Managing Finance and Budgets

1. Managing Finance and Budgets Lecture 1

2. Managing Finance and Budgets - Aims • To enable you to understand the role of finance and budgets in relation to SMEs, VCOs* and large organisations • To provide you with the knowledge and understanding of theory and practice required to enable the student to determine and evaluate the choices available to SMEs, VCOs and large organisations in using resources and to critically analyse available methods. • To enable you to develop a range of transferable skills useful for undergraduate study and for working in UK SMEs, VCOs and large organisations *SMEs = Small and Medium-sized Enterprises VCOs = Voluntary and Charitable Organisations

3. Managing Finance and Budgets - Key Topics • Introductory Background • Financial Statements • Costing • Pricing Techniques • Investment Decisions • Sources of Finance • Budgets • Ethical Issues

4. Managing Finance and Budgets - Methods of Learning • Reading - Compulsory and supporting texts • Self-assessment exercises • Notes, case studies • Module Communication Centre • Lectures - theory • Seminars - application of theory • Assessment - case study

5. The Required Text Book • You will need to purchase: McLaney & Atrill 1999 Accounting: An Introduction Pearson Education London • Each week you will be set chapters from this text as reading (see the programme in the handbook), and the seminar material will draw on exercises from this text.

6. How the Module will be Taught Within each week: • There will be an introductory one-hour lecture. It will be useful if you have already read the chapter in the set text beforehand (see the handbook for details). • You will be given certain directed tasks. These will be followed up within the seminars a few days later. In order to maximise learning you will be allocated to a seminar group, and a study group of about three or four students. During each seminar your group may or may not be called on to report on the tasks. You should come prepared to report. • At the end of the seminar, the tutor will review the main learning issues of the week, and will answer questions.

7. Session 1 - Introduction and Background • Learning outcomes: Explain the role and limitations of the finance function particularly in relation to SMEs, VCOs and large organisations • Key concepts: The role of finance & budgets in the organisation The differing requirements of stakeholders Different branches of accounting Legal and regulatory frameworks The Different types of Financial Statement.

8. The Role of Finance and Budgets There are four separate, but linked functions: • Planning • working out what we should do • Controlling • making sure we are doing it • Reporting • proving we are doing it • Decision-Making • working out how to do it better

9. The Role of Finance and Budgets PLANNING • Producing forecasts and budgets • Ensuring that the organisation will have enough cash to survive • Allocating money in line with the mission and objectives of the organisation • Setting targets for the organisation and for each department in the organisation • Providing each department with the money it needs to operate

10. The Role of Finance and Budgets CONTROLLING • Monitoring income - checking that each department achieves its targets • Monitoring expenditure - checking that departments do not over-spend • Monitoring the overall position - checking that the overall organisation is profitable and does not run out of cash

11. The Role of Finance and Budgets REPORTING • Classification of transactions into different categories • Summarising for different users • Reporting on performance - internally - who brought in how much income, who spent what, how is the organisation performing • Reporting externally - to shareholders, tax office, VAT office, Companies House, non-executive Directors

12. The Role of Finance and Budgets DECISION-MAKING • Helping the company to achieve its financial objectives - e.g. increasing wealth of owners • Helping the company and its staff to make decisions about which projects to invest in • Helping the company to determine where to get its money from • Helping the company to decide what to do with its money

13. Stakeholders and their Needs SHAREHOLDERS Organisational performance Value of shares Management performance Return v risk EMPLOYEES Job security Remuneration comparison CUSTOMERS Continuity of supply SUPPLIERS Credit risk GOVERNMENT PAYE, Corporation Tax, VAT Statutory legislation

14. Stakeholders and their Needs LENDERS Security Credit risk Financial structure COMMUNITY Environment Contributions Jobs MANAGERS Performance Plans Objectives

15. Activity One Discuss the following: • Why should a non-accountant study accounting? • What sources of information other than accounts might users employ to gain an impression of the financial position and performance of a business?

16. Activity One: A Possible Solution (1) Why should a non-accountant study accounting? • For a stakeholder in a business, its financial performance is a very important indicator of its health as an organisation. • A crucial way in which a business reports its success or failure is through the language of accountancy. • Managers, shareholders, employees and customers all have stakes in the continued running of an organisation. In order to safeguard their interests, they need to interpret accounts, and to be able to judge to what extent their investment (career, capital etc.) is being safeguarded.

17. Activity One: A Possible Solution (2) • What sources of information other than accounts can be used to find out about the performance of a business? • Meetings with managers or employees • Publications or announcements concerning the business • Media reports • Industry watchdogs/reports • FTSE or other performance indicators

18. The Different Types of Accounting There are two main types of accounting • Financial Accounting • This is the main ‘public’ or external financial scrutiny undergone by an organisation in order to demonstrate its effectiveness. • Management Accounting • This is the internal financial scrutiny used to steer the organisation towards the achievement of its mission.

19. Financial Accounting Seeks to meet needs of other stakeholders General purpose, summary reports with little detail Subject to regulations and standardised format Tends to be annual or six-monthly, backward-looking Audited, objective measurement of financial position May be certified by auditor Management Accounting Seeks to meet needs of managers Detailed and focused on specific needs Does not require a specific or standardised format Produced as frequently as required, with forecasts May incorporate information which is less objective or verifiable Financial Accounting & Management Accounting

20. Financial Accounting Statutory requirements Financial statements Cash-flow statements Accounting standards Interpretation of accounts Annual reports Management Accounting Costing Cost-volume-profit analysis Pricing Budgeting Investment Analysis Sources of finance Key Topics

21. Other Branches of Accounting • Auditing - checking accounts to ensure there is a true and fair view - may be a legal requirement • External auditing - answering to shareholders • Internal auditing - answering to management • Book-keeping - collecting basic financial data and producing financial statements (usually through a double-entry book-keeping system) • Cost accounting - focusing on costs in greater detail • Taxation - specialised, technical advice

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

23. Activity Two: Possible Solution • Which of the following is the most useful: - Financial Accounting, Management Accounting, Book-keeping, Auditing, Cost-Accounting or Taxation. • Each of these have their uses to particular groups of people, and for an organisation to survive it needs all of them. • However, some are merely ‘external measures’ designed to address the issues of accountability - ( Financial Accounting, Auditing, Taxation) • Others are ‘internal measures’ designed to help management improve performance - ( Management Accounting, Book-keeping, Cost-Accounting) • It could be argued that while the first group is necessary, it is the second group which is actually useful to the organisation itself.

24. Financial Statements • There are three different types of financial statement which are used by an organisation: • The Cash-flow Statement is designed to answer the question “What happened to all the money?” • The Profit & Loss Account is designed to answer the question “How much money did we make (or lose)?” • The Balance Sheet is designed to answer the question “Do the books balance?”.

25. Financial Statements - Example • You decide to run a soft drinks stand at a car boot sale to earn some extra money. You borrow £50 from a friend and you buy 200 cans of lemonade at 20p per can. It costs you £5 entry fee, and on the first day you sell 150 of your cans at 50p each. • Produce a Cash-flow Statement, Profit & Loss Account and Balance Sheet for the one day of operation.

26. Example Cash-flow Statement Opening Balance: £ 0 Loan: £ 50+ Goods purchased: £ 40- (200 x 20p) Entry Fee: £ 5- Cash received: £ 75+ (150 x 50p) Closing Balance: £ 80 “What happened to all the money?”

27. Example Profit & Loss Account Sales: £ 75 (150 x 50p) Cost of Sales: £ 30 (150 x 20p) Gross Profit: £ 45 Entry Fee: £ 5 Net Profit: £ 40 “How much money did we gain (or lose)?”

28. Example Balance Sheet Assets: Cash: £ 80 Stock: £ 10 (50 x 20p) Total: £ 90 Liabilities: Loan outstanding: £ 50 Retained profits: £ 40 Total: £ 90 “Do the books balance?”

29. Types of Organisation • Sole Trader • Partnership • Limited Company (Ltd) • Public Limited Company (PLC) • Voluntary organisations • Central and local government • Quasi-governmental bodies

30. “Sole Trader” • Owned and controlled by one person (though more may work in it) • Advantages: Simple, flexible, full control and full retention of profits • Disadvantages: Unlimited liability, Difficult to raise capital, limits growth • Requirements: Licence (if appropriate), VAT registration (if appropriate) Accounts (for tax reasons) Health & Safety regulations Employment regulations

31. “Partnership” • Similar to Sole Trader but for more than one person • Governed by formal or informal partnership agreement (“Deed of partnership”) or subject to Partnership Act 1890 • Shared responsibilities • Shared finance and profits • “Jointly and severally liable” • Liability of “sleeping partners” can be limited

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

33. Limited Company (Ltd) Advantages: Protection of limited liability Continuity through separate identity Easier to raise finance Credibility £100 to start up Disadvantages: Legal formalities & costs Lack of privacy of accounts Accountability to shareholders Conflict between owners & directors

34. Public Limited Company (PLC) • Similar to Limited Company but shares traded publicly through Stock Exchange • Must adhere to specific legislation (e.g. 6 monthly accounts, qualified accountant as Company Secretary) • Method of raising finance (e.g. through sale of shares) • Original owners can realise some of the value of their shares

35. Statutory Requirements for Incorporated Companies • Annual report including: Annual return Profit and Loss Account, Balance Sheet & Cash-flow Statement Notes to Accounts Directors report Auditors’ report (if appropriate) • Information required is dependent on size of the Company (small, medium, or large)

36. Voluntary Organisation - Unincorporated • Collection of individuals with common aim • May have a membership structure and constitution • No separate legal status - cannot incur debts or be sued • Individuals may therefore be jointly liable (but may take out liability insurance) • A trust may be suitable for organisations with charitable aims • A trust is normally governed by a trust deed - trustees manage the assets for the benefit of a specific purpose

37. Voluntary Organisation - Incorporated • Company limited by guarantee or Industrial and provident society • Can hold property, enter into contracts and employ staff in own name • Limits personal liability (to the guarantee) assuming no breaches of trust • Has to comply with law and legislation and will incur additional costs

38. Charitable Status • A group MAY register as a charity if its aims and objectives are “charitable” according to the Charity Commissioners’ definition - i.e. they fall into one of the 4 “heads of charity”: - relief of the poor, the handicapped & the aged - the advancement of religion - the advancement of education - other purposes beneficial to the community • Trustees may not benefit from the organisation and beneficiaries cannot be those who give (i.e. self-help groups are not charitable)

39. Charitable Status • A group MUST register if its aims and objectives are “charitable” according to the Charity Commissioners’ definition AND: Its income exceeds £1,000 It uses or occupies land or buildings It has a permanent endowment • There is NO sanction for not registering • Charity Commission decides if aims are charitable

40. Advantages Financial - including exemption from most forms of direct taxation Status/credibility of charity registration number Disadvantages Political and campaigning activities are limited Trading activities are limited Must comply with charity law - submitting annual accounts; stating charitable status of official documents Monitored by Charity Commission Application process (though now simplified including model governing documents) Charitable Status

41. Discuss the following: What are the main advantages and disadvantages which should be considered when deciding between becoming a sole trader or a partnership business? What are the main advantages and disadvantages which should be considered when whether or not to become a limited liability company? What are the main advantages and disadvantages when deciding whether or not to apply for charitable status? Activity Three

42. Advantages and disadvantages of being a sole trader or partnership Advantages: Sole Trader: full control and full retention of profits Partnership: Shared responsibilities, shared finance Disadvantages: Sole Trader: Unlimited liability, difficult to raise capital Partnership: “Jointly and severally liable”. Shared profits. Activity Three: Possible Solutions

43. Advantages and disadvantages of becoming a limited liability company Advantages: Protection of limited liability, easier to raise finance Disadvantages: Legal formalities & costs, accountability to shareholders Activity Three: Possible Solutions

44. Advantages and disadvantages of applying for charitable status: Advantages: Financial - exemption from most forms of direct taxation, Status/credibility of charity registration number Disadvantages: Trading activities are limited, must submit annual accounts Activity Three: Possible Solutions

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

46. Case Study 1 Clare Wong spends a lot of her time working for a large charity. The charity has grown enormously in recent years, and the trustees have been advised to overhaul their accounting procedures. This would involve its workers (most of whom are voluntary) in more book-keeping, and there is a great deal of resistance to this move. The staff have said that they are there to help the needy, and not to get involved in book-keeping Prepare some notes that you could use in speaking to the voluntary workers in order to try to persuade them to accept the new proposals. Dyson (1997) - Accounting for non-Accounting Students.

47. Case Study 2 You are a personnel officer in a manufacturing company, and one of your employees, a young engineering manager has been chosen to attend the local Business School to study for a diploma in management. He is reluctant to sign up for the course because it includes a subject called “Financial Management”. As an engineer, he thinks it will be a waste of time to study such a subject. Prepare some notes that you could use in speaking to the engineering manager in order to show him the benefits to him of studying financial management. Dyson (1997) - Accounting for non-Accounting Students.

48. Read Chapter 1 - McLaney & Atrill Revise key concepts: The role of finance & budgets in the organisation The differing requirements of stakeholders Different branches of accounting Legal and regulatory frameworks Prepare Case Study 1 and 2 individually N.B. During the seminar, you will be allocated to groups of three or four people and be asked to work on each case study, presenting your solutions to the group. Seminar One - Preparation