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 2...25 1 Accruals (or matching) concept...26 2 Going concern...27 3 Consistency...27 4 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 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
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 100...87 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 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...100 Depreciation for tax purposes...100 Expenditure eligible for allowances...101 Rates of capital allowances...101 Property...102 Long-term liabilities...102 Long-term debt...103 Long-term leases...103 Leasing...105 Sale and leaseback...110 Other long-term debt...110 Discounts, premiums and cash flow...112 Deep discounts...113 Sinking funds...113 Warrants...113 Notes, loan notes and commercial paper...114 Bonds...114 Mezzanine finance...114 Provisions and estimated liabilities...114 Provisions...115 Pensions...115 Commitments...116 Contingent liabilities...116 Owners equity in companies...117
CONTENTS 5 Ordinary shares: basic concepts...117 Preference shares: basic concepts...118 Ordinary shares: technical terms...119 Share premium account...119 Stock dividend...120 Scrip or bonus issue...120 Share splits...120 Rights issue...121 Share options...121 Retained earnings...121 Revaluation reserve...122 Other reserves...122 Notes to the accounts...122 Overview...122 Annual report and accounts...123 Directors report...124 Notes to the accounts...124 Stock valuation...126 Depreciation and amortisation charge...126 Changes in accounting policy...127 Leases...127 Contingent liabilities...128 Debt structure...128 Equity structure...129 Contractual liabilities...129 Segmental and geographical analysis...130 Other types of notes to the accounts...130 GAAP mechanism...130 Generally Accepted Accounting Principles...130 Organisations that influence GAAP...131 Auditing principles...132 Role of the auditor accounting firms and services...132 Audited financial statements...133
6 MASTERING FINANCIAL MANAGEMENT Limitations of the auditing process...134 The audit report...135 Basic elements...136 Statements of responsibility...137 Expression of opinion...137 Unqualified opinion...138 Qualified opinion...138 Limitations of audit scope...140 Disclaimer of opinion...140 Adverse opinion...141 Except for disagreement...141 Fundamental uncertainty...141 Directors responsibilities...142 Unaudited financial statements...142 Chapter 5: Budgeting and management accounting...145 Budgeting...146 Introduction...146 Budgeting in general...147 Control...147 Reward...148 Communication...148 Long and short-term planning...148 Budget problems...150 Period for the budget...150 Budget administration...150 Setting a budget...152 Critical factor...152 Sales budget...153 Other budgets...153 Negotiation...153 Co-ordination and review...154 Final acceptance...154
CONTENTS 7 Reviewing a budget...155 Inherent uncertainty...155 Three level budgets...156 Probability analysis...157 Sensitivity analysis...158 Zero-based budgeting...159 Purpose of zero-based budgeting (ZBB)...159 The principle of ZBB...160 Advantages of ZBB...161 Disadvantages of ZBB...162 Budgeting behaviour in organisations...162 Motivation...162 Your business...163 Cash budgeting...163 Monitoring a budget...168 Definition and purposes of budgetary control...168 Budget realism...169 Control limits...169 Comparing actual and budget...170 Marginal or total costing...170 Management accounting...171 Responsibility and variances an improvement on the common-sense approach...171 A more realistic standard...172 Planning and operational variances...173 Reasons for variances occurring...173 Controllable and uncontrollable costs...174 When to investigate variances...174 Better management accounting...175 Balanced business scorecard...180
8 MASTERING FINANCIAL MANAGEMENT Chapter 6: Costs...183 Introduction...184 Break-even...185 Break-even charts...185 Bringing businesses to life...187 Outsourcing...187 Finance out...188 Risk and reward...188 Break-even points...189 Life is not all straight lines...190 Building up costs...192 Menu pricing...193 Total costing pitfalls...194 Overheads...195 Mark-up and margin...196 Marginal versus total costing...198 Comprehensive example...199 Direct and indirect costs...201 Business cost generalisations...203 Product profitability...203 Typical allocations...204 Typical conclusions...206 New good, old bad?...207 Activity based costing...207 Drawbacks to ABC...208 Decision-making...209 Backwards and forwards...209 Inside and outside...210 Brave new world...211 Winds of change...211 Decision time case study...212 Look forward...213 Golden rules for decisions...215
CONTENTS 9 Sunk costs...215 Relevant costs...215 Incremental or opportunity...215 A worthwhile opportunity?...217 If the figures don t fit...220 Sensitivity analysis...220 Make or buy decisions...221 Buy...221 Does anyone get it right?...222 A good move?...223 Organisational decision flaws...224 Profit centres...224 Play make-believe...225 Bend the rules to suit...226 Transfer prices...227 The wasted debate...228 Profit centre decay...228 Directors as referees...229 Profit centre disaster 1...229 Profit centre disaster 2...231 One inevitable conclusion...232 Payment in paper clips, please...233 Pros and cons of profit centres...233 Terminal decay...234 Chapter 7: Computing future decisions...235 Dealing with the future...236 A more scientific approach...236 Conventions...237 Accounting rate of return...237 An alternative scenario...238 Payback period...239 Payback norms...239
10 MASTERING FINANCIAL MANAGEMENT A cash flow measure?...240 Single independent project...240 Mutually exclusive projects...241 Time value of money...241 Present values...241 Discounting...242 Future values, or compounding...243 Inflation plays no part...243 Discounted cash flow...244 Net present value...245 Effect of discount rate...245 Internal rate of return...246 IRR and NPV together...246 Summary of criteria...247 Interest rate...247 Marginal...248 Weighted...248 Hurdle or premium...249 Time scale...250 Accuracy...251 Final pleas...251 Learning cycle...252 Plan, do, review, think or do we?...253 Comprehensive example...254 Solution...254 Final thoughts...257