Accounting And Finance Introduction To Financial Management 2666614

1 MMGT6003 Accounting and Finance Introduction to Financial Management Professor Suresh Cuganesan Overview – Course, Content, Objectives 2 Accounting’s importance in measuring and communicating performance and position % Finding Measure Particularly Valuable Investors Analysts Cash Flow 94 68 Earnings 92 97 Market Share 90 81 New product development 90 77 Customer Retention 72 74 Product Quality 72 48 Customer Satisfaction 58 45 Environmental Compliance 54 35 › Criteria used by stock market analysts and investors demonstrate the weighting of cash flow and earnings measures › Management need to deliver strong financial performance in competing within markets Source: PriceWaterhouseCoopers But need to be avoid being a ‘naïve’ user of accounting information 3 But need to be avoid being a ‘naïve’ user of accounting information › Mass-market segment? – high-volume, low margin simple products – repetitive purchases – volume growth at 10% per year › Niche segment? – Lower volumes but high margin and complex products – Infrequent purchases – Volume growth at 5% per year Accounting and Finance also useful for management decision-making – business model choices 4 Accounting and Finance also useful for management decision-making – business model choices? › Immediately increase manufacturing capacity at your production facilities at a total cost of $100 million ? OR › Delay investment, paying significant overtime and subcontracting costs to see if demand remains strong or if financing costs reduce? How to respond to these challenging decisions? ›How does accounting and financial information work? What do they represent? ›How do I analyse using which tools and techniques? ›How do I utilise analytical insights in decisionmaking? 5 Span of the Course Topic Introduction to financial management Financial Analysis: Working capital Financial Analysis: Ratio techniques Management Decision-making and value drivers in the shortterm Valuation analysis and NPV Capital budgeting and firm value Introduction to Financial Statements 6 11 Controlling Accounting Practice: Generally Accepted Accounting Principles WHAT MAKES FINANCIAL INFORMATION USEFUL COMPARABILITY Consistency Disclosure Similarities and differences can be discerned and evaluated RELEVANCE Predictive Value Confirmatory Value Information that has the ability to influence decisions UNDERSTANDABILITY User’s abilities Aggregation & Classification The significance of the information can be perceived RELIABILITY Faithful Representation Neutral & Complete Free from Error Conservative Information that is a complete and faithful representation THRESHOLD OF MATERIALITY Source: UK Accounting Standards Board Corporation and Economic Resource Flows Assets Debt Equity Returns Reinvestment Balance Sheet Income Statement Profits = Revenue – Expenses Cash Flow Statement is cash version of all resource flows 7 Accounting Elements – Revenue x Definition x Inflows or savings in outflows of economic benefits x Result in increase in Owners Equity during the period x Examples: Sales Revenue, Interest Revenue, Dividend Revenue, Discounts Allowed x Recognition Criteria: x Probable that benefit has accrued x Benefits can be measured reliably x Practically – what is the trigger-point for revenue recognition? Revenue Recognition – Provision of Goods › Consider – Transfer of risks/rewards of ownership – Transfer of control over goods – Reliable measurement and probability of benefits accruing Order placement /Customer payment Goods leave warehouse Goods delivered to customer/ invoice Customer payment 8 Revenue Recognition – Provision of Services › Consider – Reliable measurement and probability of benefits accruing – Stage of completion of transaction at reporting date: – Survey of works completed – Proportion of services performed to date – Proportion of costs recognised to date Order placement /Customer payment Customer payment Performance of service Revenue Recognition Issues Source: IDC survey of senior financial executives from 586 companies 9 Accounting Elements – Expenses x Definition: x Reduction in Owners Equity representing consumption or loss of economic benefits x Reduces assets or increases liabilities other than distribution to owners x Recognition: x Probable that consumption of benefits has occurred x Consumption of benefits can be measured reliably x Examples: Salaries, Bad Debts Expense, Marketing, Depreciation/Amortisation 18 Financial Statements: Income Statement › Measures performance over a period in terms of $ profits › Profit for a period = Revenue – Expenses › Profit accrues to Owners (increases the owner’s stake in the business) › Typically reports: – Gross Profit (Sales Revenue – Cost of Goods Sold) – Operating Profit or Earnings before Interest and Tax – Net Profit 10 19 A Starting Point to analysing an Income Statement › Profit or loss performance? Comparison to last year? › Source of performance? – Revenue Growth – Margin Growth – Efficiency? Link between Income Statement and Balance Sheet Assets = Liabilities + Equity 1000 = 200 + 800 Revenue – Expenses – Taxes = Profit 700 – 500 – 60 = 140 Assets = Liabilities + Equity 1140 = 200 + 940 11 21 Financial Statements: Balance Sheet › Snapshot of Firm at a point in time in terms of: – Economic benefits/resources controlled by firm (assets) – Claims on those resources from external parties (liabilities) – Residual claims of owners (owners equity) › Balances economic benefits/resource of firms against external and owner claims on those resources › Reflects accounting equation Î A = L + OE Î A – L = OE Accounting Elements – Assets › Definition: x Future economic benefits/resources x Controlled by the Entity x Result of past transactions x Can be x Tangible: Land, Buildings, Cash x Intangible: Patents, Goodwill x Comprises x Current Assets: Inventory, Accounts Receivable, Cash x Non-Current Assets: Machinery, Land, Motor Vehicles, Property Plant and Equipment 12 Accounting Elements – Assets x Recognition Criteria x Probable that future economic benefits embodied in asset will eventuate x Asset possesses a cost or other value that can be measured reliably x Note: x Depreciation/Amortisation – allocating the cost of limited-life long-term assets over useful life x Historical cost and Impairment – reducing the recorded value of an asset to an estimate of its recoverable amount or cash flow potential Accounting Elements – Liabilities › Definition: x Future sacrifices of economic benefits/resources x Entity is presently obliged to make x Result of past transaction/event x Comprises: x Current Liabilities: Accounts Payable, Interest Payable x Non-Current Liabilities: Long-term loan x Recognition Criteria x Probable that future sacrifice of economic benefits will be required x Amount of liability can be measured reliably 13 Accounting Elements – Owners Equity › Definition: Residual interest of owners, equivalent to net assets of firm › Reflects legal precedence of claims by creditors over claims by owners › Comprises – For non-corporates: – Capital (original contributions plus additional) – Drawings (which are netted against Capital at end of period) – For corporates: – Issued Capital – Retained Earnings (accumulation of profits/losses) – Reserves – Note: Dividends reduce retained earnings 26 Financial Statements: Balance Sheet › Assets – Current assets (likely to be converted into cash within 12 months) – Non-current assets (likely to be converted into cash after 12 months) › Claims on these resources are disclosed – Liabilities – split into current and non-current components – Owners’/Shareholders’ Equity – capital, retained profits and reserves 14 27 A Starting Point to using a Balance Sheet › As one indicator of ‘worth’, what is the level of net assets or equity in the firm? Has it grown over the period? › Considering short-term position – Level of cash? Level of current assets (inventory, receivables)? – Level of current liabilities and comparison to current assets? › Considering long-term position – Level of productive/infrastructure assets – Level of debt (long-term loans etc) – Equity growth through profit generation or new funds being raised? 28 Taking a Step Back: Consider The Accounting Landscape › What is accounting › Who uses it and for what purpose? › What are the implications of this for the preparation of accounting information? 15 Classifying Transactions and Events: Issues and Risks › The firm has spent money – is there going to be a future benefit? – Impact of Yes/No on Financial Statements? › The firm has received cash from customers – have all acts of performance necessary to earn it been completed? – Impact of Yes/No on Financial Statements? › The firm is entering into agreements with suppliers for them to perform services – is there a obligation? – Impact of Yes/No on Financial Statements? Cash versus accrual accounting › Ideally we want both strong operating results and strong cash positions › Organisations can survive operating at an accounting loss provided they have sufficient cash – the reverse is not true › A Cash view of performance is also less ‘subjective’ 16 Cash Flow Statement ? The cash flow statement identifies cash flow associated with the three main sources and uses of cash within an entity over a specified time period ? Cash from operational activities – day to day operations ? Cash related to investment activities – purchase/disposal of non-current assets and investments ? Cash related to financing activities – changes to capital structure (debt, equity, dividend payments) Summary › How financial statements work to convey insights into performance and position › Issues with accounting statements and the use of financial information 32

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