SUMMARY NOTES: CHAPTER 10 – FINANCIAL ANALYSIS
Advantages of a formal budgeting system in a company.
- A well-prepared budget will help an organization to set realistic targets across
all departments. Realistic targets place a degree of accountability on
functional management for their departments.
- Where managers are provided with clear targets related solely to their area of
responsibility this may serve to boost their morale, motivating them to work
harder as their own performance can be closely measured against the
budgets set.
- The company may benefit from increased goal congruence as senior
management can convey what is expected of departmental heads while also
improving the understanding of target setting and co-ordination between
departments.
Variance reporting
The initial budget should be adjusted to reflect the actual level of activity and to
ensure that variance calculations are not influenced by the budgeted level of
activity. Separating the variable and constant components of expenses would also
help to identify which costs fluctuate with activity.
Customer satisfaction
Customer satisfaction surveys and feedback forms can be used to monitor praise and
repeat business, and also complaints in order to effect improvements. If feedback
form surveys are acted upon, it will show to the customer that you value their business,
attract loyalty from them and build profitability through repeat customers and
referrals.
THE FINANCE FUNCTION
Impact of technology on finance functions and professionals
- BIG DATA – analyze large amounts of data very quickly and deliver results in
time. This may include financial and non-financial data.
- CLOUD COMPUTING – reduce costs by eliminating the need for in-house
hardware and maintenance staff and offer benefits such as a more intuitive
interface, mobile access and built-in analytics.
- PREDICTIVE ANALYSIS – specialist software can use data to assess probable
future trends.
FINANCIAL ANALYSIS AND DECISION-MAKING TECHNIQUES
FINANCING REQUIREMENTS
Type of decisions:
- Investment – identify investment opportunities and decide which ones should
be accepted.
- Financing – how should the organization be financed in the short or long term.
- Dividend – how much to pay out as dividends to shareholders.
Organizations will need to prepare cash forecasts to understand what funding will be
required in the future.
Consider including sensitivity analysis in their forecast to understand the impact of
changes in certain variables, such as demand or inflation on their future cash needs.
Sensitivity analysis: calculating the effect of changes in certain variables such as
demand or inflation on a forecast
Leading and lagging: raising cash by delaying payments to suppliers and
accelerating receipts from customers
SOURCES OF FINANCE
Can be evaluated using SAF model:
- Suitability: is method of finance appropriate for the use we want to make of it?
- Acceptability: will the method be acceptable to stakeholders, including
current providers of finance?
- Feasibility: can the additional finance be raised?
INVESTMENT APPRAISAL
ROCE – also known as accounting rate of return/return on investment. It can be used
for projects as well as organizations.
PAYBACK – a calculation of how long it will take an investment to pay itself back,
ignoring the time value of money
NPV – a calculation of all cash flows relating to investment, allowing for the time value
of money
IRR – the discount rate that will bring the NPV to 0 for a given set of cash flows.
DEALING WITH RISK AND UNCERTAINTY
Risk: involves situations or events which may or may not occur, but whose probability
of occurrence can be calculated statistically, and the frequency predicated.
Uncertainty: involves situations or events whose outcome cannot be predicted with
statistical confidence.
Expected value: A weighted average value, based on probabilities.
The expected value for a single event can offer a helpful guide for management
decisions. However, evaluating decisions by using expected values has a number of
limitations:
1. The probabilities used when calculating EV are likely to be estimates. They may
therefore be unreliable or inaccurate.
2. EV are long-term averages and may not be suitable for use in situations
involving one-off decisions. This may therefore be useful as a guide to decision
making.
3. EV does not consider the attitudes to risk of the people involved in the decision-
making process. They do not consider all of the factors involved in the decision.
4. The time value for money may not be considered.
Probabilities and EV can be represented diagrammatically using decisions trees in
order to aid decision making.
DECISION TREE: a diagram which illustrates choices and the possible outcomes of
decisions. It shows both the probability and the value of expected outcomes.
COST AND MANAGEMENT ACCOUNTING
STRATEGIC COST MANAGEMENT AND CONTROL
FULL COST: the total amount sacrificed to achieve a particular objective, including
all related costs.
Supports decision making in a number of areas, including:
• Pricing and output – how much should be made and what price charged to
the customer?
• Exercising control – by comparing actual and budgeted performance and
addressing discrepancies
• Assessing efficiency – current processes can be compared with different
locations, or alternative methods of working, to determine the current
efficiency.
• Assessing performance – revenue generated by a product or service can be
compared to its full cost.
FORECASTING
Can help with planning and decision making by making predictions about the
future. They can be qualitative and based on judgment. Techniques including:
1. Delphi technique – selecting a panel of experts, each of whom is asked to
produce an independent forecast. These forecasts are shared, and each
then goes on to produce a revised forecast. The process continues until they
agree, and a definitive forecast is produced.
2. Sales force opinion – involves a sales manager gathering input from the sales
team and collating their opinions into an aggregate forecast.
3. Executive opinion – arise from meetings of high-level managers during which
they develop forecasts based on their own individual areas of responsibility.
4. Market research – involves the use of customer surveys to evaluate potential
demand.
Organizations can also use quantitative techniques, which are based on the use of
historical data to predict the future. They involve the identification of patterns and
variation between variables, including linear regression and time series analysis.
