Investors Report

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Chapter

Chapter 12

Working Capital Management

12.1 Introduction 163 12.2 Inventory 164 12.3 Trade Receivables 167 12.4 Trade Payables 170 12.5 Cash 171 12.6 Summary 173

Learning Objectives

After completing the study of this unit you should be able to:

• explain the need to manage working capital

• describe the factors to be considered to manage inventory

• describe the factors to be considered to manage trade receivables

• describe the factors to be considered to manage cash

• assess critically different working capital scenarios.

12.1 Introduction

One of the most important tasks managers face today is to make sure that the business has enough short-term assets to keep the business going on a day-to-day basis. It is not enough for a firm to be profitable, since it is possible to make profits and go out of business − this is not uncommon for new firms.

In modern business the only person who pays at the point of purchase is you − the consumer. Business works on credit. If a business gives too much credit, it can fall into the trap of overtrading as illustrated in Figure 12.1.

This unit begins by considering the benefits of the overall budgeting process before looking in detail at its preparation and implementation. Knowledge of the environment, the industrial sector, the resources available and the objectives of the company all need to be integrated in order to develop a meaningful ‘plan of action’.

Figure 12.1 Overtrading

In order to get sales we sell on credit. We also buy goods to sell on credit. At some point we have to pay for our inventory and if we take too long to get cash in we may end up becoming bankrupt.

So how does a business deal with this? The solution is to plan and manage the firm’s working capital.

What is working capital? Working capital is the short-term assets and liabilities of a company.

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Current assets Current liabilities

Inventory Trade payables

Trade receivables

Cash

Net working capital = Current assets − Current liabilities

Working capital management involves decisions about current assets and current liabilities. Their use, mix and level and how working capital should be financed. This is a continuous process.

Working capital is necessary to run a business. Working capital is turned over frequently.

Figure 12.2 Working capital cycle

This cycle is not necessarily synchronised.

12.1.1 Operating Cycle and Cash Conversion Cycle

The operating cycle is the length of time from receiving raw materials to receiving cash from the final product.

The cash conversion cycle is the operating cycle minus the credit period from suppliers.

The length of the operating cycle and the cash conversion cycle is a function of operational management, the business you are in, and financial management. The longer the operating cycle the more finance the business requires.

The aim must be to reduce the operating cycle without affecting other objectives of the business.

12.2 Inventory

The purchase of inventory represents an investment. There are three main types of inventory:

1. raw materials

2. work in progress

3. finished goods

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The type of business will dictate which of these different types of inventory the business will keep. A manufacturing company holds all three types, whilst a retailer would normally hold only finished goods.

12.2.1 Cost of Holding Inventory

The cost of holding inventory must be related to benefits. We can categorise the costs into two areas:

1. Ordering costs

F Admin costs

F Monitoring costs

2. Carrying costs

F Costs over time

F Counting, admin, systems

F Storage and handling

F Obsolesence and deterioration

F Insurance

F Interest charges

These two types of cost vary in indirect proportion to each other. The cheapest way of carrying costs would be to get goods delivered every day, but then the ordering costs would be very high. The cheapest way of ordering costs would be to order a year’s supply all at once but then we have to find room to store all this inventory.

This conundrum has led many companies to adopt just-in-time systems.

12.2.2 Inventory out Costs

We have all suffered the frustration of going to a shop and finding that the item we want is out of stock. In one sense it is easy for a company to measure sales lost because it ran out of inventory. We simply tally up all the orders we have had to refuse because we were ‘out of stock’. What we don’t know is how many associated sales we have lost. How many other things was the person, who was told we didn’t have the first thing they asked for, going to buy?

In a manufacturing concern, the cost of running out of inventory is also difficult to measure. If we run out of raw materials or work in progress we have a delay in the production process and during this delay we still have to pay our worker’s wages. We can also incur costs if the delay means that order is not on time. Either financial penalties now, or loss of orders in the future.

If the company is out of finished goods then the loss is the lost profit on the order we cannot fulfil.

However, the cost of never being out of inventory is high. We have to pay for every square metre of storage space. Inventory can deteriorate if kept too long. It can become obsolete or it can be damaged or stolen. Inventory control becomes necessary. Models are required to determine the optimal inventory levels. Inventory models vary from simple deterministic models to more complex probabilistic models.

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Worked example 12.1

In Chapter 5 you used ratios to analyse company accounts. We will use some of these ratios to analyse working capital

A wholesale firm supplies wine to restaurants and off-licenses.

Annual sales 3600 cases

Inventory 180 cases

Inventory turnover = Sales Inventory =

3600 180 = 20 times per annum

or Inventory × 365

Sales = 180 × 365

3600 = 18.25 days

Both ratios mean exactly the same, but it is a matter of personal preference which one we prefer to use.

Inventory and sales can be given a value, e.g. wine sells for £30 a case.

Annual sales: 3600 × £30 = £108,000 Sales value of inventory: 180 × £30 = £5,400

Inventory turnover in days = Inventory × 365 Sales

= £5 400 × 365 £108 000 = 18.25 days (as above)

This is part of the operating cycle of the business. If we reduce it, we reduce the amount of funding required but do we also reduce sales?

For internal purposes how can this inventory model be improved?

We could have a ratio for each sales type or we could use future sales (budget) rather than past sales. One common approach would be to have a target inventory number of days for each commodity (wine, spirits, beers).

12.2.3 Basic Economic Order Quantity Model

The Basic Economic Order Quantity model (EOQ) is a deterministic model which assumes that there is a known uniform demand and that lead times are known. The model can be made more realistic, but then it becomes more complex.

EOQ - value of Q which minimises total costs (ordering & carrying)

EOQ = √

2 BN C

where:

EOQ = quantity in units B = cost of placing order or set up cost C = annual cost of carrying one unit N = annual demand in units

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Worked example 12.2

A firm sells 3,600 cases of wine.

Ordering costs £31.25 per order

Carry cost £10 per annum per unit

EOQ = √

2 × 31.25 × 3600 10

= 150 units (cases)

Wine should be ordered:

150 × 52 3600

= 2.16

every 2.16 weeks.

If lead time for an order is 2 weeks what is the re-order level?

Q = Lead time × N Weeks in year

= 2 × 3600

52 = 139 cases (round up)

The EOQ model is used by retailers, institutional caterers and by some manufacturers.

In general, Finance wants low inventory and Operations want high inventory. This is an area of conflict between the two functions.

Inventory levels should be determined in conjunction with other variables in the system, such as:

• Prices

• Output levels

• Sales

• Promotions

• Opportunity costs.

We must consider the implications of inventory policy in terms of the firm’s overall objectives:

• Profit

• Growth

• Survival

• Image

• Shareholder wealth maximisation.

12.3 Trade Receivables

When a business grows beyond being very small it will tend to deal with all other businesses on a credit basis. Selling to customers on credit creates a trade receivable in your balance sheet. This is an investment decision and like all investment decisions has an element of risk attached to it. There are a number of benefits and costs associated with this decision.

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• Benefits

F Sales

F Gross profit

• Costs

F Opportunity cost of finance

F Operating cost of control

F Bad debts

An optimal credit policy depends on:

• Credit standard

• Credit terms

• Collection effort.

This policy will be based on evaluation of individual credit applications.

12.3.1 Credit Standards

Credit standards are the criteria used to screen credit applicants. A number of factors need to be considered. How long will a customer take to repay? Will most of the customers pay within the agreed time limit? Will customers default? It would be unusual for a customer to default intentionally, i.e. commit fraud. Most customers who default do so unintentionally, i.e. the reason they don’t pay is because they can’t pay. This could create conflict between Sales and Finance. Sales want to give credit as easily as possible in order to stimulate interest (and earn commission). Finance want to be sure that the money will be forthcoming when payment time comes around

Customers can be ranked 1−10 (say), and then the costs and benefits of extending credit to lower ranked customers can be evaluated. For an example of this, see Worked example 12.3.

Worked example 12.3

Extending credit to riskier sector of customer (10% risk they will not pay up). Should the firm trade?

Benefits

Additional sales £2000

Less 10% bad debt 200

Additional revenue 1800

Costs

Production and selling costs 1200

Collection and interest costs 300 1500

Net incremental profit £300

From this we can see that it is worth risking losing the amount for bad debt because of the overall incremental profit, so we should extend the credit.

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12.3.2 Credit Terms

These will include the length of the credit period and any cash discount that may be available. Cash discount is not, as the name suggests, a discount for paying by cash. If someone paid by cash they would not be part of our trade receivables. Cash discount is given for early payment of an invoice amount.

The length of credit period varies from industry to industry. This can be as little as 7 days and as long as 6 months. The most common credit period is that an invoice will say ‘30 days net’; this means that the invoice should be paid within 30 days. In practice, regular customers will order items all month and receive a statement at the end of a calendar month, showing the balance due and stating the agreed date in the following month when payment will be taken from the customer’s account by direct debit.

Large companies tend to treat small suppliers badly by delaying payment beyond the credit periods agreed. In most countries, the largest company is the government who are frequently proved to be the worst payers! When deciding terms, firms must balance benefit of increased sales against increased costs.

Worked example 12.4

Murdoch Ltd is trying to decide whether cash discount of 2% should be offered to its customers. It is estimated that 50% of customers would take advantage of the discount and that the amount outstanding would fall by £150,000. Annual credit sales for the company are £3,000,000.The company has a cost of capital of 20%.

Benefit - Lower collection period

Earnings on funds released: £150 000 × 20% = £30 000 Cost of discount: Annual sales × % take up × % discount

£3 million × .5 × .02 = £30 000

Therefore, the cost = benefits.

In this case, Murdoch Ltd should review the situation and try to find a more beneficial solution.

12.3.3 Collection Effort

The collection effort involves a number of different areas. Firstly, we have to monitor the level of Trade Receivables. We should know our customers and try to spot problems before they occur. We should also produce an aged trade receivable analysis on a regular basis which should serve as an early warning system. Experience will tell us that the older a debt, the less likely it is to be paid.

We should have regular contact with our customers through statements and if there seems to be a problem we should contact them by phone. If payment is badly in arrears, there are a number of possible courses of action: we could cut off supplies, use a collection agency or take legal action. When taking action, the firm must consider the effect on future customers, as well as the costs involved.

If a regular customer with a good payment record is in arrears, does this suggest some kind of dispute?

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12.3.4 Evaluation of Credit Applications

With credit applications, as with any decision, we gather information, analyse it and then make our decision. There are various sources of the information we require and the amount of information is limited by time, cost and availability.

One possible source of information is the financial statements of the company. However, this information will normally be anything from 6 to 18 months old, and will probably be of limited value. Another source is to go to a credit agency and find out the credit rating of the firm. This will tell us if the firm has a previous history of bad payment. A third source is to get a reference letter from the company’s bank. In general this is a futile exercise since this letter will be very non-committal. The best method is to ask the company for a reference from another supplier. This has the added benefit of usually being someone in the same trade that will be known to us.

There is no magic formula for deciding on credit worthiness. You should look for:

Character − Willingness

Capacity − Ability

Capital − Financial strength

Collateral − Security

Conditions − General economic climate.

12.4 Trade Payables

When we buy goods on credit from our suppliers, this creates a liability on our balance sheet. Trade payables are the opposite of trade receivables. As a company we should aim to hold off payment for as long as we can, while still ensuring that we pay on time.

• Credit terms

F Length of payment: Generally this will be ‘30 days net’ in most circumstances but as previously mentioned most companies work on a monthly statement with direct debit payments on an agreed date the following month.

F Cash discounts: As before, should we pay early and take advantage of this discount?

F Retrospective discounts: This can apply where certain target amounts are reached in a previously agreed time frame. This is ideal for the smaller firm who are unable to take advantage of the discounts available for bulk purchases.

• Cost of trade credit

The amount of trade credit will expand as the volume of purchases expands. The idea of using someone else’s money to fund your business makes trade credit attractive as well as easy to access but is it free? In truth, there is no such thing as ‘free’ in business so like everyone else the supplier bears the cost and passes it on.

A firm with cash will be able to negotiate better prices, and a firm with a lot more cash will negotiate a lot better price!

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There are other sources of short-term funds available to a firm:

• Spontaneous

F Trade credit

F Accrued expenses

• Negotiated

F Bank credit

F Bills of exchange

F Factoring.

12.4.1 Operating Cycles

Different types of business have different operating cycles and the way they pay their debts and receive monies due has a large bearing on the length of operating cycle they have.

Worked example 12.5

Let us look at a typical supermarket as an example.

Operating cycle of typical supermarket.

Stock days 14

Receivable days 1

Payable days 30

Cash operation cycle (15)

Who is funding the business? Why do suppliers allow supermarkets to do this?

Basically because they have no choice. Companies cannot afford to refuse to supply a supermarket and cut off one of their biggest markets.

12.5 Cash

12.5.1 Management of Cash

One of the hardest questions in business is: How much cash should a firm have?

There is no easy answer because we have to make a subjective assessment of the future.

We must balance liquidity and profitability. If the company is too liquid, we have too much cash and an opportunity to invest this surplus cash is lost.

If we have too little cash, the company could have difficulty with payments which could lead to ultimate bankruptcy.

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12.5.2 Why Hold Cash?

According to economic theory (first brought to our attention by Keynes in the 1930s), we hold cash for three reasons:

1. Transaction motive

2. Precautionary motive

3. Speculative motive.

The cycle of working capital means that cash will be required for 1.

The unpredictable nature of business and the environment requires a balance is kept for 2.

Few firms hold cash for 3.

If we have too little cash we could have difficulty with payments which ultimately could lead to bankruptcy.

We must beware of idle cash balances − companies with lots of cash are often the target of much takeover activity, much of this attention being unwelcome.

The key to successful cash management is cash budgeting which was covered in Unit 4. This highlights crucial traits like seasonality and any surplus funds available.

We can also calculate borrowing required by analysing planned elements, such as:

Sales − payments

Purchases − operating cycle

Other income − timing

Payment of expenses.

Cash problems are physical as well as theoretical. Cash has no loyalty or affiliation (a credit card or chequebook can easily be identified to the owner), and also places temptation in the way of many employees.

Attention to detail of physical and electronic cash flows can improve the cash balance and therefore reduce costs. We should deposit cash as soon after receipt as possible. Remember that cheques take time to work through the clearing system.

Worked example 12.6

Annual turnover £20m (all on credit)

250 working days: £80,000 per day

Interest rate 8%

Deposits are one day faster.

− £80 000 × .08 = £6400

Annual increase in profit and one off increase in cash balance of £80,000.

In order to manage working capital successfully a company must manage all the different elements in tandem. We must ensure every part of the system is working effectively.

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12.6 Summary

In this unit you have studied one of the most important decision-making areas for management today − the need to manage working capital.

You are aware that:

• working capital management is part of the day-to-day running of a business

• this involves keeping a careful balance between the various elements of working capital.

It is vital, therefore, for management to appraise themselves of the key factors involved in the cash conversion cycle.

You have considered the pros and cons of the four main elements of working capital manage- ment:

• inventory

• trade receivables

• trade payables

• cash.

We concluded proper management of all the elements of working capital is vital for a business to survive.

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175

Index

accounting concepts 11, 14 accounting conventions 11,

accounting information characteristics 8, 10

accounting policies 4 accounting rate of return

(ARR) 154–155 accounting standards

regulatory framework 42–43

Accounting Standards Board (ASB), regulatory frame- work 42

accruals, accounting concept 13

acid test, ratio analysis 62 administration overhead,

cost accounting 90 annual accounts, annual

reports 4 annual general meeting

(AGM), annual reports 6

annual reports 1, 6 AGM 6 annual accounts 4 audit report 5 Chairman’s statement 2 Chief Executive’s state-

ment 3 Directors’ report 3–4 environment report 5 five-year record 5 OFR 2

assets accounting concept 14 classification 19 current 39 financial statements 17 non-current 39

associates, consolidated financial statements 44

attitude to risk, decision- making 133

auditors, external 41 audit report, annual reports

authorised share capital 35

bad debts, accounting concept 13

Balanced Scorecard criticisms 142

Balanced Scorecard, man- agement accounting 138, 142

balance sheet accounting concept 14 financial statements 15,

31, 38–39 layout 20 worked example 23, 30

beer wholesale business, financial statements 23, 30

benchmarking, management accounting 85

‘blue-chip’ companies, dividends 37

breakeven analysis contribution 111, 113 cost behaviour 111, 114

breakeven point 113–114 budgets/budgeting

cash budgeting 49, 53 coordination 165

business entities, types of 33–34

business segment analysis segmental reporting 78,

worked example 79–80

capital accounting concept 14 share capital 35

capital investment 151, 162 ARR 154–155 cost of capital 155–156 DCF 155–156 discounting 155 forecast, cash budgeting

IRR 155, 159, 161 NPV 155–156, 161 payback 152 time value of money 155–

156

worked examples 151, 161

cash importance 49 payments 49 receipts 49

v. profit 47, 57 cash and cash equivalents,

cash flow statements 55 cash budgeting 49, 53

benefits 49, 56–57 cash flow statements 53,

constructing a cash budget 49, 53

forecasting 50 furniture business 51, 53 worked example 51, 53

cash flow, cash budgeting 49, 53

cash flow statements cash and cash equivalents

cash budgeting 53, 57 financial statements 14 financing activities 56 format 54–55 investing activities 56 objective 54 operating activities 55

cash management 171 Chairman’s statement 2 charities/political parties,

users, financial reporting 8

Chief Executive’s statement 3

claims, financial statements 17, 19

committed costs decision-making 120, 122

Companies Act 41 key elements 41

company tax, financial state- ments 36

comparability/consistency, accounting information 10

comparisons, ratio analysis 71

competitors, users, financial reporting 7

completeness, accounting information 10

comprehensibility, account- ing information 9

computer transaction, profit v cash 47, 49

concepts, accounting 11, 14

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176

consistency, accounting concept 14

consistency/comparability, accounting information 10

consolidated financial state- ments 43, 45

contribution breakeven analysis 111,

113

cost behaviour 111, 113 control

management accounting 84–85

conventions, accounting 11, 14

coordination, budgets/budgeting 165

corporate governance defining 3 financial reporting 3

corporate income tax 36 cost accounting 88, 99

administration 90 cost analysis 91 overheads 89, 91, 99 period costs 90–91 product costs 90–91 production overhead 89 selling and distribution

overhead 90 worked example 88, 90

cost analysis, cost account- ing 91

cost behaviour breakeven analysis 111,

114

contribution 111, 113 decision-making 107, 117 fixed costs 108, 111 semi-variable costs 109,

111

variable costs 109, 111 worked examples 107–

108, 110 cost/benefit analysis, man-

agement accounting 88 cost-benefit/timeliness,

accounting information 9

cost efficiency, management accounting 86

cost of capital, capital investment 155–156

costs committed 120, 122 decision-making 120, 124

incremental 120, 122–123 opportunity 120, 123–124 sunk 120–122

credit, accounting concept 14

credit standards worked examples 168

credit terms worked examples 169

criticisms Balanced Scorecard 142

current assets 39 current liabilities 20, 39 current ratio, ratio analysis

customers, users, financial reporting 7

cycle time, management accounting 86

debit, accounting concept 14

debt ratio, ratio analysis 65 decision-making

attitude to risk 133 committed costs 120, 122 cost behaviour 107, 117 costs, relevant 120, 124 incremental costs 120,

122–123 limiting factors 124, 130 management accounting

84, 87–88 model 131, 133 objectives 120 opportunity costs 120,

123–124 qualitative factors 134 relevant costs 120, 124 relevant information 119,

135

risk 133 sunk costs 120–122 uncertainty 130, 133 worked examples 107–

108, 114, 116, 119, 125, 133

direct expenses, cost accounting 89

direct labour, cost account- ing 89

direct materials, cost accounting 88

Directors’ report 3–4 discontinued operations,

performance measure- ment 74, 76

discounted cash flow (DCF) 155–156

discounting, capital invest- ment 155

dividend payout, ratio ana- lysis 70

dividend per share, ratio analysis 70

dividends ‘blue-chip’ companies 37 financial statements 37

dividend yield, ratio analysis 70

double-entry bookkeeping, accounting concept 14

duality, accounting concept 14

earnings per share (EPS) 70 economic value added

(EVA) 142, 147 adjustment 143 bonus bank 143 criticism 147

efficiency, ratio analysis 62– 63

employees, users, financial reporting 7

entities, types of business 33–34

entity, accounting concept 13

environment report, annual reports 5

EOQ worked examples 167

equity financial statements 39–

statement of changes in equity 40

European Union, regulatory framework 41

expenses accounting concept 14 financial statements 21–

22, 36 sources 21

external auditors, regulat- ory framework 41

external benchmarking, management accounting 85

financial reporting 1, 10 annual reports 1, 6 characteristics, account-

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177

ing information 8, 10 reflective exercises 8 requirements summary 1 users 6, 8 Vodafone plc 1, 8

Financial Reporting Council (FRC), regulatory frame- work 42

Financial Reporting Review Panel (FRRP), regulatory framework 43

financial statements 14, 30 accounting concepts 11,

basic 11, 31 beer wholesale business

23, 30 consolidated 43, 45 IAS1 4 interpreting 59, 72 limited liability companies

35, 40 overview 14, 16 ratio analysis 60, 71 ratio analysis limitations

real ale business 23, 30 shareholders’ investment

ratios 70–71 worked example 23, 30

financial v management accounting 82–83 legal require-

ments/regulations 82

level of detail/accuracy 82 nature of the reports 82 range of information 83 reporting timescale 82 time horizon 83

financing activities, cash flow statements 56

five-year record, annual reports 5

fixed costs cost behaviour 108, 111 semi-variable costs 109,

111

worked examples 107– 108, 110

flexibility/innovation, man- agement accounting 86

forecasting, cash budgeting 50

furniture business, cash budgeting 51, 53

gearing, ratio analysis 65 generally-accepted account-

ing practice (GAAP) 41 general public, users, finan-

cial reporting 7–8 global operations, perform-

ance measurement 73, 80

going concern, accounting concept 12

government, users, financial reporting 8

gross profit (GP) defining 23 financial statements 23 ratio analysis 60

guitar business, decision- making 131, 133

high-low method, semi- variable costs 110

historic cost, accounting concept 12

human resources, manage- ment accounting 87

income, accounting concept 14

income statement discontinued operations

financial statements 15, 21, 23, 30, 35–36

format 22, 30, 35–36, 75 performance measure-

ment 75 worked example 23, 30

incremental costs decision-making 120, 122–

123

worked example 123 indirect labour, cost

accounting 89 indirect materials, cost

accounting 88 inflation, accounting

concept 12 innovation/flexibility, man-

agement accounting 86 intangible assets, accounting

concept 12 interest cover, ratio analysis

internal benchmarking, man- agement accounting 85

internal rate of return (IRR), capital investment 155,

159, 161 International Accounting

Standards segmental reporting (IFRS

8) 76 International Accounting

Standards Board (IASB) 43

International Accounting Standards (IASs) 43 EPS (IAS 33) 70 financial statements

(IAS1) 4 International Financial

Reporting Standards (IFRSs) 43

interpreting financial state- ments 59, 72

inventory 164, 167 cost 165–166 worked examples 166

inventory forecast, cash budgeting 50

investing activities, cash flow statements 56

investment analysts, users, financial reporting 8

investors/shareholders, users, financial report- ing 6–7

issued share capital 35

job and service costing 99, 104

worked examples 100, 104

joint ventures, consolidated financial statements 45

legal issues Companies Act 41 limited companies 34 regulatory framework 40,

substance over form 14 UK company law 41

legal require- ments/regulations, fin- ancial v management accounting 82

lenders, users, financial reporting 8

level of detail/accuracy, financial v management accounting 82

liabilities accounting concept 14

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178

classification 20 current 20, 39 non-current 20, 39

limitations, ratio analysis 71 limited companies, business

entity type 34 limited liability companies

33, 45 financial statements 35,

limiting factors decision-making 124, 130 multiple 126, 130 worked example 125, 130

liquidity, ratio analysis 62, 69

management accounting 81, 105

approach 81 Balanced Scorecard 138,

142

benchmarking 85 control 84–85 cost accounting 88, 99 cost/benefit analysis 88 cost efficiency 86 cycle time 86 decision-making 84, 87–88 financial v management

accounting 82–83 human resources 87 innovation/flexibility 86 job and service costing

99, 104 legal require-

ments/regulations 82

level of detail/accuracy 82 manufacturing 87 nature of the reports 82 non-financial perform-

ance indicators 86 performance measure-

ment 85 planning 83, 85 purchasing 87 purposes 83, 88 quality 86 range of information 83 reporting timescale 82 resource allocation 88 selling/marketing 87 SWOT analysis 84–85 time horizon 83 TQM 86

management systems performance manage-

ment 138 managers/directors, users,

financial reporting 8 manufacturing, management

accounting 87 materiality, accounting

concept 13 miscellaneous forecasts,

cash budgeting 50 money measurement,

accounting concept 11–12 multiple limiting factors 126,

130

nature of the reports, fin- ancial v management accounting 82

net assets, segmental ana- lysis 76

net present value (NPV), capital investment 155– 156, 161

net profit defining 23 financial statements 23

non-current assets 39 non-current liabilities 20, 39 non-financial performance

indicators, management accounting 86

notes to the accounts 4 nuts/bolts manufacturer,

ratio analysis 66, 69

objectives cash flow statements 54 decision-making 120

operating activities, cash flow statements 55

operating and financial review (OFR) 2

operating expenses, ratio analysis 61

operating profits, ratio ana- lysis 61

opportunity costs decision-making 120, 123–

124

worked example 124 ordinary shares 35 overheads

absorption rates 96, 98 administration 90 allocating 91, 99 apportionment 92, 94 charging to jobs 98–99 collecting overhead costs

cost accounting 89, 91, 99 production 89 selling and distribution 90 service departments 94,

worked examples 93, 99

partnerships, business entity type 34

payback capital investment 152 worked example 153

performance management 137, 147 management systems 138

performance measurement 73, 80 discontinued operations

74, 76 global operations 73, 80 income statement 75 management accounting

non-financial perform- ance indicators 86

segmental reporting 76, 80

Sportsequip Ltd 73, 80 worked examples 74, 79–

period costs, cost account- ing 90–91

periodicity, accounting concept 14

planning management accounting

83, 85 policies

accounting policies 4 political parties/charities,

users, financial reporting 8

preference shares 35 price earnings ratio (P/E

ratio), ratio analysis 71 product costs, cost

accounting 90–91 production overhead, cost

accounting 89 profitability, ratio analysis

60, 62 profit and loss account 40 profit or loss, segmental

analysis 76 profits

dividends 37–38

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179

GP 23 net 23 profit for the period 37 retained 37–38 v. cash 47, 57

prudence, accounting concept 13

purchasing, management accounting 87

qualitative factors, decision- making 134

quality management accounting

range of information, fin- ancial v management accounting 83

ratio analysis acid test 62 comparisons 71 creditors’ payment period

current ratio 62 debtors’ collection period

debt ratio 65 dividend payout 70 dividend per share 70 dividend yield 70 efficiency 62–63 EPS 70 financial statements 60,

gearing 65 interest cover 65 limitations 71 liquidity 62, 69 long-term

solvency/stability 63, 69

nuts/bolts manufacturer 66, 69

operating expenses 61 operating profits 61 P/E ratio 71 profitability 60, 62 ROCE 61 shareholders’ investment

ratios 70–71 short-term

solvency/liquidity 62–63

solvency 62, 69 stock turnover 63, 71 Thomson Ltd 66, 69

trends 71 ’window dressing’ 71 worked example 63–64

real ale business, financial statements 23, 30

realisation, accounting concept 13

reflective exercises financial reporting 8

regulatory framework 40, 43 relevance, accounting

information 9 relevant costs, decision-

making 120, 124 relevant information,

decision-making 119, 135 reliability, accounting

information 9 reporting timescale, fin-

ancial v management accounting 82

reserves financial statements 39–

revaluation 39 resource allocation, man-

agement accounting 88 retained profits 37–38 return on capital employed

(ROCE), ratio analysis 61 revaluation reserves 39 revenue

financial statements 21 segmental analysis 76 sources 21

risk attitude to 133 decision-making 133 worked example 133

sales forecast, cash budget- ing 50

segmental analysis, seg- mental reporting 76, 78

segmental reporting business segment analysis

78, 80 IFRS 8 76 performance measure-

ment 76, 80 segmental analysis 76, 78

selling and distribution over- head, cost accounting 90

selling/marketing, manage- ment accounting 87

semi-variable costs cost behaviour 109, 111

high-low method 110 service and job costing 99,

104

worked examples 100, 104

share capital 35 categories 35 ordinary shares 35 preference shares 35

shareholders’ investment ratios, ratio analysis 70– 71

shareholders/investors, users, financial report- ing 6–7

share premium 35 share premium account 39 short-term

solvency/liquidity, ratio analysis 62–63

sole trader, business entity type 33–34

solvency, ratio analysis 62, 69

Sportsequip Ltd, perform- ance measurement 73, 80

standards, accounting regulatory framework

42–43 statement of changes in

equity, financial state- ments 40

statements Chairman’s 2 Chief Executive’s 3

Stern Stewart’s EVA 142, 147 Stock Exchange, regulatory

framework 41 stock turnover, ratio ana-

lysis 63, 71 subsidiaries, consolidated

financial statements 44 substance over form,

accounting concept 14 sunk costs

decision-making 120–122 worked example 121–122

suppliers, users, financial reporting 7

tax company tax 36 corporate income tax 36

Thomson Ltd, ratio analysis 66, 69

time horizon, financial v

enu-fmd-bk-en-GB January 6, 2015 - 15:22 184

180

management accounting 83

timeliness/cost-benefit, accounting information 9

timescale, reporting, fin- ancial v management accounting 82

time value of money, capital investment 155–156

total quality management (TQM) quality 86

trade payables 170–171 operating cycles 171

trade payables forecast, cash budgeting 50

trade receivables 167, 170 collection effort 169 credit standards 168–169 credit terms 169

trade receivables forecast, cash budgeting 50

trends, ratio analysis 71 types of business entities

33–34

UK company law, regulatory framework 41

uncertainty decision-making 130, 133 worked example 131, 133

Urgent Issues Task Force (UITF), regulatory frame- work 43

users, financial reporting 6, 8

charities/political parties 8

competitors 7 customers 7 employees 7 general public 7–8 government 8 investment analysts 8 investors/shareholders

6–7 lenders 8 managers/directors 8 political parties/charities

shareholders/investors 6–7

suppliers 7

variable costs cost behaviour 109, 111

semi-variable costs 109, 111

worked examples 107– 108, 110

Vodafone plc, financial reporting 1, 8

’window dressing’, ratio analysis 71

worked examples balance sheet 23, 30 business segment analysis

79–80 capital investment 151,

161

cash budgeting 51, 53 cost accounting 88, 90 cost behaviour 107–108,

110

credit standards 168 credit terms 169 decision-making 107–108,

114, 116, 119, 125, 133 EOQ 167 financial statements 23,

fixed costs 107–108, 110 income statement 23, 30 incremental costs 123 inventory 166 job and service costing

100, 104 limiting factors 125, 130 opportunity costs 124 overheads 93, 99 payback 153 performance measure-

ment 74, 79–80 ratio analysis 63–64 risk 133 service and job costing

100, 104 sunk costs 121–122 uncertainty 131, 133 variable costs 107–108,

110

working capital management 163, 173