finance by KratikaBhadoriya


									    Aims of finance department
Category: Strategy

The finance department of a business takes responsibility for organising the financial and accounting affairs including
the preparation and presentation of appropriate accounts, and the provision of financial information for managers.
The main areas covered by the financial department include:

1. Book keeping procedures.

Keeping records of the purchases and sales made by a business as well as capital spending. These records today
are typically kept on computer files. But we still use the term ledger entries to refer to the days when all financial
transactions were carefully recorded in thick books (ledgers).

2. Creating a balance sheet and profit and loss account.

Financial statements need to be produced at given time intervals, for example at the end of each financial year. Trial
balances are extracted from the ledger entries to create a Balance Sheet showing the assets and liabilities of a
business at the year end. In addition, records of purchases and sales are totalled up to create a Profit and Loss (P&L)

3. Providing management information.

Managers require ongoing financial information to enable them to make better decisions. For example, they will want
information about how much it costs to produce a particular product or service, in order to assess how much to
produce and whether it might be more worthwhile to switch to making an alternative product.

4. Management of wages.

The wages section of the finance department will be responsible for calculating the wages and salaries of employees
and organising the collection of income tax and national insurance for the Inland Revenue.

5. Raising of finance.

The finance department will also be responsible for the technical details of how a business raises finance e.g. through
loans, and the repayment of interest on that finance. In addition it will supervise the payment of dividends to

Management accounts

There is an important distinction between management accounts which involves the provision of information to
managers for ongoing decision making, and financial accounting which is concerned with the preparation of financial
statements outlining the financial health and performance of a company in previous time periods.

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    Sources and uses of finance
There are a number of ways of raising finance for a business. The type of finance chosen depends on the nature of
the business. Large organisations are able to use a wider variety of finance sources than are smaller ones. Savings
are an obvious way of putting money into a business. A small business can also borrow from families and friends. In
contrast, companies raise finance by issuing shares. Large companies often have thousands of different

To gain extra finance a business can take out a loan from a bank or other financial institution. A loan is a sum of
money lent for a given period of time. Repayment is made with interest. The lender of money needs to know all the
business opportunities and risks involved and will therefore want to see a detailed business plan. The lender may
also want some form of security should the business run into financial difficulty, and may therefore prefer to provide a
secured loan.

Another way of raising short-term finance is through an overdraft facility with a bank. The borrower is given
permission to take out more from their account than they have put in. The bank fixes a maximum limit for the
overdraft. Interest is charged on the overdraft daily.

Businesses may also qualify for grants. Government and private funds are sometimes made available to businesses
that meet certain conditions. For example, grants and loans may be available to firms setting up in rural areas or
where there is high unemployment.

A small business can also attract extra finance by taking on a partner or by selling shares. The problem caused by
bringing in extra people is that profits have to be shared.

A further way of raising capital that has become popular is that of venture capital. Larger businesses with cash to
spare have been putting funds into small- and medium-sized enterprises.

Once a business is up and running there are various ways of financing its expenditures. Expensive items of
equipment can be leased. Rather than buying the equipment the business hires it from a leasing company. This
saves having to lay out sums of money and the business does not have to worry about having to carry out major
repairs itself. Motor vehicles, machines and office equipment are often leased.

Hire Purchase is an alternative way of purchasing items of equipment. With a leased item you use and pay for the
item but never own it. With hire-purchase you put down a deposit on an item and then pay off the rest in instalments.
When the last instalment has been paid you become the owner of the item.

Another common way in which firms can finance their business in the short term is through trade credit. In business it
is common practice to purchase items and pay for them later. The supplier will normally send the purchaser a
statement at the end of each month saying how much is owed. The buyer is then given a period of time in which to

Large companies like Argos will raise finance in a variety of different ways. Not only do they raise capital from
shareholders, but they also take out loans from banks to finance major capital projects. Capital equipment such as
vehicles and computers may be leased. In turn these companies will provide finance

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   Financial records and documents
Accounting involves the creation of financial records of business transactions, flows of finance, the process of
creating wealth in an organisation, and the financial position of a business at a particular moment in time. A number
of users make use of accounts for different purposes:

Shareholders read accounts to examine the health of business, and the returns (dividends) that they can expect to
make. Employees read accounts to see how safe their jobs are. The Inland Revenue read accounts to calculate how
much tax businesses should be paying. Suppliers read accounts to check that the company they supply with goods
on credit will be able to pay the money owed when it becomes due. In a typical large business the accounting
function might be organised in the following way:

Financial accounting is concerned at one level with book-keeping i.e. recording daily financial activities, and at a more
advanced level with preparation of the final accounts e.g. the profit and loss account and balance sheet.

Management accounting is concerned with providing managers with management information such as information
about costs, and forecasts of future costs and revenues.

Financial information can be fed to those who require such information for decision-making and record-keeping
purposes. For example, managers need information in order to manage the business efficiently and constantly to
improve their decision-making capabilities. Shareholders need to assess the performance of managers and need to
know how much profit of income they can take from the business. Suppliers need to know about the company's ability
to pay its debts and customers wish to ensure that their supplies are secure.

Financial performance

Any provider of finance of the business (e.g. bank) will need to know about the company's ability to make
repayments. The Inland Revenue needs information about profitability in order to make an accurate tax assessment.
Employees have a right to know how well a company is performing and how secure their futures are.

The reasons why businesses keep accounts for these users can therefore be summarised as:

1.To comply with legal and other requirements e.g. Stock Exchange listing rules.

2.To provide information for stakeholders about financial performance and viability.

3.To provide managers with information for decision making.

4.To provide a structure to business activity based on the careful processing of numerical data.

Public limited companies like BT, Cadbury-Schweppes and Polestar produce an annual report including a set of
financial statements. These statements are produced in line with a number of UK and international accounting
standards, and provide users with a clear picture of business performance over the previous year (through the Profit
and Loss Account) as well as a clear picture of the financial position of the business at the end of the financial year
(in the Balance Sheet).

Financial statements must provide a 'true and fair' description of the financial position of a company in line with
accounting standards.

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   Banking services/Financial institutions
Banks provide a number of important financial services to businesses:

1. Loans provide businesses with expansion capital. A secured loan is one that is guaranteed by some form of asset
such as buildings and property. An unsecured loan is not backed in the same way. A bank will lend a business a
given sum for a specified period of time e.g. £6,000 for 2 years. The business will then repay the capital sum in
instalments with interest added e.g. £360 per month. The rate of interest on unsecured loans is higher than for
secured loans.

2. Business account services enable a business to transact its day-to-day affairs, for example paying wages into
employee's accounts, paying bills, and taking up periods of credit when applicable. Businesses are able to use bank
services such as standing orders and direct debits to pay water, electricity, business rates and other regular bills.

3. Overdraft facilities enable a business to have a short period of credit to smooth out cash flow difficulties. The
business arranges an overdraft limit with its bank and is permitted to borrow up to the arranged overdraft ceiling.
Interest is only charged on the amount overdrawn each day. So, for example, if the bank was only overdrawn by £100
for 1 day of the year it would pay 1/365 of annual interest rate for £100.

4. Cheques, credit cards and bank drafts enable a business to smoothly manage its day-to-day payments and
transactions. Bank statements enable the business to keep a regular check on its accounting position.

5. The bank will also provide systematic and ongoing advice, particularly to small businesses and start ups. For
example, the bank will provide detailed advice on how to construct and organise a business plan.

6. Banks also provide long-term finance in the form of mortgages for the purchase of land and property.

7. Merchant banks and issuing houses also support companies in the management of share issues, for example, by
arranging for financial institutions to underwrite a new share issue.

Financial Institutions

Financial institutions, such as the Bank of England, Stock Exchange, High Street Banks, Pension Funds, Insurance
Companies and others, enable business to take place smoothly. Financial intermediaries, such as banks, channel
funds from savers to borrowers.

The variety of financial institutions reveals the complex requirements of both borrowers and lenders. Banks, building
societies, investment trusts and pension funds are just a few of the organisations whose job it is to channel funds to
those that require them.
These institutions operate in the short-term (money) market and the long-term (capital) market.

In the money market, the main activity centres around funds, which are lent for periods from as short as overnight up
to about one year. The capital market focuses on money borrowed and lent for periods of five years or more. There is
a grey area, of one to five years that is not incorporated into the two definitions and, hardly surprisingly, this is called
the medium-term market.

The main functions of financial institutions are:
1. To help businesses manage risks e.g. by providing insurance in the case of insurance companies.

2. To provide corporate finance as is the case with banks, or investment trusts, which enable lots of investors to own
shares in a range of companies.

Buying stocks and shares

The Stock Exchange makes it possible for large companies to raise finance. Members of the public can buy shares
through Stock Exchange dealers in a number of ways:
1. You can deal directly with a market maker (who belong to firms that buy and sell shares first hand). This is
commonly done by large buying institutions e.g. pension funds and investment trusts.

2. You can deal with a local broker/dealer who will then buy on your behalf (e.g. through your local bank).

3. You can buy from a share shop, which deals directly in stocks and shares. Some major department stores have
departments specialising in stocks and shares.

Shareholders are part owners of a company. Many large financial institutions like pension funds are major
shareholders in leading companies.

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   Interpreting financial information
Category: Finance
Business accounts are produced to meet the needs of their users. Typical users and the use they make of accounts is
shown below:

Shareholders -to check on quality of direction of company, as well as profitability, solvency, value of company and
other signs of health.

Employees - to check on job security and scope for wage and benefit increases.

Suppliers - to check that a company is generating the cash to be able to pay up.

Inland Revenue - for calculations of Corporation tax.

There are three main financial statements that are produced by company accountants. These are:

1. The Balance Sheet setting out the financial position of the company at a particular moment in time e.g. the year

2. The Profit and Loss Account showing how the profit or loss of the business has been generated.

3. A cash flow statement setting out the cash inflows and outflows to the business during a particular period of time

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