Digital Finance Course Notes PDF

DIGITAL FINANCE FINANCE FUNCTION TRANSFORMATION ROLE AND ACTIVITIES OF THE FINANCE FUNCTION DISRUPTIVE CHANGES...................................................................................................... 3 CHANGE IN ORGANISATIONS..........................................................

DIGITAL FINANCE FINANCE FUNCTION TRANSFORMATION ROLE AND ACTIVITIES OF THE FINANCE FUNCTION DISRUPTIVE CHANGES...................................................................................................... 3 CHANGE IN ORGANISATIONS............................................................................................. 3 Changes to roles in the finance function....................................................................................5 THE DRIVERS OF CHANGE.................................................................................................. 5 CORPORATE SOCIAL RESPONSIBILITY (CSR)........................................................................7 Benefits for the business....................................................................................................................7 CSR in different parts of the world................................................................................................8 Building CSR into the organisation...............................................................................................8 Carroll's pyramid of Corporate Social Responsibility.............................................................9 THE FINANCE FUNCTION................................................................................................. 11 Activities................................................................................................................................................ 12 Some specialist roles of the finance function.........................................................................14 FINANCIAL ACCOUNTING................................................................................................ 16 External stakeholders........................................................................................................................16 The financial position.......................................................................................................................17 Accurate reporting and asset valuation....................................................................................18 Compliant statutory reporting......................................................................................................18 MANAGEMENT ACCOUNTING..........................................................................................18 Cost control.......................................................................................................................................... 20 Budgeting.............................................................................................................................................. 20 Role of the finance department in budgeting........................................................................22 Variance analysis................................................................................................................................ 22 Feedforward control.........................................................................................................................23 Operational reporting......................................................................................................................23 Systems.................................................................................................................................................. 24 TREASURY MANAGEMENT............................................................................................... 24 Sourcing finance.................................................................................................................................25 Currency management....................................................................................................................26 Effective tax management..............................................................................................................26 Efficient management of working capital.................................................................................27 COMPANY SECRETARIAL................................................................................................. 28 INTERNAL AUDITING...................................................................................................... 30 Limitations of internal auditing....................................................................................................32 Audit Committee................................................................................................................................32 OPERATIONS MANAGEMENT.......................................................................................... 33 KEY EXTERNAL RELATIONSHIPS....................................................................................... 35 What are stakeholders?...................................................................................................................35 Classifying stakeholders..................................................................................................................36 EXTERNAL STAKEHOLDERS.............................................................................................. 37 2 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Disruptive Changes The sections ‘Change in organisations’ and ‘Drivers of change’ provide two slightly different perspectives on the changes disrupting the business environment and, hence, the finance function. The section ‘Corporate Social Responsibility’ focuses solely on corporate social responsibility, which should also be considered a key area of change as, increasingly, organisations need to consider and meet the needs of their other stakeholders. Change in organisations The rate at which change happens in the world is accelerating. We can see evidence of this change all around, especially in the way that technology is becoming more integrated into our live. Next time you’re in a public place, take a look around to see just how many people are using some form of technology. It’s almost guaranteed that you’ll see someone on a mobile phone! Yet only 30 years ago, the Internet hadn’t been invented and very few people had mobile phones or a personal computer. We can see evidence of the increasing rate of change in business, with the number of patents filed to protect intellectual property increasing, and the average life-span of products decreasing. Change is becoming an everyday reality of an organisation, and in this increasingly volatile environment, organisations are having to adapt the way they do business. 3 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Some key factors of change which are forcing organisations to adapt are: Changing technology – The key driver of the changes we are experiencing is thought to be the increasingly rapid rate of technological change, unparalleled in recent history. Organisations are having to adapt to emerging technologies, with capabilities that allow them to take over routine tasks, such as data entry, and carry out new tasks which have never been possible before, such as the analysis of massive data sets. Changing levels of competition – Organisations are also having to deal with rapid changes to the levels of competition, with new entrants entering the market seemingly out of nowhere or causing disruption to whole industries. For example, the ride-share company Uber quickly established and grew rapidly in cities across the world, causing massive disruption to the taxi industry. Growing collaborative consumption – This is the growing popularity of sharing of goods and services, which is causing disruption to their respective industries. A good example is Airbnb, in which owners rent out their private accommodation to others, which is causing disruption to the hotel industry. 4 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function This is creating new business models which existing competitors are having to adapt to. Changes to customer expectations – A number of factors are changing what a customer expects from an organisation and its products. For example, with faster communication channels, enabled by social media and improvements in technology, consumers now expect speedier customer service and greater efficiency from an organisation. Organisations are having to adapt to ensure that they are fulfilling changing customer needs. Less customer loyalty – With greater access to information, through the development of the Internet and mobile technologies such as smartphones, combined with a more competitive market, businesses are finding that consumers are no longer loyal to a particular brand. Consumers are more likely to ‘shop around’, and studies have shown that over 80% of customers will research a product online before buying it. Globalisation – Economies and cultures are becoming more integrated with one another through interconnected networks, such as trade, and the spread of technology and media. It is getting easier for businesses to source supplies from other countries, and sell their products to foreign markets. Changes to roles in the finance function In line with how organisations are adapting to change, the roles of business professionals are evolving, and the roles of those working in the finance function are evolving. You will hear the term ‘finance function’ a lot. For now, to understand this last point, you just need to know that the finance function is the part of the organisation which controls and manages anything related to finance and so as wider changes happen to the organisation so the finance function has to change too. The drivers of change Just like with the natural environment, the business environment also changes quickly, and this is for a number of reasons. Some of the most common changes include the following: 5 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Drivers of change Effect and example Economic uncertainty causes unpredictable demands in various sectors. Economic uncertainty In 2019 in the UK, the uncertainty surrounding Brexit caused consumer spending to drop and the housing market to stagnate. The global nature of some companies means that they are subject to issues that affect individual countries. Globalisation In February 2019 a multi-national insurer announced it was moving almost £8 billion worth of assets to Ireland because of Brexit uncertainty. Political policies of individual countries affect how well certain businesses can succeed in some countries. Geopolitics In 2019 China unveiled tariffs of £60 billion on US goods in response to tariffs placed on their own goods by the American government. Brazil, Russia, India and China are collectively known as the BRIC economies. They are high growth, emerging economies. Economists believe that by 2050 they will become the dominant suppliers of manufactured good, services and raw materials. BRIC economies These should be ideal places to invest and conduct business, but there are various other factors that may affect the predictability of such investments such as the endemic corruption levels in the BRIC nations. 6 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Drivers of change Effect and example Changing populations affect the make up of nations, but also has implications globally. Demographics The growth of the middle classes in some emerging countries means that more people than ever are (and will be) using digital technology and be connected to the Internet. In recent years, consumers have become increasingly concerned with the environmental impact of themselves and any organisations with which they interact. Sustainability As such, laws and regulations relating to sustainability have been enacted and organisations have had to proactively find ways to mitigate their environmental impacts in order to attract customers or do business with other sustainable firms. Corporate social responsibility (CSR) Have you ever wondered why big companies give to charity or promote certain ethical choices? It's likely that this has more to do with their CSR policy than their social conscience! Corporate Social Responsibility is, as the name suggests, a company's responsibility to society. CSR policies tend to cover issues such as environmental policy and sustainability, health and safety, treatment of staff, charitable work and contribution and supporting local communities. Benefits for the business Brand differentiation and reputation In crowded marketplaces, companies strive for a unique selling proposition that can separate them from the competition in the minds of consumers. CSR can play a role in building customer loyalty based on distinctive ethical values. Several major 7 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function brands, such as The Co-operative Group, The Body Shop and American Apparel are built on ethical values. Avoiding regulation Corporations are keen to avoid interference in their business through taxation or regulations. By taking voluntary steps, they can persuade governments and the wider public that they are taking issues such as health and safety, diversity, or the environment seriously. CSR in different parts of the world Different countries tend to take different views on CSR. In the US, philanthropy is often the approach that is favoured. By the end of 2015, the Bill and Melinda Gates foundation had given away $37bn, for instance. Bill Gates decided to give away his huge wealth as part of the foundation rather than through doing good within his company Microsoft. In Europe, the focus is often on being responsible – acting ethically and doing what is right, with most large European companies have active CSR rules and policies. In developing countries, CSR is more limited, partly because of weaker regulation by governments, and cultures where it is yet to be seen as important. One driver of change in these countries is that Western companies need to be seen to be CSR- focused from a reputational perspective and so are forcing the change in practices in their foreign suppliers. Building CSR into the organisation There are a variety of ways to build CSR into an organisation, such as: Mission and objectives Inclusion of CSR values within the mission statement has become common practice. This creates focus for directors when setting strategy to ensure that CSR is built in. Creating focused CSR objectives with clear plans for achievement also helps to focus CSR activity, particularly when these are linked to managerial performance and reviewed regularly. CSR policies A CSR policy is an internal statement of rules and expectations on CSR issues to be applied within the organisation. 8 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Philanthropy A common element of CSR is philanthropy. This includes monetary donations and aid given to local organisations and impoverished communities worldwide. Benchmarking Benchmarking helps an organisation to compare their CSR performance against other organisations. It involves reviewing competitor CSR initiatives, as well as measuring and evaluating the impact that those policies have on society and the environment. Social accounting, auditing and reporting Social accounting involves accounting for and reporting on social and environmental effects of a company's economic actions. A number of reporting guidelines or standards have been developed to serve as frameworks for social accounting, auditing and reporting including: Global Reporting Initiative's Sustainability Reporting Guidelines The ISO 14000 environmental management standard Many companies now produce externally audited annual reports that cover Sustainable Development and CSR issues ("Triple Bottom Line Reports"), but the reports vary widely in format, style, and evaluation methodology (even within the same industry). Carroll's pyramid of Corporate Social Responsibility So, how do you keep track of all the areas you need to work on? Carroll devised a four-part model for CSR and argued that any organisation wishing to implement CSR would need to satisfy each of the following levels: 9 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Economic responsibility The organisation has a primary responsibility to stay in business, return value to shareholders, pay its employees and deliver quality to customers. Today public feeling may find the pursuit of cash distasteful, but this is the primary purpose of a profit-making entity and a necessity for non-profits if they wish to continue to operate. For example, a company that spent all its money developing clean energy systems and then couldn't afford to pay its staff would be operating irresponsibly. So, keeping the company afloat and generating cash comes first. Legal responsibility The organisation also has a primary responsibility to operate within the law in each country of operation. It's not just about staying out of jail: the law provides a baseline for acceptable behaviour. So when it comes to developing CSR policies, the legal requirements provide a starting point and a minimum licence to do business. Most large companies and particularly multinational companies will have someone working purely on compliance. For example, in 2012, the UK Advertising Standards Authority referred Groupon to the Office of Fair Trading, a regulatory authority, after the company was found to 10 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function have broken UK advertising regulations more than 50 times in less than a year. That wasn't just illegal, it was not good social responsibility. Ethical responsibility The top half of Carroll’s pyramid looks at discretionary responsibilities. In theory, these responsibilities are optional because the organisation may not be held legally accountable. In practice, however, they are not really optional, since unethical practices will eventually create a bad reputation and threaten the primary responsibility of generating wealth. Ethical responsibility is about going beyond compliance and doing what is right and fair. For example, Tesco, the UK supermarket, came under media criticism for its use of private label food brands such as Willow Farms and Boswell Farms. Critics said this gave the impression that the food was sourced from local British farms but in reality no farms of that name existed and most of the food was produced abroad. Legally, Tesco can call its brands what it likes and there is no suggestion that it broke any laws. But critics felt the ploy was unethical and misleading. Ethics vary from person to person, some think it is unethical to eat meat whereas others do not. Therefore, it is up to companies to try to maintain ethics that will coincide with those of the society in which they operate. Philanthropic responsibility This is about discretionary acts of corporate citizenship: making a contribution to the wider good of society. These are the things that no one expects you to do and no one will require you to do, but you do them anyway. For example, in an effort to provide better technological support for governments that are slow to embrace technology, Google provides Code for America, a charity, with an annual gift of $3 million to develop civic technological solutions. There's no direct benefit to Google, it's just something the company believes would make the world a better place. The finance function All companies need finance to be able to operate. It's that vital capital that enables the business to invest. It's through having the cash in the bank that enables the employment of staff, the purchasing of goods and materials and the investment in 11 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function assets. But who has stewardship of the financial resources? Who is responsible for interpreting and reporting the financial position? Who collates and provides information for internal management? Who is responsible for budgeting, forecasting and cost control? Well, these are all contributions of the finance function. The finance function is the part of the organisation which controls and manages anything related to finance. Activities There are 5 key activities that the finance function is responsible for: Additionally to the key contributions mentioned above, the finance function is also responsible for: Stewardship of the financial resources within the organisation, meaning that they are 'looking after' the financial resources on behalf of the organisation. Interpreting and reporting the financial position for external stakeholders so that they are kept informed. 12 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Collating and providing information to internal management to support business decisions. For example, this could be by collecting together information from across geographical divisions and producing one report. Budgeting and forecasting to help with business planning. Being a business partner to departments around the organisation, giving them financial advice and support and providing guidance on how to deal with variances identified in their business area. Variance analysis and cost control to keep costs down and the business well managed. These activities are carried out by the components of the finance function. The 5 key components of the finance function are: 13 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Some specialist roles of the finance function Before we jump straight into looking at the different components of the finance function in more detail, let's take a quick look at a few specialist roles that the finance function supports outside of these five components. Financial planning and analysis This involves gathering data, examining subsequent information and analysing trends to best support decision-making to ensure the organisation is profitable, is able to grow and undergoes effective management of cash flows. Those involved in financial planning and analysis (FP&A) use both quantitative and qualitative data to analyse and evaluate the organisation’s progress, as well as economic and market trends. Insights from these analyses are used to provide predictions and forecasts to best prepare the business for its continuing operations and strategy implementation to meet its long-term goals. Project management The role of a project manager is to lead a project team to complete a specific task within a specific time frame. The finance function supports project managers by sharing knowledge with them that helps with their decision making as well as 14 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function ensuring that the right resources are available at the right time for the project managers and their team. Project appraisal Another important role that the finance function supports is assessing projects, and deciding whether or not they should be undertaken from a financial perspective. This is known as project appraisal and can be done in several ways, including by using the following calculations: Net Present Value (NPV) - This is a project appraisal technique which uses relevant net cash flows generated by a project over its total lifetime to calculate a project’s net contribution to an organisation. Basically, NPV tells us whether it's worth doing a project or not! Internal rate of return (IRR) – This calculation provides the cost of capital at which the net present value of all cash flows from a project is 0. Or, in other words, it tells us at what level the cost of capital should be so that the project at least breaks even (neither making a profit nor a loss). Payback period - This is the length of time it will take for an investment to be paid back. The longer the payback period, the greater the risk, as a greater period of time is being allowed for problems to arise. But don’t panic if these sound complicated! For this syllabus, you just need to be aware of how the finance function can use these calculations, rather than how to work them out yourself. Taxation As the saying goes, “there are only two sure things in this world: death and taxes.” But while taxes are somewhat inevitable, that doesn’t mean there isn’t any work to be done. The specifics of taxation aren’t examined in CIMA but it’s worth knowing a little about what these specialists are involved with in order to understand the scope of the finance function's activities. Taxation specialists help the organisation with tax compliance, ensuring they comply with the most up-to-date tax requirements that will affect the organisation (following all of the relevant rules, regulations and procedures for the tax jurisdiction). The specialists will also help with tax planning, helping the organisation to plan for how the organisation can legally reduce the taxes that are payable (or otherwise make the process more efficient). 15 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Now, on to the five key components of the finance function... Financial accounting As you can imagine, it's pretty important for external stakeholders to be able to access accurate accounts of the company's finances. After all, these are the people who are going to be affected by any major changes. Financial Accounting is generally concerned with producing these reports for stakeholders, based on the current financial state of the business. External stakeholders So who are these groups that take an interest in the company's financial position? They include: Shareholders Suppliers Banks Customers Bond holders 16 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Tax authorities Shareholders want to know the position of their investment and the return they are likely to make. Suppliers, banks and bond holders want to know that the money they are owed is likely to be paid back. Tax authorities want to ensure that the company is paying the right amount of tax. The financial position In order to understand an organisation's financial position, financial accountants must first record transactions in the books of prime entry. These include: Sales day book – Where all sales are listed and totalled Purchase day book – Where all the purchases made by the business are listed Cash book – Contains all cash receipts and payments Petty cash book – Contains small miscellaneous expenses such as paying for coffee delivered to a morning meeting Journal – Where any accounting adjustments are first recorded The day books are totalled and entered into ledgers. At the end of the financial year these ledgers are used to create the financial statements. The financial position is provided in the financial statements, which include: An income statement (or profit and loss account) SOPL – This shows the costs and revenues in a particular period. It shows whether the costs out- weigh the revenues, resulting in a loss or the revenues outweigh the costs, resulting in a profit. A statement of financial position (or balance sheet) SOFP – This is produced once a year and shows the assets, liabilities and capital of an organisation. A cash flow statement – This is the incomings and outgoings of cash in an organisation over a certain amount of time (often by month, quarter or year), this a legal requirement. 17 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Accurate reporting and asset valuation There is no point looking at a report that is simply not true. The finance function owes a duty of care to everyone who uses the reports to ensure that they are accurate. This means ensuring that all transactions are recorded accurately, and the processes of producing the accounts are correct. Financial accounts often include a lot of controls to ensure that this is the case, e.g. a bank reconciliation - reconciling the cash balance to the bank statements to ensure that they match. One element of reporting is valuing assets for presentation in the financial reports, so, for example, the valuation of inventories or buildings. Another role of financial accountants is to ensure these estimates are accurate. They might, for instance, ensure that the valuation of buildings is undertaken by an expert, independent valuer. Compliant statutory reporting The mandatory submission of financial (and indeed non-financial) accounts to government/regulatory bodies is called statutory reporting. Different countries and industries have different regulations and rules regarding the submission of these accounts, but in many countries the International Financial Reporting Standards (IFRS) are used instead. If regulation requires it then a company must submit financial accounts, failure to do so will result in legal action which may lead to the freezing of company assets or a huge fine. That is why it is essential to have a diligent financial function. Management accounting As we've seen financial accountants produce statutory information for external stakeholders. Those financial statements tell them the position of the business to support their decision making. But what about internal stakeholders – managers who have to make internal decisions? Can't they just use that same information to find out how the business is performing? Well, they can, but the problem is that the information which is right for external presentation may not help make good internal decisions. 18 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Let's take Gerty, who runs one of the many local shoe shops in the Big Shoes Group. It's interesting for her to see the income and profits of the whole organisation but does that really help her run her store? Of course not. What financial information does she need? The following perhaps: Sales in her shop compared with previous months to understand how well her shop is performing. Costs by category, e.g. staff costs, costs of shoes sold, property lease and maintenance costs. Comparative costs compared with previous periods are also useful so she can see how spending compares over time. Gerty might, for instance, notice that staff costs have risen every month for the last 6 months which might make her examine why this is and whether the additional spending is necessary. The budget she has to work within. A breakdown of sales by products so she can decide what shoes to stock in her shop in future. The overall profitability (which is key to her as her bonus depends on it!) Whereas financial accounting produces information for external stakeholders, management accounting produces financial information for internal stakeholders to support their decision making. As we can see from this example, 19 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Gerty's needs are quite different from those of external stakeholders and so different information is required. In comparison to financial accounting, management accounting: Is primarily forward-looking, supporting future decisions, instead of historical (recording past transactions). E.g. what shoes should Gerty stock in future to meet customer needs and maximise profits? Looks at information with a degree of prediction and estimation about the future to support decision making, instead of being purely factual and based on past events. What will Gerty's expected sales be in the next year? Is intended for use by managers within the organisation (such as Gerty) to make decisions in the business, instead of being intended for use by shareholders, creditors, and public regulators to review a companies past performance. Is usually confidential and used by management, instead of being publicly reported. Is produced to meet the users or business's needs rather than to general accounting standards. If Gerty wants some new information produced in a way that doesn't agree with external accounting standards then that's fine. There are no externally dictated rules for management accounting; it's about what is right for the business. Cost control Cost control is the practice of monitoring and evaluating costs with an aim to control and/or reduce them. Two key elements of cost control are budgeting and variance analysis, let's look at these in more detail. Budgeting I'm sure you've come across budgeting in your day to day lives. You have probably asked yourself “how much do I need to save here so that I can spend more there?” Well, management accountants use budgeting in much the same way. Let's see a formal definition of a budget: A budget is a quantified financial plan for a forthcoming accounting period. 20 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function A budget is a financial plan of operations, which serves as part of the planning and control process. The purposes of budgeting are: Planning Planning is essential in all organisations. Without a plan managers will not be aware of their goals and objectives. This ultimately leads to poor performance. Preparation of budgets helps provide defined targets for managers to achieve, and the budget setting process itself forces management to plan ahead. Responsibility A budget gives managers authority to spend money and incur expenditure. However, it also presents them with the responsibility to manage this expenditure, ensuring that it is controlled and spent with the organisation’s best interests in mind. Co-ordination A budget is a formalised plan for achieving the organisation’s goals. With this in place, managers are aware of how their operations relate to other departments, ensuring that everyone moves in the same direction. This co- ordination and communication between different departments is often a critical part of maximising efficiency. Motivation Budgets are an excellent tool for measuring performance and setting remuneration levels, which serves a source of motivation for staff. Control The ability to compare actual results with budgeted targets is a powerful 21 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function control tool for assessing the organisation’s success in reaching its goals. Role of the finance department in budgeting The finance department is responsible for producing accurate budgets. To do this it will: Review the budgets of previous years and the actual results of previous years in order to provide a starting point for the next period's budget. Gerty's sales were €400,000 last year and so that's where the accountant's start when preparing the next year's budget. Examine how the business environment has changed The country where Gerty's shop is based is coming out of recession and growth in the economy is expected to see shoe sales rise. Gerty's budget goes up to €420,000. Use forecasting techniques to help forecast likely changes based on past data The Big Shoes Group is growing quickly with sales in most stores growing by 5% per annum. Gerty finds her target for the next year is 5% higher as a result. It goes up to €441,000. Consider business plans to consider how those will affect future budgets The plan is for Gerty's shop to be expanded in the next year and so she finds her sales target increased to account for this. Her final budgeted sales are €485,000. Variance analysis One key element of cost control is variance analysis. Variance analysis compares the budget with the actual results and reports the differences. A positive difference (where less was spent than expected) is a favourable variance. E.g. actual sales of €500,000 were achieved by the end of the year – a €15,000 favourable variance. A negative difference (where more was spent than expected) is an unfavourable variance. E.g. actual sales were only €450,000 a €35,000 adverse variance. 22 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Once such a difference has been found, it is analysed to discover the root cause, then the finance function works with the respective department of the business to rectify it. For example, an overspend in Gerty's shop on staff might be identified and Gerty will need to consider whether she operates with fewer staff going forward, employs lower skilled staff in future to reduce costs or aims to justify the higher staff spending, perhaps due to the growth in sales of her shop. Feedforward control Feedforward control compares budgets to forecast results, encouraging managers to deal with issues before they occur. For example, Gerty has target sales of €485,000 for the year. However, six months in she has only turned over €200,000 and so it is forecast that by the year end she will have sales of €400,000. This forecast information about the future enables her to see that sales are not as strong as expected and can enable her to take action to turn the business around. By increasing marketing, employing some new sales staff and having an extra sale, Gerty manages to hit her target. The advantage of feedforward control is getting new information early. Had Gerty had to wait until the end of the year to see she was behind her targets it would have been too late for her to do anything to change. Operational reporting Imagine you are the CEO of Big Shoes Group. You will need to think about how profitable each of the shops are and why some shops are more profitable than others. Which products are selling and which are not? Who are the customers, and what are their preferences? Is one shop more expensive to staff than others and, if so, why? What are competitors doing, and how are they performing? To answer these questions, the CEO would need to have reports produced regularly on each of these areas. This is called operational reporting. A formal definition would be: Operational reporting generally revolves around producing management information, often focused on recording incomes and costs, analysed in different ways according to the business needs. Imagine you are a management accountant at Big Shoes. Here you will need to compile reports on many different things. Reports might be focused on: 23 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Business function – For example, costs in the marketing department, production department, finance department and so on Division – For example, comparing sales in the North American market and the European market, to help decide where to expand the business Product – For example, comparing whether boots or shoes are performing better, to help make future product decisions Customer – For example, assessing profitability by different customer groups, to understand who the company should target The next stage would then be to analyse the information gained from the reports and using it to make changes where necessary in each of the given areas. In our example, this could be to alter the supply of certain products in particular regions where some perform better than others; alternatively, it could lead to changing the product itself, taking into consideration a report relating to customer satisfaction per customer age group. Systems Management accountants produce a range of information for the business. Key to doing this well will be having the right finance systems and processes so that information is produced on time and accurately. Some organisations have specific staff who are responsible for managing finance systems, called systems accountants, to ensure that the systems in place are suitable for the organisation's needs. Treasury management The word 'treasury' is derived from the word 'treasure'. Therefore, treasury management is about finding and then looking after the organisation's treasure! 24 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function For a more accurate definition: treasury management is the management of the company’s capital and financial holdings, with the ultimate goal of maximising the company’s liquidity and value, whilst mitigating the financial risks the company faces. Mitigating financial risks can include risks of losses due to currency changes, paying more tax than necessary or not having enough cash to pay suppliers. In fact that last risk is known as liquidity: having the cash available, or the ability to be able to raise cash at short notice such as through selling investments, so that debts can be paid as they fall due. The treasury function is often responsible for: Sourcing finance Currency management Effective tax management Working capital management Sourcing finance Ultimately the responsibility for raising capital for the business falls on the treasury; it is up to them to identify how much additional funding is required and the best place to get it (a bit like hunting for treasure). 25 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Sources of finance include: Banks – Overdrafts or loans (debt finance) Shareholders – Equity finance (selling shares) Venture capitalists – Who provide debt and equity finance to growing businesses Individuals or businesses – Who may loan funds Debt factors – Who may advance funds based on amounts owed from customers, e.g. if we are expecting £1m from a customer in two months’ time the factor may give those funds in advance for a fee Debt has compulsory interest payments whereas with equity, shareholders' are paid dividends which are optional (the company does not have to make them if they cannot afford it or want to reinvest in the business). As such debt is seen as more risky as payments have to be made even in bad times and if they cannot, the firm can be wound-up. As such when the financial gearing ratio [debt ÷ equity] is high, there is seen to be higher risk and it may be harder to raise more debt finance. While debt is often considered to be riskier, it is also most often cheaper than equity finance. Currency management Currency risk is the potential change in the exchange rate of one currency against another. Investors or businesses face an exchange rate risk when they have assets or operations across national borders or if they have loans or borrowings in a foreign currency. An exchange rate risk can result in an exchange gain as well as a loss. Poor currency management can de-value the organisation's assets, investments, and their related interest and dividend payment streams. The treasury department are responsible for managing those risks. Effective tax management Effective tax management requires tax to be paid in full and on time; however, often businesses will try to configure their finances in a way that allows them to pay 26 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function as little tax as possible. Assuming this is done legally it is called tax avoidance. Where it is done illegally it is called tax evasion and is obviously unacceptable. Tax avoidance makes sense from a business perspective but can lead to a negative public image. A famous example of this occurred when it was discovered that Starbucks coffee had been transferring losses from other European countries (where there was a low tax rate) to the UK (where there is a higher tax rate) which caused an illusion of making a loss in the UK and thus did not have to pay UK tax. When this came to light the public responded by protesting at Starbucks outlets and boycotting the chain altogether. Efficient management of working capital If the business runs out of cash it can't pay its creditors or its staff. “No cash” often means “no business.” The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both short- term debt (e.g. paying a supplier) and upcoming operational expenses (e.g. paying staff salaries). Working capital management often involves: Cash management Cash flow forecasting identifies the expected cash balances over the coming weeks and months. It enables the prediction of peaks and troughs in the cash balance. This helps with planning how much and when to borrow, and how much cash will be available to meet payments due to suppliers or other creditors. The business needs sufficient cash to meet day to day expenses, but not too much – otherwise, large amounts of cash are sitting around instead of earning a return in the business. Managing receivables Receivables are the monies owed to the business from customers (known as debtors). In other words, money the business will receive. Some organisations can take up to 60-90 days to collect debts, which can have a significant effect on cash flow. 27 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Managing payables Payables are the opposite of receivables. In this case we are the customer, and have received goods on credit from our suppliers. In other words, money the business will have to pay to someone else. Payables are beneficial because they act as a free source of finance – we receive the goods today and pay for them later. This also gives us the convenience of paying all our bills at once, rather than every single time a purchase is made. The concepts behind payables management are very similar to those of receivables management – after all, our receivables are someone else’s payables and vice versa. For example, in receivables management we try to collect debts as soon as possible, while in payables management we try to delay payment for as long as possible. In both cases we need to determine the costs/benefits of early collection/payment. Company secretarial Company secretarial is a role typically undertaken by the company secretary. The role is to ensure that the company meets statutory and regulatory requirements. The finance function may incorporate this role under their remit or it may be part of a separate legal function. However, it is included in the CIMA syllabus as one of the five key components of the finance function. 28 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Responsibilities of a company secretary generally include some or all of the following: Managing governance structures to comply with the country's governance regulations. Compliance with business and company law. Compliance with industry regulation (e.g. telecoms companies in the UK abiding by rules set by the telecoms regulator, OFCOM). Attending shareholder meetings, partly to ensure compliance with regulation over conduct of meetings. Maintaining contact with regulatory and external bodies. Shareholder reports and regulatory circulars. Supporting the production of financial accounts, with a focus on ensuring compliance with regulatory standards. Maintaining the company’s statutory register which includes records that must be kept by law. In the UK, for example, companies must keep records of directors, shareholders and charges on property. 29 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Ensuring that all requirements of the country's Registrar of companies (Companies House in the UK) are met. For example, in the UK an annual return is required which includes details of the company's shareholders, directors and details such as the company's registered address. Organising and attending board and general meetings. Internal auditing It is important to manage risks so that they don't do permanent damage to the organisation. Organisations are faced with many risks, and to manage those risks controls are put in place. The risk of a fire might be controlled through fire prevention controls, for instance. However: Do those controls adequately cover the risks? Are the fire prevention controls sufficient to stop most fires? Are the controls that are in place actually being applied as they should be? Are fire extinguishers regularly checked? If not then the control system will not work. 30 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function It makes sense then to have a team in the organisation who are responsible for the review of processes and controls and advising on how to improve them. That's the main role of internal auditors. Now internal auditors also do other things too, and can take on a broader role reviewing and advising on the business. Therefore, we have a broader definition of their role which is as follows: Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisation's operations. Under this wider remit internal auditors then undertake the following types of audits: Compliance audits – Internal auditing most frequently involves measuring compliance with the organisation's policies and procedures, by identifying procedures and controls, testing these and reporting on how well they are applied and how they might be improved. These may also be used to identify occurrence of fraud. Value for money auditing – Auditor’s investigate the Effectiveness, Efficiency and Economy of a department or division and recommend improvements. This is common in the public sector where there is no profit motive to drive the 3E’s. Management audits – These review the performance of managers and their divisions and suggest improvements in performance. Social and environmental audits- These focus on Corporate Social Responsibility and environmental issues and the organisation’s performance in these areas, alongside compliance with internal policies and external regulation. Fraud investigations – Where fraud is identified (e.g. as part of a systems audit) specific investigation of the fraud may be undertaken to identify the cause and extent. Information may be used to support a legal case, and recommendations will be made to avoid similar frauds in the future. Post-implementation project reviews/audits – At the end of major projects, the final step is to review the effectiveness of the project and learn lessons to apply to future projects. While often this is carried out by the project manager, sometimes the internal audit team take part in this review as it helps bring independence to the assessment. 31 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Limitations of internal auditing Audit Committee An audit committee is a senior group of directors. One of their roles is to oversee the work of the internal auditors to make sure they are focusing their work on the key strategic risks to the business. They also ensure that recommendations made by internal audit are taken seriously and acted upon. 32 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Operations Management Look at your phone or computer, this is an example of a finished article. But have you ever thought about how the company designs a product like this and assembles it from many different components, not just once but thousands of times, in exactly the same way? How does the company ensure that the product is produced consistently and reliably in volume, to the same standard and then packaged and shipped across the markets where it is sold? The answer lies in good operations management. We can define operations management as: Overseeing, designing and controlling the process of production and aligning business operations for more efficient and effective production of the organisation's goods and services. Operations management will involve the development of an operational strategy which is key to the success of an organisation's operations. It includes the management of production, capacity, inventory, and suppliers. The importance of operations to the business can be viewed using the four Vs: Volume The volume of inputs (e.g. materials) processed – the greater the volume the greater the requirement for standardised processes (e.g. a mobile phone factory producing identical products in a standardised way) and the more there is to manage and organise. Variety The range of differing products produced – the more produced the greater the flexibility needed in the production approach and greater the need for flexible production methods, the wider the range of skills needed in staff, and the greater the planning that will be needed. Variation in demand The requirement to be flexible based on changes in customer demands e.g. for extra demand at holiday periods. Operations need to be able to be flexible e.g. having more staff in a hotel during the busy summer season. 33 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Visibility Whether production is visible to customers. In a factory it is not visible, customers only care about the end product, but in a hotel it is completely visible and the appearance becomes of vital importance and all staff need to focus on good customer service. 34 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Key External Relationships Do you have shares in Google? Well, you might have! But even if you do not stand to gain financially from Google's business activities, you still have an interest, or a stake, in how they do. This is because you use the service every day. If Google went out of business, it would make your life more difficult. This makes you, as a customer, a stakeholder in Google. What are stakeholders? Stakeholders are any parties that can affect, or be affected by, an organisation's strategy and policies. Let’s imagine a publicly funded school, who would the stakeholders be? Well, we would probably quickly come up with a list that included: Teachers Pupils The pupils’ parents and families The administrative staff The local education authority All these groups can clearly affect or be affected by the school’s strategy and policies. So would this be it? No! It would also include: Teachers’ unions – Who could organise a strike if they didn’t agree with the school’s policies Local businesses – Who may offer work experience or internships to pupils The wider community – House prices may be affected by a school with a great reputation, or a bad one! The local council – Who will run other services for pupils that will require collaboration with the school 35 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function Other local schools - Who may be competitors, trying to achieve better results to attract more pupils Local media – Who will report, favourably or unfavourably on incidents at the school Exam boards – schools must hold exams based on the rules of the exam boards they choose to use The government – Who decide how much of the national budget goes towards education So, there we go, a list of lots more stakeholders that you may not have immediately first thought of. However, this is still not an exhaustive list and the brief examples of how they may affect/be affected by the school are also not the only ways it could happen! Classifying stakeholders To make informed decisions and policies regarding all the business's stakeholders, it is crucial that an organisation classifies its stakeholders into various groups. This can be done in a number of ways; for example, the organisation can determine whether the stakeholder is internal, external or connected. The ICE mnemonic can be a useful way to remember these. 36 © 2022 ASTRANTI  FLP - Role and Activities of the Finance Function External stakeholders As you can imagine, it's pretty important for external stakeholders to be able to access accurate accounts of the company's finances. After all, these are the people who are going to be affected by any major changes. Financial Accounting is generally concerned with producing these reports for stakeholders, based on the current financial state of the business. So, who are these groups that take an interest in the company's financial position? They include: Shareholders Suppliers Banks Customers Bond holders Tax authorities Shareholders want to know the position of their investment and the return they are likely to make. Suppliers, banks and bond holders want to know that the money they are owed is likely to be paid back. Tax authorities want to ensure that the company is paying the right amount of tax. 37 © 2022 ASTRANTI