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Analysing what Henry Ford once remarked, "Money is an arm or a leg. You either use it or lose it". It appears quite simple though very meaningful. It brings home the value of Money or Finance. In any business, the role of money has hardly altered. A firm's success and o say the least, its survival depends upon how effectively it is able to generate funds, as and when needed. However it would not be proper to pass the entire credit of the success of the business enterprise to finance. It also depends on how effectively the money is utilised in the organisation.
According to Paul G. Hastings ,"finance" is the management of monetary affairs of the company which includes establishing the cost need to be paid for raising the money on the best term available, and devoting available funds to the best use.
Ken Midgley and Ronald Burns state that "Financing is the process of organising flow of funds so that a business firm can carry out its objective in the most efficient manner and meets its obligation as they fall due".
"In an overall sense finance embraces many areas other than corporation finance, money, banking and credit of various types and classes. Considered as a whole, finance can be described as a circulatory system of the economic body, making possible the needed co operation between many units of activities".
While accounting is the data collection process dealing with accurate reporting, finance is a managerial or decision making process. Arising out of close relationship of finance with accounting a new branch of accounting has emerged under the title "financial accounting"
Ericsson - Company Background
Ericsson is world's 5th largest Information and Communications Technology (ICT) hardware, software and services provider. Its headquarters is based in Sweden with 104,525 employees located globally. It has customer base in more than 180 countries, mostly large network operators
Ericsson operates in five business segments which includes two joint ventures, well summarised in the image below
Joint Venture (JV)
Ericsson has recognised the present trend in ICT sector and has shifted focus and business strategy to align with market opportunity. "Going mobile" holds true for everything these days. Internet, machine to machine connectivity and video cloud service is driving evolution.
Ericsson is working in three different directions to achieve business growth. The first is "portfolio momentum" second is "To gain market share" and the third is "mergers, acquisitions and partnering".
Key Business Result Highlights of 2011
Ericsson's revenues grew by 12% to 227 billion and sales increased by 19%. It's has reported net income of SEK 12.6 billion. Also there was a decline in gross margin attributed by acquisition modernization and sales of services. Losses were reported by both joint ventures.
Net cash position of SEK 39.5 billion puts Ericsson in the state of strong financial position.
Ericsson also announced acquisition of Telcordia-world's leading OSS/BSS system provider as well as divestment of 50% of joint venture share of Sony Ericsson to Sony corp.
Finance management Function
Inevitably business is finance oriented. It is the process of using money to make money. The Finance functions cannot work effectively unless it draws on the disciplines which are closely associated with it. According to Paul G. Hastings,"finance" is the management of monetary affairs of the company which includes establishing the cost need to be paid for raising the money on the best term available, and devoting available funds to the best use.
Financial Management is responsible for planning, control, decision making and managing risk for an organisation
Planning is done at 3 level, Strategic, operational and tactical. Strategic planning is long term planning however operational is medium term and tactical is short term.
Strategic planning involves high level of risk as it is long term planning and hence covers high level of uncertainty simply because it is difficult to predict future. Therefore it is very important that accurate, timely and reliable information are available based on which decision can be made.
This brings in scope for a system where such information is available- Accounting.
Financial decisions have been considered as the means to achieve long term objectives of the corporate. At broad level financial decisions can be classified into four categories:
Once decisions are made and policies are implemented then the next question comes- How to measure and analyse performance of decision, in light of objectives.
How do we know that where we are? How we are doing? Whether we are going into right direction or have we achieved our objective? If a decision cannot be measured then they will be difficult to manage.
It requires financial metrics to analyse and measure performance of all financial decisions.
Here again accounting acts as information system where outcomes can be measured financially.
Actual outcome need to be measured and compared periodically with those planned and budgeted for, for each responsibility centre of an organisation which are under designated management control. Management need to react appropriately and in timely manner, on such variance in performance, so that organisational objectives are met.
It is the Accounting Information System which facilitates such performance reports.
Although " No risk, no gain" is a common adage, in the world of business uncertainties, financial management has to calculate financial risk, business risk or any other risk that may work to the disadvantage of the firm before embarking on any course of action. In order to calculate such risk factor current and historical financial performance information of the firm need to be analysed in light of present and predicted economic climate.
Again it is Accounting Information System which facilitates required information for this purpose.
Account Information System (AIS)
In the section above we have observed, that Management is the process of converting information into action and for this purpose they are highly dependent on accounting for operating facts as accounting is the source of most of information that is used for this purpose.
Therefore we can say that "Accounting is the science of book keeping and establishes the principles and concepts which should govern the collection and presentation of financial data". It is a discipline which provides information essential for efficient conduct and evaluation of the activities of any organisation.
Modern business management to a large extent has only been made possible by accounting information. Two major categories of accounting information are given below:
Financial accounting [External Focus]
The kind of accounting which provides information to decision maker outside the firm is called financial accounting. Financial accounting is concerned with the preparation of reports which provides information to users outside of the firm. The most common one is the financial investment included in the annual report. The dominance of the balance sheet in financial accounting underscores the financial aspect of this function.
Management accounting [Internal Focus]
Management accounting is presentation of financial data as part of the management task of management decision and control. Management accounting reduces the bulk of business information originating in the company to a digestible form. It is the kind of accounting that provides all essential information to the management which assist them in creation of policy and in day to day operation of an undertaking.
Characteristics of an Accounting System
There is wide variety of extensive financial information compressed in different published sources ,so much so that one is totally confused, not knowing what to choose ,unless one is able to get the exact source of information and knows what one is looking for.
Therefore fundamental role of Accounting is concerned with deciding which data is needed and which is to be recorded, determining how the data are to be processed, deciding how the reports are to be designed, and determining how the information is to be communicated to the relevant users.
There are certain characteristics which influences the usefulness of an information system.
The accounting information is vital to the firms activity, for it is used to make decisions with in the organisations (by the management) and outside the organisation (by investor and creditors). Its real value will depend upon its end use purpose. Financial information is required by:
Accounting principles and concepts
Regardless of focus, accounting statement has to fairly represent true worth of the business well as results of its operation. There for a concept of "True and Fair view" was developed for accounting and to adopt this concept accounting principles were drawn.
A company takes help and guidance from of these principles and formulates some rules in order to derive best approach to achieve the needed output of the accounting i. e. financial statements. These rules are called accounting policies which includes procedures for measuring and recording transactions, method for representing financial information in various financial statement so that it can be meaningful to end users.
So that all financial statements represent true and fair view of the company, all transactions must be recorded. Image [xxx manual page30] represents the sequence in which transactions are recorded.
Process of recording all financial transactions is known as Book Keeping". Two commonly used Book-Keeping systems are
Single Entry System
Double Entry System.
Double entry system is most commonly used system by business and enterprise. For the purpose of this assignment I will discuss and use Double Entry System only.
Double entry system is based on the principle that every transaction has dual effect on the business and therefore it should be recorded twice to reflect the effect. Every debit entry recorded into one account has a corresponding credit entry of equal amount recorded into another account. Therefore
All Debits = All Credits.
Limitation of accounting as an information system
Although accounting information is vital tool for financial management function still there are areas where it fails to provide required information. Some of them are illustrated below.
It gives only a limited picture of the state of affair of a company because it includes only those items which can be expressed in monetary terms.
All future decisions are made based on the Information derived from historical data recorded in the system. If data is not accurate then decision could be horribly wrong.
It provides financial information derived over a period of time hence fails to provide financial information of day to day activities.
It is difficult to judge operational efficiency of the organisation.
It provides financial information for the whole organisation. It doesn't give financial information like cost incurred by function, department or process.
It doesn't provided data which are required to compare cost of operation of two different firms.
It doesn't provide adequate information which could help in setting selling price for the product.
It doesn't provide details using which a firm can understand reason for a loss.
Expenses are recorded as a whole rather than under proper head like direct, indirect, fixed, variable etc.
It doesn't provide tool or information to evaluate cost effective alternatives to consider during expansion or contraction project or initiative by a firm.
We only get information not the decision. Decision and implementation are done by financial management and hence always contains an element of intuitive decision which limits the usefulness accounting.
As we have discussed in earlier section that financial accounting concern with external reporting of financial position of a company. For this purpose a company has to produce corporate report which comprises of:
Out of these reports are Balance Sheet, Profit and Loss account (Income Statement) and Cash Flow statement are three key reports.
All key financial statements are based on the fundamentals of Debit and credits. If all these entries are recorded correctly in relevant account then following must hold true for a business
Assets = Owner's Equity + Liabilities
It provides snapshoot of the financial position of the business, in terms of assets and liabilities, at the end of accounting period. Balance sheet Equation is shown below:
Income Statement (Profit and Loss account)
An income statement summarises the results of business operations during a specific period and shows them in the form of net income or net loss. While a balance sheet is like a still photograph, an income statement is like a moving picture as it is designed to measure the transactions between two balance sheets date.
A simple layout of the income statement represented below:
Cash Flow Statement:
A cash flow statement is a statement designed to indicate changes in financial position on cash basis, between two reporting period. A standard layout of cash flow statement is represented below:
It is of vital importance for the financial management. It is an essentials tool for short term financial analysis. Main advantages of cash flow statements are:
Very useful in evaluating the current cash position of an enterprise.
By disclosing the past behaviour of the cash cycle it helps management controlling use of cash in the future.
It helps management evaluating business ability to its obligations such as repayments of loans, payment to creditors, payment of interest dividend and taxes etc.
It highlights factors responsible for inadequate cash balance despite of an increase in profit or vice versa.
It indicates the cause for change in cash position of an enterprise between two balance sheet dates.
It helps management in preparing cash budget and achieving minimum financial cost and sound financial position.