Financial Management Concepts Tools Exercises

Does financial management exist? What would a business look like that had little or no financial management? One way to find out more about something is to pretend a world in which it didn’t exist … ………………………………………………………………….

Cash and Profit You can pay a bill with cash but not with profit! The business ’s cash is the amount of money (including money at the bank) it has available to pay bills etc. Profit is not so easy to understand – for instance it is surprisingly common for businesses to fail because they don’t have enough cash even though they are very profitable! Profit is the left over amount once all expenses have been taken away from income – if there is a plus figure you have a profit (otherwise you have a loss) Your project may make a profit (earn enough to cover costs plus a bit on top) – but if you run out of cash your project will fail This is why cashflow forecasts are so useful – they let you plan for when you will have cash coming in and going out to make sure you don’t run out (a profit & loss account shows profit – a cashflow shows cash)

Cashflow and other financial problems If a business has a short-term cashflow problem, an arranged overdraft may ease the symptoms – but overdrafts are expensive and can be called in at any time Also, the bank is likely to demand personal guarantees from management team members (which means they become personally liable) If the business has no realistic prospect of ever paying off its bills then: It needs to seek advice urgently If the business is a company limited by guarantee it may be unlawful for it to carry on operating If the business carries on regardless, management team members could lose their limited liability status and be held personally responsible for debts

Forecasts A forecast revises the business ’s anticipated income and expenditure by taking development into account which occurred since the budget was drawn up When examining forecasts, management team members should test them and not merely take them at face value: Are the assumptions on which the forecasts are based reasonable? Do they need to be adjusted up or down? Have all factors been taken into account? What are the implications of any adjustments? Finally, depending on how accurate the forecasts are, does the project need to take steps to ensure they become more accurate?

Budgets A budget is a really useful planning tool for controlling costs Essentially a budget forces you to allocate a specific amount of money for each different type of expenditure (or ‘budget head’ as its sometimes known) – for the year as a whole and also for each month in the year These allocations are target figures, differences between what was projected and what happened in real life are called ‘variances’ Once variances have been spotted, the business may decide to do something about them – perhaps to transfer money between budget heads, or to cut costs elsewhere Budgeting takes time and imposes a discipline – but you will be in control Budgets don’t have to be just about money – you can use the same techniques to manage other things such as project outputs

Why budget? Each year your business needs to draw up a budget – an estimate of how much it expects to pay out and receive during the year – it needs to do this because: Realistic budgets and cashflows enable members of the management team to use financial resources more effectively, minimise problems, and exploit opportunities Budgeting is a useful planning tool which helps identify potential problems before they occur Budgets can be used to monitor income and expenditure during the year Budgets require us to put a value on assets and resources needed in the project And finally, all funders and bankers require budgets and cashflows

Some budgeting terms Direct costs – directly linked to level of activity; eg raw materials, wages used for delivering a service or making a product (also called variable costs) Indirect costs – are not linked to level of activity; eg rent, rates, insurance etc (also called fixed costs) Revenue – day-to-day running costs of the project Capital – generally one-off expenditure on fixed assets Break-even point – the level of sales (service or product) required to cover all costs (direct and indirect) Balanced budget – where projected income equals projected expenditure Variance – the difference (if any) between a projected figure and the actual figure that came about

Financial management needs – exercise (1) In two sub-groups, consider a scenario where you are a member of either Grants Committee (A) or (B) of a well-resourced charity. Please complete either Task A or B as directed: Task for Grants Committee (A) – next year this committee will have a lot more money to distribute. Can you come up with a prioritised list of selection criteria for giving out funds. Task for Grants Committee (B) – the committee has just decided to approve a large funding application from the learners’ project (even though they were a bit worried about how sensibly the money would be spent). Can you come up with a prioritised list of conditions the project must meet in order to get the money. Note: the grants committees’ primary function is to see that funds are spent well and not wasted

Financial management needs – exercise (2) Then the two sub-groups can feed back to each other: Ask each sub-group to feedback completely before moving on if you can confidently use phrases such as ‘capital receipts’ or ‘accruals’ please be aware that others may find such jargon off putting Appoint firm but fair timekeepers Encourage positive language and attitudes Discourage possessive feelings amongst learners towards ‘their’ points Finally, in the last five minutes try to create an agreed outline list of the business’s financial management needs

Sweeties money maze – exercise (1) In two sub-groups, consider this scenario: You are new on the management committee of Sweeties Pre- School & Training Centre, which provides places for over 50 children as well as a wide range of adult training. You employ 14 staff and get funding from a variety of sources including a new large package of grants from government. Sweeties has been running well for several years. However, the project director has informed the committee that the new money that should be coming from government has been coming in late. In fact you have just learned that you haven’t received any payments for the last two quarters and that there is some kind of problem brewing. The finance committee has asked for the management committee to get involved and a special meeting has been called to look at the issues and take. As you are still new to Sweeties, the project director has asked if you want any specific financial information before the meeting takes place.

Sweeties money maze – exercise (2) In sub-groups, try to answer these five key questions: What do you need to know? What do you think you should ask for? What will help you understand the problems and make good decisions? What financial/legal responsibilities must you bear in mind? What steps could you take so that this doesn’t happen again? Don’t spend too much time trying to figure out the particular problem at Sweeties – you are not given enough information to know what it is …