance for a
period of greater than 1 year and often up to 5 years or more.
There is ONE GOLDEN RULE : Long term sources of funds should be used for long term applications.
AND
Short term sources of funds should be used for short term applications.

In this way, the source is MATCHED to the application. Interest rates should be carefully
considered and the ability to repay the loan together with the flexibility allowed.
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197

FACTORING AND INVOICE DISCOUNTING

The financing of trade debtors may involve either the : -

OR

Assignment of Debts

(called invoice discounting)

The Selling of Debts

(called factoring)

The purpose is simply to use the companys debtors as a means to raise finance for the business.

With invoice discounting, the risk of default by the debtor remains with the borrower.
With factoring, the factor bears the loss in the event of bad debt.
The common factoring process provides cash upfront of up to 80% of the value of invoices,
repayments are paid, together with the interest charged, from the cash collected by the factoring
agent from debtors.
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198

OTHER SOURCES OF LONG TERM FINANCE

VENTURE CAPITAL

is a term to obtain start-up capital. Venture Capital

Companies (VCCs) select relatively high risk businesses
where the upside pay-off for a successful venture is
substantial so that the VCC can recoup their investment and
make an additional return. Participation on the Board is
often a requirement of the VCC as a condition for
advancing the required capital.

GOVERNMENT
ASSISTANCE

is often available through grants, interest free loans, tax

exemption schemes and tax honeymoons, all of which are
designed to attract, in particular, foreign direct investment
into a country.

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199

DISCUSSION QUESTIONS
IMAGINE YOU ARE ABOUT TO START UP A NEW BUSINESS FOR THE FIRST
TIME. WHERE WOULD YOU SOURCE CAPITAL FOR YOUR NEW VENTURE ?
HOW WOULD YOU KEEP THIS BUSINESS FINANCIALLY STABLE ?
IF YOU WERE FACING DIFFICULTIES BECAUSE CUSTOMER DEMAND HAS
DROPPED AND YOU ARE ALSO FACING DIFFICULTIES IN COLLECTING
MONEY FROM DEBTORS . . . WHAT ACTIONS CAN BE TAKEN ?

Page

200

ANNEX 1

SEMINARS

Page

 6 SEMINARS IN TOTAL ARE PLANNED FOR THIS MODULE TO COVER

POTENTIAL SYLLABUS DISCUSSION QUESTIONS PROPOSED AT THE
END OF EACH SESSION.
ASSESSMENT BASED SEMINARS SHOULD ALSO BE HELD FOR
ASSIGNMENT PREPARATION, REVISION AND EXAMINATION
BRIEFING.

Page

ASSESSMENT SEMINARS SEQUENCE

1.

ASSIGNMENT PREPARATION

2.

ASSIGNMENT OUTLINES -- PRESENTATION

3.

ASSIGNMENT OUTLINES -- PRESENTATION

4.

REVISION OF SYLLABUS TOPICS FROM FRONT SHEETS OF

EACH SESSION (TOPICS 1 TO 7)

5.

REVISION OF SYLLABUS TOPICS FROM FRONT SHEETS OF

EACH SESSION (TOPICS 8 TO 14)

6.

EXAMINATION BRIEFING

Page

SEMINAR 1 : ASSIGNMENT PREPARATION

EXPECTATIONS
University Protocols
Structure of a Good Assignment
Content Expected
Referencing to meet Academic Requirements
Examples from previous courses
Conclusion How to make this effective
Using Appendices
Student
Task

Students produce A Roadmap to address the assignment question of choice

Page

SEMINAR 2 & 3 : ASSIGNMENT OUTLINE PRESENTATION

1. Students Are Required To Present The Plan For Their Financial Management
Assignment
2. Students Will Be Selected For Presentation Depending Upon Class Size
3. Group Feedback From Peers Will Be Obtained
4. Critique Given By Tutor
5. Tutor Explains How The Assignment Is Marked And The Criteria Used For
Assignment Evaluation

Page

SEMINAR 4 : REVISION OF SYLLABUS

TOPICS 1 TO 7

Page

SEMINAR 5 : REVISION OF SYLLABUS

TOPICS 8 TO 14

Page

SEMINAR 6 : EXAMINATION BRIEFINGS

Protocols

Examination Techniques

Tutor Expectations

The Content Of A Good Answer

Sample Questions & Answer Discussions

Criteria For Marking Examination Answers

Page

ANNEX 2

RECOMMENDED READING

Page

Atrill (2006) Financial Management for Decision Makers, 4th Ed, Financial Times Press

Block, S. B. & Hirt, G. A. (2008), Foundations of Financial Management, 12th Ed,

McGraw-Hill Education

Brealey, R. A., Myers, S. C. & Allen, F. (2008), Principles of Corporate Finance, 9th
Edition, McGraw-Hill

Brooks, R. (2009), Financial Management : Core Concepts, 1st Ed, Pearson Education

Higgins, R. (2007), Analysis for Financial Management, ISE Edition, McGraw Hill
Education

Neale, B. & Pike, R. (2009), Corporate Finance and Investment Decisions & Strategies,
6th Ed, Prentice Hall

Titman, S., Martin, J. & Keown, A. (2010), Financial Management : Principles and
Applications : International Edition, 11th Ed, Pearson Education
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Journals and Periodicals

Websites

Financial Times newspaper

www.bloomberg.com
www.corporateinformation.com
www.hoovers.com
www.londonstockexchange.com
http://finance.yahoo.com/
www.hemscott.com

Page

ANNEX 3

SAMPLE ASSIGNMENT QUESTIONS AND SAMPLE

EXAMINATION PAPERS

Page

ANNEX 3

SAMPLE ASSESSMENT QUESTIONS

Sample Assignment Questions

Sample Examination Questions

Page

SAMPLE ASSIGNMENT QUESTIONS

1. Using a set of published accounts of your choice, you are required to assess the
financial position of the business for a 2-year period.
You are required to calculate and interpret management rations to cover the following
areas :

Efficiency
Liquidity
Profitability
Financial Gearing

You are required to summarise the analysis with your key findings from this overview.

Page

2. Select any one area from the course on Financial Management and then prepare a
report outlining the following : 2.1
2.2
2.3
2.4
2.5

The Definition of Concept

The Value to the Financial Management of a Business
A Worked Example of the Concept
The Difficulties Faced in Implementation
The Insights you have gained in completing this assignment

3. You have been asked to advise an international company in the textbook publishing
industry upon how to improve their book sales by considering all the relevant concepts
of financial management related to costs, costing and cost behaviour.

Page

SAMPLE EXAMINATION PAPER ( 1 )

Answer 2 Questions from 7. Time allowed : 2 hours
1. Explain the key functions performed by Financial Management and argue where the
priorities should be placed for a mature company in an established industry operated in
the London Stock Exchange.
2. One fundamental role of the Management Accountant is to communicate relevant,
timely, economic data and information to a companys stakeholders. Discuss.

3. What is Cash Management and how is this function normally achieved by the Finance
Manager.

Page

4. Explain the term Working Capital . How do we ensure that this type of capital is
working effectively.
5. Why do trading companies need profits ?

6. To assess the financial position of a business, a financial analyst would use a series of
financial ratios. Outline the main types of ratios and explain what they are intended to
achieve.

7. Explain the purpose of budgeting for any business organisation and outline what is
typically involved to achieve a system of budgetary control.

Page