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Financial Management
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Financial Management
Higher Business ManagementToday
‡ Role of Finance
‡ Annual Accounts
‡ Trading, Profit & Loss AccountRole and importance of
Financial Management
Efficient management of finance is crucial to an
organisations success. They have to:
‡ Ensure adequate funds are available for
resources needed to help achieve organisational
objectives
‡ Ensure costs are controlled
‡ Ensure adequate cash flow
‡ Establish and control profitability levelsDuties of Finance
‡ Maintain financial records
‡ Payment of bills and expenses
‡ Collection of accounts due
‡ Monitoring of funds
‡ Payment of wages and salaries
‡ The main role Finance provides
information for managers and decision-
makers within businessAnnual Accounts
‡ There are four main financial
statements used (called Final
Accounts):
‡ Trading account
‡ Profit and loss account
‡ Balance sheet
‡ Cash flow statementTrading, Profit & Loss Account
‡ The trading account records how much
money is made from selling goods against
how much it costs to make. The gross profit
is calculated in the trading account.
‡ The profit and loss account shows the
businesses incomes and expenditures. The
net profit is calculated in the profit and loss
account.Trading Account Format
£ £
‡ Turnover (or sales) 180,000
‡ Cost of sales
‡ Opening Stock 40,000
‡ Purchases 95,000
135,000
‡ Less: Closing Stock (45,000) 90,000
‡ GROSS PROFIT 90,000Profit and Loss Account
Format
£ £
‡ Gross Profit 90,000
‡ Other income
‡ Interest received 11,000
101,000
‡ Expenses
‡ Rent and rates 25,000
‡ Wages and salaries 45,000
‡ Insurance 2,000 72,000
‡ NET PROFIT 29,000Profit and Loss Account Key
Terms
‡ Trading account ± provides summary of
businesss trading activity during financial year
‡ Sales ± monies received through selling
goods/services
‡ Cost of sales ± cost of sales to a business
before a profit margin is added
‡ Opening stock ± value of stock at start of the
financial period
‡ Closing stock ± value of stock at end of the
financial periodProfit and Loss Account Key
Terms
‡ Purchases ± cost of goods business has
bought for resale to customers
‡ Purchase returns ± value of goods purchased
but returned to supplier
‡ Sales returns ± value of goods bought by
customer but returned to the firm
‡ Expenses ± any expenses incurred by the
business in the course of normal operationInterpretation of Trading, Profit
& Loss Accounts
‡ Was this years trading result good or bad,
compared with last year or with a rival company?
‡ Has the Gross Profit improved this year,
compared with last year?
‡ Are we making efficient use of our stock?
‡ Does our Net Profit figure compare favourably
with those of other organisations in the same
industry?Recap
‡ Role of Finance
‡ Annual Accounts
‡ Trading, Profit & Loss AccountToday
‡ Balance Sheet
‡ Assets
‡ Liabilities
‡ Capital
‡ Liquidity
‡ Working CapitalBalance Sheet
‡ The profit and loss account shows the
history of the business activity
throughout the financial year.
‡ The balance sheet shows a snapshot of
a particular date in time.
‡ CAPITAL = ASSETS - LIABILITIESBalance Sheet
Assets Liabilities & Capital
BalanceAssets
‡ Assets ± are what a business owns
‡ Fixed assets ± have a lifespan of more
than one year, eg machinery, motor
vehicles
‡ Current Assets ± are constantly
changing eg stock, debtors, bank, cashLiabilities
‡ Liabilities ± what is owed by the business
‡ Current Liabilities ± eg trade creditors
(suppliers of goods on credit), bank
overdraft, short-term loans (less than 1
year)
‡ Long-term liabilities ± normally longer than
1 year ± eg mortgage, bank loanCapital
‡ Capital ± provided by the owner of the
business and treated as being owned to the
owner of the business
‡ Profits ± may increase capital
‡ Drawings ± may decrease capital
‡ Reserves ± monies retained by businessLiquidity
‡ Liquidity shows us whether a business
has enough assets to cover its debts.
‡ Turning assets into cash to pay off
debts is what normally happens.
‡ Stock is the hardest to turn into cash.
Why?Working Capital
‡ Working Capital is:
‡ Current Assets ± Current Liabilities
‡ If a business has too much working
capital then they are not using their
resources properly.
‡ If too little, then they may not be able
to pay off short term debts.Balance Sheet Format
‡ Fixed Assets
‡ Current AssetsRecap
‡ Balance Sheet
‡ Assets
‡ Liabilities
‡ Capital
‡ Liquidity
‡ Working CapitalToday Ratio Analysis
‡ What are ratios?
‡ Uses of ratio analysis
‡ Limitations of ratios
‡ Profitability ratios
‡ Liquidity ratios
‡ Asset usage ratiosWhat are Ratios?
‡ Ratios are a way of comparing different
figures.
‡ Ratios should only be used when comparing
like with like (ie same size of business; same
industry)
‡ Ratios can compare results with previous
years or rival firms
‡ Ratios, however are historic, and do not take
into account of other factors such as quality
of workers, inflation, economic situationUses of Ratio Analysis
‡ Compare current performance with
previous years
‡ Compare performance against similar
organisations
‡ Identify changes in performance to aid
future actions
‡ Identify trends over timeLimitations of Ratio Analysis
‡ Information is historic
‡ Comparisons must only be made with
similar organisations (size, industry)
‡ No account of external factors (PEST)
‡ No account of NPD or declining
products
‡ No account of human factors (staff
morale, staff turnover)Ratios
‡ Profitability ‡ Liquidity
‡ Gross Profit ‡ Current Ratio
percentage ‡ Acid Test Ratio
‡ Net Profit
percentage
‡ Asset Usage
‡ Return on Capital ‡ Rate of Stock
Employed (ROCE) TurnoverGross Profit Percentage
Gross Profit X 100%
Sales Revenue
‡ Measures profit made from buying and
selling stock
‡ For every £1 of sales, how much profit is
made?
‡ Increase = more sales generated or cost of
materials have fallen
‡ Decrease = cost of materials may have went
upNet Profit Percentage
Net Profit X 100%
Sales Revenue
‡ For every £1 of sales, how much profit
after expenses is made?
‡ Increase = handling expenses better
‡ Decrease = expenses may have went
upReturn on Capital Employed
(ROCE)
Net Profit
X 100%
Capital Employed
‡ If you invest £100 in a firm how much
will you get back?
‡ ROCE should be measured against
interest rates. Since your savings can
make money in a high interest bank
accountCurrent Ratio
Current Ratio = Current Assets:Current Liabilities
Looks at how business can pay off its debts
A ratio of 2:1 is considered prudent, but does not
take into account stock being held.
Higher than 2:1 means money may not being
invested in the business properly
Having less than 2:1 may mean the firm is in
danger of not being able to pay off debts (too much
money tied up in stock?)Acid Test Ratio
‡ Acid Test =
‡ Current assets ± stock: current liabilities
This is a tougher ratio than the current ratio
because it excludes stock, since stock is the
hardest asset to transform into cash.
This ratio should be around 1:1.Rate of Stock Turnover
Cost of Sales
‡ Stock turnover = Average Stock
Stock hanging around is bad for the firm. Stocks
can go off, out of fashion or out of date.
This ratio works out how many times stock is used
up.
Note: Average Stock is calculated by adding Closing
and Opening Stock and then dividing by 2Recap Ratio Analysis
‡ What are ratios?
‡ Uses of ratio analysis
‡ Limitations of ratios
‡ Profitability ratios
‡ Liquidity ratios
‡ Asset usage ratiosToday
‡ Cash Flow Statements
‡ Cash Budgets
‡ Cash Flow ProblemsBudgets
‡ Budgets are statements of anticipated
future expenditure covering a specific
time period
‡ Cash Budgets ± show expected
receipts & payments on a monthly basis
to help assess potential cash flow
problemsUses of Budgets
‡ To monitor & control
‡ Gain information
‡ To set targets
‡ To delegate authorityHow budgets help managers
‡ Make them accountable for decisions
‡ Help check income & expenditure
‡ Can highlight need for corrective action
‡ Help develop long term plans
‡ Assists with decision making
‡ A means of comparison with actual
resultsCash Flow Statements
‡ Cash Budgets/Cash Flow Statements contain
estimated figures of cash position of an
organisation over a period of time.
‡ Remember the closing balance is cash and
not profit!
‡ Cash Budgets are used to highlight potential
shortages or surpluses of cash resourcesCash BudgetCash Budgets and Role of
Manager
Plan Borrow or not?
Organise Bulk buying? Trade discounts?
Command Departmental budgets
Coordinate Departmental reports
Control Measure performance
Delegate Budgets spent by Dept. Mgrs.
Motivate Giving financial control may empower
individualsCash Flow Management
‡ Liquidity ± as mentioned, to check either
shortages or surpluses of cash resources.
‡ Decision-making ± the role of the manager
can be aided by cash budgets.
‡ Projection ± different variables and scenarios
can be used (on a spreadsheet) to see what
can affect the cash position of the
organisation.Recap
‡ Cash Flow Statements
‡ Cash Budgets
‡ Cash Flow ProblemsToday
‡ Users of Financial Information
‡ Internal Sources of Finance
‡ External Sources of Finance
‡ Additional Sources of FinanceUsers of Financial Information
‡ Shareholders ± can assess Boards
performance and decide about
investment or disinvestment
‡ Potential Shareholders ± decide
whether firm is a worthwhile risk
‡ Short term creditors ± should credit be
granted to the firm?
‡ Long term creditors ± should money be
lended to the firm? Will it be paid back?Users of Financial Information
‡ Government and local authorities ± look to
directors report and business plan. Do these plans
affect local area?
‡ Competitors ± compare themselves with rivals to
work out market share and if plans conflict with
their own
‡ Employees ± can the firm pay better wages? Is
the future sound?
‡ Management ± use info to evaluate past
performance and used to plan for future
‡ Customers ± is firm likely to still be around? Other
concerns, eg environmentSources of FinanceInternal Sources of Finance
‡ Retained Profits ± profit kept by
company for future activities
‡ Selling Assets ± money raised by selling
off an asset no longer needed
‡ Both are Short-termExternal Sources of Finance
‡ Long Term (10 years +)
‡ Issuing Shares ± capital raised by
selling shares
‡ Debentures ± a fixed interest long term
loan
‡ Loans ± borrowing money, repaid over
a time period with interest
‡ Mortgages ± a loan secured for propertyExternal Sources of Finance
‡ Medium Term (1-10 years)
‡ Leasing ± renting equipment or
premises
‡ Hire Purchase ± acquiring an asset on
credit followed by fixed payments. After
last instalment purchaser owns asset.
‡ LoansExternal Sources of Finance
‡ Short Term (up to 1 year)
‡ Overdraft ± borrowing more money
than is available in bank account
‡ Trade Credit ± businesses receive goods
first, then pay later
‡ Factoring ± a specialist business
collecting unpaid debts for a feeAdditional Sources of Finance
‡ LEC ± Scottish ‡ Grants and
Enterprise allowances ±
Renfrewshire Repayable Grants,
‡ Local authorities ± Soft Loans,
East Renfrewshire Subsidies
Council ‡ EU grants ±
‡ Government Regional
Partnerships ± Development Fund
Business Gateway & Social FundRecap
‡ Users of Financial Information
‡ Internal Sources of Finance
‡ External Sources of Finance
‡ Additional Sources of Financea) What four main areas does financial
information cover?
b) For what purposes might a manager use
financial information?
c) List at least four characteristics of useful
financial information.
d) List at least five users of financial
information.
e) Taking the users of financial information
that you have made, suggest a reason for
each of them to be using the information.
Higher Business ManagementToday
‡ Role of Finance
‡ Annual Accounts
‡ Trading, Profit & Loss AccountRole and importance of
Financial Management
Efficient management of finance is crucial to an
organisations success. They have to:
‡ Ensure adequate funds are available for
resources needed to help achieve organisational
objectives
‡ Ensure costs are controlled
‡ Ensure adequate cash flow
‡ Establish and control profitability levelsDuties of Finance
‡ Maintain financial records
‡ Payment of bills and expenses
‡ Collection of accounts due
‡ Monitoring of funds
‡ Payment of wages and salaries
‡ The main role Finance provides
information for managers and decision-
makers within businessAnnual Accounts
‡ There are four main financial
statements used (called Final
Accounts):
‡ Trading account
‡ Profit and loss account
‡ Balance sheet
‡ Cash flow statementTrading, Profit & Loss Account
‡ The trading account records how much
money is made from selling goods against
how much it costs to make. The gross profit
is calculated in the trading account.
‡ The profit and loss account shows the
businesses incomes and expenditures. The
net profit is calculated in the profit and loss
account.Trading Account Format
£ £
‡ Turnover (or sales) 180,000
‡ Cost of sales
‡ Opening Stock 40,000
‡ Purchases 95,000
135,000
‡ Less: Closing Stock (45,000) 90,000
‡ GROSS PROFIT 90,000Profit and Loss Account
Format
£ £
‡ Gross Profit 90,000
‡ Other income
‡ Interest received 11,000
101,000
‡ Expenses
‡ Rent and rates 25,000
‡ Wages and salaries 45,000
‡ Insurance 2,000 72,000
‡ NET PROFIT 29,000Profit and Loss Account Key
Terms
‡ Trading account ± provides summary of
businesss trading activity during financial year
‡ Sales ± monies received through selling
goods/services
‡ Cost of sales ± cost of sales to a business
before a profit margin is added
‡ Opening stock ± value of stock at start of the
financial period
‡ Closing stock ± value of stock at end of the
financial periodProfit and Loss Account Key
Terms
‡ Purchases ± cost of goods business has
bought for resale to customers
‡ Purchase returns ± value of goods purchased
but returned to supplier
‡ Sales returns ± value of goods bought by
customer but returned to the firm
‡ Expenses ± any expenses incurred by the
business in the course of normal operationInterpretation of Trading, Profit
& Loss Accounts
‡ Was this years trading result good or bad,
compared with last year or with a rival company?
‡ Has the Gross Profit improved this year,
compared with last year?
‡ Are we making efficient use of our stock?
‡ Does our Net Profit figure compare favourably
with those of other organisations in the same
industry?Recap
‡ Role of Finance
‡ Annual Accounts
‡ Trading, Profit & Loss AccountToday
‡ Balance Sheet
‡ Assets
‡ Liabilities
‡ Capital
‡ Liquidity
‡ Working CapitalBalance Sheet
‡ The profit and loss account shows the
history of the business activity
throughout the financial year.
‡ The balance sheet shows a snapshot of
a particular date in time.
‡ CAPITAL = ASSETS - LIABILITIESBalance Sheet
Assets Liabilities & Capital
BalanceAssets
‡ Assets ± are what a business owns
‡ Fixed assets ± have a lifespan of more
than one year, eg machinery, motor
vehicles
‡ Current Assets ± are constantly
changing eg stock, debtors, bank, cashLiabilities
‡ Liabilities ± what is owed by the business
‡ Current Liabilities ± eg trade creditors
(suppliers of goods on credit), bank
overdraft, short-term loans (less than 1
year)
‡ Long-term liabilities ± normally longer than
1 year ± eg mortgage, bank loanCapital
‡ Capital ± provided by the owner of the
business and treated as being owned to the
owner of the business
‡ Profits ± may increase capital
‡ Drawings ± may decrease capital
‡ Reserves ± monies retained by businessLiquidity
‡ Liquidity shows us whether a business
has enough assets to cover its debts.
‡ Turning assets into cash to pay off
debts is what normally happens.
‡ Stock is the hardest to turn into cash.
Why?Working Capital
‡ Working Capital is:
‡ Current Assets ± Current Liabilities
‡ If a business has too much working
capital then they are not using their
resources properly.
‡ If too little, then they may not be able
to pay off short term debts.Balance Sheet Format
‡ Fixed Assets
‡ Current AssetsRecap
‡ Balance Sheet
‡ Assets
‡ Liabilities
‡ Capital
‡ Liquidity
‡ Working CapitalToday Ratio Analysis
‡ What are ratios?
‡ Uses of ratio analysis
‡ Limitations of ratios
‡ Profitability ratios
‡ Liquidity ratios
‡ Asset usage ratiosWhat are Ratios?
‡ Ratios are a way of comparing different
figures.
‡ Ratios should only be used when comparing
like with like (ie same size of business; same
industry)
‡ Ratios can compare results with previous
years or rival firms
‡ Ratios, however are historic, and do not take
into account of other factors such as quality
of workers, inflation, economic situationUses of Ratio Analysis
‡ Compare current performance with
previous years
‡ Compare performance against similar
organisations
‡ Identify changes in performance to aid
future actions
‡ Identify trends over timeLimitations of Ratio Analysis
‡ Information is historic
‡ Comparisons must only be made with
similar organisations (size, industry)
‡ No account of external factors (PEST)
‡ No account of NPD or declining
products
‡ No account of human factors (staff
morale, staff turnover)Ratios
‡ Profitability ‡ Liquidity
‡ Gross Profit ‡ Current Ratio
percentage ‡ Acid Test Ratio
‡ Net Profit
percentage
‡ Asset Usage
‡ Return on Capital ‡ Rate of Stock
Employed (ROCE) TurnoverGross Profit Percentage
Gross Profit X 100%
Sales Revenue
‡ Measures profit made from buying and
selling stock
‡ For every £1 of sales, how much profit is
made?
‡ Increase = more sales generated or cost of
materials have fallen
‡ Decrease = cost of materials may have went
upNet Profit Percentage
Net Profit X 100%
Sales Revenue
‡ For every £1 of sales, how much profit
after expenses is made?
‡ Increase = handling expenses better
‡ Decrease = expenses may have went
upReturn on Capital Employed
(ROCE)
Net Profit
X 100%
Capital Employed
‡ If you invest £100 in a firm how much
will you get back?
‡ ROCE should be measured against
interest rates. Since your savings can
make money in a high interest bank
accountCurrent Ratio
Current Ratio = Current Assets:Current Liabilities
Looks at how business can pay off its debts
A ratio of 2:1 is considered prudent, but does not
take into account stock being held.
Higher than 2:1 means money may not being
invested in the business properly
Having less than 2:1 may mean the firm is in
danger of not being able to pay off debts (too much
money tied up in stock?)Acid Test Ratio
‡ Acid Test =
‡ Current assets ± stock: current liabilities
This is a tougher ratio than the current ratio
because it excludes stock, since stock is the
hardest asset to transform into cash.
This ratio should be around 1:1.Rate of Stock Turnover
Cost of Sales
‡ Stock turnover = Average Stock
Stock hanging around is bad for the firm. Stocks
can go off, out of fashion or out of date.
This ratio works out how many times stock is used
up.
Note: Average Stock is calculated by adding Closing
and Opening Stock and then dividing by 2Recap Ratio Analysis
‡ What are ratios?
‡ Uses of ratio analysis
‡ Limitations of ratios
‡ Profitability ratios
‡ Liquidity ratios
‡ Asset usage ratiosToday
‡ Cash Flow Statements
‡ Cash Budgets
‡ Cash Flow ProblemsBudgets
‡ Budgets are statements of anticipated
future expenditure covering a specific
time period
‡ Cash Budgets ± show expected
receipts & payments on a monthly basis
to help assess potential cash flow
problemsUses of Budgets
‡ To monitor & control
‡ Gain information
‡ To set targets
‡ To delegate authorityHow budgets help managers
‡ Make them accountable for decisions
‡ Help check income & expenditure
‡ Can highlight need for corrective action
‡ Help develop long term plans
‡ Assists with decision making
‡ A means of comparison with actual
resultsCash Flow Statements
‡ Cash Budgets/Cash Flow Statements contain
estimated figures of cash position of an
organisation over a period of time.
‡ Remember the closing balance is cash and
not profit!
‡ Cash Budgets are used to highlight potential
shortages or surpluses of cash resourcesCash BudgetCash Budgets and Role of
Manager
Plan Borrow or not?
Organise Bulk buying? Trade discounts?
Command Departmental budgets
Coordinate Departmental reports
Control Measure performance
Delegate Budgets spent by Dept. Mgrs.
Motivate Giving financial control may empower
individualsCash Flow Management
‡ Liquidity ± as mentioned, to check either
shortages or surpluses of cash resources.
‡ Decision-making ± the role of the manager
can be aided by cash budgets.
‡ Projection ± different variables and scenarios
can be used (on a spreadsheet) to see what
can affect the cash position of the
organisation.Recap
‡ Cash Flow Statements
‡ Cash Budgets
‡ Cash Flow ProblemsToday
‡ Users of Financial Information
‡ Internal Sources of Finance
‡ External Sources of Finance
‡ Additional Sources of FinanceUsers of Financial Information
‡ Shareholders ± can assess Boards
performance and decide about
investment or disinvestment
‡ Potential Shareholders ± decide
whether firm is a worthwhile risk
‡ Short term creditors ± should credit be
granted to the firm?
‡ Long term creditors ± should money be
lended to the firm? Will it be paid back?Users of Financial Information
‡ Government and local authorities ± look to
directors report and business plan. Do these plans
affect local area?
‡ Competitors ± compare themselves with rivals to
work out market share and if plans conflict with
their own
‡ Employees ± can the firm pay better wages? Is
the future sound?
‡ Management ± use info to evaluate past
performance and used to plan for future
‡ Customers ± is firm likely to still be around? Other
concerns, eg environmentSources of FinanceInternal Sources of Finance
‡ Retained Profits ± profit kept by
company for future activities
‡ Selling Assets ± money raised by selling
off an asset no longer needed
‡ Both are Short-termExternal Sources of Finance
‡ Long Term (10 years +)
‡ Issuing Shares ± capital raised by
selling shares
‡ Debentures ± a fixed interest long term
loan
‡ Loans ± borrowing money, repaid over
a time period with interest
‡ Mortgages ± a loan secured for propertyExternal Sources of Finance
‡ Medium Term (1-10 years)
‡ Leasing ± renting equipment or
premises
‡ Hire Purchase ± acquiring an asset on
credit followed by fixed payments. After
last instalment purchaser owns asset.
‡ LoansExternal Sources of Finance
‡ Short Term (up to 1 year)
‡ Overdraft ± borrowing more money
than is available in bank account
‡ Trade Credit ± businesses receive goods
first, then pay later
‡ Factoring ± a specialist business
collecting unpaid debts for a feeAdditional Sources of Finance
‡ LEC ± Scottish ‡ Grants and
Enterprise allowances ±
Renfrewshire Repayable Grants,
‡ Local authorities ± Soft Loans,
East Renfrewshire Subsidies
Council ‡ EU grants ±
‡ Government Regional
Partnerships ± Development Fund
Business Gateway & Social FundRecap
‡ Users of Financial Information
‡ Internal Sources of Finance
‡ External Sources of Finance
‡ Additional Sources of Financea) What four main areas does financial
information cover?
b) For what purposes might a manager use
financial information?
c) List at least four characteristics of useful
financial information.
d) List at least five users of financial
information.
e) Taking the users of financial information
that you have made, suggest a reason for
each of them to be using the information.
