financial management and function

Introduction to financial management

Financial Management can be defined as:
The management of the finances of a business / organisation in order to achieve financial objectives
Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:
• Create wealth for the business
• Generate cash, and
• Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested
There are three key elements to the process of financial management:

(1) Financial Planning

Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.
In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions.
(2) Financial Control

Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as:
• Are assets being used efficiently?
• Are the businesses assets secure?
• Do management act in the best interest of shareholders and in accordance with business rules?
(3) Financial Decision-making

The key aspects of financial decision-making relate to investment, financing and dividends:
• Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers

A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.
Introduction to financial management
Financial Management can be defined as:
The management of the finances of a business / organisation in order to achieve financial objectives
Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:
• Create wealth for the business
• Generate cash, and
• Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested
There are three key elements to the process of financial management:

(1) Financial Planning

Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.
In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions.
(2) Financial Control

Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as:
• Are assets being used efficiently?
• Are the businesses assets secure?
• Do management act in the best interest of shareholders and in accordance with business rules?

(3) Financial Decision-making
The key aspects of financial decision-making relate to investment, financing and dividends:
• Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers
• A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.

Capital and Revenue Receipts, Payments, Profits and Losses

Capitalized and Revenue Receipts:

Receipts refer to the actual amounts of cash received. They can be either of capital nature or revenue nature.
Capital receipts include the following:

1. Capital brought in by the proprietor at the commencement and any additions made subsequently.
2. Money borrowed from partners, bankers, private individuals etc.
3. Money received by the sale of fixed assets.
4. Money received on account of capital profit.
Revenue receipts include the following:
1. Money received by the sale of floating assets - by sale of goods.
2. Money received on account of some revenue profit.

Capital and Revenue Payments:
Definition and Explanation:

Capital payment is an amount paid on account of some capital expenditure and a revenue payment is an amount actually paid on account of some revenue expenditure. Expenditure is the full amount incurred whether paid or not, whilst payments refer to the amount actually paid.
Example:
If a building is purchased for $20,000 from X and $10,000 is paid in cash and the remaining sum to be paid after six months; $20,000 is capital expenditure, but $10,000 is only capital payment. Similarly if goods are purchased from X for 30,000 and $15,000 is paid in cash; $30,000 is revenue expenditure but only $15,000 is revenue payment.

Capital and Revenue Profits:
Definition and Explanation:

Capital profit means a profit made on the sale of a fixed asset or profit earned on raising monies for the business. For example a building purchased for $20,000 is sold for $25,000 the profit $5,000 thus made is a capital profit.

Revenue profit on the other hand is a profit made by the business e.g., profit on the sale of goods, income from investments, commission earned etc.
Whenever, capital profit is made it should either be transferred to the capital account of the proprietor or credited to capital reserve account which would appear as a liability on the balance sheet. But capital profits should in no case be transferred to profit and loss account because it is non-trading profit. Revenue profits on the other hand should be transferred to profit and loss account because they arise out of regular trading operation.

Capital and Revenue Losses:
Definition and Explanation:

Capital loss means a loss made on the sale of a fixed asset or a loss incurred in connection with the raising of money for business. Capital loss may be shown as an asset in the balance sheet. But as this asset is a fictitious nature, it would would advisable to write off it.
Revenue loss, on the other hand, is the loss incurred in trading operations such as loss on the sale of goods. Revenue losses are charged to profit and loss account of the year in which they occur.

revenue expenditure

Capital expenditure

The amounts shown as assets are known as capital expenditure, capital expenditure normally yields benefit over a long period. Capital expenditure results in fixed assets.
The various types of capital expenditure are explained as under:
Expenditure which results in the acquisition of a permanent asset:
All assets mean anything which can be converted into cash later. All money spent for acquiring an asset is capital expenditure.
Expenditure in connection with the purchase, receipt or erection of a fixed asset:
All expenses, in addition to the purchase price, incurred for making the asset ready for use are added to the cost of the asset and thus this expenditure are called capital expenditure. Expenditure of this type are wages paid to workers for erecting machines, the cost of the platform on which the machine will be fixed, overhaul of second-hand machines purchased, interest on the loan raised to purchase a fixed asset, etc.
Expenditure for the extension of or improvement in fixed assets:
If because of any expenditure the profit earning capacity is increased, through lowering cost or increasing output the expenditure will be capital expenditure.
Expenditure incurred to acquire the right to carry on business:
The expenses necessary for either establishing the business, like preliminary expenses for floating a company, or obtaining license will be capital expenditure. Similarly the cost of a patent that is the right to produce certain goods in a certain manner will be capital expenditure.
Expenditure incurred to acquire a tangible asset:
Even if the asset does not prove to be profitable, the expenditure incurred on it is treated as capital expenditure.

capital expenditure

Revenue expenditure
is expenditure concerned with the costs of doing business on a day to day basis. When companies make a revenue expenditure, the expense provides immediate benefits, rather than long term ones. This is contrasted with capital expenditures, which are long term investments intended to help a business grow and thrive.
It is sometimes said that businesses have to spend money to make money. Businesses use their revenues both to amass capital which can be used in the long term, and to cover immediate expenses. Revenue expenditures include things like maintenance, wages and salaries, and costs for utilities. The revenue expenditure consists of expenses which must be covered immediately to keep the business running and which provide immediate benefits.

Companies break their expenses into revenue expenditures and capital expenditures so that they can see how they are using their funds and they can assess whether or not they are operating efficiently and effectively. Routinely high revenue expenditure can make it difficult for a business to build up capital, which means that it cannot make long term investments and it may not be prepared in the event of a crisis situation. For example, if a restaurant is spending most of its earnings compensating employees, paying suppliers, and performing maintenance, it may be in trouble if the freezer system goes down and needs to be replaced.
At times, a calculated capital expenditure can cut down on revenue expenditure. To borrow the restaurant example again, the owners might sit down and realize that buying a building in which to operate would be cheaper than renewing a lease. Thus, they might make the decision to expend capital for that purchase in the interests of cutting down operating costs and establishing a long term presence. The new building will also be an investment itself; the restaurant now has an asset it can sell or rent if it needs to.
Certain revenue expenditures may be deductible for tax purposes. It is recognized that a portion of business revenue applied to immediate expenses should not be taxed and business can claim such expenses as deductions. For example, a business is not required to pay taxes on the money it uses to pay payroll taxes. The rules for deductions are very complex and for a large business it may be necessary to consult an account to get accurate information and advice so that taxes will be filed properly.

fund flow statement

Meaning of Fund Flow

The financial statement of the business indicate assets, liabilities and capital on a particular date and also the profit or loss during a period. But it is possible that there is enough profit in the business and the financial position is also good and still there may be deficiency of cash or of working capital in business. If the management wants to find out as to where the cash is being utilized, financial statement cannot help. Therefore, a statement is prepared of the sources and applications of funds from where Working Capital comes and where it is utilized. This is called Fund Flow statement.
Meaning of ‘Fund’
In a popular and generally accepted sense the term ‘fund’ is used to denote the excess of current assts over current liabilities :
Working Capital = Current Assets – Current Liabilities
Meaning of ‘Flow’ of Fund
Flow of funds means transmigration (coming and going) of funds. In other words, Flow of funds means change in Working capital, as in funds flow statement the words ‘funds’ mean net working capital.
Definition:
According to R.N. Anthony, “Fund Flow is a statement prepared to indicate the increase in cash resources and the utilization of such resources of a business during the accounting period.”

please see practical in references book

cash flow statement

 financial accounting, a cash flow statement,
 also known as statement of cash flows or funds flow statement, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and cash out of the business. The statement captures both the current operating results and the accompanying changes in the balance sheet.As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals with cash flow statements.
People and groups interested in cash flow statements include:
• Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses
• Potential lenders or creditors, who want a clear picture of a company's ability to repay
• Potential investors, who need to judge whether the company is financially sound
• Potential employees or contractors, who need to know whether the company will be able to afford compensation
• Shareholders of the business.

Cash flow activities

The cash flow statement is partitioned into three segments, namely: 1) cash flow resulting from operating activities; 2) cash flow resulting from investing activities;and 3) cash flow resulting from financing activities.
The money coming into the business is called cash inflow, and money going out from the business is called cash outflow.
Operating activities

Operating activities include the production, sales and delivery of the company's product as well as collecting payment from its customers. This could include purchasing raw materials, building inventory, advertising, and shipping the product.
Under IAS 7, operating cash flows include:[11]
• Receipts from the sale of goods or services
• Receipts for the sale of loans, debt or equity instruments in a trading portfolio
• Interest received on loans
• Payments to suppliers for goods and services.
• Payments to employees or on behalf of employees
• Interest payments (alternatively, this can be reported under financing activities in IAS 7, and US GAAP)
• buying Merchandise
Items which are added back to [or subtracted from, as appropriate] the net income figure (which is found on the Income Statement) to arrive at cash flows from operations generally include:

• Depreciation (loss of tangible asset value over time)
• Deferred tax
• Amortization (loss of intangible asset value over time)
• Any gains or losses associated with the sale of a non-current asset, because associated cash flows do not belong in the operating section.(unrealized gains/losses are also added back from the income statement)
[edit] Investing activities
Examples of Investing activities are
• Purchase or Sale of an asset (assets can be land, building, equipment, marketable securities, etc.)
• Loans made to suppliers or received from customers
• Payments related to mergers and acquisitions.
• Dividends received on equity securities

Financing activities

Financing activities include the inflow of cash from investors such as banks and shareholders, as well as the outflow of cash to shareholders as dividends as the company generates income. Other activities which impact the long-term liabilities and equity of the company are also listed in the financing activities section of the cash flow statement.
Under IAS 7,
• Proceeds from issuing short-term or long-term debt
• Payments of dividends
• Payments for repurchase of company shares
• Repayment of debt principal, including capital leases
• For non-profit organizations, receipts of donor-restricted cash that is limited to long-term purposes
Items under the financing activities section include:
• Dividends paid
• Sale or repurchase of the company's stock
• Net borrowings
• Payment of dividend tax

Disclosure of non-cash activities

Under IAS 7, non-cash investing and financing activities are disclosed in footnotes to the financial statements. Under US General Accepted Accounting Principles (GAAP), non-cash activities may be disclosed in a footnote or within the cash flow statement itself. Non-cash financing activities may include[11]
• Leasing to purchase an asset
• Converting debt to equity
• Exchanging non-cash assets or liabilities for other non-cash assets or liabilities
• Issuing shares in exchange for assets

Direct method

The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments. Under IAS 7, dividends received may be reported under operating activities or under investing activities. If taxes paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly linked to investing activities or financing activities, they are reported under investing or financing activities.
Sample cash flow statement using the direct method[13]
Cash flows from (used in) operating activities
Cash receipts from customers 9,500
Cash paid to suppliers and employees (2,000)
Cash generated from operations (sum) 7,500
Interest paid (2,000)
Income taxes paid (3,000)
Net cash flows from operating activities 2,500
Cash flows from (used in) investing activities
Proceeds from the sale of equipment 7,500
Dividends received 3,000
Net cash flows from investing activities 10,500
Cash flows from (used in) financing activities
Dividends paid (2,500)
Net cash flows used in financing activities (2,500)
.
Net increase in cash and cash equivalents 10,500
Cash and cash equivalents, beginning of year 1,000
Cash and cash equivalents, end of year $11,500