Lecture 2: Role of Finance and Accounting in Decision Making PDF

BAF1013 Finance & Accounting for Decision Making __________________________________________________________________________________ Lecture 2: Role of Finance and Accounting in Decision Making Learning Objectives At the end of the lecture, you should be able to: 1. Describe the nature and purpo...

BAF1013 Finance & Accounting for Decision Making __________________________________________________________________________________ Lecture 2: Role of Finance and Accounting in Decision Making Learning Objectives At the end of the lecture, you should be able to: 1. Describe the nature and purpose of finance and accounting. 2. Explain how financial information serves the needs of different stakeholders. 3. Describe different types of business activities and ownership structures. 4. Describe the roles and functions of finance and accounting in supporting business decisions. 1. The Nature and Purpose of Finance and Accounting Definition of Finance and Accounting Finance is the management of money, including investing, borrowing, lending, budgeting, saving, and forecasting. Accounting is the process of recording, summarizing, and reporting financial transactions to provide useful information for decision-making. Purpose of Finance: Capital Allocation: Businesses need to make decisions about how to allocate limited resources (money) to achieve their goals. This could be in the form of investment in equipment, new projects, or employee salaries. Budgeting: Planning how much money is available and deciding where it should be spent to support business strategies. Purpose of Accounting: Financial Reporting: Provides information about a business’s performance through financial statements like income statements, balance sheets, and cash flow statements. Compliance: Ensures businesses follow laws and regulations, including paying taxes and meeting legal financial requirements. 1 BAF1013 Finance & Accounting for Decision Making __________________________________________________________________________________ 2. Financial Information and Stakeholders Who are the Stakeholders? Stakeholders are individuals or groups who are affected by a business’s actions and decisions. They rely on financial information for their decision-making. Different Types of Stakeholders and Their Information Needs: Owners/Shareholders: Want to know if the business is profitable and if their investment is growing. Managers: Need detailed financial data to make decisions about day-to-day operations. Employees: Interested in the financial health of the company because it affects job security and potential pay raises. Creditors and Lenders: Want to ensure the business can repay its debts. Government/Tax Authorities: Require financial information to assess taxes and ensure compliance with laws. Customers: Are interested in the long-term stability of a business, especially if they rely on its products or services. 3. Types of Business Activities and Ownership Structures 3.1 Types of Business Activities: o Service Businesses A service business provides intangible products—services—rather than physical goods. These businesses perform tasks or activities for customers, often based on specialized knowledge or skills. Examples: Consulting firms, Healthcare services, Legal and accounting services. Key Features: Services are often consumed at the point of delivery and cannot be stored. Customer satisfaction and experience play a major role in service businesses. Service quality is harder to measure than product quality. 2 BAF1013 Finance & Accounting for Decision Making __________________________________________________________________________________ o Trading Businesses A trading business is involved in buying and selling tangible goods. These businesses purchase goods from suppliers (manufacturers or wholesalers) and sell them to customers at a markup. Examples: Retail stores: Supermarkets, clothing stores, electronics shops that sell directly to consumers. Wholesalers: Businesses that buy in bulk from manufacturers and sell in smaller quantities to retailers or other businesses. E-commerce businesses: Online platforms like Amazon or smaller online shops that sell goods directly to consumers or businesses. Key Features: The primary focus is on buying and selling physical products. These businesses earn profit through a markup on the cost of goods sold (COGS). Inventory management is crucial for trading businesses to maintain stock levels and avoid shortages or overstocking. o Manufacturing Businesses A manufacturing business is involved in producing goods by transforming raw materials or components into finished products through a series of processes. Examples: Automobile manufacturers: Companies like Ford or Toyota that build cars and trucks. Textile manufacturers: Businesses that produce clothing or fabric. Electronics manufacturers: Companies like Samsung or Dell that produce electronic devices and gadgets. Food processing companies: Businesses like Nestlé or General Mills that produce packaged foods. Key Features: Manufacturing businesses focus on production, which involves sourcing raw materials, using labour and machinery, and creating products. These businesses sell finished goods either directly to consumers or to retailers and wholesalers. 3 BAF1013 Finance & Accounting for Decision Making __________________________________________________________________________________ The production process can vary significantly in complexity depending on the product. 3.2 Ownership Structures: o Sole Proprietorship A business owned and operated by one person. The owner is responsible for all liabilities. Simple to set up, but the owner bears all the risks. o Partnership A business owned by two or more individuals who share profits, losses, and responsibilities. Combines resources, but conflicts may arise between partners. Partners of a general partnership bear all the risks. o Corporation A separate legal entity owned by shareholders. It can own assets, borrow money, and is responsible for its liabilities. Limited liability for owners, but more complex and regulated. 4. Roles and Functions of Finance and Accounting in Supporting Business Decisions How Finance Supports Decision-Making: Investment Decisions: Finance helps businesses decide whether or not to invest in new projects, equipment, or ventures based on financial projections. Risk Management: Finance identifies potential risks and helps develop strategies to mitigate them. How Accounting Supports Decision-Making: Cost Control and Budgeting: Accounting provides accurate financial data that help managers control costs and adhere to budgets. o Example: Tracking actual expenses against the budget to ensure the company does not overspend. Performance Evaluation: Financial statements help in assessing whether a company is meeting its financial goals. o Example: Analyzing quarterly profit margins to see if the company is on track. 4 BAF1013 Finance & Accounting for Decision Making __________________________________________________________________________________ The Relationship Between Finance and Accounting: Finance uses the data generated by accounting to make informed decisions. While accounting focuses on the historical recording of transactions, finance is more forward-looking, helping businesses plan and strategize for the future. Example: A Tech Startup's Decision-Making Process Scenario Overview Let’s imagine a tech startup called InnovateTech that creates software for small businesses. The company is thinking about launching a new product that helps retail businesses manage their inventory better. To decide if they should move forward, InnovateTech uses both finance and accounting to guide their decision. How Finance Supports Decision-Making 1. Investment Decisions: Financial Projections: The finance team estimates the costs and revenues for the new product. They believe it will cost about $200,000 to develop but could bring in $500,000 in revenue during the first year. Net Present Value (NPV): Finance calculates the NPV, which is a way to see if the future profits from the project are worth the money spent today. If the NPV is positive, it means the project should be profitable. 2. Risk Management: Identifying Risks: The finance team also looks at possible risks, like competition from other companies, problems with the technology, or changing customer needs. Mitigation Strategies: To reduce these risks, the team might conduct market research to understand what customers want or invest in strong technology to make sure the product works well. How Accounting Supports Decision-Making 1. Cost Control and Budgeting: Budget Creation: The accounting team creates a detailed budget for the product, outlining how much money will be spent on research, development, marketing, and selling the product. Tracking Expenses: As the product is being developed, accountants track how much money is actually spent. For example, if they budgeted $120,000 for development but 5 BAF1013 Finance & Accounting for Decision Making __________________________________________________________________________________ spent $150,000, the management team will need to adjust the plan to prevent overspending. 2. Performance Evaluation: Financial Statements: Once the product is launched, accounting produces financial reports every few months, showing how much profit the product makes and how well it sells. Analyzing Performance: The management team looks at these reports to see if the product is meeting expectations. For example, if they expected a 20% profit margin but only got 10%, they would need to figure out why, maybe by adjusting the price or cutting costs. The Relationship Between Finance and Accounting 1. Using Data Together: Finance relies on accounting data to make informed decisions. For example, if accounting tracks expenses accurately, the finance team can decide whether they should invest more money in the product or make changes. 2. Looking Back vs. Looking Forward: Accounting focuses on recording what has already happened (like money spent on development). Finance, on the other hand, uses this past data to predict future cash flows and decide if the company should invest more or change its strategy. Conclusion In this scenario, InnovateTech shows how finance and accounting work together to make smart business decisions. By using financial projections, assessing risks, tracking costs, and evaluating performance, the company is better prepared to make decisions and grow successfully. Summary Finance and accounting are essential tools for decision-making in businesses. They support the needs of various stakeholders and provide a foundation for making informed business choices. ~ End ~ 6