Financial Decision Making - Term Paper Example

Financial Decision Making In today's fast changing economic environment, competitiveness, in terms of cost and productivity, has become the key to success for any productive enterprise. The task of managing finance has traditionally been entrusted to financial executives, but in the changed scenario, such a responsibility has become very relevant at all the key decision making points in an organization. Every enterprise, whether public or private, large or small, profit making or not is a financial concern. Most of its decisions involve finance. Success or failure of the decisions and hence the enterprise depends on the quality of its financial decisions. Therefore, it won't be an exaggeration to say that finance is the lifeblood of all enterprises. This is particularly so when economics are undergoing structural changes and economic reforms are in the making to introduce greater elements of competitive forces. In a competitive environment managers are faced with a challenge to compete for resources and to find a better utilization of such resources. Finance is a specialized subject in itself but it draws heavily on other related functions like marketing, production, personnel, purchase etc. Drury (2004, p.5) states "Management accounting is concerned with the provision of information to people within the organization to help them make better decisions and improve the efficiency and effectiveness of existing operations" (Lev, 2001) stated that existing financial accounting standards sharply distinguish between physical and intangible assets. While physical assets (e.g., property, plant, and equipment) are valued on the balance sheet at the price paid to obtain them, less accumulated depreciation, intangible "assets" are expensed as incurred. Accounting is therefore considered an integral part of the knowledge management within an organization. Understanding the determinants of the value of accounting information happens to be the prerequisite to understanding existing and proposed Knowledge Accounting. The company uses this knowledge accounting to look ahead for further investments/ diversification/ expansion etc. Financial decisions involve; Does the company have enough cash to invest How much to invest Where to obtain capital What credit rates and terms to negotiate What mix of equity and debt to use How much financial risk to take Making a calculated financial decision makes a big difference between a prosperous and growing business and a liability. The prime function of a management executive in a business organization is decision-making and forward planning. Decision making means the process of selecting one action from two or more alternative courses of action whereas forward planning involves means establishing plans for the future. The question of choice arises because resources such as capital, land, labor and management are limited and can be employed in alternative uses. The manager is thus supposed to analyze the past data, current information and the estimates about future predicted as best as possible. This application of economic theory to business management is known as managerial economics. This is micro-economic in character as the unit of study is the company. The following aspects are said to be generally under the ambit of managerial economics; Demand analysis and forecasting Cost and production analysis Pricing decisions, policies and practices Profit management Capital management. Often a distinction is made between management accounting and financial accounting. Management accounting measures and reports financial and non-financial information that helps managers make decisions to fulfill the goals of the organization. Its focus is on internal reporting. On the other hand financial accounting is considered to have a focus on reporting to external parties. It measures and records business transactions and provides financial statements that are based on the 'Generally Accepted Accounting Principles (GAAP)'. Therefore managers are responsible for the financial statements issued to investors, government regulators and other outside parties. If we see the historic development of the management accounting system, we find that these accounting principles are basically guided by the challenges facing managers in delivering the best product to the customer. The production industry therefore presents four key themes that are important to managers attaining success in their planning and control decision. These are; i. Customer Focus: Customers are pivotal to the success of an organization. The number of organizations aiming to be "customer driven" is large and increasing. The challenge for managers is to keep investing resources in good measure towards customer satisfaction for retaining the existing customers and attracting more customers. ii. Key success factors: These are the operational factors directly affecting the economic viability of the company. Key success factors include; a. Cost: Companies are constantly under pressure from customers to reduce the costs of their products or services. b. Quality: In this era of cut-throat competition quality has taken a centre-stage. This has become one very crucial component for product differentiation. Customers have become increasingly quality conscious and expect the best at lowest possible prices. c. Time: The time to deliver a quality product or service in the market or to the customer determines the level of market study undertaken by the company. Costs are involved in studying/ analyzing the market as well as in completing the activities faster. A company establishes its credentials in the market place depending upon the responses to customer requests and reliability with which the promises are met. d. Innovation: Continuous investment in research and development activities marks the heightened recognition that the market expects a continuing flow of innovative products. iii. Continuous Improvement: Gordon Moore, co-founder of Intel, made an interesting observation in 1965 about the doubling of the number of transistors per square inch on integrated circuits. In subsequent years this trend continued with data density doubling approximately every 18 months. This law calls for continuous improvement in order to effectively compete with competitors. To compete, companies concentrate on continually improving different aspects of their own operations. iv. Value chain and supply chain analysis: This theme has two related aspects: a. Treating each of the business functions as an essential and valued contributor, and b. Integrating and coordinating the efforts of all business functions in addition to developing the capabilities of each individual business function. The term value chain describes the flow of goods, services and information from one step to another on the production line, while 'value chain' refers to the sequence of business functions in which usefulness is added to the products and services of an organization. 'Value' of the product or service increases with its usefulness. Management accountants provide decision support for managers in each of the following six business functions. Research and development Design of products, services, or processes Production Marketing Distribution Customer service Besides the production set-up of big companies the retail sector is also impacted by the financial decision constraints. Convenience stores provide an 'anchor' function for town and district centres, helping in preserving their viability and vitality. Retail sector in general includes; Regional Shopping Centres, District Centres, Large Food-stores, Discount Food-stores, Retail Parks and Retail Warehouses, Factory Outlet Centres, Retail Warehouse Clubs, Shops in Small Towns and Rural Areas, Village Shops, Local Shops, Petrol Filling Stations etc. Management accounting plays a crucial role in this sector on account of; Competition within the retail sector The supply of products to consumers at lower prices and the effect on the cost of living Consumer choice; and The supplier base Retail sector also feels the tremors of wider economic social and environmental costs and benefits associated with planning control and development policies. For retailers the cost of goods sold constitutes the largest single cost item. In general they have low percentages of net income to revenues, which calls for them to take better decisions regarding the purchasing and managing of goods. Retailer's inventory management includes; Purchasing costs: i.e. the cost of goods acquired from suppliers. It also includes the incoming freight or transportation costs. Ordering costs: This includes costs of preparing, issuing, and paying the purchase orders. Receiving and inspecting costs are also included here. Carrying costs: These costs arise when an organization holds an inventory of goods for sale. This includes the opportunity costs of the investment tied up in inventory and the costs of storage. Stock-out cost: A stock-out is said to occur when a retailer runs out of a particular item for which there is customer demand. Quality costs: The conformance with a pre-announced or pre-specified standard is called its quality. References: 1. Stone, Dan N. and Sony Warsono, (2003), 'Handbook on Knowledge Management. Vol.1' Springer, Berlin, pp 273-270. 2. Drury, C. (2004), 'Management and Cost Accounting' (6th ed.) Thompson Learning. 3. Lev, B., (2001) 'Intangibles: Management, Measurement, and Reporting'. Washington: Brookings Institution. 4. Horngren, Charles T et al., (2000) 'Cost Accounting: A managerial emphasis', Prentice Hall. 5. Baile Atha Cliath, (2000), 'The Impact of the Draft Retail Planning Guidelines on the Retail Sector', the stationery office, Dublin Read More