Financial and Legal Role of Financial Planning Activities in Business - Assignment Example

FINANCE MANAGEMENT Name Finance Management – spring 2016 ETC International College June 26, 2016 SECTION 1 P1: Financial and legal role of financial planning activities in business Financial reporting is part of the financial planning activities, which entails presentation of documents and records that show the financial position of an organization to the government, stakeholders, and management. These documents are collectively referred to as the financial reports of the organization, and they include income statements, statements of shareholders’ equity, balance sheets, and cash flow statements (Greenwood, 2002). Most of the businesses carry out financial reporting annually while others conduct it after every six months. The financial reporting enables the stakeholders to assess the financial status of the organization and subsequently make important decisions such as how to enhance the financial performance of the organization. Apart of financial purposes, financial reporting is also required for legal purposes. In most of the countries across the globe, financial reports of companies and public organizations are required for financing, investment, and tax purposes (Greenwood, 2002). There are four different kinds of financial reporting and statements that companies typically do, and these include income statements, statements of shareholders’ equity, balance sheets, and cash flow statements. P2: Meaning and function of cost, profits, and revenues in business Revenue is the amount of income that a company gets over a specific period of time. Also known as sales revenue, turnover, sales, or total revenue, revenue is equivalent to overall income of a company and measures all income received from the sale of goods and service. Cost is the total expenditure incurred by a business in developing a product or in the process of running various business operations. Costs are categorized into two major categories: variable and fixed costs. Variable cost changes with the amount produced while fixed cost does not change regardless of the amount produced. Costs are also classified into direct and indirect costs. Indirect cost is that which cannot be linked directly to a product, and an example of such costs is rental expenses (Greenwood, 2002). On the other hand, direct costs can be linked to a product. Cost of raw materials is an example of direct costs. Profit, is the amount financial resources that are left after deducting all costs from the revenue. Mathematically, profit is calculated by subtracting the total costs from the total revenue as follows: profit = total revenue – total cost (Greenwood, 2002). All the above aspects, including the costs, profits, and revenues are very important in business are important in business as they help in determining the financial status of the business. P3: Break-even analysis and Break-even point Break-even analysis is an analysis level of sales at which a company would make zero profit. It used to determine the relationship between total costs, total profits, and total revenue of a company at different levels of output. In other words, it is about determining profit at various projected sales levels, determining the breakeven point, and making key management decision regarding the relation between the breakeven point and the probable sales (Greenwood, 2002). On the other hand, break-even point is a point at which the total cost is equivalent to the sales volume at which the business has neither incurred a loss nor made a profit. In simple terms, it is a point at which there is no loss or profit. Break-even point is calculated as follows: Break-even point = Fixed Costs + [(variable costs/revenues) x Sales] (Greenwood, 2002) Example a business has fixed costs of $40,000, variable costs of $75,000, and total revenue of $150,000. Therefore, the volume of sales at break-even point is calculated as follows: Sales at break-even point = Fixed Costs + [(variable costs/revenues) x Sales] = 40000 + [(75000/150000) x Sales] = 40000 + [(1/2) x Sales] = 40000 + 1/2 x Sales Therefore, Sales at break-even point – ½Sales = 40000 Sales at break-even point = 80000 (breakeven point in terms of $ of revenue exactly offset by total costs) M1: Importance of undertaking regular financial planning in business It is important to undertake financial planning regularly as this helps in choosing between alternative courses of action, plan action to be taken during a given period, as well as evaluate performance of business once the identified action has been taken. A good financial planning is one in which what is done conforms to the purpose of the company and the managers of that particular company, whatever those purposes and however they may be measured and evaluated (Greenwood, 2002). In essence, financial planning is important because it helps business organizations to determine their long-term and short-term goals and develop a suitable plan to achieve those goals. For example, at Wal-Mart, managers undertake financial planning regularly as a means of establishing the company’s long and short-term goals in order to develop a suitable plan to achieve those goals. D1: Effectiveness and limitations of using financial planning tools in management of a small business Financial planning for businesses can be a daunting task to undertake for many managers, but with the help of financial planning tools, this task can be undertaken very easily and in a more effective manner. Financial planning tools help business owners to easily and effectively choose between alternative courses of action, plan action to be taken during a given period, as well as evaluate performance of business once the identified action has been taken (Debarshi 2011). These tools offer guidelines for evaluating the performance of a business as well as identifying the sources of strengths and weaknesses in the performance. These tools however have numerous limitations that make them unsuitable for financial planning. For example, most of the financial planning tools are sophisticated and requires some knowledge and skills to be able to use, which many small business owners do not have (Greenwood, 2002). Secondly, financial planning undertaken using the financial planning tools may not satisfy the needs and desires of small business owners as these tools are preset by their developers and cannot be adjusted by the users to fit their individual requirements. SECTION 2 P4: Importance of cash-flow forecasting and cash flow statements Cash flow is the movement of cash into and out of a business. It is also described as the difference in the amount of cash available at the start of a specified period of time and the amount available at the end of that period (Caux, 2015). The amount of cash available at the beginning of the specified period is called opening balance, while the amount available at the close of the period is called closing balance. Cash flow can be used as a measure of parameters that give information regarding the value of a business such as liquidity and solvency (Caux, 2015). Cash flow forecasting is a process of modeling the future financial liquidity of a business over a given timeframe. Large companies, such as Wal-Mart, and other small businesses often use cash flow forecasting to plan their future cash needs in order to evade the risk of liquidity. This is carried out at regular intervals, for example on annual basis, to ensure that the company does not run into a liquidity crisis. The main advantage of cash flow forecasting it is that it helps businesses ensure that adequate funds will be available when they are needed at an acceptable cost (Bort, 2012). On the other hand, the disadvantage of cash flow forecasting is that it does not provide entirely accurate information and therefore it cannot be relied upon. SECTION 3 P5: Role of income statements in financial reporting An income statement, also known as a profit and loss statement, is a report usually generated monthly or yearly that shows the income of a business organization by indicating all relevant expenses and revenues for the purpose of determining the net income or loss (Debarshi 2011). It lists all the expenses and revenues over a given period in order to show the financial performance of the company. Income statement is important in financial reporting as it shows profitability or lack of profitability of the company over a specific period of time. It has three main parts: operating section, non-operating section, and the bottom line. Operating section includes expenses and revenues, while non-operation section includes revenues from non-primary business activities, interests, and income tax expense (Debarshi 2011). In essence, the financial data contained in various sections of the income statement contains include income, cost of goods, operating expenses, gross profit margin, total expenses, net profit, depreciation, earnings before taxes and interest, taxes, interest, and net profit before taxes (Debarshi 2011). The data, however, vary from one business to another depending on the industry in which the business operates. P6: Role of balance sheet in financial reporting A balance sheet, also known as a statement of financial position, is a financial statement that itemizes all the assets and liabilities of a business as well as the equity of shareholders at a given point in time. These three items forms the three main parts of a balance sheet. A balance sheet is important in financial reporting as it offers investors idea on what the business owes and owns, and the amount invested by shareholders (Craig, 2007). Below is a formula that a typical balance sheet uses: Liabilities + Equity of shareholders = Assets As mentioned above, a balance consists of three main parts: assets, liabilities, and shareholder’s equity. Under assets is a list of things owned by the business. Assets are divided into current and non-current assets. Current assets are those that can be converted to cash within a period of not more that twelve months, while non-current assets are those that cannot be converted to cash within a minimum period of twelve months (Craig, 2007). Liabilities section contains a list of financial resources that the business is owed, and these may include, among others, salaries, bills to pay suppliers, and rental dues. Liabilities are categorized into two: current liabilities and non-current or long-term liabilities (Craig, 2007). Current liabilities are those that are due within a period of not more than one year, whereas, long-term or non-current liabilities are those that are due in a period not less than one year (Craig, 2007). M2: Importance of using Income Statements and Balance Sheets in financial reporting Income statements and balance sheets are usually prepared by business organizations at the end of a given trading period to examine the financial activities and strength of the business, as well as to satisfy the legal requirements. These documents show the financial strength of the business and relay financial information to various interested parties. Using income statements and balance sheets in business financial reporting is very important as they enable business owners or managers to understand about the growth, profitability, financial strength, and solvency of their businesses. Balance sheets give investors idea on what the business owes and owns, as well as the amount invested by shareholders, while the income statements show profitability or lack of profitability of the company over a specific period (Craig, 2007). According to Debarshi (2011), income statements and balance sheets in financial are prime tools in the hands of the management of business organizations by which they can present the financial status of the organization before the interested parties such as creditors, lenders, and investors. References Bort, R. 2012. Medium-term funds flow forecasting: corporate cash management handbook. New York: Warren Gorham & Lamont Press. Caux, T. 2015. Cash forecasting: treasurer's companion. London: Association of Corporate Treasurers. Craig, R. 2007. Personal balance sheet: a practical career planning guide. Ontario: Knowledge to Action Press. Debarshi, B. 2011. Management accounting. Delhi: Pearson Education India. Greenwood, R. 2002. Handbook of financial planning and control. London: Gower Publishers. Read More