Business Budgets and Accounts (RLE Accounting)

Harold Edey

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781134677832
• Edition: 1
• Topic: Business
• Subtopic: Contabilità
• Index: Business

This book shows the relevance of accounting methods to the economic and administrative problems of business. The book has been arranged to take the reader through the budgeting procedure of a representative business: demonstrating the relationship between budgets, accounts and the various business activities and showing how budgets and accounts link together the balance sheets at the beginning and end of the year.

1

INTRODUCTION

WE CAN assume that all human beings wish to economize resources, whatever their views and philosophies, and whatever the objectives they wish to attain. By this we mean that they prefer to achieve more, rather than less, with any given set of resources, or—which is the same thing—achieve any given objective with fewer, rather than more, resources, since thereby more resources are left for other purposes. This applies to churchmen building cathedrals, scientists spreading knowledge, dictators waging war, or the administrators running businesses with whom we are concerned in this book.

Budgets and accounts are tools intended to help in the economizing of resources. They are numerical statements about economic data: a budget is a statement about what is expected or planned to happen; an account is a statement about what has happened. A budget may, therefore, be regarded as an estimate or forecast of an account, and in this sense the account is the fundamental statement. Accounting, the activity concerned with accounts, has, indeed, been called the language of business; and as with other languages the art of interpretation must be acquired. Our first task is, then, to examine the nature of accounting.

The first characteristic to be noted about accounts is that they are concerned with economic values, expressed in terms of money. The tests by which we determine whether resources are being economized are made in terms of values gained or lost. If, for example, a given result can be achieved in two ways, one of which will consume less value than the other, we regard the former as the more economical. The figures with which we shall deal relate, therefore, to values.

Before proceeding we must note, however, that the precise way in which the value, or change in value, of resources is determined in any given context, sometimes raises difficult questions. Broadly speaking, in economic matters it is the market value of a resource that we are concerned with, for it is this that determines the purchasing power that is gained if it is disposed of, or is foregone or sacrificed by retaining it. In practice, however, it is often found necessary to use conventional values that are not closely related to the market. There are several reasons for this. In the first place, the market value of any resource can never be determined precisely until it actually changes hands. Secondly, in business many resources are not held for sale, but in order to assist in the production of other resources, and the market value of the former (if it can be found) is not necessarily a good measure of the sacrifice involved in using them for one purpose inside the business rather than another. Finally, it is impracticable in economics, as in other fields, to insist on working to very close margins of error at all times: it is often desirable, having regard to the cost and trouble of precision, to accept quite rough approximations. Nevertheless, it is essential to bear in mind that the power to purchase goods and services is what economic measurement is ultimately concerned with.

As we proceed we shall have much to say about costs and revenues. These terms are merely shorthand expressions for negative and positive changes in the value of a given resource or collection of resources, costs being falls in value and revenues rises. It is often convenient to use the terms ‘net cost’ or ‘net revenue’ for the difference between the costs and revenues caused by a particular action or set of actions. The resources of the business we shall also call assets, and the claims on the business of people other than the owners we shall call liabilities.

Accounting was originally largely concerned with the problem of conserving resources in the physical sense, as distinct from that of economizing them by ensuring that they were put to the best use. This kind of accounting arose particularly with respect to the preservation of debts, and of money or goods entrusted to third parties. Ancient legal systems were such that the recovery of these might require the production of written evidence so that legal processes could be invoked, and in any case the owner, or his steward, might require a reminder of the amounts owed by different people.¹ It has remained an important function of accounting systems to provide checks of this kind. Thus, the risk of loss inside a business is dealt with by a system that makes it clear under whose responsibility a given asset or collection of assets lies, maintains a continuing record of the assets for which each person is responsible, with double checks, and is arranged so that the work done by different people is interlocked with the result that if one person makes a mistake or commits fraud it will automatically be detected by another in the course of his work. This kind of control is not, however, confined to the internal administration of businesses and other organizations. The legal codes of many countries include provisions that require accounts to be kept by company directors for the benefit of their shareholders and creditors, by all businesses for the benefit of the tax authorities, by trustees for the benefit of the beneficiaries of the trusts, and so on.

In the modern world, however, it is less easy to distinguish between the mere physical control of resources, and their preservation or enhancement by ensuring that they are put to the best economic use. Even in ancient accounting records we sometimes find devices the aim of which was to ensure the most efficient use of resources: for example, accounting records show that women employed in textile manufacture in the temple of the god in the cities of ancient Sumeria were allowed a certain tolerance for wastage in manufacture: this is an exact parallel of the system of standard material costing to be found in advanced industrial accounting systems today. Again, it will not help the shareholders of a company very much to know that their directors have not, in the physical sense, lost their resources, or stolen them, if they have used them so badly that there have been great losses in value. As for the internal administration of a business, the increase in the complexity of business, and the growth of large-scale enterprise, have enhanced greatly the importance of accounts in the pursuit of the best use of resources: the size, variety and variability of the resources available are such in all but very small or simple enterprises that no one person can bear them all in mind, or visualize the ways in which the amounts of all these resources, and their values, are changing in response to the changing economic and technical conditions of the business; yet a knowledge of these things is an essential condition of successful administration. In consequence of this the features that characterize modern, as distinct from earlier, accounting methods are the techniques of data collection and the ordering of the collected information: the formulation of accounting statements and the classification of data in ways that can suggest fruitful lines of enquiry into the operation of the business, but which will also continue to provide the continuing control over physical assets that remains as necessary in the more complex circumstances of today as it was in the time of Hammurabi.

The economic aims of business in any given period of time, so far as these are relevant to accounting, can be subsumed under three main headings:

(a) To achieve the target revenues and costs: the income problem.¹

(b) To achieve the target figure of available money at all times during the period: the financial or liquidity problem.

(c) To achieve the target pattern of resources other than money at all times during the period: the asset structure problem.

It is important to notice that aim (a), the attainment of the required level of income or, as it is often called in commercial concerns, net profit, is not the same as aim (b), the attainment of the required level of money at different points of time. A revenue or cost is a gain or sacrifice of value—money’s worth: this may not be in the form of available money at all; a business that has made a profit in a given period and thereby increased the total value of its collection of resources may yet be short of ready money, and even be forced into bankruptcy because it is unable to find the cash to pay its debts as they fall due, so that, for example, other resources have to be sold rapidly at knock-down prices; and a business may make a loss at a time when it still holds a large cash balance at the bank. There is, however, a close connection between aims (a) and (b) in the longer run: a business whose costs persistently exceed its revenues must sooner or later run out of money; and on the other hand, a business that is consistently profitable will usually be able to obtain ready money fairly quickly by borrowing, or even by selling some of its non-money resources. There is also a continuing relationship between aims (a), (b) and (c), taken together, with which we shall become familiar as our study proceeds.

The accounting statement of the type that we call the income, or profit and loss, account, is devised to provide a classified analysis of the component revenues and costs that together make up the net profit for any given period. The net profit itself is a measure of the degree of success achieved in meeting whatever figure justifies the continued use in the business of the resources as a whole. We shall note in Chapter 10, after we have learnt more about the construction of the profit and loss statement and its components, some of the problems that arise in setting this target figure, which, indeed, often represents more a theoretical concept than a conscious idea in the mind of the business administrator; even when this is true, however, the profit (or loss) achieved, and the question whether this should have been greater or less, remains of fundamental importance.

The detailed analysis of the profit and loss components is a guide to the relative contributions, positive or negative, of the different activities carried on inside the business. The revenues and costs can be analysed in ways that correspond to the particular types of goods and services that have been absorbed in carrying on the business activities: the costs can be determined, for example, of using different kinds of raw materials for manufacture, of hiring particular kinds of labour, and so on. A well-constructed income account, with adequate supporting analysis extending to what is called ‘cost accounting’, can be a powerful engine of economic control, providing a detailed analysis of transactions that enables, within limits, the causes of the revenues and costs to be isolated and studied, and the interrelations between these to be examined, with the object of learning from the past how better results can be obtained in the future.

It is particularly important that the administrator of any business undertaking, or part of an undertaking, should be continually aware of the size of the inward and outward flow of money, and the quantity of ready money available at all points of time. This study of the ‘liquidity’ of the undertaking is almost impossible in all but the simplest business situations unless careful accounting records are maintained of the money flows. Businesses vary a good deal in the quality of their accounting systems and many small businesses have systems that provide much less information than would probably be useful; it is most unusual, however, to find any business that does not keep a fairly accurate record of its cash flows. The administrator must always be ready to take quick action if it should appear, from the trend in the flows, and from the information available about the probable flows in the near future, that there will not be enough ready money available to meet the debts that are falling due, or to take advantage of the business opportunities that appear likely to offer themselves.

The changes in the quantity of money held by the business are, by definition, dependent upon the changes in all the other assets and liabilities, both in form—that is, in the type of asset or liability—and in the total value. In our progress through the book we shall see how all the changes in the assets and liabilities, including money, interlock. This dependence of the inflow and outflow of money upon the set of assets of which a business disposes, and the liabilities, is one of the reasons why the asset structure must be kept under close watch. For example, the amount of debts that are owing to the business at any moment of time determines in part the amount of money that will shortly be collected, and the amount of short term liabilities from the business to outsiders determines the amounts of money that will shortly have to be paid out. The asset structure is also important because the nature of the business assets, together with the available money, and subject to the liabilities, determines what can be achieved in the future. Unless the business administrator and his assistants are constantly aware of the assets at their disposal, and of the claims against these, they will be unable effectively to deploy the former in the business interests. Changes in the amounts of the assets and liabilities are also closely interrelated with the revenues and costs, but it should be noted that asset structure changes can take place without implying necessarily a change in the value of the net assets as a whole, that is of the assets less the liabilities.

Summaries of assets and liabilities at any given moment of time may be described as ‘balance sheet’ types of statements. We shall see an example of a balance sheet in Chapter 3. As we proceed through the book, however, we shall find that although the balance sheet itself summarizes the business resources, the administrative problems call for much more detailed analyses and sub-divisions of the assets and liabilities by classes than are found in the usual conventional balance sheet, which may be regarded merely as a formal summary of these.

A most significant feature of most business undertakings is the delegation of authority. In almost every business there is a hierarchy of administrators: that is, of people who have charge of resources and a certain discretion in their use. Thus, at the lowest level of the organization we may find workmen carrying out mechanical operations of some kind on materials supplied to them; they are left with some choice and are therefore administering—however small may be the discretion left to them—the resources of material, machine-power, factory space, etc., placed in their hands. Above them is the foreman responsible for a greater quantity of resources than any one of the workmen; above the foreman is the works manager, and so on, until we reach the board of directors and above them the shareholders or, in the case of a state industry, the ministry and the legislature.

One of the aims of the accountant is to classify his material in such a way that the costs and revenues reflect the results of particular persons’ administration of resources, and so that the records of assets and liabilities reflect the responsibility of particular persons for their best use. This is separate from, but parallel to, the accounting arrangements for the physical control of assets which we have already discussed. Sometimes the control over the best use of assets, and the physical control over these, are very closely related and in the hands of the same person; more frequently, however, the physical control of resources may represent merely one part of the responsibility of a given person, a part which he necessarily delegates to some subordinate. At other times the physical control of resources for the best use of which a particular person is responsible may be in the hands of some other person not even under his authority. Here we see the stewardship principle operating, so to speak, in two different ways at the same time.

At the very top of the administrative hierarchy we may regard the whole list of the assets of the undertaking, less the liabilities which have to be settled out of these assets, as reflecting the responsibility of the person or persons who have been placed in direct control of the whole business on behalf of the ultimate owners, whether the latter be shareholders, the state, or what you will. In the same way the total of the revenues and costs for the year may be regarded as providing in some degree a check upon the efficiency of the top administrator when related to the target figures. As we descend the administrative hierarchy, however, the accounting aids will relate to a smaller and smaller area of the business, and at the lower levels they may become redundant, or amount at most merely to such simple statements as periodic records of physical production.

It is desirable at this point to comment on some of the limitations which the nature of the economic process imposes upon the use of accounting data.

Business operations tend to resemble, not so much the steady pursuit of a single well-defined objective, as a number of parallel skirmishes and campaigns conducted within the framework of a general overall strategy. In war some operations may in themselves be unsuccessful while yet contributing, through diversion of enemy strength and in other ways, to the success of the campaign. Similarly in business, it does not follow that all operations are expected to be profitable in themselves: an after-sales service department may be run ‘at a loss’ because sales of the main product are thereby stimulated; and the same is true of many of the individual activities of a business taken separately. The management have to decide whether the net advantage of any given activity to the business as a whole justifies the continuance of the activity at some given level of cost.

There is also interdependence over time. If, as often happens, the effects of a proposed activity will not be limited to the present, an attempt has to be made to assess its future effects, positive or negative. The net advantage to the business must be considered over time, as well as over the complex of business activities.

This interdependence of business activities is of considerable importance, for it limits the significance of information that can be presented in accounting records. For example, suppose that the after-sales service just mentioned is run 20 per cent more cheaply by reducing the quality of the service offered. The management will want to know how this has affected costs and revenues. The accounts can show the direct economies obtained through reduction of staff salaries and other expenses. What cannot be measured so precisely is the fall in sales revenue that results from the lower satisfaction customers obtain. Comparison of the accounting data with that of earlier periods, and with the budget, may, indeed, show that sales revenue is less than expected; but it will be another matter to say how much greater would have been the revenue had there been no reduction in the after-sales s...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Original Copyright
• Table of Contents
• Preface
• 1 Introduction
• 2 The Annual Budgets
• 3 The Balance Sheet
• 4 Sales
• 5 Production—I
• 6 Production—II
• 7 Production—III
• 8 Production—IV
• 9 Miscellaneous Overhead Costs
• 10 The Profit and Loss Statement
• 11 Materials, Debtors and Creditors
• 12 Finance
• Short Reading List
• Index