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Financial management is essential for the company to make the company beneficial. It gives the management the maximum profit by creating the maximum output from various projects. Financial management maximizes the wealth of the company by maximizing its profit. So the company should maintain strong financial management department for calculating the actual value of the projects. Our company is working on a growing stage. As an incorporated company listed in the UK stock exchange it must get the competitive advantage from the financial purpose.
The purpose and requirements for keeping records:
The success of a company partially depends on the accuracy and up-to-date keeping the records. Keeping accurate records the company can be success in a long run. So the management of the company should give importance to it. According to peter and Frank (2004) sometimes the business can fall for the inaccurate accounting of the accountants. So the business must maintain the documentation of the report. Record keeping is the base for accounting. The importance of keeping records can't be overstated. It is the formulation for the accounting process. It includes the daily transactions and the relevant bills. All substantial transactions are included to it.
The requirements for the record keepings are given below:
The right payment of tax should be accounted.
The extra tax and penalties should be avoided.
The track of expenses should be kept.
The actual amount of the liabilities should be calculated
Time and accountancy cost should be minimized.
Right amount of benefits or credit should be recorded.
Some other requirements should be performed. The management should assist the accountants in preparing the financial report. Proper information should be provided. The managers should assess the situation quickly.
Techniques for keeping financial records:
Financial records are kept on a regular basis. The recordings should be done in scheduled time. though the time spent in book keeping seems very time consuming and if someone thinks he or she will give this time to his or her running business it will be a major fault of collapse the financial activities (Jack and John, 1991). We have already discussed the benefits of keeping the records now we will discuss on the techniques of the keeping the records.
Once you understand the recordkeeping practices of your business you may decide to hire an employee to manage the daily transactions, or engage an external bookkeeper. You could also hire an accountant to prepare financial reports and tax returns.
According to Kevin (2008) many small business owners handle their day-to-day book-keeping requirements but consult an accountant for help with formal reporting functions. Before deciding whether you will manage your own finances or outsource the process, it helps to understand the difference between book-keeping and accounting.
There are two types of techniques that can be followed. These are discussed below:
Cash basis accounting:
In cash basis the transactions are recorded when the transactions made the cash out or in. so they records the expense when it laid out the cash from the entity. The revenue is recorded when the company actually holds the cash in their hands.
In this basis the transactions are recorded when the expense or the revenue occurred. It is not related with the cash. The cash may relate or not if there is any expense or revenue occurred it will be recorded. It is recognized by GAAP.
Legal and organizational requirements for recording:
Financial statements are the written documents of a financial institution. It includes the balance sheet of a company and the income statement which shows the financial condition and the performance of a particular company. There is also cash flow statement which shows the solvency of a company. Kevin (1997) states the financial statement is an organ which communicates with the outside parties. Which gives a idea about a company for the interested group. The financial statements are prepared for the use of the insider and the outsider parties for their needs. The outsider of the company includes present and potential owners, creditors, legal authorities etc.
The financial accounting standards board urges the importance of the financial statements for communicating the external users. It provides useful information about the investment purpose and credit decisions assessing the prospect of the company. The statements show the resources, claims of the company and the changes in the financial condition.
Usefulness of financial statements for the stakeholders:
The stakeholders are interested for the financial condition of the particular company. The traditional purpose of the financial statement is to provide the information to management. But the stakeholders are the center of the company. So they need to know how their company I performing because the beneficial activities of the company will make the stakeholder beneficial. The employees of the company the investors of the company need to know about the performance.
The performance of the company can be justified by assessing the income statement, balance sheet and cash flow statement. According to Richard (2004) these statements show each and every activity performed by the company. So the stakeholders can judge the company by seeing the other company's performance. They can observe the repayment of the liabilities by the current asset and the meeting up the cost of operating activities of the firm. The income statement shows the net benefits or the loss so the stakeholders can forecast the future performance of the company.
Difference between the management and financial accounting:
In this section we will discuss about the differences between the management accounting and financial accounting.
Management is not specialized for the financial statement preparation. It doesn't need the training of CA and the qualification level of it.
It only works for the internal operations where financial accounting works for the external use.
So management accounting can be defined as the internal accounting and the financial accounting can be defined as the external accounting.
The data showed in the financial accounting is used for the decision making and the interest of the stake holders and the data used in the management accounting is necessary for the managerial activities of the company.
The management accounting provides the information in more depth level than financial accounting
Financial accounting is related only with the representation of the data but managerial accounting is related with the cost of the assets and the product and its minimization.
In a short budget means the quantitative economic plan of a company. It is made by keeping pace with the time. Budget is completely related with the resource allocation of a company. It is expressed in monetary units (Frank and Keith, 2007). Do the plan which is expressed in a monetary unit is called the budget. So the planning must be in authorities forecast of the plan. In a wider sense it can be defined as the managerial tool for the financial control of the company. It structures the financial control of the company. Budgeting has been practiced in the business for a long time. In a reality budgeting is related with more mathematical applications. It is used for the view of the company with its desired goals. If the budget can be used properly the profit of the company can be maximized. Properly used budget can minimize the cost and maximize the profits of the company.
Different costing methods used for pricing purposes:
Different business follows the different methods for costing. This ascertains their products. The method is adopted by the company depends on the nature of their production and the industry they work in. different methods of costing are discussed below:
Job costing: it is related with the cost of each job or the work order. This type of costing is used by the business when the works are carried out by the customer's requests.
Contract costing: this type of costing is used for the contract work like constructions of dam or building.
Batch costing: A batch can be defined as a group of identical products. Under the method the batch is considered as the unit of the product and the cost is ascertained under the cost.
Process costing: this type of method is used for the product which goes in the long processing way and different stages before becoming the finished goods. The cost is determined for the different process.
Service costing: this costing is used for the industries which render service. Under this method the cost of providing service is considered as the cost.
Operation costing: this type of costing is useful for the industries which have a continuous operation and the products are identical.
Multiple costing: this type of method is the combination of the stated methods which are described above. Where the product is assembled in parts or the components cost of the product is calculated for the different components used for the ultimate product which is finally assembled. So the multiple costing is used for the process (Apte, 2009).
Calculation of variance:
7900 Favorable (Note: i )
770 Unfavorable (Note: ii )
240 Favorable (Note: iii )
50 Favorable (Note: iv )
Variance can be favorable or Unfavorable to the situation based on the budgeted amount. If actual amount increases the profit then the variance is considered favorable otherwise it is considered as unfavorable.
Budgeted sales price £ 62 , Output 1000 unit
Budgeted sales = £ 62 - 1000
= £ 62000
Sales Quantity Variance = Standard Sale Price (Actual output - Budgeted Output)
= £ 62 (1100-1000)
= 6200 favorable
Sales Variance = Actual sales -Budgeted sales
= 69900 - £ 62000
= 7900 favorable
So this amount should be added with the budgeted profit. The sales variance has been occurred because of change of output from Budgeted output and change of sales price form budgeted sales price.
Budgeted Direct Labor £22/hour, Actual Labor Hour 1075 hour
Budgeted Direct labor = £ 22 - 1075
= £ 23650
Direct labor Rate Variance = Actual -Budgeted
= 24420 - 23650
= 770 unfavorable
So this amount should be deducted from budgeted profit. This variance has been occurred because of change of direct labor rate from budgeted direct labor.
Budgeted Direct Material £ 20/Kg, Actual Material 1175 Kg
Budgeted Direct Material = £ 20 - 1175
= £ 23500
Direct Material Price Variance = Actual -Budgeted
= 23260 - 23500
= (240) favorable
So this amount should be added with budgeted profit. Change of direct material price from budgeted amount has caused direct material variance.
Budgeted Fixed Overhead £ 6/hour, Actual Labor Hour 1075
Budgeted Fixed Overhead = £ 6 - 1075
= £ 6450
Fixed Overhead Rate Variance = Actual -Budgeted
= (50) favorable
So this amount should be added with the budgeted profit. As the fixed overhead rate has been changed from budgeted fixed overhead, the fixed overhead variance has occurred.
If actual sales price were given it would be possible to calculate the sales price variance. Sales price variance is included in the sales variance. Sales variance mainly consists of sales price variance and sales quantity variance. Budgeted labor hour would give a scope to calculate labor efficiency variance and fixed overhead quantity variance. The Budgeted direct material (Kg) would help to calculate direct material quantity variance.
Appraisal methods of project:
Appraisal methods are used for the calculation of the projects. It determines the benefits of the project. So the tools are very useful for evaluating the finance for the company. There are 4 appraisal methods discussed below:
The given problem is
We have to calculate the accounting rate of return, net present value, payback period and the internal rate of return under this problem.
Accounting rate of return, we know ARR = Average accounting profit ÷ initial investment
So for project 1 Average accounting profit is =
So average accounting income is, = (20000÷200000) -100
So ARR for project 1 = 10%
For project 2 annual accounting profit = (36000-4000+8000) ÷ 3
So ARR for project 2 = (13333 ÷ 120000) - 100
So project 2 is giving higher rate of return. So the company should go for project B.
Payback period method:
Payback period method is dependent on the cash flow whether it is even or uneven, there is two different methods for the two types of cash inflow.
We know Payback period is = initial investment ÷ cash inflow per period.
But when the cash inflows are uneven the formula will be = A + B÷ C
Here A = last period with a cumulative negative cash inflow
B = is the absolute value of cash flow at the end of period A
C= total cash flow during the period after A
For project 1,
The value of the project 1 is 200000
At the 2nd year it has the negative value 2000 so at the end of the 2n year the cumulative cash flow was 58000 and the total value at the end of the period A is 600000
So payback period of project 1 = 2 + (58000÷60000)
For project 2,
The value of project 2 = 120000
At the end of the 2nd year the negative value was 4000 the cumulative cash flow at the end of the 2nd year was 36000 and the total cash flow at the end of the period is 40000.
So the payback period for project 2 = 2 + (36000÷40000)
Project 2 has less payback period. So the company should invest on project 2 considering the payback period.
Net present value calculation,
Net present value calculates the present value of the future cash flows. It is the most used appraisal methods in the business.
− Initial Investment
(1 + i)1
(1 + i)2
(1 + i)3
Here R denotes the return of the cash inflows and 'i' is the cost of capital.
Annual cash flow= (depreciation +profit)
Present value of the annual cash flow
58000 + 62000= 12000
4000 + 62000=
Present value of the residual value is = 10500 (14000 - .75)
= (109200 + 49800 + 49500 + 10500) - 200000
For project 2,
Annual cash inflow
PV of the cash inflow
36000+ 36000= 72000
(4000) + 36000= 32000
8000 + 36000= 44000
Present value of the residual value is= 12000-.75= 9000
= (65520+26560+33000+9000)- 120000
So under the calculation of present value project 1 has higher NPV than project 2 so the management should take project 2 under the consideration of NPV.
Calculation Internal Rate of return:
In internal rate of return the discount rate of NPV where the investment of is become 0. So IRR is the rate which makes the net present value of the future cash flow and the initial investment equal.
In our problem there are two projects we have to choose one project under IRR.
We know IRR = A+ C÷D (B-A)
Here A= lower discounting rate
B= Higher discounting rate
C= net present value at the lower discounting rate
D= difference between the net present value at higher discounting rate and at lower discounting rate
At 15% the NPV = 2800 which is the immediate positive value and at 16% the NPV is negative value which is 1200
So for project 1 IRR = 15 + 2800÷4000 (.16-.15)
For project 2,
At 16% the project has the immediate positive value 1440 and at 17% the project has immediate negative value (720).
So IRR for project 2 = 16 + 1440÷2160 (.17-.16)
So project 2 has the higher IRR so the manager should take project 2 under the consideration of IRR calculation.
So from the report the management can take the decision about the internal projects of the company. The report is all about the financing problems and the solutions. The projects appraisal methods and the calculation of the variance gives us a good idea about the decision making process under a complex situation. So the management should perform the daily task according to the process