Financial and Project Management
Basics of financial management
Chapter 2 Financial management
2.1 Financial management disciplines
It is customary to divide financial management into finance and accounting.
Accounting may subsequently be divided into management accounting and
financial accounting.
Corporate finance: It covers not only the question of how the assets of a
company must be finances but also the question of which assets the business
should invest in.
Finance: The selection of assets in which investments are to be made. A
company invests in assets in order to create value – as a result of the production
and sales process.
Accounting:
- Management accounting (internal reporting): Provision of financial
information to the management with the purpose to support this
management in the many decisions that have to be taken in a company.
Cost accounting is an important aspect of this discipline. Setting up and
maintaining a budgeting system is also an important aspect of the
discipline of management accounting, because this system of planning and
control makes it possible to use financial data to monitor whether or not
the company is performing according to expectations and where, if
necessary, company management can intervene.
- Financial accounting (external reporting): Disclosure of information
by the organization’s management to other stakeholders. Financial
accounting is particular comes in the form of disclosure of annual
accounts, like the balance sheet and the profit and loss account. The
purpose of financial accounting is supporting the decision-making process.
Differences between management accounting and financial accounting:
Management Financial accounting
accounting
Target group Management Other stakeholders
Purpose Supporting decision- Supporting decision-
making making, Accountability
Focus Future Past
Regulations No Yes
Tendency towards No Yes
creative accounting
Nature of information Detailed Rough outline
Speed a priority? Yes No
Creative accounting: In external reporting a company’s management may be
tempted to disclose coloured information, for instance by reporting profit figures
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,that are higher than the actual profit. For internal reporting purposes, there is
little point in fooling oneself.
2.2 Relationships with other disciplines
Bookkeeping: In order to provide information, accounting needs basic data,
which is provided by the bookkeeping department of the company. The backbone
of the bookkeeping system is formed by the system of ledger accounts, in which
changes in the company’s assets, debts, revenue and costs are registered.
Company law: Financial accounting is subject to legal rules. These prescribe
which companies are obliged to disclosure information in the form of an annual
report, what this information should consist of and in accordance with what
principles it must be prepared. Besides this, every company is obliged to have a
bookkeeping system.
Tax law: The profit a company makes is subject to taxation.
Organizational behaviour: In order to achieve a manageable company it is
necessary to build an efficient and effective organizational structure in the
company. The process of budgeting and unit cost calculations are influenced by
the organizational structure.
2.3 Job opportunities in financial management
For instance:
- Bookkeeper: Processes purchases and sales, salaries, depreciations etc. in
the bookkeeping department.
- Internal auditor: Checks that the bookkeeping system is functioning
properly, so that the entries are an accurate representations of what
actually goes on in the company.
- Controller: Sees to the overall financial control of the organization (setting
up a system of cost calculation, budgeting, assessing capital budget
projects, preparing annual financial statements).
- Treasures: Is responsible for optimal cash management in the company
and investment of temporarily superfluous cash; makes finance
agreements.
Glossary
Accounting: Providing information about a company.
Bookkeeper: Processes purchases and sales, salaries, depreciations,
etc. in the bookkeeping department.
Controller: Is responsible for setting up a system of cost
calculation, budgeting, and assessment of capital
budgeting projects and for preparing the annual
financial statements.
Creative accounting: Disclosure of figures that present a coloured picture of
the company’s financial position.
Finance: Discipline that deals with the question of how the assets
of a company must be financed, and also of which
assets the business should invest in.
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,Financial accounting: External reporting; the disclosure of information by a
company’s management to other stakeholders in the
company.
Internal accountant: Checks that the bookkeeping system is
functioning properly.
Management accounting: Discipline relating to the provision of information
to a company’s management.
Public accountant: Audits the disclosed financial statements of a
listed company.
Treasurer: Is responsible for optimal cash management in the
company and the investment of temporarily superfluous
cash; makes finance agreements.
Chapter 3 Financial statements
3.1 Investment and finance
Assets are production facilities. We can make a distinction between fixed and
current assets.
- Fixed assets serve a business for a long period (more than one year).
- Current assets are in business for a period shorter than a year.
Assets generate a capital requirement and must be financed.
Equity or owner’s equity has been made available by the owner of the
business. Equity is available to the company for an unlimited period. The reward
for providing equity is the profit. It is up to the owner to decide whether or not
they want to pay the profit out or to retain it, in which case extra equity is
available (retained earnings). As the amount of profit depends on all kinds of
uncertainties involved in running a business, equity is sometimes called risk-
bearing capital.
Credit or debt, commonly referred to as liabilities, has been created by
creditors. Liabilities are temporary; advance arrangement have been made for
them to be repaid. Under normal circumstances a fixed interest is paid on credit.
For this reason liabilities are sometimes characterized as risk-avoiding capital.
3.2 Balance sheet and profit and loss account
At any given moment one can compare, on the one hand, the value of the assets
in which a company has invested and, on the other hand, the way in which these
investments have been financed. This is called a balance sheet.
We can analyse the profit in more detail by looking at the revenue and the costs
that were incurred in a period in question. Such a comparison of revenue and
costs is called a profit and loss account or income statement.
3.3 Profit vs. cash flow
The profit (revenue – costs) over a certain period must not be confused with the
cash flow (receipts – expenditure) over that certain period.
Three factors lead to differences between cash flow and profit:
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, Depreciation
Fixed assets serve a company during a number of years. In order to present a
correct picture of the company’s financial position, the investment that is made
at the time of purchase must not be charged to the profit and loss account in one
go, but must be spread over the lifespan of the asset. There are different
depreciation methods (look at the examples in the book, page 65):
- Straight line depreciation
- Accelerated depreciation
Sum-of-the-years-digits (SYD) method
Declining balance method
- Depreciation on the basis of use
Provisions
Provisions are made against possible future liabilities, which may occur as a
result of operations in the past year. In making a provision, costs are included in
the profit and loss account before any payment is made.
So, cash flow cannot be manipulated, but profits may be adjusted positively or
negatively as a result of exaggeratedly optimistic or pessimistic estimates in
determining provisions. In external reporting there may be a tendency to present
the company’s position in a rosier light than is true. In that case we have
creative accounting.
Direct changes in equity
Earlier we argued that the profit over a certain period is equal to the increase in
owner’s equity in that period. This need not always be the case. If the owner of a
business brings in money or withdraws money from the business, these private
contributions and private drawings must not have any influence on the profit
because they do not stem from business operations.
Glossary
Accelerated depreciation: Depreciation method that allows larger
deductions in early years, trailing off to smaller
deductions in later years.
Assets: Economic resources controlled by a business that
are expected to benefit future operations.
Balance sheet: Financial statement representing the assets,
liabilities and equity of a business at a point in
time.
Equity: Capital provided to the business by its owner(s).
Liabilities: Financial obligations of a business.
Profit and loss account: Financial statement that summarizes the sales
revenue and costs incurred by a business over a
period.
Provisions: Future obligations arising from current business
operations, the exact amount and/or timing of
which is unknown.
Straight line depreciation: Equal amounts are depreciated every year.
Chapter 5 Capital budgeting
5.1 Capital budgeting projects and cash flow
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