2. Finance Advanced Diploma in Management Practice Steve Pollard

3. Advanced Diploma in Management Practice Contact: Steve Pollard [email_address]

4. Course Secretary: Lee Hutchinson Room No: 2 D 15 Telephone: 028 9036 8077 Email: [email_address] Advanced Diploma in Management Practice

5. Setting the Scene

7. People Knowledge Resources Results Finance Monitor and Evaluate Business Processes Leadership Strategy ______ _____

8. Finance The science that describes the management of money, banking, credit, investments, and assets. Basically, finance looks at anything that has to do with money and the market

9. AIMS The aim of this module is to enable you to critically evaluate and appraise the performance of the organisation as a whole, and subsets within that organisation and to use accounting-based information for planning, decision-making and control.

10. Setting The Scene

15. MANAGERIAL VALUE OF OBJECTIVES Principle: Companies whose managers set objectives for each KEY RESULT AREA and then pursue actions calculated to achieve their performance targets typically outperform companies whose managers have good intentions, try hard, and hope for success

17. STRATEGIC MANAGEMENT PRINCIPLE Every company needs both strategic and financial objectives!

18. EXAMPLE: CORPORATE OBJECTIVES To achieve 100 percent total customer satisfaction. . .everyday. . .in every restaurant. . .for every customer. McDONALD’s

19. EXAMPLE: CORPORATE OBJECTIVES To increase annual sales from $1 billion to $2 billion in 5 years. To enter a new market every 18 to 24 months. To have 30% of sales each year come from products not in the company’s product line five years earlier. To be the lowest cost, highest quality producer in the household products industry. To achieve a 15% average annual growth in sales, profit, and earnings per share. Rubbermaid

20. Financial objectives Goals related to returns that a business will strive to accomplish during the period covered by its financial plan. Financial plan: A blueprint relating to the financial future of a Business

26. What is Financial Management ? Handout: What is Financial Management

27. “ Financial management is all about getting the most appropriate manpower, materials or equipment at the best price (economy), making sure that the resources are used in the most productive way (efficiency) to meet the organisation’s objectives (effectiveness).” Chartered Institute of Management Accountants

28. Collier (2003: 18) believes that: financial management is concerned with, Funds from stakeholders or financiers to provide the capital the business needs to sell and produce goods and services.

29. Financial Accounting: The measuring and reporting of accounting information for external users (those users other than Managers of the business) Atrill McLaney 2005

30. Management Accounting: The measuring and reporting of accounting information for the Managers of a Business Atrill McLaney 2005

32. Planning - To ensure that: Enough funding is available at the right time to meet the needs of the business. Working Capital Why does a business need Working Capital?

34. The working capital cycle can be defined as: The period of time which elapses between the point at which cash begins to be expended on the production of a product and the collection of cash from a customer Working Capital

35. The diagram below illustrates the working capital cycle for a manufacturing firm Working Capital

36. Financing Working Capital

38. The key aspects of financial decision-making relate to investment , financing and dividends : • Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers • A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.

39. Key Resources

40. Assets and Resources of the Firm Financial capital Physical capital Social capital Human capital Intellectual capital Customer capital

41. financial capital – the money available for investment and growth intellectual capital – specialised or protected knowledge or property physical capital – physical resources, including IT human capital – staff resources and capabilities social capital – ‘good name’, goodwill, similar cultural characteristics customer capital – the size, value and loyalty of customers information capital – systems, databases, networks organisational capital – culture, leadership, alignment Benchmark against other organisations in our sector. To what extent are our assets better, the same or worse than competition? Are they stable, strengthening, or becoming weaker? Assets and Resources Source: Grant, Kaplan and Norton

43. Understanding Costs

44. Cost “ The amount of resources, usually measured in monetary terms, sacrificed to achieve a particular Objective.” Atrill & McLaney

46. Direct or Variable Costs: “ Costs that can be identified with specific cost units, to the extent that the effect of the cost can be measured to each unit of output” Atrill & McLaney

47. Overheads (Indirect Costs or Fixed) Costs that do not vary with changing sales or production volumes e.g. rent, rates, administration, depreciation, telephones, heat, light & power, insurance, professional fees, stationery etc.

48. Fixed Costs Costs which in the short term remain unchanged regardless of the level of activity.

49. Financial Framework Sales Volume (Cumulative ) Costs & Business activity and the P & L Account Value € /£ 0 5 10 15 20 25 A B C Fixed Costs Sales Variable Costs

50. Contribution and Margins Which company would you invest in? Why?

52. Financial Reporting - The Traditional Accounting Control Model Handout: Introduction to Financial Accounts

55. Financial Framework Profit and Loss Account Describing the trading performance of the business over the accounting period Balance Sheet Statement of assets and liabilities at the end of the accounting period (a "snapshot") of the business Cash Flow Statement Describing the cash inflows and outflows during the accounting period Notes to the Accounts Additional details that have to be disclosed to comply with Accounting Standards and the Companies Act Directors' Report Description by the Directors of the performance of the business during the accounting period + various additional disclosures, particularly in relation to directors' shareholdings, remuneration etc

56. The Balance Sheet

61. Balance Sheet (amounts shown in £' millions) 24 February 200x 26 February 200x FIXED ASSETS 10,038 8,527 Current Assets 1,694 1,342 Short-term creditors (4,389) (3,487) NET CURRENT LIABILITIES (2,695 (2,145) Total Assets less Current Liabilities 7,343 6,382 Long-term creditors (1,927) (1,565) Provisions (24) (19) TOTAL NET ASSETS 5,392 4,798 Equity shareholders' funds 5,356 4,769 Minority interests 36 29 Total Capital Employed 5,392 4,798

62. Draw Up A Personal Balance Sheet

63. Profit & Loss Account P&L Describing the trading performance of the business over the accounting period

64. £'000 £'000 Revenue 12,500 10,000 Cost of Sales 7,500 6,000 Gross Profit 5,000 (40%) 4,000 (40%) Operating Costs Sales and distribution 1,260 1,010 Finance and administration 570 555 Other overheads 970 895 Depreciation 235 210 Total Operating Costs 3,035 2,670 Operating Profit (gross profit less operating costs) 1,965 1,330 Operating profit margin (operating profit / revenue) 15.7% 13.3% Interest (450) (475) Profit before Tax 1,515 855 Taxation (455) (255) Profit after Tax 1,060 600 Dividends 650 400 Retained Profits 410 200

65. The Trading Account. This records the money in (revenue) and out (costs) of the business as a result of the business’ ‘trading’ (Gross Profit) The Profit and Loss Account proper This starts with the Gross Profit and adds to it any further costs and revenues, including overheads. The Appropriation Account. Retained for future investment and growth, Returned to owners eg a ‘dividend’ or Paid as tax. 3 Parts to P&L

66. Cost of Goods Sold – The directly attributable costs of products or services sold e.g. materials, direct labour, production costs. Gross Profit – Where sales revenue (turnover) exceeds the cost of goods sold Glossary of Terms

67. Overheads (Indirect Costs or Fixed) Costs that do not vary with changing sales or production volumes e.g. rent, rates, administration, depreciation, telephones, heat, light & power, insurance, professional fees, stationery etc.

68. Net Profit Where sales revenue plus other income (such as rent received) exceeds the sum of cost of goods sold plus overheads

70. How Is This Business Doing? £'000 £'000 Revenue 12,500 10,000 Cost of Sales 7,500 6,000 Gross Profit 5,000 (40%) 4,000 (40%) Operating Costs Sales and distribution 1,260 1,010 Finance and administration 570 555 Other overheads 970 895 Depreciation 235 210 Total Operating Costs 3,035 2,670 Operating Profit (gross profit less operating costs) 1,965 1,330 Operating profit margin (operating profit / revenue) 15.7% 13.3% Interest (450) (475) Profit before Tax 1,515 855 Taxation (455) (255) Profit after Tax 1,060 600 Dividends 650 400 Retained Profits 410 200

71. Interpretation of the Statements Performance Area Key Issues Profitability Is the business making a profit? Is it enough? Efficiency Is the business making best use of its resources? Is it generating adequate sales from its investment in equipment and people? Is it managing its working capital properly? Liquidity Is the business able to meet its short-term obligations as they fall due from cash resources immediately available to it? Stability What about the long-term prospects of the business? Is the business generating sufficient resources to repay long-term liabilities and re-invest in required new technology? What is the overall structure of the businesses' finance - does it place a burden on the business? Investment Return What return can investors or lender expect to get out of the business? How does this compare with similar, alternative investments in other businesses?

72. The Main Tools of Review Area for Review Comments Review of the Business; Chairman's and CEO's Review The accounts of all quoted companies (and many private companies) include some commentary from senior management on the strategy and performance of the business. This is often the most useful place to start. The statements (usually one each from the Chairman, CEO and Finance Director) will reveal many "qualitative" things about the business. These include a description of the business activities, objectives, developments and competitive environment. Political, environmental and macro-economic issues may also be raised. Cash flow statement The cash flow statement will reveal where the company's resources have come from and how they have been applied during the year. Calculation of significant ratios between figures in the accounts Ratio analysis is an important tool for understanding and comparing business performance. However, ratios and other financial calculations are rarely useful when looked at in isolation. it is important to carry out calculations of ratios and other significant financial figures with previous years (many companies publish five or ten year summaries as part of their annual reports) in order to identify positive or adverse trends). Comparison with other, relevant competitors and industry "norms" is also important.

73. : Key Profitability Ratios Ratio Calculation Comments Gross Profit Margin [Gross Profit / Revenue] x 100 (expressed as a percentage This ratio tells us something about the business's ability consistently to control its production costs or to manage the margins its makes on products its buys and sells. Whilst sales value and volumes may move up and down significantly, the gross profit margin is usually quite stable (in percentage terms). However, a small increase (or decrease) in profit margin, however caused can produce a substanial change in overall profits. Operating Profit Margin [Operating Profit / Revenue] x 100 (expressed as a percentage) Assuming a constant gross profit margin, the operating profit margin tells us something about a company's ability to control its other operating costs or overheads. Return on capital employed ("ROCE") Net profit before tax, interest and dividends ("EBIT") / total assets (or total assets less current liabilities ROCE is sometimes referred to as the "primary ratio"; it tells us what returns management has made on the resources made available to them before making any distribution of those returns.

74. Key Efficiency Ratios Ratio Calculation Comments Sales /Capital Employed Sales / Capital employed A measure of total asset utilisation. Helps to answer the question - what sales are being generated by each pound's worth of assets invested in the business. Note, link with the primary ratio - ROCE. Sales or Profit / Fixed Assets Sales or profit / Fixed Assets This ratio is about fixed asset capacity. A reducing sales or profit being generated from each pound invested in fixed assets may indicate overcapacity or poorer-performing equipment. Stock Turnover Cost of Sales / Average Stock Value Stock turnover helps answer questions such as "have we got too much money tied up in stock"?. An increasing stock turnover figure or one which is much larger than the "average" for an industry, may indicate poor stock management.

75. Key Efficiency Ratios Credit Given / "Debtor Days" (Trade debtors (average, if possible) / (Sales)) x 365 The "debtor days" ratio indicates whether debtors are being allowed excessive credit. A high figure (more than the industry average) may suggest general problems with debt collection or the financial position of major customers. Credit taken / "Creditor Days" (Trade creditors + accruals) / (cost of sales + other purchases)) x 365 A similar calculation to that for debtors, giving an insight into whether a business i taking full advantage of trade credit available to it.

76. Liquidity Ratios Ratio Calculation Comments Current Ratio Current Assets / Current Liabilities A simple measure that estimates whether the business can pay debts due within one year from assets that it expects to turn into cash within that year. A ratio of less than one is often a cause for concern, particularly if it persists for any length of time. Quick Ratio (or "Acid Test" Cash and near cash (short-term investments + trade debtors) Not all assets can be turned into cash quickly or easily. Some - notably raw materials and other stocks - must first be turned into final product, then sold and the cash collected from debtors. The Quick Ratio therefore adjusts the Current Ratio to eliminate all assets that are not already in cash (or "near-cash") form. Once again, a ratio of less than one would start to send out danger signals.

77. Stability (Long-Term Health) Ratios Ratio Calculation Comments Gearing Borrowing (all long-term debts + normal overdraft) / Net Assets (or Shareholders' Funds) Gearing (otherwise known as "leverage") measures the proportion of assets invested in a business that are financed by borrowing. In theory, the higher the level of borrowing (gearing) the higher are the risks to a business, since the payment of interest and repayment of debts are not "optional" in the same way as dividends. However, gearing can be a financially sound part of a business's capital structure particularly if the business has strong, predictable cash flows. Interest cover Operating profit before interest / Interest This measures the ability of the business to "service" its debt. Are profits sufficient to be able to pay interest and other finance costs?

78. Key Investor Ratios Ratio Calculation Comments Earnings per share ("EPS") Earnings (profits) attributable to ordinary shareholders / Weighted average ordinary shares in issue during the year A requirement of the Stock Exchange - an important ratio. EPS measures the overall profit generated for each share in existence over a particular period. Price-Earnings Ratio ("P/E Ratio") Market price of share / Earnings per Share At any time, the P/E ratio is an indication of how highly the market "rates" or "values" a business. A P/E ratio is best viewed in the context of a sector or market average to get a feel for relative value and stock market pricing. Dividend Yield (Latest dividend per ordinary share / current market price of share) x 100 This is known as the "payout ratio". It provides a guide as to the ability of a business to maintain a dividend payment. It also measures the proportion of earnings that are being retained by the business rather than distributed as dividends.

79. Over To You Port of Belfast Annual Accounts 2005

80. Understanding Costs

82. Exercise Costs in Year One for a New Start Community Day Care Centre 15 – 20 minutes

83. Break-Even When Sales Revenues = Costs Point at which enterprise is making neither a profit or loss

85. Calculating Break-Even One Product or Service Overheads__________________ Price of unit – direct costs of unit = No. Units

86. Community Day Care Centre Example £111,767 = 1,242 weeks per year £100 - £10 Open 50 weeks p.a. then 1,242 / 50 = 25 Children

87. Break Even Analysis 20,000 40,000 60,000 20 40 Units £’000 C F E D B A

103. Which company would you invest in? Why?

104. Return on Capital Invested Now which would you invest in?

110. Financial Planning and Monitoring

111. Planning and Monitoring Market Research Objectives Description Costings Targets Commercial Community Benefit What product or service? What market gap? Confirm business Objective(s) What will the business do? By whom? With what? Materials, labour, overheads; Turnover, margins, price Agree targets:sales, turnover, profit What community needs ? Define social and environmental objective(s ) What will be done? By whom? How? When ? Time, use of facilities, materials Confirm realistic social performance targets

112. Planning and Monitoring Management & Financial Information Monitor Adjustments Annual Audit Commercial Community Benefit Set up systems: cash flow, P&L, balance sheet, time management, job sheets etc. Monthly management accounts Adjust in light of reality Assets/liabilities, liquidity, performance, net worth Set up social book keeping and accounting systems Monthly/quarterly report on social performance and cost Adjust in light of reality Performance verified showing cost to company and contribution to society PROFIT/LOSS Pearce, J. “Social Enterprise in Anytown” 2005 Calouste Gulbenkian Foundation

113. Monitoring Performance Required by law to exercise control Need effective systems for monitoring financial performance in place Need to gather and understand financial information needed to make decisions

114. How?

124. BBRT

130. Exercising Control

133. Where Are We At?

134. Information Management Exercise

136. Component 1: Ownership structure and influence Transparency of ownership. Concentration and influence of ownership. Component 2: Financial stakeholder rights Voting and shareholder meeting procedures. Ownership and financial rights. Takeover defences. Component 3: Financial transparency and information disclosure Quality and content of public disclosure. Timing of and access to public disclosure. Independence and integrity of audit process. Component 4: Board structure and process Board structure and composition. Role and effectiveness of board. Role and independence of outside directors. Director and executive compensation, evaluation and succession policies. Source: Standard & Poor's Governance Services (2002) Components of S&P corporate governance score