Understanding Finance to Influence Strategic Decisions

Introduction• New business leaders and managers have to develop at least basic skills in

financial management. Expecting others in the organization to manage finances is clearly asking for trouble. Basic skills in financial management start in the critical areas of cash management and bookkeeping, which should be done according to certain financial controls to ensure integrity in the bookkeeping process. New leaders and managers should soon go on to learn how to generate financial statements (from bookkeeping journals) and analyze those statements to really understand the financial condition of the business. Financial analysis shows the "reality" of the situation of a business -- seen as such, financial management is one of the most important practices in management. This topic will help you understand basic practices in financial management, and build the basic systems and practices needed in a healthy business.

The Strategic Financial Decision-Making Framework

• Capital investment is the springboard for wealth creation. In a world of economic uncertainty, the investors want to maximize their wealth by selecting optimum investment and financial opportunities that will give them maximum expected returns at minimum risk.

• Since management is ultimately responsible to the investors, the objective of corporate financial management should be to implement investment and financing decisions which should satisfy the shareholders by placing them all in an equal, optimum financial position.

• The satisfaction of the interests of the shareholders should be perceived as a means to an end – maximization of shareholders’ wealth.

• Since capital is the limiting factor, the problem that the management will face is the strategic allocation of limited funds between alternative uses in such a manner, that the companies have the ability to sustain or increase investor returns through a continual search for investment opportunities that generate funds for their business and are more favorable for the investors.

• Therefore, all businesses need to have the following three fundamental essential elements:– A clear and realistic strategy;– The financial resources, control and systems to

see it through; and– The right management team and processes to

make it happen.

Strategy

A method or plan chosen to bring about a desired future, such as achievement of a goal or solution to a problem.(businessdictionary.com).

Strategy

"Strategy is the direction and scope of an organization over the long-term: which

achieves advantage for the organization through its configuration of resources within a challenging environment, to

meet the needs of markets and to fulfill stakeholder expectations".

(Johnson and Scholes)

Strategy

“A general direction set for the company and its various components to achieve a desired state in the future. Strategy results from the detailed strategic planning process”. (managementstudyguide.com)

Strategy

A strategy is all about integrating organizational activities and utilizing and allocating the scarce resources within the organizational environment so as to meet the present objectives. While planning a strategy it is essential to consider that decisions are not taken in a vacuum and that any act taken by a firm is likely to be met by a reaction from those affected, competitors, customers, employees or suppliers.

This is the long term direction and scope of an organization to achieve competitive advantage through the configuration of resources within a changing environment for the fulfillment of stakeholder’s aspirations and expectations.In an idealized world, management is ultimately responsible to the investors. Investors maximize their wealth by selecting optimum investment and financing opportunities, using financial models that maximize expected returns in absolute terms at minimum risk.

• What concerns the investors is not simply maximum profit but also the likelihood of it arising: a risk-return trade-off from a portfolio of investments, with which they feel comfortable and which may be unique for each individual.

• Strategic financial management combines backward-looking, report-focused discipline of accounting with the more dynamic, forward-looking subject of financial management.

• It is basically about the identification of the possible strategies capable of maximizing an organization’s market value. It involves the allocation of scarce capital resources among competing opportunities.

• It also encompasses the implementation and monitoring of the chosen strategy so as to achieve agreed objectives.

• This is the portfolio constituent of the corporate strategic plan that embraces the optimum investment and financing decisions required to attain the overall specified objectives.

• In this connection, it is necessary to distinguish between strategic, tactical and operational financial planning.

• While strategy is a long-term course of action, tactics are intermediate plans, while operational are short-term functions.

• Irrespective of the time horizon, the investment and financial decisions functions involve the following functions:– Continual search for best investment

opportunities– Selection of the best profitable opportunities– Determination of optimal mix of funds for the

opportunities– Establishment of systems for internal controls– Analysis of results for future decision-making.

Key Decisions

• Financial Decisions– This deals with the mode of financing or mix of

equity capital and debt capital. If is possible to alter the total value of the company by alteration in the capital structure of the company, then an optimal financial mix would exist – where the market value of the company is maximized.

Key Decisions

• Investment Decisions– This involves the profitable utilization of a firm’s

funds especially in long-term projects. Because the future benefits associated with such projects are not known with certainty, investment decisions necessarily involve risk.

– The projects are evaluated in relation to their expected return and risk.

– These are the factors that ultimately determine the market value of the company.

– To maximize the market value of the company, the financial manager will be interested in those projects with maximum returns and minimum risk.

– An understanding of cost of capital, capital structure and portfolio theory is a prerequisite here.

Key Decisions

• Dividend Decisions– Dividend decision determines the division of

earnings between payments to shareholders and reinvestment in the company.

– Retained earnings are one of the most significant sources of funds for financing corporate growth, dividends constitute the cash flows that accrue to shareholders.

– Although both growth and dividends are desirable, these goals are in conflict with each other.

– A higher dividend rate means less retained earnings and consequently, slower rate of growth in future earnings and share prices.

– The finance manager must provide reasonable answer to this conflict.

Key Decisions

• Portfolio Decisions– Portfolio analysis is a method of evaluating

investments based on their contribution to the aggregate performance of the entire corporation rather than on the isolated characteristics of the investment themselves.

– When performing portfolio analysis, information is gathered about the individual investments available, and then chooses the projects that help to meet all of our goals in all of the years that are of concern.

– Strategic Portfolio Management takes the insights gained form portfolio analysis and integrates them into the decision-making process of a corporation.

Interface of Financial Policy and Strategic Management

• “The starting point of an organization is money and the end point of that organization is also money.” – this fact must be appreciated so that the interface of strategic management and financial policy will be clearly understood.

• No organization can run an existing business and promote a new expansion project without a suitable internally mobilized financial base or both internally and externally mobilized financial base.

• Sources of finance and capital structure are the most important dimensions of a strategic plan. The generation of funds may arise out of ownership capital and/or borrowed capital.

The Decision-Making Process

The Decision Making Process

• Definition:•A set of eight steps that begins with identifying a problem; it moves through selecting an alternative that can alleviate the problem and concludes with evaluating the decision’s effectiveness

• This process can be used to describe both individual and group decisions.

The Decision Making Process

Identificationof aProblem

Identificationof DecisionCriteria

Allocationof Weightsto Criteria

DevelopmentofAlternatives

AnalysisofAlternatives

Selectionof anAlternative

Implementationof theAlternative

EvaluationofDecisionEffectiveness

Step 1: Identification of a Problem

• A Problem: a discrepancy between an existing and a desired state of affairs.

• In real world, most problems are not clear.. Thus, problem identification is not simple.

• Also, problem identification is subjective.• Furthermore, managers who mistakenly solve the wrong

problem are not different from those who don’t solve it!.

How Can Managers Identify Problems?

• They need to make comparisons between current state of affairs AND some standard

• The standard can be:– past performance.– previously set goals.– the performance of some other unit within the

organization or some other organization.

Step 2: Identification of Decision Criteria

• Here, we select specific criteria that we will use in making the decision. The criteria include: price, weight, size, number of employees, hours needed ... etc.

• Decision Criteria (single is criterion): factors that are relevant in a decision.

• Every decision making has a criteria whether explicitly stated or not.

• If a factor is not included, it’s considered irrelevant.

Step 3: Allocation of Weights to Criteria

• In this step, we give weights to the criteria identified in the previous step

• A simple approach: Give 10 to the highest important factor, and then assign weight the rest against that standard

• For example: if you give another criterion 5, the standard is twice as important

• Mainly, you use your personal preferences. In a more studied decisions, you will use data, statistics, studies, analysis, and research

Important Criteria and Weights in a Car-Buying Decision

Criterion Weight

Price 10

Interior Comfort 8

Durability 5

Repair Record 5

Performance 3

Handling 1

Step 4: Development of Alternatives

• Here, we list all the alternatives that could succeed in solving the problem.

• We only list them, without evaluating them.

Step 5: Analysis of Alternatives

• Each alternative is evaluated by appraising it against the criteria.

• The strengths and weaknesses of each alternative become both evident as we compare them to the criteria and weights established in step 2 and step 3.

• The assessment is clearly a personal judgments.

Assessment of Possible Car Alternatives

Alternative

Initial Price

Interior Comfort

Durability

Repair Record

Performance

Handling

Mazda C230 5 6 9 10 7 7 44

Isuzu Ascender 7 6 8 6 5 6 38

BMW 335 9 7 6 4 4 7 37

Toyota Camry 6 5 10 10 6 6 43

VW Passat 8 6 6 5 7 8 40

What if?• If one alternative scored 10 on every criterion, we

wouldn’t need to consider the weights.• Similarly, if the weights were all equal, you could

evaluate each alternative merely by summing up the appropriate lines.

Evaluation of Car Alternatives:Assessment Criteria x Criteria Weight

Alternative

Initial Price[10]

Interior Comfort

[8]Durability

Repair Record

[5]Performance

[3]Handling

[1]Total

Mazda C230 5 50 6 48 9 45 10

50 7 21 7 7 221

Isuzu Ascender 7 70 6 48 8 40 6 30 5 15 6 6 209

BMW 335 9 90 7 56 6 30 4 20 4 12 7 7 215

Toyota Camry 6 60 5 40 10 50 10

50 6 18 6 6 224

VW Passat 8 80 6 48 6 30 5 25 7 21 8 8 212

Step 6: Selection of an Alternative

• Here, we choose the best alternative among those assessed

• We merely choose the alternative that scored the highest score in step 5

• In our example: Toyota Camry

Step 7: Implementation of the Alternative

• Decision implementation: putting a decision into action

• This includes conveying the decision to those affected and getting their commitment to it

Step 8: Evaluation of Decision Effectiveness

• Managers appraise the result of the decision to see whether it has corrected the problem; did the alternative chosen in step 6 and implemented in step 7 accomplish the desired result?.

Learning Outcomes• Decision making is a process of eight steps.• Managers use criteria to make decisions, whether

they mention them or not.• Managers should make alternatives and evaluate

them based on the criteria.• Managers need to evaluate their decisions to make

sure they are solving the right problem.

Addressing Financial Management Challenges

Today’s Discussion

• Outline the key public sector financial management issues, especially during a global economic slow-down.

• Describe the leadership role that the controllership function and the financial community must play in supporting the decision-makers through this challenging time.

• Provide some thoughts on how the financial function may need to transform to support the emerging economic and public sector environment.

Key Messages• An effective controllership function is forward looking, acting

as the business’s “head lights”: scanning the environment, anticipating issues and seeking effective resolutions.

• Controllership must be involved in the front-end of the decision-making process helping to assess options and thereby contribute to successful implementation.

• Controllership function must balance a professional understanding with practical skills in advanced management accounting, risk management, process and structure cost control, and revenue management.

What is Controllership and Why is it Challenging?

What is (Financial) Controllership?• Controllership is:

– ethical behaviour;– conscious managing of risks;– clear lines of accountability;– stewardship of resources; and,– reporting and evaluation of results against stated objectives.

Why Controllership is important?• Accountability to the public. • Stability and transparency. • Ensures compliance against stated standards.• Enables efficient and effective use of public resources.• Defines roles and responsibilities.• Enables performance measurement against agreed

expectations.• Fulfills legal obligations and mandate.

Why is Controllership Challenging?

• Equal Footing: financial/controllership analysis not always on an equal footing to policy, operational and communication considerations, in the decision-making process.

• Management Perceptions: controllership seen by management as “end state” technical process rather being critical to transparency and accountability.

• Credible Information: ability to produce timely, reliable, usable and accurate financial and risk information to decision-makers.

• Communication: providing clear and accessible financial/controllership information to line-management.

• Capacity: revitalizing financial capacity by attracting, retaining and developing financial/controllership talent.

Key Principles in the Controllership’s Evolution

• Supporting the evolution of the Controllership function are four key principles:

– Credibility – a trusted business advisor, providing accurate, timely and reliable financial information and advice;

– Competence – combine business knowledge with financial expertise to optimize value added;

– Commitment – a shared commitment to the goals of financial management and effective program service and delivery; and

– Communication – open communication across government, with external professional organizations and counterparts in other jurisdictions.

“Think globally, act locally”

Controllership’s Transformation in Challenging Economic Times

Key Challenges New Economic Challenges • Borderless global economic recession, where governments have a role

supporting families, jobs and industry.• Financial market uncertainty and impact of the economic environment

on government revenues and expenses.Existing Structural Challenges• An aging population increasing demands for healthcare and income

security.• The need to address the infrastructure deficit through sustainable

capital investments. Current Financial Management Challenge• Governments must balance the need to respond to these immediate

economic challenges without compromising its responsibilities for addressing the longer-term objectives.

• Increased complexity of transactions and external reporting requirements (PSAB, IFRS).

Today’s Operating Environment

• Greater public expectations for seamless, quality and value-for-money services.

• Focus on results and financial sustainability in health care, education and social services.

• Government’s evolving “oversight” role, where increasingly Broader Public Service (BPS) partners deliver front-line services.

• Increased intergovernmental cooperation and collaboration between federal/ provincial/ municipal governments.

• Advent of new technologies enabling integrated business and financial solutions.

• Increasing demand to elevate financial management function in supporting programs, managing risk and leveraging strategic outcomes.

Controllership must exercise Financial Leadership

• During economic downturns, the role of the public sector financial community is even more critical.

• Our role is to provide government decision-makers with the best financial information possible, so that they can make well informed decisions amongst the competing public policy demands.

• To be successful in this role, in supporting financial decision-making, we must:

• establish a robust financial management framework;• emphasize value for money and fiscal accountability;• balance immediate fiscal impacts with longer-term stewardship;• ensure appropriate controls are in place and functioning;• apply financial risk management principles; and• ensure transparency in financial reporting through public disclosure.

Controllership’s role in financial management

The controller/controllership function plays a key financial management role in making the government’s business objectives achievable.Controllership adds to the financial management discipline by providing assurance of compliance with financial reporting and controls.However, the controllership function’s “value” is fully realized by supporting decision-makers with financial analyses that identifies:

links between costs and performance;opportunities to reduce direct and indirect costs; andopportunities to increase delivery efficiency in meeting public policy goals.

Realizing this contribution can only happen when we fully apply advanced management accounting, risk management, effective costing and revenue management.

Financial Management Transformation*

CatalystStrategistStewardOperator

Controllership: Focused on the prudent

use of resources by standardizing, consolidating and automating processes.

Procedural policies. Establishing financial data

integrity, timeliness and accuracy

Results Planning: Ensuring effective

budgeting, forecasting and planning systems in place.

Asset/Capital Management.

Establish policy framework

Risk management and effective controls

Decision Support: Focused on performance

management and supporting effective investment decisions

Ensure value-for-money Policies that strengthen

performance by promoting positive behaviours.

Effective BPS management

Robust Cost/Benefit analysis

Leader: Support decision-makers

and identify opportunities for service delivery transformation

Creates partnerships to drive innovation and service delivery efficiency

Finance integrated with policy and operational considerations

Enterprise risk management

Effective horizontal management

Trusted AdvisorAnalysisControls

* Four Faces Framework discussed in Deloitte study “Mastering finance in government: Transforming the government enterprise through better financial management”

Required Financial Management Elements• Management Decision Support

– Financial evaluation expertise– Business risk management expertise– Capital investment analysis expertise– Financial performance management expertise

• Business Planning, Fiscal Planning and Budgeting– Strategic business planning expertise– Risk-based Fiscal planning expertise– Capital planning expertise– Integrated capital, operating and cash-flow budgeting expertise– In-year fiscal management expertise

• Accounting, Appropriations and Financial Reporting– Accounting policy application and control expertise– Appropriation compliance and control expertise– Costing and pricing expertise– Financial reporting expertise– Financial information analysis and integrity assurance expertise

• Risk Management, Accountability and Control– Program risk management and control expertise– Project risk management and control expertise– Asset and Liability risk management and control expertise– Transfer Payment, Agency and Trust risk management and control expertise.

Financial Competencies needed

Business Knowledge

Effective Costing, Planning & Evaluation

Risk Management

Standards Compliance

Effective Communication

Performance Management

Forecasting, Planning and Budgeting

Accounting/ Financial Knowledge

Valued-added Advice

Value-for-

StrategicFocus

Competencies

How is the OPS Responding to this challenge

• Integrated Planning: a reconstituted Treasury Board Office integrates fiscal planning, controllership and audit leadership enabling government to be better equipped to deal with the competing demands.

• Financial Management: review of the appropriate financial management functions to assist ministries in providing decision support to line-ministry decision-makers.

• Policy Framework: revitalize and streamline financial policy framework to clarify and strengthen roles, responsibilities and accountabilities.

• Transfer Payment Accountability: continue efforts to reduce administrative duplication for TP recipient partners while ensure improved accountability.

• Asset Management: capitalization of minor Tangible Capital Assets so that ministries can more effectively plan, account and budget for their portfolio of investments.

• Capacity: revitalize OPS financial capacity through attraction (financial internships and foreign-trained professional programs), training on core competencies and retention, so that Ontario can build the financial leadership of the future.

Section 2: Questions

• What do you think needs to happen for the controller/controllership function to assume a more advisory “decision support” role?.

• In your role as controller, what strategies can you employ to strengthen the controllership function's links with line-management decisions?.

• What incentives can we develop to support the transformation of the controllership function?.

Case Studies

Case Study 1: Government support for the Auto Sector • Challenge: Balancing socio-economic imperative to save manufacturing jobs against the public policy and accountability requirements. • Objective: Provide ailing automobile companies a credit bridge through difficult times. • Key Issues:

– Supporting the auto sector is multi-jurisdictional issue. Loan agreements cannot be made in vacuum and must take into account all aspects of the various governments’ initiatives. – Managing the risk of longer-term investments in an industry with weak consumer demand and volatile stock markets. – Ensuring public money is spent appropriately and contributes to wider public policy goals, such as more environmentally friendly cars. – Making sure public loans are repaid and that government exposure is based on the associated risks.

Case Study 2: Vancouver Olympics Capital Projects • Challenge: City of Vancouver has taken full financial control of the 2010 Olympics athletes village $1 billion project.• Objective: Balancing increasing costs against a drop-dead deadline, without encumbering the city with substantial debt. • Key Issues:

– Short-term “showcase” event against a substantial public debt at a time of falling revenues. – Original Alternative Financing and Procurement (AFP) agreement was supposed to transfer the “risks” of construction and financing to the developer. With evaporation of “market” credit the construction company has been unable to make payments. Since September, 2008 the city has covered construction costs through a $100 million loan to the developer. – The city’s takeover could help cut the interest rate from as much as 11.5 per cent to as little as five per cent. – Risk that assuming the liability could downgrade of the city’s triple “A” credit rating which could make it harder to borrow other funds until the athletes’ village loan is paid off.– The take-over of financial responsibility for the project means that the city now has the entire “village” as an asset (and project liabilities), not just the land it sits on.

Case Study 3: Alternative Financing Arrangements • Challenge: Ontario has an infrastructure deficit estimated at more than $100 billion.• Objective: Alternative Financing and Procurement (AFP) represents an opportunity to leverage private-sector project management expertise and financing to help bridge the infrastructural deficit. • Key Issues:

– Public policy considerations in the government’s construction, management and ownership of assets. – The higher private-sector financing rates must be balanced against construction risks (i.e. cost overruns) transferred to the private partners. – Long-term AFPs that include design, build and asset management components, require performance criteria to ensure value-for-money throughout the asset’s life-cycle. – The openness and transparency of the alternative financing process are critical to ensure the highest return on investments and public accountability.– Differing financing rates methodologies impact the recognised value of the assets. Using a project costing model will increase financing costs, while a internal discounted rate will decrease financing costs and change the asset’s value.

From a Controllership Perspective• We need to ensure:

– solid financial management information is provided to support an effective balance between the need to stimulate the economy against the stewardship role of asset management for the longer-term;

– a strong and transparent decision-making framework is in place that provides value-for-money to taxpayers;

– public resources are effectively controlled in accordance with legislative and public sector accountability standards;

– a strong understanding and independent assessment of AFP rival bids based on robust and reasonable costing/financing assumptions; and,

– transactions are accurately accounted for and represented in the province’s Public Accounts.

• Overall, we need to put this in a language that helps the decision makers make informed investment choices.

Key Requirements for Success• Informed Decisions: Further integration of risk and performance management into the fabric of financial decision-making.• Effective Governance: establishing clear roles and accountabilities, linked to decision-making structure and supported by a robust policy framework.• Financial Leadership: to set priorities, support capacity improvements and provide a strategic financial “voice” at the decision-making table. • Financial transformation: continue to migrate the financial function away from a transaction-rules focus to an “advisory” decision support and oversight role.• Business “ownership” of Finance: progressively, delegate financial management to program managers and other government organizations, while maintaining accountability and oversight. • Measuring Progress: establish clear performance measures, evaluate progress toward achieving the desired goals and taking remedial action when necessary.• Communications: open and transparent communications to allow knowledge of risks, challenges and solutions to flow throughout the organization(s). • Financial Capacity: attract, retain and develop financial capacity that is aligned to future needs.

Looking Ahead• Controllership closes the financial management “accountability

loop”. • Effective controllership provides the front-end financial information

to make informed business decisions but also ensures controls are met in the achievement of results.

• As the demands of controllership function increase, it is critical to integrate risk management, process and structure cost control, and revenue management into the fabric of decisions.

• Ultimately, our success depends upon the professional knowledge we bring to the decision-making table. Only up-to-date, strategic competencies and a robust financial community can ensure we provide value-added expertise needed to achieve public policy goals.

A more complex world…

Understanding The Financial Planning Process

The Rewards of Sound Financial Planning

• Maintain and improve standard of living.• Control spending in order to live well today and

tomorrow!• Accumulate wealth.

Average Propensity to Consume:

The percentage of each dollar of income that is spent, on average, for current needs rather than

saved.

i What is your average propensity to consume?

Income spent on current needsTotal income

The Personal Financial Planning Process

• Taking conscientious and systematic steps toward fulfilling your financial goals.

Steps in the Financial Planning Process:

1. Define financial goals.2. Develop financial plans and strategies to achieve

goals.3. Implement financial plans and strategies.4. Develop budgets to monitor and control progress

toward goals.5. Evaluate results by using financial statements.6. Revise goals as situations change.

1. Define financial goals

2. Develop plans

3. Implement plans

4. Develop budgets

2. Develop plans

FINANCIAL ACTIONS•Basic asset decisions•Credit decisions•Insurance decisions•Investment decisions•Retirement and estate decisions

3. Implement plans

4. Develop budgets

2. Develop plans

5. Evaluate results

6. Revise plans

FINANCIAL ACTIONS•Basic asset decisions•Credit decisions•Insurance decisions•Investment decisions•Retirement and estate decisionsPrepare financial statements

Money:• Used as a medium of exchange. • Financial goals are stated in dollar

amounts.• Need to consider utility, or amount of

satisfaction derived from purchases, as well as cost.

• May be closely linked to personal psychological concepts.

• May play key role in personal relationships.

To attain your financial goals:• Be specific in defining goals and focus on

results.• Make goals realistically attainable.• Involve family members and enlist their

cooperation.• Prioritize goals and set a definite time frame.

Putting target dates on financial goals:

• Short-term goals—to be accomplished within the next year.

• Intermediate-term goals—to be accomplished in the next 2-5 years.

• Long-term goals—to be accomplished in time periods greater than 5 years.

From Goals to Plans: A Lifetime of Planning

• Early childhood.• High school and college.• Family formation.• Career development.• Pre-retirement.• Retirement.

Income

10 20 30 40 50 60 70 80

Income Stream

Personal Financial Planning Lifecycle

Retirement/Estate

Savings/Investment

Asset AcquisitionLiability/Insurance

Benefits

Benefit of planning:

• Your money works more efficiently for you by...

• Utilizing the financial wonder—

The power of compounding through time!

Growth of $1,000 at 8 % interest:

21,725

10,0634,6612,159

$10,000

$20,000

$30,000

$40,000

$50,000

0 10 20 30 40Years

Growth of $1000 at 10% interest:

17,449

6,7272,594

$10,000

$20,000

$30,000

$40,000

$50,000

0 10 20 30 40Years

21,725

45,259

Use the personal computer to:

• Prepare financial statements

• Plan retirement

• Prepare and file tax returns

• Track investments

• Analyze needs

The Planning Environment

Financial planning is carried out in an economic environment created by the interactions of

hGovernmenthBusinesshConsumers

BUSINESS GOVERNMENT CONSUMERS

Money payments of wages, rentsinterest, and profit

Money payments for goodsand services

Land, labor, and financial capital

Goods and services

Land, labor, and financial capital

Goods and services

Public goods &services, regulations,

and revenues

Government policy decisions are used to regulate the economy in an effort to:

• Provide economic stability.• Maintain acceptable employment levels.

• Controls money supply• Used to stimulate or contract economic

growth

Fiscal Policy• Controls levels of taxation• Sets levels of government spending on various

programs

Monetary Policy

Policies seek to control:• Economic Cycles– Stages related to employment and production

levels– Growth measured by changes in GDP

• Inflation– Measured by changes in CPI– Affects purchasing power and interest rates– Affects financial plans and goals

Economic Cycles

Expansion Recession Depression Recovery

Levels of Employment and Production

What Determines Your Personal Income?

• Age, marital status• Education• Where you live• Career choice

The Fundamentals of Financial Statements

Purpose of Financial Statements• Financial statements are:

“Structured representation of the financial position and financial performance of an entity.”

• Objective: To provide information about:– the financial position,– financial performance, and – cash flows

of an entity that is useful to a wide range of users in making economic decisions.

The Framework• The International Financial Reporting Standards

(IFRS), in particular guidance on presentation and disclosure

• Local statutory requirements– The Companies’ Ordinance, 1984, in particular the Fourth/ Fifth

Schedule for presentation purposes – Directives of the regulatory bodies– Industry specific legislation– Generally accepted accounting principles

Amendments of the Finance Bill 2007-2008

• The AGM must now be held after three months of the end of the accounting year. (previously 4 months)

• Power of FG to require additional matters in the auditors’ report now vested in Commission

• NBFCs to comply with minimum equity requirements rather than minimum capital requirement for incorporation

• Penalty for failure to comply with NBFC laws enhanced from Rs 5 m to Rs 50 m

• Mandatory for listed Co to have independent share registrar.• Substantial share holder (12.5%) can apply for re election of directors in

the case of a listed company.

Amendments of the Finance Bill 2007-2008 (Contd.)

• Power of FG to specify business of banking companies now vests in the SBP.

• Perpetual non cumulative preference shares included in definition of share capital of Banking Company.

• Additional conditions for eligibility to pay dividends by banking company• Additional provisions for auditors: all significant matters to be reported to

SBP, SBP may revoke the appointment of auditors.• New Act ‘Payment System for Electronic Fund Transfer 2007’ introduced.• Contract worker now entitled to benefits under the Companies Profits

(worker Participation) Act 1968, and amount of profit no longer subject to audit adjustments.

Responsibility for Financial Statements

• Final responsibility for fair presentation of financial statements rests with the BoD.

• Companies’ Ordinance 1984: directors to present in the AGM annual accounts that give a true and fair view of state of affairs and Profit and loss of the Company (u/s 233 & 234).

The Auditor’s Responsibility

“To express an opinion on financial statements based on their audit”

• Audit is a statutory requirement for all companies.• Auditor to be Chartered Accountant for the following:

– Public Cos.,– Private Co that is a subsidiary of a public company, and– Private Co having paid up share capital of Rs 3m or more

• Auditors also issue reports on:– Review of interim f/s (listed Cos.).– Report on consolidated financial statements.– Report on changes in accounting policies (listed Cos.)

The Auditor’s Responsibility (contd.)– Review of compliance with Best Practices of Code of Corporate Governance (Listed Cos.).– Assets, liabilities, profits and losses, share capital and its breakup value for prospectus (Schedule II).– Certification of financial information in statutory report (for Co limited by shares etc).– Significant issues identified during audits (listed Cos).– Industry specific reports (basel II, profit rate verification, credit review reports etc).

Components of Financial Statements

• General purpose financial statements comprise of:– Balance Sheet.– Profit and loss account.– Statement of changes in equity.– Cash flow statement.– Notes to the financial statements.

Components of Financial Statements (contd.)

Listed Cos . – Balance sheet– Profit and loss– Statement of changes in

equity– Cash flow– Notes

• 4th schedule applies• This includes private

companies and public non-listed companies that are subsidiaries of listed companies

Non Listed Cos.– Balance sheet– Profit and loss– Notes

• 5th schedule applies

The Annual Report – other information

TYPE OF REPORT REQUIREMENT OF:Director’s report Companies’ Ordinance 1984

Statement of Compliance with Code of corporate governance

Listing regulations

Company information including financial progress reports, management structure etc

Other information includes the following:

The auditor may review the information in relation to the accounts under audit

Review of the Financial Statements

• Variation in presentation may arise from difference in:

– Nature of business of the entity– Type of Company (listed, non-listed public, private)– Consolidated or unconsolidated accounts– Management judgement on matters not specified by statute / standards

Review of the Financial Statements (Contd.)

• Identification of each f/s component.• Name of reporting entity.• Specified if accounts related to group entity.• Balance sheet date/period of account.• Presentation currency.• Level of rounding used in presenting amounts• Comparatives.• F/s amounts supported by adequate notes.• Each F/s component signed by director and chief executive.

Review of Balance Sheet Presentation• Please review the sample balance sheet:• Our discussion will follow the line items:ASSETS• Fixed Assets• Long term investments• Long term loans and advances• Long term deposits and prepayments• Current assets

– Stores and spares– Stock in trade– Trade debts– Loans and advances– Trade deposits, prepayments– Interest accrued– Other receivables– Financial assets– Tax refunds– Cash and bank balances

Balance Sheet (Contd.)SHARE CAPITAL & RESERVES● Share capital● Capital reserves● Revenue reserves● Surplus on revaluation of fixed assetsNON CURRENT LIABILITIES● Long term financing● Debentures● Liabilities against assets subject to finance lease● Long term Murabaha● Long term Deposits● Deferred Liabilities

Balance Sheet (Contd.)

CURRENT LIABILITIES

• Trade and other payables• Interest, profit, markup accrued• Short term borrowings• Current portion of long term borrowings• Current portion of long term murabaha• Provisions for taxation

CONTINGENCIES AND COMMITMENTS

Review of Income Statement Presentation

• Please review the sample profit and loss account• Line wise discussion follows:TURNOVEREXPENSES• Cost of sales• Distribution cost• Administrative expenses • Other operating expenses• Finance costOTHER OPERATING INCOME• Income from financial assets• Income from investments/debts of related parties• Income from assets other than financial assets

Review of Cash Flow Presentation

• Please review sample cash flow statements• Cash flows may be prepared under the indirect or direct method.• These methods affect the method of arriving at operating cash flows only• Discussion will follow the line items of the sample cash flow:

– from operating activities.– from investing activities.– from financing activities.– cash& equivalents.

• Cash flows are prepared in accordance with the requirements of IAS 7.

Review of Statement of Changes in Equity

• Please review sample statements of changes in equity• Statement may either show:

– All changes in equity– Changes other than transactions with equity holders

Variations for Industries

• Variations can be seen in presentation & disclosures of f/s for different industries, eg:– Banking Companies.– Manufacturing companies.– Telecom industry.– Petroleum exploration and production– Funds.– Insurance companies.– Leasing Companies and other NBFCs.

The End

Understanding Finance to Influence Strategic Decisions

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Transcript of Understanding Finance to Influence Strategic Decisions

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