Understanding and Managing Finance Lecture 1

What do we mean by Finance & Accounting? Finance is: Concerned with the way in which funds used in a business are raised and invested Accounting is: The process of identifying, measuring and communicating financial (and other) information so as to permit informed judgements and decisions to be made by the stakeholders in a business.

The Role of Accounting, Finance and Budgeting There are four separate, but linked functions: Reporting providing information about what we are doing Decision-Making working out how to do things better Controlling making sure we are doing what we said we would do Planning working out in detail how we should do things

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

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

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

The Role of Finance and Accounting 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

Activity 1.1 Question What is the normal order in which the four functions occur?

Stakeholders and their Needs For Accounting information to be useful, it must be put in a form which is relevant to the needs of the user. The next slide identifies 10 possible stakeholders in a business. Each will have their own need in terms of information on which they will base their decisions

Stakeholders and their Needs CUSTOMERS Continuity of supply Ability to meet needs COMPETITORS Threats to sales & profits Provide comparisons EMPLOYEES Job security Remuneration comparison GOVERNMENT PAYE, Corporation Tax, VAT Statutory legislation COMMUNITY Environment Contributions Jobs

Stakeholders and their Needs SUPPLIERS Ability to Pay, Credit risk LENDERS Ability to meet obligations, Security of investments Credit risk Financial structure MANAGERS Remuneration Company Performance & Planning SHAREHOLDERS Organisational performance Value of shares; Return v risk Management performance FINANCIAL ANALYSTS Company Performance Plans & Objectives

Discuss the following: Activity 1.2 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?

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

Financial Accounting & Management Accounting 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

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

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

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

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

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

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

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

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

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

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

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

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

Charitable Status 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) Advantages Financial - including exemption from most forms of direct taxation Status/credibility of charity registration number

Discuss the following: Activity 1.4 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?

Seminar One Case Studies The two case studies which follow ask you to reflect on what you have learnt from the presentation and your reading of the set text. They are constructed in such a way that you will need to think of arguments (in a variety of forms: business, managerial, personal and career) as to why accounting might be a “good idea”. In doing this, you will need to draw on facts as well as opinions.

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

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

Seminar One - Preparation Read Chapter 1 - McLaney & Atrill Revise key concepts: The role of finance & budgets in the organisation The differing requirements of stakeholders Different branches of accounting Legal and regulatory frameworks Prepare Case Study 1 and 2 individually, but come with notes for a solution. 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.