Nature and Importance of the Finance Function - Essay Example

Word Count: 3079 excluding Bibliography Nature and Importance of the Finance Function The common thread running through all the decisions taken by the various managers is money and there is hardly any manager working in any organization to which money does not matter. In order to get a clear picture of the above statement, observing the following instances would help. The R & D manager has to justify the money spent on research by coming up with new products and processes which would help to reduce costs and increase revenue. If the R & D department is like a bottomless pit only swallowing more and more money but not giving any positive results in return, then the management would have no choice but to close it. No commercial entity runs an R & D department to conduct in fructuous basic research ((ICMR), 2003). Management accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information that assists managers in specific decision-making within framework of fulfilling the organizational objectives (The ICFAI University Press, 2004). Like water, this rising tide of data can be viewed as an abundant, vital and necessary resource. With enough preparation, we should be able to tap into that reservoir -- and ride the wave -- by utilizing new ways to channel raw data into meaningful information. That information, in turn, can then become the knowledge that leads to wisdom. The idea is that information, knowledge, and wisdom are more than simply collections. Rather, the whole represents more than the sum of its parts and has a synergy of its own. In an organizational context, data represents facts or values of results, and relations between data and other relations have the capacity to represent information. Patterns of relations of data and information and other patterns have the capacity to represent knowledge. For the representation to be of any utility it must be understood, and when understood the representation is information or knowledge to the one that understands (Ponzi, 2002). The value of Knowledge Management relates directly to the effectiveness with which the managed knowledge enables the members of the organization to deal with today's situations and effectively envision and create their future. Without on-demand access to managed knowledge, every situation is addressed based on what the individual or group brings to the situation with them. With on-demand access to managed knowledge, every situation is addressed with the sum total of everything anyone in the organization has ever learned about a situation of a similar nature. Management accounting --- Importance of Stakeholders In the highly competitive environment, the survival of an organization may depend on how well stakeholders are managed. However, when managers delegate this responsibility of managing the stakeholder interests, there is no systematic way to evaluate their performance. With an evaluation method, such as a report card, managers no longer rely on observations regarding the outcomes of stakeholder management; they receive direct information from their stakeholders and can plan interventions accordingly (Slovensky, 2002). Management planning and control system is related to accounting system. Suitable goals are set based on the information provided by the accountants. Projections of futures sales, expenses, incomes and estimation of profit are made depending on the accounting information. After setting goals while examining alternatives, information about these alternatives comes from accounting system and the accountant is made to combine the data and produce meaningful reports. Though, implementation of chosen alternative is done by the mangers alone without the intervention of accounting system, the accountant is required to collect and summarize data about the success of the chosen plan. The evaluation of performance depends heavily on the accountant accumulates and reports. Though, accounting system is helpful in the process of planning and control it should be emphasized that the accountant does not necessarily participate in the management, and that his information may not necessarily prove that the success or failure has been achieved or suffered. Management Accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information that assists managers in specific decision-making within the framework of fulfilling the organization objectives (Birnberg). Comparison of Financial and Management Accounting A comparison of the two systems of accounting reveals that while management accounting differs in several ways from financial accounting, they also do have certain similarities. It would be a total waste of money to have two different data collecting systems existing side-by-side. For this reason, Management Accounting makes extensive use of routinely generated financial accounting data, which will be improved upon as per the requirements of the decisions to be taken or the problem to be resolved. This was not the case in the earlier days. It was strongly believed that Management Accounting focuses on providing information for internal users such as supervisors, managers etc as internal users do not need the same kind of information as needed by external users like stockholders, creditors etc. This view has changed now-a-days. Today, even the external users mentioned above are benefiting from the variability associated with Management Accounting (Bell). Both financial Accounting and Management Accounting rely heavily on the concept of responsibility. Financial Accounting is concerned with the concept of responsibility or stewardship over the company as a whole while Management Accounting is concerned with stewardship over its parts; and this concern extends to the last person in the organization who has, any responsibility over cost and this is the reason why now-a-days, it is felt by many that Financial Accounting needs to be harmonised and standardised. By nature, management accounting refers to reports prepared to fulfil the needs of management. The accounting statements and reports in management accounting are situation-specific. That is, management accounting reports attempt to fill the information needs of managers with respect to a specific problem, situation or decision. Management Accounting is not confined to the area of product costing, cost and price information. In management accounting, the objective is to have a data pool which will provide any and all sorts of information that management may need. This fact could be well understood from the following examples. Let us say, the management of an organization decides to depend on long-term debt for expansion of business, it may be investigated as to what effect this decision will have upon the earnings per share Should debt in the capital structure be too large or small Similarly, management may be interested in knowing the adequacy of cash inflows to pay current obligations or the effect of inflation on business decisions and performance. Thus, Management Accounting helps management deal with the total situation. In achieving this goal, management accounting makes use of information that is draw from financial accounting and other disciplines, such as economics, finance, statistics, operational research and other similar branches of study. The fundamental purpose of management accounting is to help an organization achieve its strategic objectives. Meeting these objectives satisfies the needs of its customers and other stakeholders. Typical stakeholders include shareholders, creditors, suppliers, employees, and labour unions. Strategy is the way that a firm positions and distinguishes itself from its competitors (Bierman Jr.). Positioning refers to the selection of target customers or markets. Distinctions are made on the three dimensions of quality, cost, and time. Different customers have different expectations about the features and performance reliability (quality) they want in a product, the price (cost) they are willing to pay, and when and how quickly they want the product or services delivered (time). An ice cream company, such as Hagen Dazs, specializes in premium high butterfat content and high priced ice creams. Hagen Dazs is quite different from Lady Lee which makes an everyday variety of low butterfat and lower priced ice creams. The two companies compete for different types of ice cream consumers. Hagen Dazs also competes more directly with Ben & Jerry's on providing a high quality premium ice cream, at the best price (cost), with timely introduction of new flavours. As already stated, management planning and control system is related to accounting system. Suitable goals are set based on the information provided by the accountants. Projections of futures sales, expenses, incomes and estimation of profit are made depending on the accounting information. After setting goals while examining alternatives, information about these alternatives comes from accounting system and the accountant is made to combine the data and produce meaningful reports. Though, implementation of chosen alternative is done by the mangers alone without the intervention of accounting system, the accountant is required to collect and summarize data about the success of the chosen plan. The evaluation of performance depends heavily on the accountant accumulates and reports. Though, accounting system is helpful in the process of planning and control it should be emphasized that the accountant does not necessarily participate in the management, and that his information may not necessarily prove that the success or failure has been achieved or suffered. To have strategic value, management accounting must help accomplish the three strategic objectives of quality, cost, and time by providing information that: 1. Links the daily actions of managers to the strategic objectives of an organization. 2. Enables managers to effectively involve the entire extended enterprise of customers, suppliers, dealers, and recyclers in achieving the strategic objectives (Bell, 2002). 3. Takes a long-term view of organizational strategies and actions. Achieving strategic goals requires linking the daily actions of everyone in an organization to the larger strategic objectives. The Japanese refer to this as hoshin planning or "policy deployment." All the above discussed points clearly show how the shareholders and other stakeholders benefit from the variability associated with management accounting. If the meaning of Financial Accounting is too explained in simple words, 'accounting' merely means, 'reckoning' or 'recounting'. In an organization context too, 'accounting' has more or less the same meaning. As an organization comes into being and commences its operations, one would like to evaluate the organization's past performance for various reasons. However, in order to be able to do so, it is necessary that as far as possible whatever has transpired in the organization be 'reckoned' or 'recounted' in a summarized form in monetary terms. Thus, the process of accounting involves recording, classifying and summarizing of past events and transactions of financial nature, with a view to enabling the user of accounts to interpret the resulting summary. The utility of accounting information is greatly increased when it is compiled in a systematic manner and financial statements are prepared at periodic intervals. For the purpose of compilation, all monetary events are recognized as 'transactions' and classified into various 'account' heads. The 'account' heads are then summarized under related and significant groups so that interpretation becomes possible. If the same aspect is explained with an example, let us say when a trader procures an item, this event is recognized as a transaction. This transaction will be recorded under the account head 'purchases.' At the end of a specified period, all purchases and other costs associated with sales would be summarized into a 'cost of goods sold' figure. On comparing the cost of goods sold with sales, the difference can be interpreted as the profit or loss for the period. Accounting is best known as the language of business and communicates the results of the business. As the accepted lingua franca in addition to being the medium of communication it also satisfies the role of understanding the existing as well as potential additions to the available literature. As with every credible language, Accountancy also has its own rules and syntax which comprises the principles on which the system is based, known as the Generally Accepted Accounting Principles (GAAP). To standardize the accounting information, every organization would have to establish certain accounting policies based on GAAP. Accounting policies encompass the principles, bases, conventions, rules and procedures adopted by managements in preparing and presenting financial statements. There are many different accounting policies in use even in relation to the same subject. Since the task of interpreting financial statements is complicated because of the adoption of diverse policies in many areas of accounting, in formulating the GAAP the three conventions of relevance, objectivity and feasibility are followed. To communicate the necessary, vital and relevant information, the requirements of the prospective users are identified and a systematic process is adhered to resulting in the formation of 'Financial Statements.' They are primarily the Income Statement and the Position Statement more commonly known as the 'Trading & Profit and Loss Account' and the 'Balance Sheet' respectively. The major purposes basically are: Providing information which in turn becomes the basis for exercising decisions and actions by the potential users like the management and the shareholders, Reflect the financial progress and present health of the business, Aid in the formulation of policies and procedures for the smooth and efficient conduct of the business, Enable the management to discharge their obligations and stewardship functions effectively. In earlier times there used to be no distinction between the ownership and the management and was concerned only with providing information to the owners. But with their separation and the increasing emphasis on the business being managed by qualified and competent professionals, the role and purpose of financial accounting has undergone a paradigm shift to that of stewardship thereby highlighting the accountability aspect of managing the enterprise (p.). The cause of the new orientation is the increasing reliance by the interested entities such as stakeholders, investors, trade creditors, employees, customers, statutory authorities like Income Tax and Excise departments, the Government and other agencies. They do not have any participation in the management of the affairs of the organization and as such collect the required information from the financial statements. Such interest displayed by a varied group of constituents necessitates the presentation of a true and fair portrayal of the financial conduct of the business. In a company form of organization, the owners or the shareholders elect a group of people to manage the day-to-day affairs of the company. Since these managers are ultimately responsible for the financial performance, they must periodically compile and interpret the financial statements (simon). As the major users of financial statements of business, they range from individuals with limited shareholding to institutions like insurance companies and mutual funds which have high volume of funds at their disposal. The focus of this class of users is either on investment or stewardship. The financial position of the company is known by the shareholders through the financial statements which state the profit gained or loss suffered and the measure of its assets and liabilities. A realistic estimation of the safety of the intended investment and the return expected to be earned as a result of such investments can be made with the support of the financial statements. Each interested party may have a different focus. For instance, an owner may be largely interested in the profitability of his firm so that he may be able to assess his own share in the assets of the firm. Income tax authorities may be preoccupied with taxable profits generated in a business the Sales tax or Excise duty authorities may have yet narrower focus. The lenders and creditors may primarily be interested in ensuring the safe-holding of their loans. The banks may be interested in assessing the working capital needs of a firm. The managers may be primarily interested in various cost and control information pertaining to different department or functions. However, the balance sheet, profit and loss statement and funds flow statements are general purpose statements which are by and large of interest to everybody. The role of mandatory Accounting Standards in presenting clear-cut accounts on a uniform basis cannot be overemphasized. The standards represent the ideal practice of accounting and ensure comparability of accounts because of uniformity in their presentation. Hence, such accounts are bound to show the clear position of the state of affairs. Decision - making requires critical analysis and careful interpretation of the published financial statements. In general, the common tools used by the management to facilitate analysis are Ratio Analysis, Funds flow Statement, Cash Flow Statement, Comparative Statements and Common Size Statements. According to the statement made by the Official Directory of a famous Stock Exchange, financial Statements are prepared for the purpose of presenting a periodical review or report on progress by management and deal with the status of investment in the business and the results achieved during the period under review. They reflect a combination of recorded facts, accounting conventions and personal judgements, and the judgements and conventions applied affect them materially. The soundness of the judgement necessarily depends on the competence and integrity of those who make them and on their adherence to the Generally Accepted Accounting Principles and Conventions. Accounting data is of great importance for carrying out detailed financial analysis. Financial analysis is usually carried out to study the financial position of the company for the point of view of the following interested parties. Shareholders Debenture holders Banks i.e. for working capital purpose Financial Institutions Statutory Agencies Others like potential buyers of companies in takeovers or mergers Capital as known to many of us is the contribution made by the owner or owners in the business and is regarded as a liability to the business in the nature of owners' equity. The underlying feature is the distinction between the owner and that of the business owned by them as a result of which the business is vested with an implied obligation to repay such sum to the owners. The income of the business is arrived at by matching the revenues of defined period with the expenses of the same period, accrues to the owners. This matching or revenues and expenses can be either is on an Accrual Basis or Cash Basis or it can also be the mixture of both accrual and cash bases. The main purpose of income calculation is to give people an indication of the amount which they can consume without impoverishing themselves. Income is the amount which a person can consume during a period and still remains well off at the end of the period as he was at the beginning. This implies that only income representing surplus can be consumed and the income determination ought not to affect the capital. Finally, the observation of all the various points discussed above clearly proves that the harmonisation and standardisation of financial accounting benefits shareholders and other stakeholders. In contrast, these groups benefit from the variability associated with management accounting. Bibliography 1. (ICMR), ICFAI Center for Management Research. Financial Management for Managers. Hyderabad: ICFAI Center for Management Research , 2003. 2. Anthony, R.N. "Reminiscences about management accounting." Journal of Management Accounting Research (1) (1989): 1-20. 3. Badu, Edwin Ellis. "Macro Environment Analysis for Strategic Management." Libri (2002): 2-6. 4. Bell, Shahid Ansari &Jan. "Strategy and Management Accounting." Exclusive modules (2002): 5-7. 5. Bierman Jr., H. "A Review of Alfred Rappaport's Creating Shareholder Value." Journal of Management Accounting Research (2) (1990): 140-154. 6. Birnberg, J. G. "Management accounting: A personal history." Journal of Management Accounting Research (15) (2003): 247. 7. Brezillon, A. G. (2005). A Context-Based representation of Organizational Structures. American Association of Artificial Intelligence. 8. ICFAI Center for Management Research ICMR. Financial Accounting & Financial Statement Analysis. Hyderabad: ICFAI Center for Management Research, 2004. 9. Internal Revenue Service. Financial Management Information System (FMIS). 3 May 2008. 7 July 2008 . 10. J., Francis. "Discussion on empirical research on accounting choice." Journal of Accounting & Economics, 31 (2001): pp. 309-319. 11. p., Lev B. and Zarowin. "The boundaries of financial reporting and how to extend them." Journal of Accounting Research, 37 (1999): 353-385. 12. Ponzi, M. K. (2002). Knowledge Management: Another Management Fad Information Research Journal , 8-12. 13. simon, Jon. "Why do companies use creative accounting" Association of Chartered Certified Accountants - Articles 01 May 1998: 4-7. 14. Slovensky, Dr. "Managing Stakeholders." Healthcare Management Review (2002): 1-2. 15. The ICFAI University Press. Introduction to Management Accounting. Hyderabad: The ICFAI University Press, 2004. Read More