ACCT & FINC LECTURE NOTES PDF

4/10/24 - Introduction to Accounting and Finance - Accounting Framework WK1 L1 Course Content Financial accounting ○ The building blocks of accounting and the characteristics of accounting information ○ Basic accounting model: income statement and balance sheet ○ Equity and...

4/10/24 - Introduction to Accounting and Finance - Accounting Framework WK1 L1 Course Content Financial accounting ○ The building blocks of accounting and the characteristics of accounting information ○ Basic accounting model: income statement and balance sheet ○ Equity and share issuing ○ Cash ow statements Cost and Management accounting ○ Cost classi cation ○ Breakeven analysis ○ Budgeting Financial management ○ Analysing and interpreting nancial statements ○ Capital investment appraisal techniques ○ Sources of nance What is accounting? "the language of business" Identi cation select economic events (transactions) Recording Record, classify, and summarize Communication Prepare accouting reports Analyze and interpret for users The accouting process includes the bookkeeping function. fi fl fi fi fi The modern accountants role - making decisions, not simply doing the bookkeeping. Types of accounting management versus nancial accounting Managerial accounting Information for decision making, and control of an organisation's operations. ○ internal users ○ speci c purpose ○ quite detailed ○ no restrictions ○ whenever required ○ both past and future ○ can contain non- nancial information; less focus on objectivity and veri ability Financial accounting Published nancial statement and other nancial reports. ○ external users (mainly) ○ general purpose ○ broad overview ○ accounting standards and other regulations ○ mainly semi-annual or annual ○ mainly historical ○ quanti able in money terms; focus on objective and veri able data fi fi fi fi fi fi Who uses accounting data? Internal users Marketing - what price for a nokia cell phone will maximise the companies net income Management - Which PepsiCo product line is the most pro table? Should any product lines be eliminated Finance - Is cash suf cient to pay dividends to shareholders Human Resources - Can we afford to give Toyota employees pay raises this year? External users Investors - Is Royal Dutch Shell earning satisfactory income? Creditors - Will Singapore Airlines be able to pay its debts as they come due? The larger the entity, the greater the interest from various groups of people. Users need information in order to make decisions. owners managers lenders suppliers customers competitors employees government and tax authority community representatives investment analysis fi Conceptual framework The accounting profession developed a conceptual framework to help bring consistency to accounting concepts and practices Accounting standards International Accounting Standards Board (IASB) International Financial Reporting Standards (IFRS) ○ IFRS is primary used for the nancial reporting of plc's. Private companies such as small and medium sized enterprises use UK GAAP Financial Accounting Standards Board (FASB) Generally Accepted Accounting Principles (GAAP) Main elements in Accounting Assets - A resource controlled by the entity from which future economic bene ts are expected to ow to the entity. Liability - An entity's obligation to transfer economic bene ts as a result of past events Equity - The residual interest in the assets of an entity after deducting all its liabilities Income - Increase in equity (other than those relating to contributions from owners) Expenses - Decrease in equity (other than those relating to contributions from owners) Accounting concepts and conventions Business entity - The business is seperate from the owner(s) Historical cost - Transactions are recorded at the cost when they occured Going concern - The entity will continue in operation for the forseeable future Accruals - Revenue and costs must be recognised as they are earned or incurred, not as money is recieved or paid. Consistency - The presentation and classi cation of items should stay the same from one period to the next. Materiality - Information is material if its omission or misstatement could in uence the economic decision of users. fl fi fi Financial statements Statement of nancial position (balace sheet) ○ assest and liabilities etc. Statement of pro t and loss & other comprehensive income ○ gross and net pro t etc. Statement of changed in equity Statement of cash ows ○ cash ow in and out, closing balance etc. Accounting policies and explanatory notes Balance sheet - snapshot of where the company is at a particular point in time Income statement - how the company is doing in terms of sales, expenses and pro tability overtime Statement of cash ow - tracks the in ow and out ow of cash, providing insights into a company's nancial health Objective of nancial statements According to IASB, nancial statements is "to provide information about the nancial position, performance and cash ows of an entity that is useful to a wide range of users in making economic decisions" To prescribe basis for presentation of general purpose nancial statements, in order to ensure that the entity's own nancial statemtents can be compared with the nancial statements of other entities. fl fi fi fi fl fi fi fl fi fi fl fl fl Qualitative characteristics Fundamental qualitative characteristics: required for information to be useful include relevance (1) and be a faithful representation (2) ○ 1 - information is 'relevant' if it in uences stakeholders decisions ◆ 2 - Financial statements must capture the economic activity of an entity, information must be: ◇ complete ◇ neutral - free from any bias ◇ free of error, no rounding or omissions Enhancing qualitative characteristics: enhance usefulness of accounting information include comparability (1), veri ability (2), understandability (3) & timeliness (4) ○ 1 - provides users with information that is readily comparable (without conversion) ◆ 2 - independent and knowledgeable observers should nd similar results when measuring an item ◇ 3 - accounting information is prepared for stakeholders with 'reasonable understanding of business' 4 - helps users make informed decisions (shouldn't be out of date) fi fl Types of businesses Propiertorship (Sole Trader) generally owned by one persojn often small service type business owner recieves any pro t, suffers any losses, and is personally liable for any debts (unlimited liability) ○ an individual may enter into business alone, selling a good or service ○ if cash isn't available, they may choose to borrow from a bank or lender to start the business ○ legally, the business and owner are one in the same ◆ this means unlimited liability. the owner isnt legally required to submit accounts to companies house as they aren't a registered public company, but accounting information will be needed by ○ government - for tax collection ○ the bank - to warrant their lending ○ a person intending to buy or invest into the business Partnership owned by 2+ individuals often retail and service type businesses generally unlimited personal liability partnership agreement ○ as with a sole trader, the business is not legally seperated from the owners ○ unlimited liability still applies, but is spread ○ any pro ts will be shared amongst the partners, not necessarily equally. fi fi  Corporation (Limited company) (Ltd) ownership divided into shares seperate legal entity organised under state corporation law limited liability - liability of the owners is limited to their investment and stake in the company (their shares) ○ these companies have greater scrutiny of their nancial situation - including being legally required to produce annual accounts and submit these to companies house. ◆ ltd's are prohibited by law from offering its shares publically (e.g on the stock exchange) - all purchases of shares can be made in the form of individual agreements ◆ plc's are permitted to offer shares publically and oat their shares on the global stock exchange. 11/10/24 Introduction to Accounting and Finance - Statement of Financial Position WK2 L1 - Financial statements statement of nancial position - what is the accumulated wealth of the business income statement (pro t and loss account) - how much wealth is generated statement of cash ow - what cash movements took place statement of changes in equity - what changes in capital nancial health of the business Statment of nancial position lists the assets. Liabilities, and equity of an organisation as of the report date as such, it provides a snapshot of the nancial condition of a business as of a speci c date basic accounting equation: assets = liabilities + equity fi fi fi fl fi fi fi fl Assets resources a business owns or controls provide future services or bene ts cash, inventory, equipment, trade recievables Liabilities claims against assets (debts and obligations) creditors (parties to whom money is owed) trade payables, salaries and wages payable etc Equity ownership claim on total assets referred to as residual equity e.g ordinary share capital and retained earnings equity = the net worth of the business the basic accounting equation can also be presented as: assets - liabilities (net assets) = equity Equity ○ share capital and retained earnings ◆ revenues - expenses - dividends each transaction has a dual effect on the accounting equation dividends can only be paid if retained earnings are positive Assets = liabilities + equity Revenue - expenses = pro t (contributes towards equity) fi fi What changes equity? Investments by shareholders (INCREASES) represents the total amount paid in by shareholders for the ordinary shares they purchase investment of funds with the intention of earning a return Revenues (INCREASES) result from business activites for the purpose of earning income common source of revenue are sales, fees, services, commissions and rent Dividends to shareholders (DECREASES) the distribution of cash or other assets to shareholders reduce retained earnings Expenses (DECREASES) the cost of assets consumed or services used in the process of earning revenue (cost of sales) common expenses include salary expenses, rent expenses, utilities, property tax, etc. total revenue - total expenses = pro t for the year if you make a pro t, equity goes up, if you make a loss, equity goes down if you break even, equity does not change. every time there is an event or transaction within the business, it has 2 effects on the accounting equation. monetary unit - include in the accounting records only transaction data that can be expressed in terms of money economic entity - requires that the activities of the entity be kept seperate and distinct from the activities of its owner and all other economic entities. fi fi  table below  retained lernings transaction CASH +R ble + + Supplies + Equipment - Share - expenses idends 1. + 15 000 15000 , 2 - 7 , 000 - 7000. Ba + 1 , 600 1600 1 200 40 + , 1 , 200 So + 250 - 256 - assets [17 , 800 = = Liabilities + equity = -17 800 , the two sides must always be equal - as it is an equation not everything the business does will be a transaction that can be recorded in the nancial statements. retained lernings transaction CASH + Rathlet + + expenses Supplies Equipment - Share idends - 1 + 15, 000 + 25000 2 - 7 , 000 - 7, 000 3 + 5000 + 8000 4 - 850 - Pso S 1000 1000 - - E24150 E24158 fi 18/10/24 - Introduction to Accounting and Finance - Income statement Income statement reports the pro tability over a speci c period of time shows net pro t or loss pro t used to: ○ pay dividends ○ kept as retained earnings for the future Usefulness how well the business has performed over the last period - evaluate past performance provide a basis for predicting future performance. Helps users understand the return the entity has produced and how ef ciently resources are being used. helps assess the risk of achieving future cash ow. revenue sales of goods fees for services interest recieved, subscriptions etc. expenses costs of sales interest paid income tax expenses The accrual concept An accounting year is not necessarily the same as a calendar year. Accountants divide the economic life of a business into arti cial time periods (time period assumption) - generally a month, quarter, year fi fi fi fi fi fl Accrual vs cash basis accounting Accrual basis accounting revenue and costs must be recogniused as they are earned or paid, ont when the cash is recieved or paid ○ transactions recorded in the periods in which the transactions occured ○ revenues are recogised when earned, rather than when cash is recieved ○ expenses are recognised when incurred rather than when paid Cash basis accounting revenues are recognised when cash is recieved expenses are recognised when cash is paid ○ Cash basis accounting is not in accordance with international nancial reporting standards record as of 1st november 2021 - accrual based accounting 2/3 of the bill should be recorded in the 2021 period - £240 1/3 of the bill should be recorded for the nal month of the contract - which lies in the 2022 period - £120 recorded as an accrual - a liability ○ as it hasn't been paid yet fi q2 Income statement structure sales revenue - cost of sales = gross pro t - operating expenses = operating pro t - interest payable + interest recievable = pro t for the period cost of sales the direct costs incurred for the goods/services sold in the period ○ e.g for a retaile business, cost of sales = the purchase costs of the goods sold fi fi fi operating expenses all other expesnes incurred in trading activites ○ e.g rent, utilities, wages, transport etc. income statement example cost and sales breakdown Depreciation when purchasing an asset, it would be appropriate to expect its value to remain the same - or even increase its value may well decease over time (due to factors such as wear and tear, having a lower resale value, becoming outdated etc.) - e.g a car depreciation represents the loss of value of this asset over time methods of depreciation straight line reducing balance To calculate a depreciation charge for a period, 4 factors have to be considered the cost (or fair value) of the asset the useful life of the asset residual value (disposal value) depreciation methods Straight line method the loss of value will be spread equally over the useful life of the asset. The depreciation amount is the same each yeay/month etc. cost of machine - £78,124 estimated residual value - £2000 estimated useful life - 4 years = annual depreciation change = £76,124/4 = £19,031 Reducing balance method for each year, you work out the depreciation charge as a percentage of the accounting value brought forward bad debts a lot of businesses offer their goods and services on credit i.e the client does not have to pay immediately, but will be given a set number of days to settle the debt however, they might go bankrupt, this is when we consider their debt as bad debt if the debtors could not settle the debt, the amount that cannot be recovered is known as bad debt bad debt is considered an expense to the business Example limmy ltd sells £!0k of goods to a customer on credit increase revenue by £10k increase trade recievables by £!0k the customer pays half the amount owed reduce trade recievables by £5k increase cash by £5k the customer goes bankrupt before paying off the balance, the rest is no longer recoverable increase expenses bad debt by £5k reduce trade recievables by £5k ○ this means there is nothing remaining in trade recievables for this customer i.e no further money is recoverable 25/10/24 - Cash ow statements a statement of cash ows summarises all movements of cash in and out of a business during the accounting period the importance of cash life of the business pay suppliers pay employees pay dividends to shareholders repay debts to shareholders repay debts to lenders purchase assets classi cation of cash ows operation activities - appear rst ○ direct method ◆ only showing cash movements ◆ it works out net cash ow from operating activities by directly showing the cash only transactions ◇ e.g cash recieved from sales, cash, purchase of materials etc. ○ indirect method ◆ start of the pro t and adjust for any non cash movements ◇ takes net pro t from the income statement then adjusts for all non-cash transactions to get the net cash ow from operating activities start with operating pro t cancel non-cash transactions changes in working capital other cash paid during the year net cash from operations fi fi fi fl fl fl fi fl fl fi  cash and cash equivalent balances investing activities - appear second nancing activities - appear third depreciation expense although depreciation expense reduces net income it does not reduce cash loss on sale of equipment because companies report as a source of cash in the investing activities section the actual amount of cash recieved from the sale ○ any loss on sale is added to net pro t in the operating section ○ any gain on sale is deducted from net pro t in the operating section ○ the proceeds of the sale are then showing in investing activities changes to non-cash current asset accounts when the accounts recievable balance decreases, cash receipts are higher than revenue earned under the accrual basis when the inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold when accounts payable increases ○ company recieved more in goods than it actually paid for ○ increase is added to net income when income tax payable decreases ○ income tax expense was less than the amount of taxes paid during the period ○ decrease is subtracted from net income fi fi fi 1/11/24 - Equity in Limited Companies the main difference concerns share capital ltds are prohiibited from offering its shares to the public if any shares are proposed to be transferred, all shareholders must be consulted plcs can offer its shares to the public, these shares may also be listed on a stock exchange only plcs can offer their shares to the public plcs have to submit their accounts within 6 months of their year end (9 months for ltds) plcs need a minimum of £50k issued share capital plcs need at least 2 directors (min. of 1 for ltds) and a quali ed company secretary advantages of being a plc easier access to capital much more possible to assess value of the company (market capitalisation) easier to make acquisitions possibly gives company a more prestigious pro le equity types ordinary share capital share premium retained earnings general capital reserves fi ordinary share capital - not available for withdrawal capital invested in a company by its owners treated as equity in the SoFP ordinary shares come with voting rights at general meetings and AGMs (annual general meetings) the larger your ordinary shareholding, the more you control you hand over the company owning >50% of ordinary shares makes you the majority shareholder. share premium account treated as equity in SoFP all ordinary shares have the same nominal value, determined by the company consitution e.g £!, 50p etc but a company can sell issued shares for a higher price than the nominal value any amounts recieved in addition to the nominal value of the shares goes into the share premium account retained earnings the amount of a business's net income that is kept within its accounts, rather than paid out to shareholders this account can be used to pay dividends to shareholders general capital reserves - not available for withdrawal company can choose to move their retained earnings into a separate capital reserve account this means these reserves are no longer available to pay dividends to shareholders capital reserves could be used for further investments, or to save as a 'buffer-zone' for future years long term nance equity ○ share issues ○ retained earnings debt ○ long term borrowings ◆ e.g pref. shares, loans issuing additional ordinary shares companies can issue more shares to be purchased by the general public/invited individuals they can also offer more shares to existing shareholders via: ○ bonus issue - shareholders are given extra shares for free in proportion to their existing shareholding ◆ e.g 1 in 4 bonus issue rights issue - company gives existing shareholders the right to purchase extra shares at a price lower than the market value, again in proportion to their existing shareholders. companies accounts income statement SoFP cash ow statement statement of changes in equity narrative reporting ○ directors report ○ stratgic report fl fi directors report the names of who the directors were during the reporting period any recommended dividend the involvement of employees in the affairs of the company the employment and training of disabled persons important events affecting the company since the year end likely future developments in the business research and development activities 8/11/24 - Financial statement analysis The purpose of ratio analysis absoloute gures are of little value wihout context of comparisons uses nancial and non nancial data to make comparisons that can help remove the impact of scale and in ation to help the users of nancial statements to make informed decisions What to compare comparison with earlier years ○ identi cation of a trend? ○ does it represent an improvement? comparisons with the companys plan ○ is it in line with the company's expectations and budgeted metrics ○ not generally available in detail to an outside investor compare with other companies in the same industry ○ no two companies are exactly alike compare with industry average ○ dif cult for similar reasons, but provides a starting point. ratio analysis types pro tability types ○ an aid to judging how well the company is being run by management liquidity ratios ○ aids judgement of the adequacy of companys cash and near cash resources ef ciency ○ provides info about the speed with which a company transforms purchases into sales and then into cash gearing ratios fi fi fi fi fi fi fl fi fi  ○ a measurement of. the company's nancial risk pro tability ratios gross pro t margin operating pro t margin return on capital employed liquidity ratios current ratio acid test ef ciency ratios trade recievables settlement period inventory holding period trade recievables settlement period gearing ratios gearing interest cover gross pro t margin higher % the better costs of making goods and services there tends to be a normal value for each industry operating pro t margin higher % the better degree of competitiveness fi fi fi fi fi fi fi return on captial employed higher % the better performance of a company as a whole compared to costs of long term nance current (test) ratio expressed as a ratio, higher the better helps understand whether there are suf cient short term assets to settle short term liabilities if the ratio is less than 1:1, there is normally a need to look closely at cash ow. However industry dorms may differ an ability to generate daily cash might make a lower ratio acceptable, e.g retailer selling to the public acid test (quick) ratio expressed as a ratio, higher the better helps understand whether there are suf cient short term (highly liquid) assets present to settle short term liabilities - inventories are excluded as they're typically not very liquid expected to be around 1:1, depending on industry trade recievable settlement period expressed as a number of days - lower the better measures the speed with which a company collects cash for their creditors typically compared with the credit period given to customers fi fi fi inventory holding period expressed as a number of days - lower the better a measure of how quickly goods move through the business a period too short may risk the goods being out of stock trade payable settlement period number of days - higher the better measures the speed with which a company pays it suppliers ○ paying to fast may cause shortages within the business ○ paying too slowly may risk a company's reputation with its supplier. companies must disclose their payment policy in their directors' report typically compared year on year and to the credit period offered to them by suppliers gearing expressed as a percentage - lower the better - over 50% is deadly most often quoted to the nancial press - a high gure represents reliance on sources of long term nance also bank overdraft, if a permanent feature interest cover expressed as a number of times - higher the better indicates how safe the annual interest payments are in relation to pro t how many times pro ts can fall before the company is unable to to cover payments out of current pro ts fi fi fi fi fi limitation of ratio analysis lack of standard ratio de nitions closing balances may be unrepresentative of the year and avg. position throughout collaboration and further info required to make well informed decisions Week 7 - Management accounting differences between nancial and managerial accounting Management accounting is the sourcing, analysis, communication and use of decision- relevant nancial and non- nancial information to generate and preserve value for organisations. planning - short-term and long-term: identify alternatives and select the one that further organisations objectives. e.g sales, production, capital expenditure (new markets, products) directing and motivating - oversees the day to day activites and keeping the organisation nrunning smoothly control and monitor - is outcome in accordance with the inital plans and objectives? Feedback: various detailed reports (e.g performance report) fi fi fi fi  decision making - a primary objective of decision making is to achieve optimum utilisation of the business's capital or resources requirements - timely, relevant and accurate information; cost measurement; effective communication; responsibility & authority. direct costs costs that can be easily and conveniently traced to a unit of product or other cost objective ○ example: direct material and direct labour indirect costs costs cannot be easily and conveniently traced to a unit of product or other cost object ○ manufacturing overhead element of product cost materials - direct inputs labour - direct inputs production overheads - indirect inputs cost object a chicken pie in a pie factory ○ direct costs - meat, pastry etc. ◆ indirect costs - factory rent, general supervision etc. a surgeon's operating time in a hospital ○ surgeon's salary, associated costs etc. ◆ the nurses, the admin and building costs direct materials + direct labour + direct expenses = prime cost + production overheards = production costs + other overheads = total cost Manufacturing overheads - costs that cannot be traced directly to speci c units produced non manufacturing overhead costs - costs necessary to get the order and deliver the product variable costs  xed costs types of variable costs fi relevant and irrelevant costs relevant costs - future costs that will be changed by the decision ○ petrol costs irrelevant costs - costs that will not be affected by the decision ○ car tax ○ insurance costs relevant costs oppurtunity costs - the pro t lost when one alternativev is selected over another replacement cost - the cost of purchasing a substitute asset for the current asset being used by a company sunk cost - a cost already incurred regardless of what action is taken relevant costs in decision making xed costs are not relevant oppurtunity costs may be relevant replacement cost may be relevant past (sunk) costs are not relevant future costs are relevant if they vary across different scenarios costing for decision making differs from nancial accounting for costs non- nancial factors are often important break even analysis we need to know the selling price, xed costs and variable costs break even point ○ point at which total cost = total revenue ○ neither making as pro t nor a loss ○ costs of production equals the revenue for a product fi fi fi fi fi fi contribution contribution per unit = selling price per unit - variable costs per unit ○ how much of each sale of a unit contributes towards covering the running costs of a product/business ○ pro t per unit ○ total sales revenue = total cost ○ total sales revenue = xed cost + variable cost 29/11/24 - week 9 - nancing a business and investment appraisal sources of nance fi fi fi fi long term nance equity ○ share issues ○ retained earnings debt ◆ long term borrowing e.g pref shares loans key types of debt nancing preference shares (not treated as current liabilities) loans debentures preference shares named because they contain the right to recieve a dividend before an ordinary shareholder i.e they take preference the dividend will be a xed percentage each year, providing the company chooses to offer the dividend debentures agreement, its a loan offered by a company to a potential investor form of security that a company grants to a lender in exchange for funding debentures are the written documents setting out the terms of a loan (rate of interest, schedulue of repayments) can be secured or unsecured as with shaeres, are transferable (for plcs, can be dealt on stock exchange some offer the right to convert to shares on maturity as an investment, offer a consistent rate of return, therefore less risky than purchasing shares fi fi fi cost of capital whether a company nances via debt or equity, both incur a cost to the company, known as the cost of capital cost of equity ○ the rate of return expected from shareholders ○ this is more dif cult to assess, but is based upon their expectations but is based upon their expectations for dividends and increase in invesmtent value cost of debt ○ the cost the company incurs through the debt nancing ○ this will usually be the rate of interest being charged on the debt why is it important to know cost of capital plays a role in decision making process of nancial management helps to design the capital structure considering the cost of each source of nancing represents the minimum return a company needs in order to justify the cost of a capital project and before generating value if a company wants to raise capital which they can reinvest in the business, they need to cover the cost of capital in their expected return on investment fi fi fi fi WACC - Weighted Average Cost of Capital this is a method used by companies to work out their cost of capital if they're nanced through a mix of debt and equity as the name implies, it is weighted by the proportions that equity and debt compromise the total value of the rm ○ if a companys cost of capital swings either way, it will be weighted accordingly to work out the WACC of a company we need market value of the company's equity market value of the company's debt company's cost of equity company's cost of debt rate of corporation tax formula: corporatiojn tax is included as debt being paid, impacts your pro t, affecting how much is taken by corporation tax as overall pro t is lower doesnt affect the equity side as dividends are paid from pro t and after corp tax is taken fi fi  investment appraisal methods process of analysing whether an investment project is worthwhile or not justi es the investment in a project providing the rationale for spending limited resources it is an input to decision of investment given by the methods of investment appraisal there are 4 major methods accounting rate return (average rate of return) (ARR) ○ this method expresses the average accounting operating pro t that the investment will generate as a percentage of that capital investment payback period (PP) ○ expresses the time for the initial investment to be repaid. In other words, how long it takes the project to recover the costs of the project Internal rate of return (IRR) - represents the yield from a particular investment but the term inteinternal refers to the fact that the calculation excludes external factors, such as in ation, the cost of capital, or nancial risk net present value (NPV) - works out the npv of the cash in ows and out ows or a capital investment project npv the difference between the present value of cash in ows and present value of cash out ows over a period how much will our investments be worth in the future, given the effects of in ation etc. the time value of money the concept is that the current value or money is higher than its future value, given its potential to earn in the years to come ○ in ation ○ income lost: cost opportunity, interest earnings ○ uncertain future ○ risk: great return fl fl fl fi fi fl a sum of money in the hand has greater value than the same sum to be paid in the future. Purchasing power of money differs as time goes by. Present value of money money that could be invested when in hand for a better return in the future future value of money the same amount of money is subject to uncertainties and loses money in the future week 8 - budgeting the budget sets out the costs and revenues that are expected to be incured or earned in the future periods; the plan for the upcoming period but expressed quantitatively a budget is a plan expressed in more general quantitative terms plans can be made for: cash ows production lines working capital requirements create sustainable objectives market analysis: customers, marketing strategic intiatives fl types of budgets periodic ○ prepared for a set length of time ○ becomes a one-off exercise planned into the business cycle ○ may be revised continual or rolling ○ continually updated ○ may be broken into monthly periods ○ drop a month, pick it up a month annual budget - prepared in advance 1 year rolling budget - as each month elapses, another month is added to the end of the budget incremental budgeting - uses the previous budget as a base ○ take the last performance and change by determind gures or percentages zero based budgeting - ignores previous budgets in building new budget. Requires tat budgetary allocation must be justi ed by managers functions of budgets planning ○ budget gives a clear idea of expectations in terms of nancial position and the performance of the business. Produce detailed plans for implementation co-ordination ○ common plan, all the activities of the various parts of the organisation have to work in harmony with eachother communication ○ everyone in the business should have a clear understanding of the expectation and the part they have in achieving the annual budget control ○ is outcome in accordance with the initial plans and objectives? the budget helps managing and controcontrolling the activities and track expenditure fi fi fi  motivation ○ budget can be used as a motivational tool but has to be realistic performance evalutation ○ often a managers performance is evaluated by meausring their success in meeting the budget authorisation of expenditure ○ allocating funds to a certain department or activity: example researcg and development bene ts of budget promote forward thinking and identi cation of short term problems motivate managers to better performance provide a basis for a system of control provide a system of authorisation help co-ordinate the various sections of the business stages of budgeting de ne long term objectives form budget committee indentify limiting factors prepare an initial set of budgets prepare budgets review, check and revise budgets prepare master budget communicate to management regular reivew fi fi fi master budgets cash budget - the objective is to ensure that suf cient cash is available at all time to meet the needs budgeted income statement + budgeted balance sheet - overall picture of the planned performance for the budget period sales budget - predicitons of revenue outlines the planned volume of sales multiplied by expected sales price how to estimate sales forecast from previous year judgement of sales staff existing customers statistical techniques market research purchase of data production plan and cost of production - predictions of cost of production number of units to be manufactured each month this will be calculated using estimated opening inventory the no. of units estimated to be sold the desired closing inventory cash budget ensures suf cient cash to meet demand give advance warning of the need for overdraft or loans plan for investment of cash surpluses opening cash + receipts - payments = closing cash fi fi budgeted pro t plus all favourable variances minus all adverse variances equals actual pro t criticisms fast changing environments focus on short term quantitative rather than qualitative restrict activities time consuming to set based around business functions protect costs encourage manipulation of accounts making budgetary control effective serious attitude taken to the system clear demarcation between areas of managerial responsibility budget targets that are challening yet achievable established data collection, analysis and reporting routines reports aimed at individual managers fairly short reporting periods timely variance report action being taken to get operations back under control fi fi