Financial planning is the fundamental base to any business and is define as a process of framing objectives, policies, procedures, programmes and budgets regarding the financial activities of a company.
The importance of financial planning will be measured on how financial losses are curbed and resolved, thus avoiding losing too much. The process of planning your finances does not only involve availing insurance or mutual funds, it also requires understanding on how it actually woks. For example a good and proper financial plan is useful to face particular situation like when the company should deal with outstanding debt and rising cost. So to anticipate the condition in advance, a company should prepare the financial plan earlier. Also a company must be able to estimate the earnings for an upcoming period. Without making estimation, the company may fail.
When you plan your finance you have to estimate the annual business costs, the year's turnover and the expected profit for the year. Also is important to have some cash for when required. This means that you plan your budget in a way that will make your business successful.
In the initial stages budget will help you project finance for your business set up when you will require to borrow funds, you will know how much funds are required only from the budget. After the business has started you would want to know how much funds are required to run the business till profits are earned. If you are planning to grow your business or expand your business, budget will tell you how to proceed further and your financial requirements. If you are not making expected profits then you can control your business expenses only with the help of budgeting. Thus budgeting is very important and essential for smooth running of a business. Budgeting is the way to achieve financial targets in business easily and quickly. .
For a start-up company that doesn't establish a budget, it may find that even if it is selling as much product as expected, or has attracted as many customers as is realistic, the numbers just don't add up. It may simply be impossible to make a profit at the business, even if you achieve all the mental goals you established upfront. A lot of times with start-ups, organizations are focused so completely on recruiting customers that they don't realize how much their expenses are going to be. It is very important that you research prices and what things are likely to cost. If you can, you research the sales of other people in the same market you're in.
Financial Planning is also a very important high performance management instrument in the decisions making process.
Information requirements of decision makers
Decision-making is a key activity at all levels in an organisation. All employees make decisions: from the front-line employee who has to decide how to handle a difficult customer to an executive who has to choose between projects that are competing for funding.
Given the variety of decision making levels a decision theory has been developed to support the process of decision making .Decision theory concerns itself with rational decision making which states that decisions are based on an objective evaluation of available options and their consequences, leading to a choice that is made on the basis of such an evaluation.
Decision making as a rational process is based on: knowledge of alternatives, knowledge of the consequences of each of the alternatives, ordered preferences by which consequences can be evaluated, rule(s) by which a particular alternative can be selected. We have to assume that all alternatives, the probability distribution of consequences conditional on each alternative, and the subjective value of each possible consequence are known; we assume a choice is made by selecting the alternative with the highest expected value. This emphasis on expected value may be moderated by a risk preference. The risk arises because the business has limited information on which to base the decision and the outcome of decision may be uncertain.
A business makes decision in order to achieve objectives (example they may decide to launch a new product in order to diversify). Decision is made at all levels in an organization and is useful to have a flexible and logical process which can be fallow by all involved. After you identify the objectives a business wants to achieve you will need to gather information and ideas, for example when you want to launch a new product you will have to get information about possible sales levels and costumer reactions, cost of production and reaction of competitors. Next step it will be to analyse these information and ideas and only after that make a decision. Once the decision has been made it has to be communicate to the people who are going to carry it out because is most probably if the decision is made by the director to be carry out by the marketing manager for example when they want to launch a new product.
Stakeholders can be a person, group or organization that has interest or concern in an organization. They can affect or be affected by the organization's sanctions, objectives and policies. Some examples of key stakeholders are creditors, directors, employees, government (and its agencies), owners (shareholders), suppliers, unions, and the community from which the business draws its resources.
Not all stakeholders are equal. A company's customers are entitled to fair trading practices but they are not entitled to the same consideration as the company's employees. An example of a negative impact on stakeholders is when a company needs to cut costs and plans a round of layoffs. This negatively affects the community of workers in the area and therefore the local economy.
Conclusion and recommendations
This report has explained the importance of financial planning for organisations and the need to effectively disseminate information to various decision makers. It is very important for an organization to plan their finance and take the right decisions at all levels in order to succeed.
"Think right and decide right so that your business will be all right all the time."(Ronald C. Manalastas)
Reference:
Dyson, J.R., 2007. Accounting for Non - Accounting Students. 7th ed. Harlow: Pearson Education Limited.
Wood F, Sangster A., 1999. Business accounting 2. 8th ed. London: Financial Time
http://voices.yahoo.com/the-importance-superior-thinking-decision-making-2788378.html
http://homepages.inspire.net.nz/~jamckinnon/business/Decision-Making%20in%20Organisations.pdf
http://www.businessdictionary.com/definition/stakeholder.html#ixzz2COQJV68V
Part B:
You are a part time receptionist at Southfield Restaurant whose financial accountant has resigned with immediate effects. The directors were recently considering various sources of funding for a large oven of £10,000 for the kitchen but are concerned about the effects that this will have on the budgeted balance sheet of the company. They need to make a decision urgently and you boldly approach them and tell them that you can provide some assistance, explaining that as a part of your studies at Mont Rose College you have acquired some knowledge of how to assess the impact of finance on financial statements.
Southfield Restaurant Ltd
Balance Sheet as at 31 December 2012
ASSETS £
Fixed assets 55,020
Current assets 6.115
Net assets 61,135
LIABILITIES AND EQUITIES
Current liabilities (amount falling due within 1 year) 500
Long term liabilities (amount falling due within more than 1 year) 11,400
Issued Share Capital (par value £1 per share) 40,000
Retained earnings 9,235
61,135
Option 1: Obtaining a 1-year interest free loan of £10,000 from a partner restaurant.
A. Accounts affected: cash, liabilities, retained earnings
B. Cash increase, liability increase, retained earning decrease
C. Cash increase by £10,000, liabilities increase by £10,000, retained earnings will decrease by the end of the year with £10,000
Assets=Liability+Equity
Before the transaction £61,135 = £11,900 + £49,235
After the transaction £61,135 = £11,900 + £10,000 + £49,235 - £10,000.
Option 2: Obtaining a 2-year loan of £10,000 at 10% interest per annum.
A. Accounts affected: cash, liabilities, retained earnings
B. Cash increase, liability increase, retained earning decrease
C. Cash increase by £10,000 - (£10,000 x 0.10) = 9,000 (In fact as soon as you receive the loan, cash increase by £10,000, but you paid interest of £1,000 per year. So the total increase of cash at the end of the year is £9,000), liabilities increase by £10,000, retained earnings will decrease by £1,000(interest paid). For two years the interest paid will be £2,000.
Assets=Liability+Equity
Before the transaction £61,135 = £11,900 + £49,235
After the transaction £61,135 + £9,000 = £11,900 + £49,235 +£10,000 - £1,000 /year
Option 3: Selling unused appliances worth £3,000 at their net realisable value, with no profit made on disposal and issuing an additional 2000 shares at £3.50 per share.
Unused appliances are sold for £3000 (at their net realisable value) on disposal and company decided to issue £2,000 shares at a selling price of £3, 50 per share.
A. Accounts affected: Property, plant and equipment (assets), cash (assets) and equity
B. Equipment decrease, cash increase, equity increase
C.Equipment decrease by £3000. Cash increase by £3000 from assets and by £2,000 x £3, 50 = £7,000 from shares; equity also increase by £7,000.
Assets=Liability+Equity
Before the transaction: £61,135=£11,900+£49,235
After the transaction: £61,135-£3,000+£3000+£7,000=£11,900+£49,235+£7,000.
Task 3
Part A: Yuri, a cutlery manufacturer, produces spoons. The market in which the business operates is highly competitive, as there is a shortage of steel of adequate quality. There is a good availability of labour, but not of those who are experienced in cutlery manufacture.
Outline the budgetary control cycle and review the variance analysis of Yuri's budget. Suggest reasons for the results.
To set out a new budget you have to start from the original budget and how you are doing this depends on the size of the organization.
You have to define the performance measurements which include a set return on capital, you will set your targets and describe what you want to achieve.
Once performance measurements have been set then actual performance can be recorded. This is made possible by the use of cost centre numbers when you put the financial transactions in to the financial database.
To compare the actual with the budget, measuring actual performance is insufficient by itself without a yardstick with which to make comparison. Next step is to examining variances, the difference between actual and budget items are called variance and significant ones need to be defined as an absolute sum of money or a special percentage variation from budget.
And finally if is necessary you will have to take actions. At this stage there is no point to the previous stage if this does not happen. You will have to take into consideration the information that helps you avoid future mishaps or repeated ones. Then set a new budget for the next year.
Budget Actual Variance
Units sold 100,000 75,000 (25,000)
Materials £ 15,000 22,500 (7,500)
Direct labour £ 22,500 24,375 (1,875)
From the table below we can see that for the units sold Yuri's budget is £100,000. His actual sales are £75,000 so he is in deficit of £25,000 because of the competition. The business will need to reduce the selling price and employ more sales staff.
£100,000 - £75,000 = £25,000
On the other hand for materials the budget was £15,000 and he ended up with an actual spending of £22,500, so there is a surplus of £7,500. The market in which the business operates is highly competitive, as there is a shortage of steel of adequate quality.
£22,500 - 15,000=£7,500
For direct labour the budget was £22,500 and he has now an actual of £24,375, so the variance is £1,875. There is a good availability of labour, but not of those who are experienced in cutlery manufacture.
£24,375 - 22,500 = £1,875
Material (£) Labour (£)
Price/rate variance (4,500) (3,750)
Usage/efficiency variance (3,000) (5,625)
Total variance (7,500) (1,875)
Yuri paid more for materials (£4,500), the prices went up because of shortage in steel and he lost £3,000 in materials that couldn't t be used efficient in production. That means that he spent £7,500 more than forecast for materials.
Yuri s company paid more for experience workers but because of the shortage their wages went up with £3,750, less than forecast but he paid more for inexperience ones which worked more hours £5.625. The total variance was £1,875.
PART B: A printing company receives an order for 100,000 leaflets of A5 size printed in black ink. The cost estimator has prepared the following estimate of resources required to do the job.
Direct costs:
Paper - 204 reams of A5 at £3 per reams
Ink - 2 litres at £9 per litre
Labour time - 2 hours at £15 per hour
Indirect costs:
Production overheads and machine utilization - 2 hours at £55 per hour
Selling, distribution and administration overheads are recovered by charging £20 per hour and the company requires a 10% mark-up on selling price.
1. Explain how you would arrive at the total cost for the job and the cost per leaflet.
For the total cost will have to calculate the total cost of the paper, ink, labour time the total cost of production overheads and machine utilization and selling, distribution and administration overheads. Total cost is equal with direct cost plus indirect cost.
2. Calculate the total production cost:
204 x 3 + 2 x 9 + 2 x 15 + 2 x 55 + 20 x 2 = £810
3. Calculate the price that the company must quote for the job
Profit= (mark-up%xtotal cost)/100
P=10 x 810:100 = £81
Selling price= 810 + 81 = £891
4. Re-estimate the price that the company must quote if
i. The budgeted number of hour that the job requires is readjusted to 2.5 hours
204 x 3 + 2 x 9 + 2,5 x 15 + 2,5 x 55 + 20 x 2,5 = £855
P=10 x 855:100 = £85,5
Selling price= 855 + 85,5 = £940,5
ii. The budgeted number of hour that the job requires is readjusted to 1.5 hours
204 x 3 + 2 x 9 + 1,5 x 15 + 1,5 x 55 + 20 x 1,5 = £765
P=10 x 765:100 = £76,5
Selling price= 765 + 76,5 = £841,5+
PART C:
The following data relate to two investment projects, only one of which may be selected:
Project A Project B £ £ £
Initial Investment 50,000 50,000
Cash inflows year 1 35,000 20,000
2 30,000 20,000
3 25,000 24,000
4 20,000 36,000
At the end of year 4, project A and B will each have a resale value of £10,000. The cost of capital is 10%.(That means r=0.1, where r is the cost of capital).
1.Calculate for each project:
i.The average annual rate of return on average capital invested (Accounting rate of return) ARR=Average profitx100/Average Investment
ARR= Av profitx100/Initial Investment if there is no scrap value
Av Inv=Initial Inv + Scrap value/2 50,000+10,000/2=30,000
Project A
Depreciation =( £50,000 - £10,000)/4 =£10,000
A: Av profit= (25,000+20,000+15,000+10,000+10,000)/4=17,500
ARR =17,500/30,000x100= 58.33
Project B
Depreciation = (£50,000 - £10,000)/4 = £10,000
B: Av profit= (10,000+20,000+14,000+26,000+10,000)/4= 15,000
ARR = 15,000/30,000x100= 50.00
ii. The payback period
A: 50,000-35,000=15,000
For the second year will have to recuperate 15,000 (if you want to calculate in months will have 12 months for a year, or if you want to calculate in days or weeks will have 365 days or 52 weeks in a year).
12x15,000/30,000= 6months
The payback period will be 1 year and 6 months.
B: 50,000-20,000-20,000=10,000
For the third year will have to recuperate 10,000.
12x10,000/24,000= 5months
The payback period will be 2years and 5 months.
iii. The net present value
A: NPV = future value / (1+I) n
10% discount
Years
Discount factor
Cash flow
PV
0
1
50,000
50,000
1
0.909
35,000
31,815
2
0.826
30,000
24,780
3
0.751
25,000
18,775
4
0.683
20,000+10,000(scrap)
20,490
95,860
NPV=45,860
B: NPV = future value / (1+I) n
10% discount
Years
Discount factor
Cash flow
PV
0
1
50,000
50,000
1
0.909
20,000
18,180
2
0.826
20,000
16,520
3
0.751
24,000
18,024
4
0.683
36,000+10,000(scrap)
31,418
84,142
NVP=34,142
Workings:
Project A: Disc Factor year n=1/(1+r)power n
Initial year 1
Year1=1/(1+0.1)power 1=0.909 Y2=0.826 Y3=0.751 Y4=0.683
Present Value=Cash flow x disc fact
Initial year 50,000 x 1 = 50,000
Y1= 0.909 x 35,000 =31,815 Y2= 0.826 x 30,000= 24,780
Y3= 0.751 x 25,000= 18,775 Y4= 0.683 x 30,000= 20,490
Net Present Value is: all present values added minus initial investment
NPV=31,815+24,780+18,775+20,490-50000=45,860
Project B: Disc Factor year n=1/(1+r)power n
Initial year 1
Year1=1/(1+0.1)power 1=0.909 Y2=0.826 Y3=0.751 Y4=0.683
Y1=0,909 x 20,000= 18,180 Y2= 0.826 x 20,000= 16,520
Y3= 0.751 x 24,000= 18,024 Y4= 0.683 x 46,000= 31,418
NVP= 18,180 + 16,520 + 18,024 + 31,418 - 50,000 = 34,142
iv. The profitability index
Profitability=Net present Value/Initial capital
A: Profitability= 45,860/50,000=0.912
B: Profitability= 34,142/50,000=0.683
2. Define the internal rate of return
The internal rate of return is the rate of interest or discount rate that makes the net present value equal to 0. The internal rate of return helps to measure the worth of an investment, to set the cash flows to different discount rates, to make a comparison between the projects with different initial outlays and to asses if an investment would have a better return based on internal standards of return.
3. Briefly discuss the relative advantages and disadvantages of the four methods of evaluation mentioned in (1) above
The average annual rate of return is the ratio of money gained or lost on an investment relative to the amount of money invested. It is based on accounting profit and measures the profitability of the project. This method is easy to understand and calculate.
But this method that does not consider the investment cash flow, time value of money and the value the project will have in the end.
The payback period represent the lent of time to repay the initial capital cost and requires information of the returns the investment generates. This method is very easy to apply and to be understood by accounts or non-accounts and is very useful for comparing risky projects where the prediction of cash after first few years is difficult due to possible changes in the business environment or where short term cash flows are more important than long term cash flows. The disadvantages are that the risk involved, opportunity cost and time value of money are not taken into consideration.
The net present value is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyse the profitability of an investment or project. It takes into consideration the time value of money, the risks of projects, profitability( before and after cash flow), but is difficult to use this method especially when you need to calculate the discount rate and wrong decision can be made when projects that are considered do not carry the same period of time.
The profitability index is an index that attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio calculated as:
Profitability=PV of future cash flows/initial investment. This method takes into account cash flow during project development, calculate the exact rate of return on investment and can help to make the right decision when choosing a project, but the calculation can be difficult and its value can be irrelevant when projects have different time duration.
4. Explain which project you would recommend for acceptance
As we can see from the information above Project A is more profitable because its probability index is higher 0,912 comparing with Project B 0,683. Also NPV is higher for this project and the payback period is shorter.
Task 4:
PART A: Discuss the main financial statements
"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions" (International Accounting Standards Board, 2007).
Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting, and who are willing to study the information diligently". They may be used by different users for different purposes.
You are required to discuss the main financial statements i.e. Profit and Loss account, Balance Sheet, Cash Flow Statement and Notes by explaining for each statement:
Financial statements are without a doubt the most important resource for any individual investor.
Financial statements are sets of accounts that every company or corporation is mandated by law to produce for the benefits of its shareholders and other stakeholders. Financial statements have different components because those that have interest in the information it provides are diverse and cannot be satisfactorily represented in one single document.
IAS 1 Presentation of Financial Statements sets out the overall requirements for financial statements, including how they should be structured, the minimum requirements for their content and overriding concepts such as going concern, the accrual basis of accounting and the current/non-current distinction. The standard requires a complete set of financial statements to comprise a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of changes in equity and a statement of cash flows.
IAS 1 was reissued in September 2007 and applies to annual periods beginning on or after 1 January 2009. A complete set of financial statements should include: [IAS 1.10]
a statement of financial position (balance sheet) at the end of the period
a statement of comprehensive income for the period (or an income statement and a statement of comprehensive income)
a statement of changes in equity for the period
a statement of cash flows for the period
notes, comprising a summary of accounting policies and other explanatory notes
1.The balance sheet it shows the financial position of a company as of the date issued. It lists a company's assets (e.g. cash, inventory, etc.) and its liabilities (e.g. debt, accounts payable, etc.) and shareholders' equity. Unlike the other financial statements, it is accurate only at one moment in time, not a period of time.
If you look at a balance sheet, you'll note that the total assets are always equals with the total of liabilities and equity. This reflects what the company owns (assets) and how what it owns came about, through the funding given it by liabilities (borrowings) and equity.
Statement of Financial Position (Balance Sheet) An entity must normally present a classified statement of financial position, separating current and non-current assets and liabilities. Only if a presentation based on liquidity provides information that is reliable and more relevant may the current/non-current split be omitted. [IAS 1.60] In either case, if an asset (liability) category combines amounts that will be received (settled) after 12 months with assets (liabilities) that will be received (settled) within 12 months, note disclosure is required that separates the longer-term amounts from the 12-month amounts. [IAS 1.61]
2. The Profit and Loss Account or Income Statement is one of the important financial statements and shows the net results of the business operations during an accounting period. This account presents all the revenues or incomes and all expenses for earning that revenue. The net difference between revenues and expenses shows the profit or loss for that period.
Statement of Comprehensive Income
Comprehensive income for a period includes profit or loss for that period plus other comprehensive income recognized in that period. As a result of the 2003 revision to IAS 1, the Standard is now using 'profit or loss' rather than 'net profit or loss' as the descriptive term for the bottom line of the income statement.
All items of income and expense recognized in a period must be included in profit or loss unless a Standard or an Interpretation requires otherwise. [IAS 1.88] Some IFRSs require or permit that some components to be excluded from profit or loss and instead to be included in other comprehensive income. [IAS 1.89]
The amendments to the Standard change the title of the current statement of comprehensive income to 'statement of profit or loss and other comprehensive income', although, as is the case for other financial statement titles, this is not mandatory. An entity may still use titles for the statements other than those used in the Standard, such as 'statement of comprehensive income'.
3. Statement of Changes in Equity is an important component of financial statements since it explains the composition of equity and how has it changed over the year. A statement of changes in equity presents an entity's total comprehensive income for the period (profit or loss plus other comprehensive income for the period), the effects of retrospective application (changes in accounting policies and correction of errors for the period), reconciliations between the carrying amounts at the beginning and at the end of the period for each component and items of equity (i.e., profit or loss, other comprehensive income, and transactions with owners).
Statement of Changes in Equity IAS 1 requires an entity to present a statement of changes in equity as a separate component of the financial statements. The statement must show: [IAS 1.106]
-total comprehensive income for the period, showing separately amounts attributable to owners of the parent and to non-controlling interests -the effects of retrospective application, when applicable, for each component -reconciliations between the carrying amounts at the beginning and the end of the period for each component of equity, separately disclosing:
profit or loss
each item of other comprehensive income
transactions with owners, showing separately contributions by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control
4. Cash flow statement may provide considerable information about what is really happening in a business beyond that contained in either the income statement or the balance sheet. Analyzing this statement should not present an intimidating task, instead it will quickly become obvious that the benefits of understanding the sources and uses of a company's cash far outweigh the costs of undertaking some very straightforward analyses.
The purpose of the cash flow statement or statement of cash flows is to provide information about a company's gross receipts and gross payments for a specified period of time.
The statement of cash flows is to be distributed along with a company's income statement and balance sheet.
The balance sheet is the core of the financial statements. All other statements either feed into or are derived from the balance sheet. The income statement shows how the company's assets were used to generate revenue and income. The statement of cash flows shows how the cash balance changed over time and accounts for changes in various assets and liabilities. Many analysts come to the balance sheet first to gauge the health of the company. It is often listed first on the quarterly or annual reports.
Statement of Cash Flows Rather than setting out separate standards for presenting the cash flow statement, IAS 1.111 refers to IAS 7 Statement of Cash Flows.
5. Notes: The notes to financial statements are required to accompany the information shown on the face of the financial statements. For example, if you want to know the breakdown and movement analysis of the property, plant and equipment shown on the face of the balance sheet, you refer to the note that is cross-referenced to such asset.
Notes to the Financial Statements The notes must: [IAS 1.112] present information about the basis of preparation of the financial statements and the specific accounting policies used --disclose any information required by IFRSs that is not presented elsewhere in the financial statements and provide additional information that is not presented elsewhere in the financial statements but is relevant to an understanding of any of them.
There are two types of users of financial statements: internal users and external users. For example internal users are: managers who require Financial Statements to manage the affairs of the company by assessing its financial performance and position and taking important business decisions, shareholders who use Financial Statements to assess the risk and return of their investment in the company and take investment decisions based on their analysis or the employees of the company can use the Financial Statements for making collective bargaining agreements. The external users of financial statements are basically the investors who use the financial statements to assess the financial strength of a company. This would help them to make logical investment decisions.
Financial information is required by the different financial institutions like banks for example, or other lending institutions in order to decide whether to help the company with working capital or to issue debt security to it. Other users of financial statements are debt covenants which are looking for cash earnings (earnings before interest, taxes, depreciation, and amortization), cash flow and tangible net worth, which exclude non-cash intangible assets such as goodwill. The vendors who extend credit to a business also require financial statements to assess the creditworthiness of the business and the government use them to analyze whether the tax paid is accurate and is in line with the organizations financial strength.
