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ADVANCED DIPLOMA OF BUSINESS BSB60215

Study Support materials for

BSBFIM601 Manage finances

STUDENT HANDOUT

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ELEMENT PERFORMANCE CRITERIA

Elements describe the essential outcomes.

Performance criteria describe the performance needed to demonstrate achievement of the element.

1 Plan for financial management

1.1 Review and analyse previous financial data to establish areas which have generated a profit or loss

1.2 Undertake research to review reasons for previous profit and loss

1.3 Review business plan to establish critical dates and initiatives that will require or generate resources in the next financial cycle

1.4 Analyse cash flow trends

1.5 Review statutory requirements for compliance and liabilities for tax

1.6 Review existing software and its suitability for financial management

2 Establish budgets and allocate funds

2.1 Use previous financial data to determine allocations for resources

2.2 Make informed estimates of new items for inclusion in budget

2.3 Prepare budgets in accordance with organisational requirements and statutory requirements

3 Implement budgets 3.1 Circulate budgets and ensure managers and supervisors are clear about budgets, reporting requirements and financial delegations

3.2 Manage risks by checking there are no opportunities for misappropriation of funds and that systems are in place to properly record all financial transactions

3.3 Review profit and loss statements, cash flows and ageing summaries

3.4 Revise budgets, as required, to deal with contingencies

3.5 Maintain audit trails to ensure accurate tracking and to identify discrepancies between agreed and actual allocations

3.6 Ensure compliance with due diligence

4 Report on finances 4.1 Ensure structure and format of reports are clear and conform to organisational and statutory requirements

4.2 Identify and prioritise significant issues in statements, including comparative financial performances for review and decision making

4.3 Prepare recommendations to ensure financial viability of the organisation

4.4 Evaluate the effectiveness of financial management processes

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Student Study Support Materials

Financial Statements

There are five 5 main types of accounts used in accounting financial statements:

Assets - Things you own

Liabilities - Things you owe

Equity - Overall net worth

Income - Increases the value of your accounts

Expenses - Decreases the value of your accounts

Balance sheet: is a financial statement that shows the assets, liabilities, and owner’s equity at a specific point in time. The data is based on a fundamental accounting equation: assets = liabilities + owners' equity, and is classified under subheadings...

Assets:

Liabilities

Owner’s Equity

Assets and Liabilities’ are divided into current (short-term) and non-current (long term).

Example Balance Sheet

ASSETS Current Assets Cash 20,000 Accounts receivable 15,000 Inventory 150,000 Total Current Assets 185,000 Non-Current Assets Plant and equipment 50,000 Business premises 650,000 Vehicles 70,000 Total Non-Current Assets 770,000 TOTAL ASSETS 955,000 Current Liabilities Accounts payable 25,000 Bank overdraft 10,000 Credit card debt 5,000 Tax liability 30,000 Total Current Liabilities 70,000 Non-Current Liabilities Long term business loan 1 450,000 Long term business loan 2 50,000 Total Non-Current Liabilities 500,000

TOTAL LIABILITIES 570,000 NET ASSETS 385,000 OWNERS EQUITY 385,000

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Profit and Loss

Is a financial statement is used to summarise the amounts of revenues earned, and the expenses incurred by a business or entity over a period of time. This statement includes a summary of how a business typically incurs its revenues and expenses. Usually produced monthly the P & L will inform whether the business made or lost money for the month under review. A profit and loss has five main components:

1. revenue (sales/turnover) 2. cost of goods sold (COGS) 3. gross profit (revenue minus COGS) 4. expenses 5. net profit (gross profit minus expenses)

Formula: Sales – COGS = gross profit – expenses = net profit When reviewing your P & L it is useful to analyse four key benchmarks or performance indicators (KPIs).

Analysis KPI’s Formula

What percentage of the sales price covers the cost of providing or producing the product or service?

COGS as a percentage of sales/revenue

COGS ÷ revenue x 100

Is my business running profitably? Gross profit margin Net profit margin

Gross profit ÷ revenue x 100 Net profit ÷ revenue x 100

What percentage of the sale price covers the fixed costs of my business?

Expenses as a percentage of sales/revenue

Expenses ÷ revenue

Gross profit is an indicator of efficiency. The higher the gross profit margin the better, the business keeps more from each dollar of sales. If the gross profit margin decreases over time the financial manager will need to determine the reason and take action to address the decline. The net profit margin is an indicator of how much profit is made (before tax) from every dollar you spend. A fall in net profit margin generally means the business is paying more in expenses, which needs to be monitored. More profitable businesses generally spend less of their income on expenses. Example Profit and Loss Statement

Total revenue

1,000,000 100%

Less Cost of Goods Sold

426,200 42.6%

Gross Profit

573,800 57.4%

Less Expenses

Accounting and legal fees

11,700

Advertising

15,000

Depreciation

38,000

Electricity

2,700

Insurance

15,200

Interest and bank charges

27,300

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Postage

1,500

Printing and stationery

8,700

Professional memberships

1,800

Rent for premises

74,300

Repairs and maintenance

21,100

Training

6,900

Vehicle operating costs

20,000

Wages and salaries

223,500

Workers compensation

6,500

All other expenses

14,100

Less Total Expenses

488,300 48.8%

Equals Net Profit (BOS)

85,500 8.6%

BOS = before owner’s salary

Financial health indicators

Your P&L and balance sheet can be analysed in more detail to determine key performance

indicators (KPIs) as outlined below.

Analysis KPI Formula

What level of sales do I need to cover all my expenses?

Breakeven point COGS + expenses

Is my business operating profitably? Gross profit margin Net profit margin

Gross profit ÷ revenue x 100 Net profit ÷ revenue x 100

Does my business have too much debt? Debt to income ratio Total liabilities ÷ sales x 100

Can my business survive an economic downturn?

Debt to equity ratio Total liabilities ÷ equity x 100

Can my business afford to pay its bills? Liquidity ratio Current liabilities ÷ current assets x 100

How much working capital should I retain in the business?

Working capital ratio Current assets ÷ current liabilities

Is my business earning a worthwhile return? Return on investment Net profit ÷ equity x 100

How quickly is my stock turning over? Inventory turnover Closing stock ÷ COGS x 365

How many days do customers take to pay their bills?

Inventory turnover Closing stock ÷ COGS x 365

How quickly am I paying invoices? Accounts payable turnover

Accounts payable ÷ COGS x 365

Are my expenses under control? Expenses ratio COGS ÷ revenue

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Here is a basic description of some key balance sheet terms.

Fundamental accounting equation

└ Assets = Liabilities + Owner’s Equity

Assets and residual balance

└ This fundamental equation recognises that a portion of an

organisation’s assets are financed by debt (liabilities) and the residual balance (owner’s equity) represents the right of owners to the

organisation’s assets only after all creditors have been paid.

Balance sheet assets and liabilities

└ Assets and liabilities can be either current or non-current. Within the

asset and liability sections of the balance sheet, items are listed in

terms of their liquidity.

Matching Principle In practice, matching is a combination of accrual accounting and the revenue recognition principle.

The matching principle directs a company to report an expense on its income statement in the same period as the related revenues.

Understanding Cashflow Cashflow is the incomings and outgoings of cash for a business during the time interval specified in its heading and chosen by the business. For example, the heading may state "For

the October 1 to December 31 2015" or "The Financial Year Ended June 30th 2016.

There are normally 3 sections in a cash flow statement, each relating to a different area of the business:

cash flow from operations

cash flow from financing

cash flow from investment.

Cash is different from profit:

A business may be profitable, but have a negative cashflow, therefore not be able to pay its

debts. Many organisations have numerous assets, but minimal accessible cash.

Cash flow from operations: contains the main cash-generating activities of a business, The money earned or spent in the normal day-to-day running of a business will appear in the operations section of the cash flow statement. The largest figure in this section should be the net income generated by sales of the goods or services you provide. Accounts receivable (money owed to you) and accounts payable (money you owe) will also appear in this section. If accounts receivable is increasing at a faster rate than income from sales, you may have a problem managing debtors.

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Cash flow from financing; measures the flow of cash between the business and its owners and creditors. Cash income in this section can include:

any funds borrowed

public issues of shares or bonds Cash expenditure in this section can include:

loan repayments

dividends paid out

re-purchased shares or bonds Cash flow from investment: activities listed in this section generally include purchases or sales of long-term assets, such as property, plant and equipment. The sale or purchase of investment securities would also be included here. How to read a cash flow statement? Depending on the size and complexity of the business, the cash flow statement may include a few or many items. The crucial figure, found at the bottom of the statement, is the net cash flow. Compare this figure with the net cash flow from previous statement. An increase in cash reserves indicates the business is healthy and heading in the right direction. If cash reserves stay roughly the same, there may only be problems if the figure is low. If the cash reserves are decreasing it may be increasingly difficult to pay debts, and the business will be relying more heavily on credit. Immediate action should be taken to resolve whatever issue is causing the cash shortfalls.

Characteristics of the Cashflow Forecast

It reflects when the actual income and expenditure are likely to occur;

Details when the money will enter your bank account and when it will leave;

No non-cash adjustments such as depreciation are included in a cashflow forecast;

Purchase of capital equipment such as machinery, office fit outs and motor vehicle purchases are included in the cashflow forecast, even though they are excluded from the profit and loss. This is because a purchase of such capital items will involve cash out flows in the form of cash deposits and or finance repayments; and

The full year cashflow is usually broken down into months but some businesses will find it more beneficial to prepare their budgets on a fortnightly or weekly basis.

Blank Cashflow example next page.

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Cash Flow for [Business name] in [Financial Year]

CASH FLOW July August September October November December January February March April May June

OPENING BALANCE $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0

Cash incoming

Sales

Asset sales

Debtor receipts

Other income

Total incoming $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0

Cash outgoing

Purchases (Stock etc)

Accountant fees

Solicitor fees

Advertising & marketing

Bank fees & charges

Interest paid

Credit card fees

Utilities (electricity, gas, water)

Telephone

Lease/loan payments

Rent & rates

Motor vehicle expenses

Repairs & maintenance

Stationery & printing

Membership & affiliation fees

Licensing

Insurance

Superannuation

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Income tax

Wages (including PAYG)

More…

Total outgoing $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0

Monthly cash balance $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0

CLOSING BALANCE $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0

Assumptions:

All figures are GST

inclusive.

Use a cashflow worksheet to forecast and record cashflow. If you down load a template the figure will update as you type. The easiest way to prepare a cashflow forecast is to break the task into several steps. Then bring all the information together at the end.

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Business Budgets A budget is a financial plan used to estimate revenues and expenditures for a specific period of time. It is a management and planning tool, not just an accounting document. It assists in the allocation of resources. A budget allocation is the amount of funding designated to each expenditure line. It designates the maximum amount of funding an organization is willing to spend on a given item or program, and it is a limit that is not to be exceeded by the employee authorized to charge expenses to a particular budget line. There are a number of benefits in drawing up a business budget:

manage money effectively

allocate appropriate resources to projects

monitor performance

meet objectives

improve decision-making

identify problems before they occur - such as the need to raise finance or cash flow difficulties

plan for the future

increase staff motivation It is often confusing as to the difference between a budget and a cash flow forecast. They seem to both show similar information yet are both very different and are used in different areas of the business. Both a budget and a cash flow forecast are vital for the accurate financial management of the business.

Characteristics of a Budget

It reflects what plans there are to do with finances for a specified period of time;

Can be prepared on a monthly basis, 12 months in advance or on a weekly budget, say six months in advance;

Focuses on profit;

Different adjustments (non-cash) are often included such as depreciation;

Details the planed objectives of what the business is trying to achieve and is linked to the strategic and business plans of the company;

Provides a benchmark or target to base the business performance monitoring around. Able to can compare what is expected/wanted to happen with what actually happened for any particular month/year etc.

NOT used to monitor the balance of cash in bank accounts The main difference between a budget and a cashflow forecast comes back to the type and timing of transactions. A budget will record the income at the time the invoice was sent whereas cashflow will record when the payment was received into the bank account. It is at this point it is important to consider when customers will pay the invoice. It is quite common for businesses to have customers who pay after the due date of invoice, it is important to understand the “average debtor days” in order to prepare the cashflow as accurately as possible. This will indicate an average of how many days after invoices are sent, payment is received. Understanding the differences between a budget and a cashflow forecasts leads to the management of finances efficiently.

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Plan for Future Growth Businesses often use budgets to plan for future growth and expansions. Capital saved on regular business activities is often placed into a special reserve account designed for use on new business opportunities. Budgeting for growth opportunities ensure the business has capital on hand when needing to make quick decisions for expansion opportunities. The reserves may also be used when business is encountering slow economic times as a safety net for meeting regular business expenses.

STRATEGIC FINANCIAL TASKS

Financial tasks do not end with the balance sheet. There are other financial actions that are critical to the future direction of your business. STRATEGIC FINANCIAL TASKS CHECKLIST

TASK REGULARITY

Set targets for financial performance At least annually

Possible actions:

Consider where you want your business to be in the next year and set targets in line with that.

Work with your CPA and/ or senior staff to help set targets relevant to your industry and your business.

Incorporate targets into your strategic plan, key performance indicators and budgets.

To help set targets for performance, look at how other businesses in your industry perform through industry benchmarks.

Review financial targets against strategic plan and operational budgets at least quarterly.

Alter targets where market or other circumstances dictate.

Consider incorporating non-financial activities in targets, for example measures of throughput, number of sales calls etc.

Use visual displays around the work place to ensure all staff are aware of the key targets and progress against those targets.

Review and analyse financial statements At least annually, preferably quarterly or monthly

Possible actions:

Compare key ratios from your financial statements, such as working capital ratio, stock turnover ratio or profit per employee to averages in your industry. You can get some basic industry benchmarks through www.ato.gov.au or your CPA may be able to help you get access to more detailed industry averages.

Compare performance against financial targets and past performance.

Review actual performance against budget Monthly

Possible actions:

Ask yourself what caused any gap between budget and actual?

Consider how best to overcome any problem.

Undertake sensitivity analysis

Annually

Possible actions:

Ask yourself, what if sales dropped 15 or 20 per cent? Or you lost a major customer? Or a major supplier stopped selling to you? What if your best sales staff resigned? Factor

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answers to such questions into your budget forecasts and risk management strategies.

Possible actions:

Consider where you want your business to be in the next year and set targets in line with that.

Work with your CPA and/ or senior staff to help set targets relevant to your industry and your business.

Incorporate targets into your strategic plan, key performance indicators and budgets.

To help set targets for performance, look at how other businesses in your industry perform through industry benchmarks.

Review financial targets against strategic plan and operational budgets at least quarterly.

Alter targets where market or other circumstances dictate.

Consider incorporating non-financial activities in targets, for example measures of throughput, number of sales calls etc.

Use visual displays around the work place to ensure all staff are aware of the key targets and progress against those targets.

Review and analyse financial statements At least annually, preferably quarterly or monthly

Possible actions:

Compare key ratios from your financial statements, such as working capital ratio, stock turnover ratio or profit per employee to averages in your industry. You can get some basic industry benchmarks through www.ato.gov.au or your CPA may be able to help you get access to more detailed industry averages.

Compare performance against financial targets and past performance.

Review actual performance against budget Monthly

Possible actions:

Ask yourself what caused any gap between budget and actual?

Consider how best to overcome any problem.

Undertake sensitivity analysis Annually

Possible actions:

Ask yourself, what if sales dropped 15 or 20 per cent. Or you lost a major customer? Or a major supplier stopped selling to you? What if your best sales staff resigned? Factor answers to such questions into your budget forecasts and risk management strategies.

Set sales or production targets

Ongoing

Possible actions:

Undertake a break-even analysis to determine what you need to sell before you make a profit.

Prepare profit and loss budget Annually

Possible actions:

Make sure your budget reflects your strategic and financial targets.

Incorporate key findings from your review of your last budget, sensitivity analysis and the break-even analysis.

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Ensure that budget estimates are realistic and have not been “massaged” to fit a desired result.

Prepare cash flow forecast At least annually

Possible actions:

Have your cash flow forecast show the projected cash flows for each month in the 12-month period.

Address any future cash shortages through increasing cash sales, collecting outstanding debts, reducing expenses or through external finance (such as an overdraft facility).

If you decide to seek external finance for any purpose, go to your lender as soon as possible.

Review and update cash flow forecast in light of actual results

Monthly

Possible actions:

Update cash flow forecast to reflect actual events and monitor ongoing cash position.

Review interest rates and conditions on your loans

Annually

Possible actions:

Look at what other lenders are offering and consider whether you should switch lenders.

If considering switching, consider the terms other lenders can offer, not just the interest rate.

Provide financial statements and budgets to lenders

Annually

Comply with repayment schedules Ongoing

Review debt covenants/terms and conditions Ongoing

Possible actions:

Notify your bank immediately if you are in breach of a covenant.

If you are uncertain of your covenants read your loan agreement or ask your bank.

REGULATORY REQUIREMENTS CHECKLIST

REGULATORY REQUIREMENT ACTIONS TO CONSIDER

Income tax return Provide information, including financial statements, to your CPA for review. Highlight large or unusual transactions.

Business Activity Statement (BAS or IAS) If you have difficulties with your BAS or IAS, ask your CPA to complete it or engage a bookkeeper recommended by your CPA.

Australian Securities and Investments Commission annual report (companies only)

Ask your CPA to assist you prepare this.

PAYG withholding payment summary annual report

Perform a test reconciliation in the month before year-end to highlight any processing problems.

PAYG payment statements (group certificate) for employees

Reconcile to your accounts before lodging

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Payroll tax Speak to your CPA if you are unsure whether you have a payroll tax obligation.

Workers’ compensation insurance

salaries for the year.

so, whether they are adequately covered in another way.

Superannuation payments Pay monthly or when you do your pay run.

Fringe benefits tax return Even if not lodging a return, ensure that no relevant transactions are missed and that any employee contributions that should be made are made.

Solvency resolution (companies only) For information on solvency resolutions go to http://asic.gov.au/for-business/running-a-company/annual-statements/

Staff salaries and awards conditions Review staff salaries and conditions to ensure compliance with awards (where appropriate) and other legal requirements.

Government grants If you are in receipt of government grants, ensure you meet your reporting obligations under the grant.

For extra information review CPA GOOD PRACTICE CHECKLIST FOR SMALL BUSINESS http://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/business/good-practice-checklist-small-business.pdf

Introduction to Financial Management

The purpose of Financial Management is to ensure funds are available for the activities a business needs to perform, to meet its objectives. These funds need to be available at the right time for the business to pay for materials, staff, outsourced services, and other operating costs. An understanding of financial management requires knowledge of the relationship between financial management and accounting, accounting principles, and accounting standards.

Meaning of Financial Management and Role of the Financial Manager

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the business. It means applying general management principles to financial resources of the enterprise. Financial Managers are responsible for making sound financial decisions regarding the management for the financial resource of a business. This can be done by collecting and analysing financial data and implementing acceptable management control systems. A financial manager is also required to maintain current knowledge and compliance with relevant statutory and legislative requirements and to apply ethical standards to their decision-making. Financial Management Systems

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Financial management sits between two key accounting fields: Financial accounting and Management accounting. Financial managers will rely on information and approached of both systems to manage the finances of a business.

Financial Accounting

Financial accounting represents specific and prescribed financial reports in accordance with the accounting principles and standards established by the Australian Accounting Standards Board. (AASB) The financial reports or statements are:

The Statement of Financial Performance: also known as the Profit and Loss or sometimes the Income Statement.

The Statement of Financial Position: also known as the Balance Sheet

The target audience for this branch of accounting are external stakeholders such as:

Government agencies

Creditors

Shareholders These are not involved in the day to day running of the business but in the financial results Management Accounting focuses on the day to day internal needs of managers and directors and is used for internal decision making. The process of preparing management reports and accounts that provide accurate and timely financial and statistical information required by managers to make day-to-day and short-term decisions. Financial Accounting which produces annual reports mainly for external stakeholders, management accounting generates monthly or weekly reports for an organization's internal audiences such as department managers and the chief executive officer. They show the amount of available cash, sales revenue generated, amount of orders in hand, state of accounts payable and accounts receivable, outstanding debts, raw material and inventory, and may also include trend charts, variance analysis, and other statistics. Read more: http://www.businessdictionary.com/definition/management-accounting.html#ixzz44pFpGgyt

Objectives of Financial Management The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

To ensure regular and adequate supply of funds to the concern.

To ensure adequate returns to the shareholders this will depend upon the earning capacity, market price of the share and expectations of the shareholders.

To ensure optimum funds utilisation. Once the funds are procured, they should be utilised in maximum possible way at least cost.

To ensure safety on investment, i.e., funds should be invested in safe ventures so that adequate rate of return can be achieved.

To plan a sound capital Structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

About Australian Accounting Standards

The Australian Accounting Standards Board (the Board) is responsible for developing and issuing Accounting Standards applicable to Australian entities and the “care and

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maintenance” of the body of Standards. The Board's functions and powers are set out in the Australian Securities and Investments Commission Act 2001.

Financial reporting and accounting standards

Australian accounting standards are set by the Australian Accounting Standards Board (AASB) and have the force of law for Corporations law entities under s 296 of the Corporations Act 2001. They must also be applied to all other general purpose financial reports of reporting entities in the public and private sectors.

http://www.charteredaccountants.com.au/Industry-Topics/Reporting/Australian-accounting-standards.aspx

Preparing Financial Reporting

Financial reporting for companies, registered schemes and disclosing entities in Australia is governed by the Corporations Act 2001 (Corporations Act). Financial reports which have been prepared in accordance with the law help maintain and promote confidence and integrity in Australia’s capital markets. ASIC runs a financial reporting surveillance program with the aim of improving the quality of financial reporting. We regularly review the annual and interim financial reports of selected listed companies and other significant public interest entities to monitor compliance with the Corporations Act and Australian Accounting Standards. We also review financial reports based on complaints, other intelligence and through our audit inspection program.

Large proprietary company

A proprietary company is defined as large for a financial year if it satisfies at least two of the following paragraphs:

the consolidated revenue for the financial year of the company and any entities it controls is $25 million or more

the value of the consolidated gross assets at the end of the financial year of the company and any entities it controls is $12.5 million or more, and

the company and any entities it controls have 50 or more employees at the end of the financial year

Large proprietary companies must prepare and lodge a financial report and a directors’ report for each financial year. The accounts must be audited unless ASIC grants relief.

Small proprietary company

A proprietary is defined as small for a financial year if it satisfies at least two of the following paragraphs:

the consolidated revenue for the financial year of the company and any entities it controls is less than $25 million

the value of the consolidated gross assets at the end of the financial year of the company and any entities it controls is less than $12.5 million, and

the company and any entities it controls have fewer than 50 employees at the end of the financial year

Some small proprietary companies may have to lodge financial reports in certain circumstances.For more information, see all the information above and more on: http://asic.gov.au/regulatory-

resources/financial-reporting-and-audit/preparers-of-financial-reports/are-you-a-large-or-small-proprietary-company/