Business Studies | Creating a Business

Handling Finances

Financial information in an organisation enables managers to perform three functions:

• To record. The money values of resources and of transactions in any organisation can be recorded using accounting techniques. The records enable companies to produce periodic statements of the value of assets, liabilities and capital.

• To analyse. The presentation of financial information is required by law, and so accounting conventions have developed for presenting financial information. The standard or conventional methods of accounting enable organisations to analyse financial information, and to make comparisons of performance between one year and another (intra-firm comparisons), and between similar organisations (inter-firm comparisons).

• To control. Organisations can maintain a degree of control over departments by examining and regulating their expenditure. Accountancy provides reliable techniques for the internal management of organisations.

Principles of accountancy :

The priciples that underlay accountancy practice in firms ensure there is a high degree of confidence in the fairness and accuracy of their financial information. These principles are:

• Objectivity . Subjective judgements should be avoided, and evidence should be used to support and judgement, for instance, at the assessment of historic costs.
• Going concern . The financial information should reflect the viability of the organisation, and so should deal with present and future activity as well as past performance.
• Accruals . The records showing income and expenditure and should show transactions when due, i.e. Debts due. This is to make sure that the view of the firm’s financial position is consistent.
• Consistency . Records should be made on the same basis from year to year so that fair comparisons can be made.
• Conservatism . The accounting record should be of items that are certain rather than estimated. For example it is better to record sales made, rather than orders taken, as orders can be cancelled.

Management accounts

The purpose of management accounts is to prepare the profit and loss account in advance. They provide a forecast of a firms financial performance. Management accounts are produced fairly frequently – monthly or even weekly. They provide information in the comparative performance of different departments and sections in a company such as production, marketing/sales and personnel. The departmental managers use this information to estimate future activity, make plans and control operations. The benefits of management accounts are that they improve the co-ordination between departments and help managers in their decision-making.

Social accounting

Contemporary accounting is not solely concerned with the financial state of an organisation. There is an increasing interest in how an organisation impacts on its employees, on the community and on the environment. A social audit of a company could stress:

• Employment practices – Does the firm implement an effective equal opportunities policy?
• Concern for customers – Is the service given to issues such as customer complaints or customer information adequate? The regulator fined the rail companies for not dealing adequately with customers’ requests for timetable information.
• Concern for the environment – Does the company contribute to the sustainability of resources by minimising waste and reducing pollution.

Recording transactions

There are three reasons why organisations should record their transactions:

• The companies Acts impose statutory requirements on companies to publish their accounts. Public limited companies and non-exempt private companies must keep and publish a proper record of transactions with respect to a) receipts and expenses; b) sales and purchases; c) assets and liabilities. The accounts must give a true and fair view of a company’s affairs.
• Private commercial organisations have to pay tax on any surpluses earned thought trading. Consequently, they must keep proper books of accounts that represent in a fair way all transactions. The Inland Revenue will examine these books.
• It is in the interests of a public company to publish its financial information in a form, which is readily understood. Public limited companies require long-term finance from the general public, and the shareholders’ and potential investors assessment of a company is normally obtained through its published financial record.

The recording and presentation of financial information is carried out according to accounts conventions. The two mist important standard documents are the profit and loss account, and the balance sheet.

The profit and loss account

The profit and loss account records what has happened during a particular period (normally the financial year).

The profit and loss account is a summary of a firms activities during a financial period : it does not show that income and expenditure take place constantly, that every working day, sales will be made and resources will be required.

Profit performs two important functions. As the profit and loss account shows, if a firm makes sufficient profit after tax, then some money can be ‘ploughed back’ into the organisation through a reserve fund. Profit enables a company to grow. Equally important is the second function of profit: it provides short-term funds (working capital) to meet day to day expenses. So profit provides both long term and short term finance.

Problems in measuring profit

In spite of the development of standards in the presentation of the profit and loss account, there are problems in assessing and measuring profit.

Profit is a relative measure. Profit has more meaning when it is seen in relation to the amount of capital employed in its creation. For example, if company ABC has assets of £2,000m and makes £2m net profit, it would be unreasonable to conclude that both companies were equally successful. Net profit is a relative figure. It needs some qualification if it is to be used as a test of efficiency.

Timing . Profits can fluctuate from year to year and therefore annual profit and loss accounts describe the fortunes of a company only for a limited period.

Inflation . Money as a measure of value is not reliable during periods of inflation. Consequently, organisations have problems in valuing stocks or in deciding on the amount to set aside for the depreciation of fixed assets. Since there is an element of choice regarding the presentation of certain money values in the profit and loss account, the accounts do not always give a ‘true and fair view’ of the performance of a firm.

Allocation of costs in large organisations . In large organisations, the cost of some items is not east to apportion to particular trading activities. For example, where a large corporation spends money on corporate advertising or on cetranlised research and development, the cost of these activities is not easy to allocate. Poor allocation of costs could hide unprofitable ventures and distort profit figures.

The balance sheet

The balance sheet is a statement of the financial position of a company at a certain date. It provides details on the assets, liabilities and owners’ equity; and is required by law to be produced once during a financial year. Some companies produce ‘interim’ statements to show the position at a quarer or half-year.

The purposes of a balance sheet are:

• To show, at a specified time, the total capital employed in the business (share capital, loans and amounts due to creditors).
• To show how the organisation has converted money into real or productive assets.
• To provide a record this allows auditors and owners to keep a check on the assets of a company.
• To provide a record this can be analysed to show how the organisation is performing. The balance sheet shows the gearing of the company, the balance between fixed assets and current assets, and the balance between current assets and current liabilities.

The fixed and current assets of a company are the resources that the company employ in addition to people in order to produce goods and services. Assets are required by incurring liabilities and by using shareholders equity. Therefore the fixed and current assets should equal the equity (which includes any reserved and retained profit) and liabilities of a company. If a company’s books are correctly kept, then both sides of the balance sheet should balance.

Assets = Liabilities + Owners equity

The apparent precision of a balance sheet is misleading. The techniques of accounting, if they are carried out correctly, ensure that a balance sheet always balances. But the information that is disclosed can be deceptive. The problems of inflation and changing money values affect the accuracy of Balance sheets. Fixed assets, such as premises, do not necessarily represent their actual values. Similarly the value of stocks and the allowance for bad debts can only be estimated. It would be unwise to assume that the guesses of accountants fairest view of the position of a company. Like the profit and loss account, it is not an absolute record.

The presentation of the balance sheet in a vertical format is a relatively recent practice. The traditional form of presentation is a horizontal format. The information included in both the vertical and the horizontal formats is similar: it is customary in both formats to show assets and liabilities in order of liquidity – the least liquid item is shown first, and the most liquid last. The two advantages of the vertical format are firstly, it is generally easier to understand. For example, the horizontal layout shows shareholders’ capital as a liability and this can cause confusion. Secondly it emphasises important features such as the working capital and net worth of the company.

This passage has taken you through how to handle your finances, with accounting concepts. Legal aspects of the above mentioned also plays a big role in finance + accounts.

Wages

Salaries and wages

Most employees in the UK receive their payments in the form of salaries or wages. Salaries are expressed in annual terms (E.G production manager earns £30,000 a year) and are normally paid monthly. Salaried employees are not normally required to work a set number of hours per week though their contract of employment may state a minimum number of hours.

On the other hand, wages are usually paid weekly and employees are required to be at work for a specified number of hours. Employees are normally paid a higher rate (knows as overtime) for any additional hours worked.

Fringe Benefits

These are sometimes referred to as ‘perks’. Fringe benefits are those extras an employee receives as a park of their reward package. Examples include the following

-         A company car

-         Luncheon vouchers

-         Private health insurance

-         Employers’ contributions to pension schemes

-         Discounts for company products

Firms tend to use fringe benefits to encourage employee loyalty and to reduce the proportion of employees leaving the firm. A danger of the widespread use of fringe benefits are that costs can increase quickly, reducing profitability.

Performance related pay

Performance related pay has become more widely used over recent years and has developed along with employee appraisal systems. Performance related pay is only paid to those employees who meet or exceed some agreed targets. Under performance related pay, employees are paid for their contribution to the organisation, rather than their status within it.

A number of large-scale manufacturers such as Cadburys and Nissan, and public sector industries, for example the NHS, introduced performance related pay schemes during the early 1990’s. A recent survey indicated that 68% of private sector businesses in the UK have introduced Performance related pay for some or all of their non-manual employees, thought the rate at which performance related pay is being introduced is slowing.

Criticisms of price related pay

- A number of criticisms of performance related pay have been put forward:

Many employees perceive performance related pay as fundamentally unfair. This is particularly true of those working in the services sector where employee performance is difficult to measure. Employees fear that they might be discriminated against because they do not get on with the manager conducting their appraisal interview. This can result in their performance worsening, not improving.

- A majority of businesses operating performance related pay systems do not put sufficient funds into the scheme. Typically, the operation of a performance related pay scheme adds 3-4% to a businesses wage bill. This only allows employees to enjoy relatively small performance awards, which may be inadequate to change employee performance.

Development in performance related pay

Increasing numbers of firms are implementing a system knows as variable pay. Companies such as Levi-Strauss in America and Unilever in Britain recognise that company performance often depends upon the achievements of the few.

Variable pay is really a development of performance related pay. It is similar in that it rewards employee performance, but there are differences. Performance related pay operates according to a formula used throughout the company. Variable pay is far more flexible and the potential rewards for star employees are greater. The Bank Of England, for example, retains 10% of its pay budget to reward good performers amongst their employees.

Cost and Profit Centres

Cost and Profit Centres

A cost centre is a distinct part of a business of which costs and revenues can be determined.

A profit centre is similar to a cost centre, being a part of a business for which costs and revenues (hence profits) can be determined.

For a cost centre it is only possible to calculate the associated costs. This, the accounts department or the department providing IT services to a business could be cost centres. For these areas it is straightforward to calculate costs such as wages and salaries. However, it is impossible to calculate the revenues earned by areas of the business uscj as the accounts department, as they do not charge separately for their services.

Profit centres can calculate costs and revenues. So, it is possible to determine the profit generated by this aspect of the businesses operation.

Creating cost and profit centres

1) Some large businesses might operate a number of factories, offices or branches. In these circumstances, profit centres can be developed on a geographical basis. High street banks, for example, expect branches (Or groups of branches) to achieve agreed levels of profits.

2) In manufacturing industries, it is possible to operate smaller cost or profit centres relating to a particular product or even a single production line.

3) A relatively simple approach is to use departments or divisions as cost or profit centres. Hospitals use wards and individual departments such as x-ray to develop cost and profit centres, for example.

4) Profit and cost centres can also relate to individual products or brands.

Why operate cost and revenue centres

These are three broad categories of reason why businesses decide to operate cost and profit centres

1) Financial reasons

2) Organisational reasons

3) Motivational reasons

Financial Reasons

Businesses gain more detailed information from running a number of separate cost and profit centres, rather than merging all the figures into a single set of financial statements. Having separate cost centres allows managers to compare the costs incurred by various parts of the business. This enables managers to identify the less cost-efficient parts of the business. Senior managers can then attempt to reduce costs in this area, perhaps through more training of staff, creating a more profitable business overall.

Organisational reasons

The financial data provided by cost and profit centres gives managers more in-depth information about the operation of their business. Using this information, managers might be able to organise the business more effectively and make higher profits.

Many businesses are made up of a number of separate elements. If a company wishes to expand, having information on the relative financial performance of each of the divisions of the business will be helpful. It might be argued that they should focus on their profitable activities.

Motivational Reasons

Many psychologists recognise that giving people greater responsibility is an effective way to motivate them. This responsibility can take the form of achieving cost or profit centres. Businesses have increasingly recognised this and have sought to allow employees a greater role in managing budgets. When managing a profit or cost centre, employees have more varied and interesting jobs, as well as the satisfaction of achieving cost or profit targets.