Managing Financial Resources

Mick Broadbent,John Cullen

• Publisher: Routledge
• Year: 2012
• ISBN:
  9781136384776
• Edition: 3
• Topic: Business
• Subtopic: Business General
• Index: Business

Managing Financial Resources addresses the complicated issues of financial planning and control. These include performance measures and cost analysis, methods of improving profitability and techniques of financial monitoring and control. Real examples and case studies are used throughout to illustrate points in a practical context.All chapters have been updated and new material has been added to extend the original text in areas such as public sector management issues, audit commission, capital investment decisions, stakeholder analysis for published reports and accounts, performance measurement, outsourcing, new developments in the public sector and transfer pricing.This book is based on the Management Charter Initiative's Occupational Standards for Management NVQs and SVQs at level 4. It is particularly suitable for managers on the Diploma in Management or part 1 of the Postgraduate Diploma, especially those accredited by the Chartered Management Institute and Edexcel but this also a useful text for practicing managers and those individuals studying for a MBA.

1 Introduction: The Scope and Development of Accountancy in the Management of Financial Resources

DOI: 10.4324/9780080496269-1

The Aims of this Chapter are To

• Provide a working definition of accounting.
• Consider the historical development of financial accounting and management accounting.
• Compare and contrast financial and management accounting.
• Provide a framework for the study of the management of financial resources and a summary of the contents of this book.

Introduction

Within many sectors of the economy the last two decades have seen a greater emphasis placed on the management of financial resources. The financial management attributes of organizations are no longer the perogative and sole responsibility of higher echelons of management, but are now the day-to-day currency of all managers. This has resulted from the flattening of management structures empowering individuals to take responsibility for the broader aspects of their jobs, including finance. The public sector in particular has seen many changes resulting in the delegation of financial management to operation managers and professionals. We now have delegated budgets for general practitioners, the local management of schools has meant primary and secondary school governors are responsible for the financial wellbeing of their schools. There has been a whole spate of privatizations of previously public sector organizations, where the finances of the market now influence decision making to a greater extent. Stagecoach plc is a classic example of a company growing by the acquisition of recently privatized local authority bus and coach services. The varying changes have led to an increased emphasis on the financial aspects of all activities and this has created a growing importance of accounting information.

The management of financial resources can be considered at different levels of aggregation. For illustrative purposes we will confine these to three, but other classifications may lead to many more levels of aggregation. The levels to be considered are the individual, the organization and the economy as a whole. This book concentrates on the organization level of aggregation.

At the individual level, each of us is attempting to manage our limited financial resources for our best interests. A 14-year-old girl may be wishing to purchase a hi-fi unit and considering how it may be financed by the balancing of ‘pocket-money’, savings and gifts. In a similar manner, the purchase of a car may involve a finance deal resulting in monthly payments which will have to be met from income. Aggregating slightly, the running of a household for a family has similar financial management problems, the balancing of monthly income with outgoings, which include the normal consumables and items of a fixed asset nature, like a house or car.

In many ways an organization is like a complex household. It has to meet current expenditures with receipts while also providing for the replacement of any depreciating assets and the acquisition of others. What is different from a household is that first, an organization has a set of objectives which are not personal to the managers but are those of the organization and second, there are many more individuals concerned. These two factors mean the process must be managed using an information system to monitor the progress towards meeting objectives and a communication network between different individuals within the organization. One of the major parts of a management information system is accounting information, and its sophistication and detail will vary with the size and complexity of the organization.

Many organizations are separate legal entities from the persons involved in them. The local bowling or tennis club will have a separate legal entity from its members. A limited company will be able to trade under its own title, being legally separate from its owners, known as shareholders. Similarly, giant multinationals like Hanson Trust plc, or BP plc are an entity separate from their shareholders. This legal complexity requires an organization to provide financial information for its members or shareholders. Hence, the bowling club, the small limited company and the huge multinational company will all have annual general meetings where published financial statements are required to be presented by law. The legal requirements may differ but their principle is the same, an organization must account to its shareholders.

Thus organizations require information for internal management consumption to meet objectives and the legal obligations regarding their legal status. At the highest level of aggregation the Chancellor of the Exchequer is ‘balancing’ the budget by the management of monetary and fiscal policy, while also attempting to meet the political aspirations of his or her party members and the electorate in general.

Returning to the organization level and the financial reporting mechanisms, we have already established that any organization must maintain a set of financial records. This is because the money involved, while legally belonging to that organization, will have been loaned or invested by individuals. They are stakeholders in a general sense, and specifically loan creditors and shareholders, respectively. The annual accounts presented at an annual general meeting represent a financial summary of the transactions made by that organization during the year (known as an income statement), the financial affairs at the year end (a balance sheet) and a summary statement of cash movement over the year (a cash flow statement). The annual accounts are usually accompanied by an auditor’s report which states whether the financial statements presented to the meeting represent a true record.

Similarly, for a limited company, the management, usually through the board of directors, owe a duty to individuals who have either lent money to the company or bought shares in that company. In a similar manner to a bowling club, the information is summarized annually in the form of published accounts, which contain various statements of a financial nature and reports by the company auditors and directors. While legal requirements may necessitate information to be recorded, management practice also necessitates the maintenance of records.

The financial information of a small organization may be recorded primarily for legal reasons. As an organization grows in size the financial information becomes more complex, often including several tiers of management, or different branches or divisions within a company. Once professional managers are required because of an organization’s size then information becomes a crucial ingredient of management practice. Records must be maintained for decision making, planning and control purposes over and above those required by legislation.

Information exists in different ways within organizations, either within the formal administrative mechanisms or within the informal ones, and may be held within a paper filing system, a computerized file or within the minds of individual employees. This text is particularly concerned with the storage, use and interpretation of financial data with regard to the management of an organization in meeting both the objectives of that organization and its external interested parties.

Such a financial focus must be considered within the broader context of other information which is critical to understanding organizations. The storage and presentation of financial data either within organizations or about organizations is known as accountancy, which attempts to use a financial information system to help control and assist in the economic decision-making process relating to that organization.

Objective of Accountancy

To develop an objective for accountancy by observing what accountants do would be a lengthy and time-consuming process, as they are involved in a broad range of tasks all relating to the way financial data is recorded and applied. It would be better to approach the objective by considering the output of accountants’ labour, the provision of financial reports. Early ideas about the objectives of such reports concentrated on the issue of ensuring that organizational assets were correctly accounted for to the owners of that organization. However, over time the objective of finance reporting has broadened; a 1975 UK report put forward this definition:

… to communicate economic measurement of and information about the resources and performance of the reporting entity useful to those who have a reasonable right to such information.

(Corporate Report, 1975)

while another, American, definition gives more idea of the processes included in such reporting:

The process of identifying, measuring and communicating economic information to permit informed judgement and decisions by the users of the information.

(AAA, 1966)

Both the above definitions provide a basis for the study of the management of financial resources either using accounting information produced for users within an organization, say a budget holder, or for accounting information prepared for external users, say shareholders or creditors. These general ideas can be applied to the two main branches of accounting, which are financial reporting and management accounting. At this stage it will be sufficient to state that financial reporting provides information to users who are external to that organization, while management accounting provides information to decision makers within that organization. Before an analysis of the different roles of these two branches of accounting is presented it may be useful to consider their recent historical development, as this will also provide a useful backdrop to other areas of study within the text.

The following section provides a brief history of accounting, the initial part explaining the development of financial accounting and its links with company legislation, while the latter views the development of management accounting through management’s requirements for information.

A Recent History of Accounting

The Industrial Revolution in Britain and later elsewhere brought about the replacement of domestic traditional crafts with methods of production housed in large factories, which required substantial capital investment. Because of the size of funds required for this capital investment it was often the case that a large number of individuals would be required to provide the money (capital), as no one such individual was sufficiently wealthy. The process of bringing individuals together to invest in a single entity was legally difficult until the passing of the Joint Stock Companies Act in 1844. The shareholders (also called stockholders), or the individuals owning a share of the business, delegated the use of their money to directors and managers who were employed to run the business on their behalf. As already stated, the managers therefore owed a duty to protect the interests of their shareholders, and to operate on their behalf.

A further Act in 1855 enabled groups of individuals to form companies which had separate legal identities from their shareholders and which possessed limited liability. These two developments meant that by 1856 directors of companies owed duties of care to the sha...