Contents. Chapter 1: Finance makes the world go round Icons...11

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1 1 Contents Icons...11 Chapter 1: Finance makes the world go round...13 Who this is for...14 You are not alone...14 Overview...15 Other sources...15 Users and uses of financial information...16 Financial versus management accounting...17 Name that accountant...18 Rules governing accounting...20 Law...20 Accounting standards...20 International dimension...24 Big GAAP/Little GAAP...24 Corporate financial health...25 Audits...25 Corporate reality...25 SSAP Accruals (or matching) concept Going concern Consistency Prudence...28 Basic accounts...28 Profit and loss account...29 Balance sheet...34 The two business cycles...35 Fixed assets...35 Cost...36 Revaluations...36

2 2 MASTERING FINANCIAL MANAGEMENT Depreciation...38 Depreciation method...40 Notes to accounts...43 Current assets and current liabilities...44 Current assets...44 Working capital example...46 Current liabilities...48 Ratio analysis...48 Other current liabilities...50 Critical issues...50 Long-term liabilities...51 Creditors due after more than one year...51 Historical cost...51 Balance sheet summary...52 Other side of the balance sheet...52 Chapter 2: Analysing performance...55 Interpreting accounts using ratio analysis...56 Introduction...56 Return on capital employed (ROCE)...56 Tree of ratios...58 Profitability measures...59 Earnings per share (EPS)...60 Balance sheet measures...61 Asset turnover...61 Fixed asset turnover...61 Debtor days...62 Stock days...63 Creditor days...63 Current ratio...63 Quick ratio...64 Stock to net assets...65 Stock turnover...65

3 CONTENTS 3 Finance ratios...66 Gearing/borrowing ratio...66 Interest cover...67 Match the business with ratios...67 Proforma ratios...69 Match the business with ratios: solution...70 Practical working capital management...71 Debtors...71 Stock...72 Creditors...73 Detailed case study...73 Analysis...73 Helpful hints...74 Profit and loss account analysis...76 Balance sheet analysis...77 A calculation...83 Break-even...84 Chapter 3: External analysis...85 A source of intelligence...86 News stories...86 Back page...86 Major quoted companies...87 FTSE Share prices...87 FTSE movements...88 Share data...88 Market capitalisation...89 Price earnings computation...89 Price earnings comparison...90 Price earnings valuation tool...91 Yield gross...92 Gilts and interest rates...93

4 4 MASTERING FINANCIAL MANAGEMENT Chapter 4: Review of accounting principles...95 Introduction...96 Fixed assets and depreciation...96 Carrying cost...96 Depreciation period...97 Residual value...98 Depreciation methods...98 Straight line depreciation...99 Production or use method...99 Accelerated depreciation methods Depreciation for tax purposes Expenditure eligible for allowances Rates of capital allowances Property Long-term liabilities Long-term debt Long-term leases Leasing Sale and leaseback Other long-term debt Discounts, premiums and cash flow Deep discounts Sinking funds Warrants Notes, loan notes and commercial paper Bonds Mezzanine finance Provisions and estimated liabilities Provisions Pensions Commitments Contingent liabilities Owners equity in companies...117

5 CONTENTS 5 Ordinary shares: basic concepts Preference shares: basic concepts Ordinary shares: technical terms Share premium account Stock dividend Scrip or bonus issue Share splits Rights issue Share options Retained earnings Revaluation reserve Other reserves Notes to the accounts Overview Annual report and accounts Directors report Notes to the accounts Stock valuation Depreciation and amortisation charge Changes in accounting policy Leases Contingent liabilities Debt structure Equity structure Contractual liabilities Segmental and geographical analysis Other types of notes to the accounts GAAP mechanism Generally Accepted Accounting Principles Organisations that influence GAAP Auditing principles Role of the auditor accounting firms and services Audited financial statements...133

6 6 MASTERING FINANCIAL MANAGEMENT Limitations of the auditing process The audit report Basic elements Statements of responsibility Expression of opinion Unqualified opinion Qualified opinion Limitations of audit scope Disclaimer of opinion Adverse opinion Except for disagreement Fundamental uncertainty Directors responsibilities Unaudited financial statements Chapter 5: Budgeting and management accounting Budgeting Introduction Budgeting in general Control Reward Communication Long and short-term planning Budget problems Period for the budget Budget administration Setting a budget Critical factor Sales budget Other budgets Negotiation Co-ordination and review Final acceptance...154

7 CONTENTS 7 Reviewing a budget Inherent uncertainty Three level budgets Probability analysis Sensitivity analysis Zero-based budgeting Purpose of zero-based budgeting (ZBB) The principle of ZBB Advantages of ZBB Disadvantages of ZBB Budgeting behaviour in organisations Motivation Your business Cash budgeting Monitoring a budget Definition and purposes of budgetary control Budget realism Control limits Comparing actual and budget Marginal or total costing Management accounting Responsibility and variances an improvement on the common-sense approach A more realistic standard Planning and operational variances Reasons for variances occurring Controllable and uncontrollable costs When to investigate variances Better management accounting Balanced business scorecard...180

8 8 MASTERING FINANCIAL MANAGEMENT Chapter 6: Costs Introduction Break-even Break-even charts Bringing businesses to life Outsourcing Finance out Risk and reward Break-even points Life is not all straight lines Building up costs Menu pricing Total costing pitfalls Overheads Mark-up and margin Marginal versus total costing Comprehensive example Direct and indirect costs Business cost generalisations Product profitability Typical allocations Typical conclusions New good, old bad? Activity based costing Drawbacks to ABC Decision-making Backwards and forwards Inside and outside Brave new world Winds of change Decision time case study Look forward Golden rules for decisions...215

9 CONTENTS 9 Sunk costs Relevant costs Incremental or opportunity A worthwhile opportunity? If the figures don t fit Sensitivity analysis Make or buy decisions Buy Does anyone get it right? A good move? Organisational decision flaws Profit centres Play make-believe Bend the rules to suit Transfer prices The wasted debate Profit centre decay Directors as referees Profit centre disaster Profit centre disaster One inevitable conclusion Payment in paper clips, please Pros and cons of profit centres Terminal decay Chapter 7: Computing future decisions Dealing with the future A more scientific approach Conventions Accounting rate of return An alternative scenario Payback period Payback norms...239

10 10 MASTERING FINANCIAL MANAGEMENT A cash flow measure? Single independent project Mutually exclusive projects Time value of money Present values Discounting Future values, or compounding Inflation plays no part Discounted cash flow Net present value Effect of discount rate Internal rate of return IRR and NPV together Summary of criteria Interest rate Marginal Weighted Hurdle or premium Time scale Accuracy Final pleas Learning cycle Plan, do, review, think or do we? Comprehensive example Solution Final thoughts...257