The Significance of Accounting to the Stakeholders and the Organization - IBT Consult - Case Study Example

Business Accounting Introduction The aim of this document is to examine the significance of accounting to the stakeholders and the organization. The analysis includes a financial report of 12 month for IBT Consult Ltd for year begging on 1st April 2014 to 31st March 2015. The analysis will focus on cash flow, balance sheet and income statement of the selected company. I will also use ratio analysis to determine the company’s performance during that period. In the modern world businesses are operating in a competitive environment due to globalization, increasing competition and high consumer expectations due to changing needs (Norton & Porter, 2012). Business owners and managers should establish and implement strategies that will give the advantage over their competitors (Kakani, 2007). However, in order for the organizations to be competitive, they require information on how their businesses are performing and information that can help them to make sound decisions to improve performance (Kakani, 2007). The various forms of information include cost accounting, managerial accounting, and financial accounting information. Accounting in Business Accounting is a specialized function of the top management of the organization which involves efficient and effective administration of funds in such a way as to achieve the goals of the organization. It is involved with raising and allocation of capital both in short-term and long-term and making other decisions for efficient operation (Needles, Powers & Crosson, 2010). It involves effective and efficient management practices to plan, evaluate and control management of money or funds in such a way that will lead to achievement of business objectives. It is a top management function in the organization. In addition, financial management is involved in raising and allocating capital both in short-term and long-term and is involved in the distribution of dividends to the shareholders. It ensures the organization’s dreams are actually implemented by providing financial resources necessary for funding various business activities (Brigham & Ehrhardt, 2013). Therefore, financial management serves various objectives in an organization such as; ensuring regular and adequate funds to the concern, ensure adequate returns to the shareholders, ensure optimum utilization of funds ensure safety on investment and to plan sound capital structure. The accounting processes include maintaining track record of business transactions and recording of business revenue and expenses (Kakani, 2007). Accounting practices aims at providing critical financial information that can be used for evaluating financial position of the organization and make rigorous financial decisions. The significance of accounting in an organization is to classify and record all business activities that can influence the financial status of the organization. However, it is concerned with activities that can be categorized in monetary terms and maintained in a specific accounting record (Norton & Porter, 2012). Those activities include interest earned from investments, sales, purchases and acquisition of capital. Accounting is categorized into two. These are financial accounting and managerial accounting. According to Chartered Institute of Management Accountants (CIMA), “Management Accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of information that used by management to plan, evaluate, and control within an entity and to assure appropriate use of accountability for its resources” (Norton & Porter, 2012, p. 36). Management accounting involves decisions forecasting of markets and trends on a short period due to the dynamic nature of the business environment (Jain & Khan, 2007). Financial accounting is the field of accounting concerned with summary, analysis and reporting of financial transactions pertaining to business (Norton & Porter, 2012). It involves preparation of financial statements for internal and external stakeholders such as shareholders, banks, employees, suppliers, customers, government agencies and other persons interested in receiving such information for decision-making process (Needles at. al., 2010). The financial accounting processes are governed by both local and international accounting standards to ensure quality and reliable financial report for the users of such information. Accounting provides the relevant financial information to the users of such information for decision making. It enables the organization to monitor income and expenditure of the organization (Norton & Porter, 2012). Finally, such information aids in managing cash flow forecasts that reflects in the current financial position and enable the business to make future plans. The users of financial information are both internal and external to the organization. Financial accounting provides relevant information for both internal and external users of such information. On the other hand, management accounting provides relevant information to the internal users of such information for internal decision making (Kakani, 2007). The users of accounting information include managers, investors, government, consumers, general public, shareholders, employees, financial institution or lenders, suppliers, tax agents, etc. On the other hand, management accounting provides information for internal users (Narayanaswamy, 2011). For example, such information helps managers to determine the business performance and make various decisions such as investment decisions, financing decisions and dividends decisions. Purpose of accounting for an organization As aforementioned, accounting in an organization is subdivided into management accounting and financial accounting. Accounting is involved in keeping trail of transactions and maintaining records of income and expenditures of an organization (Narayanaswamy, 2011). It ensures that business can identify and record all transactions which impact business financially. Such records are essential for an organization during a preparation of financial statement. Such transactions include sales, purchases, interest earnings, etc. (Norton & Porter, 2012). Therefore, accounting process translates financial data into information useful for decision-making such as forecasting cash flows, sales, budgeting activities, monitoring business activities such as sales increase or decrease, receiving payment, expenses, etc. (Needles, Powers & Crosson, 2010). The financial information assists managers to carry out their functions which include making investment decisions, financing decisions and dividends decisions. Investment decision involves approaches used managers to allocate limited resources to various investment opportunities to maximize returns or gains. Financial managers are responsible for making investment decisions involving fixed assets (capital budgeting) and current assets (working capital decisions) (Needles at. al., 2010). This decision involves careful selection of financial portfolio in which they intend to commit enterprise resources. Through use of various investment assessment tools such as payback period, internal rate of return, etc. managers can assess the most viable projects which they intend to commit the enterprise resources and can either accept or reject the project based on its viability (Norton & Porter, 2012). An organization has various investment opportunities, but resources are scarce. Therefore, managers must make optimal decisions by selecting the investment decisions carefully that will help to maximize benefits (Duchac et al., 2011). This decision involves careful selection of assets in which they intend to invest their resources. The investment decisions may involve acquiring fixed assets (capital budgeting decisions) and current assets. When making investment decisions, a firm should consider the amount of returns they expect from the business or cash flow requirement for day-to-day requirements (Pandey, 2009). When making the huge investment, the organization should expect regular cash flow to meet daily expenses of the business. Other factors include return on investments, a risk involved and investment criteria (e.g. availability of labour, technologies, input, machinery, etc.). The financing decision involves managers’ decision on various sources of business funds. The sources of business funds include owners’ funds (e.g. share capital and retained earnings) and borrowed funds (debentures, loans, bonds, etc.). Financing decision involves the decision on how much to raise from owners funds and borrowed funds (Brigham & Ehrhardt, 2013). Borrowed funds bear an enormous risk of the repayment period and interest charges while owners’ funds have no fixed commitment on repayment or interest charges. This decision is concerned with the disposal of residue funds. The earnings of the firm are shared among various stakeholders such as creditors, workers, shareholders, investors, etc. (Pandey, 2009). The payment of interest on borrowings and creditors, as well as dividends paid to the shareholders, constitutes fixed liability of the company, so what company has to decide is what to do with the residual or left over profit of the company (Kakani, 2007). The residual earnings are either distributed to equity shareholders as the dividend or are retained for future use in business operations. The finance manager determines the amount of income they should distribute as dividend and the keep as retained earnings. To take this decision finance manager keeps in mind the growth plans and investment opportunities (Needles, Powers & Crosson, 2010). If more investment opportunities are available and company has growth plans then more is kept aside as retained earnings and less is given in the form of dividend, but if company intends to satisfy its shareholders and has fewer growth plans, then more is given in the form of dividend and less is kept aside as retained earnings. This decision is also called residual decision because it is concerned with a distribution of residual or left over income (Goyal & Goyal, 2012). New and upcoming companies keep aside more of retain earning and distribute fewer dividends whereas established companies prefer to give more dividends and keep aside less profit. Accounting processes provides managers with information about cost of various business activities during business operations. Such information enables managers to make decision-based on the efficiency and capability of cost (Duchac et al., 2011). The information is essential for the managers because it helps them assess the needs to control current operations and control plans. Managers are interested in various forms of information regarding cost such as variable and fixed cost in order to decide the most efficient projects in which they can commit their resources (Norton & Porter, 2012). Managers require information about various drivers of cost in order to implement mechanisms for regulating those costs (Norton & Porter, 2012). For example, information about fixed and variable costs of business will help managers to determine the sources of funding for various projects and the viability of such projects (Brigham & Houston, 2011). Managers categorize a cost according to respective cost elements such as labour, raw materials, and overhead among others. Therefore, management accounting provides managers with relevant information regarding a specific product, a department or entire firm for strategic decision-making. Capital Expenditure and Revenue Expenditure The preparers of accounting information should be able to differentiate between capital expenditure and revenue expenditure (Norton & Porter, 2012). The significance of this information is that only capital expenditure is included in the cost of fixed assets. Capital expenditure involves the costs sustained during the acquisition of fixed assets and additional expenditure that increases the earning ability of the prevailing fixed assets. The acquisition cost includes the purchase cost and any other expenses incurred in bringing fixed assets into their present place and state (Brigham & Houston, 2011). Examples of capital expenditure include cost of purchase, delivery cost, installation fee, a cost of up grading the assets, legal fee, a cost of replacement, etc. Capital expenditure has the effect of increasing fixed assets of the entity. On the other hand, the cost incurred on a maintenance of fixed assets rather than enhancing their production or earning capacity is referred as revenue expenditure (Duchac et al., 2011, p.123). These expenditures are incurred on a regular basis, and their benefits are recouped on a short period. Revenue costs include; maintenance fees, repair costs, renewal expenses and renovation expenses (Norton & Porter, 2012). Such costs do not form part of a fixed asset cost. They are charged in the income statement for the period they are incurred. Difference between revenue expenditure and capital Expenditure Revenue expenditure has temporary effects obtained within the accounting year while capital budgeting has long-term effects, and its benefits accrue for more than a year. Also, unlike revenue expenditure which does not appear in balance sheet capital expenditure appears in a balance sheet (Brigham & Houston, 2011). The entire revenue expenditure is reflected in the income statement while only a section of capital expenditure i.e. depreciation on assets is reflected the income statement while the rest is presented in the balance sheet. Revenue expenditure reduces the business revenue while capital expenditure has no effect on the profitability of the business. Revenue expenditure has no physical existence since it is incurred on items used up by the business while most of the capital expenditure has physical existence except for the intangible assets (Duchac et al., 2011, p. 354). Finally, revenue expenditure does not involve either an acquisition of assets or increase in assets value while capital budgeting involves an acquisition of assets or an increase in value of the assets. 12-month cash flow forecast to enable an organization to manage its cash Cash flow refers to the cash which comes in and the money which goes out of the business. The cash comes in mostly from sales. The cash goes out for business expenses. So, the finance manager must estimate the future sales of the business (Needles at. al., 2010). This is called Sales forecasting. Also, they have to estimate the future business expenses. An organization has various options through which they can raise additional funds. For example, they can decide to issue shares and debentures, take loans from banks and other financial institutions, and can use public deposits drawn in the form of bonds (Norton & Porter, 2012). Before making decision on where to source the finances, the financial managers should carry out cost-benefit analysis of various alternative sources and the financing period (Brigham &Houston, 2011). Cash flow statement demonstrates revenue, expenditure and investments of the organization. CASH FLOW STATEMENT IBT CONSULT LIMITED FOR YEAR ENDED 31ST MARCH 2015 Cash Flow From Operations Net earnings 116,780 Cash Flow from Investing Capital expenditure (200) Cash Flow for Year ended 31st March 2015 116,480. Cash flow statement guides the investors to understand how the business is carrying out its operations to generate income and expenses during the accounting period. Cash flow is unlike net income because it is not included in the income statement and balance sheet. Cash flow problems a business might experience IBT Consult Ltd has a challenge with its cash flow because they have limited sources of revenue. Their main source of cash inflow is sales. This can be a problem in case the market fluctuates thus compelling the company to hold stock longer hence limiting the business capacity to generate revenue. Justify actions a business might take when experiencing cash flow problems I would recommend the company to expand its sources of revenue by investing in various income generating activities. The company has a lot of cash from sales which they have not utilized appropriately. The company can utilize such cash by expanding its operations to new ventures to stabilize its cash flow. Profit And Loss Account Profit and loss account shows business situations regarding the trading activities of the business at a particular point, and profit or loss of the business IBT CONSULT LTD INCOME STATEMENT FOR THE YEAR ENDED 31ST MARCH 2015 Income Statement Sales 118,950 Less cost of sales Purchases 600 Gross profit 118,350 Expense Salaries and wages 20 Rent 300 Utilities 200 Repairs and maintenance 30 Insurance 50 Travel 150 Telephone 50 Postage 45 Office Supplies 150 Advertising 200 Marketing and Promotion 300 Bank Charges 30 Total Expenses 1,525 EBIT 116,825 Tax expenditure (45) EAT 116,780 Balance Sheet Balance sheet is a financial statement that shows the financial position of the business at a given time. It portrays the business assets, the owners’ worth in the business and what business owes non-owners or lenders. IBT CONSULT LIMITED BALANCE SHEET AS AT 31ST MARCH 2015 Fixed Assets All values are in £ Capital purchases 200 Current Assets Account Receivables 22,500 Cash 7,030 Total Current Assets 27,530 Current Liabilities Account Payables 100 Net current Assets 27,430 Total Net Assets 27,630 Capita 15,000 Long-term Liabilities Bank loan 10,000 Tax Payment 45 Profit 116,780 Ratio analysis as a measure of profitability, liquidity and efficiency Liquidity ratios Current ratio = current assets/current liabilities = 27530/100 = 275.3 This implies the organization has too much liquid assets. Leverage ratios Debt Ratio = Total Liabilities/Total Assets = 10,100/27730 = 0.36. This is health for the business because most of the assets are funded from owners’ equity and just a small proportion is financed by non-owners funds. Debt Equity Ratio = Total Debts/Net Worth of the Firm = 10,100/15,000 = 0.67. This shows the proportion of borrowed funds in business to the owners’ contribution. Lower ratio could imply the business has little reliance on external sources. However, it could also mean the business has no viable ideas for investing resources (Norton & Porter, 2012). Long Term Debt Ratio =Long Term Liabilities/Net Assets = 10,000/27,630 = 0.362. Higher ratios could imply that the business has to use net assets to generate income sufficient to repay the borrowed amount and interest on the borrowed funds (Norton & Porter, 2012). Profitability Ratios Gross margin = Gross profit/ Net Sales = 118350/118950 = 0.99. It indicates the extent to which the business is using available resources to generate income. In this case it implies the company is getter an equivalent return of what they invested (Norton & Porter, 2012). Operation Margin = EBIT/Net Sales = 118825/118950 =1.00. This ratio indicates the amount of resources that remains after the company has settled its variable costs (Norton & Porter, 2012). Net Profit Margin = EAT/Net Sales = 116780/118950 = 0.98. This ratio is important to the stakeholders because it demonstrates how the company is utilizing its revenue to increase profit for the shareholders (Needles et al., 2010). Return on capital and Equity (ROCE) = Net Profit after Tax/Net Sales 116,780/118950 =0.98. This ratio is crucial to the stakeholders because it helps in determining the efficiency with which capital is utilized to generate revenue or profitability (Needles et al., 2010). Conclusion Accounting information is essential for effective business management because it provides information to the users of such information to enable them in decision making. Accounting information provides summarized information that is easy for different stakeholders to understand. For example, cash flow statement, income statement and statement financial position or balance sheet. Ratio analysis on various accounting information can assist in determining the performance of business in terms of profitability and activities. Accountants should gather as much of the relevant information in order to obtain a clear picture of the organization. References Brigham, E. & Ehrhardt, M (2013), Financial Management: Theory & Practice. 14th Ed. USA: Cengage Learning Brigham, E & Houston, J (2011), Fundamentals of Financial Management, Concise Edition, 7th Ed. USA: Cengage Learning. Duchac J. Reeve, J & Warren, C 2011, Financial Accounting, Cengage Learning. Pp. 1-944. Goyal, R. & Goyal, V. K 2012, Financial Accounting, PHI Learning Pvt. Ltd. Pp. 1-668. Jain & Khan, (2007), Financial Management. Tata McGraw-Hill Education. Mittal R. K Kakani, R (2007), Financial Accounting for Management, 2nd Ed. New Delhi: Tata McGraw- Hill Education. Maheshwari, S & Maheshwari. S. K (2009), Fundamentals of Accounting for Cpt, 2nd Ed. Vikas Publishing House Pvt Ltd. Narayanaswamy, R 2011, Financial Accounting: A Managerial Perspective, PHI Learning Pvt. Ltd. Pp.1- 712. Needles B., Powers, M & Crosson, S. (2010), Principles of Accounting, 11th ed. Cengage Learning. Norton, C & Porter, G 2012, Financial Accounting: The Impact on Decision Makers, Cengage Learning: Pp. 1-912. Pandey, I. M (2009), Financial Management, 9th Ed. India: Vikas Publishing House Pvt Ltd Read More