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Loughborough University Understanding Financial Management Understanding Financial Management –ILM level 5 Learning objectives – to understand: The purpose of a set of accounts The jargon used by accounts The principles on which accounts are based Understanding Financial Management –ILM level 5 Learning objectives – to understand: The purpose of the main financial documents The main sources of finance into Loughborough University The types of expenditure Why cash flow is so important Sources of financial information Capital funding Performance indicators Timetable – Day One A general introduction to Finance Understand the purpose of accounting standards and the regulatory framework Understand 4 key accounting policies Understand two methods for calculating depreciation Identify a range of financial objectives Understand how a business is financed Identify key sources of finance for an organisation Timetable – Day One Understand the relationship between the 3 main financial statements and apply them: cash flow forecast, profit and loss statement, balance sheet Understand the relationship between the 3 main financial statements and apply them: cash flow forecast, profit and loss statement, balance sheet continued Cash flow forecasting Look at the Financial Statements of Loughborough University Timetable – Day Two Apply ratio analysis Financial and Management Accounting Understand the budgetary process and budgetary control Consider the challenges facing Loughborough University Consider the Economic climate in which we operate RASCAL Develop measures to populate a balanced scorecard Financial Governance at Loughborough University Review and discuss the module assignment Work Based assignment Title: Understanding financial management Purpose: to develop a greater understanding of financial management within the organisation together with the tools and techniques used in your role as a middle manager at Loughborough 3 parts: Explain finance within the context of Loughborough Work Cased Assignment – cont’d Explain the role and value of management accounting Explain the purpose of budgets and budgetary control Suggested word count: 1,500 to 2,000 Submission date: 19th December Deadline for feedback from your tutor: 12th December So this is accounts What is the answer ? So this is accounts What is the answer ? Zero So this is accounts What is the purpose of a set of accounts? So this is accounts What is the purpose of a set of accounts? give a true and fair view of the state of the group’s and University’s affairs as at 31 July 2013 and of its surplus for the year then ended It is a BSc here! Why do we do accounts To support business decisions To identify trends To explore opportunities To use financial information to understand what is happening in a business Lets start at the very beginning Cash Accounting Double Entry Book keeping Trial Balance Lets start at the very beginning Debits o Assets o Expenses o Profits / Surpluses Credits o Liabilities o Income o Losses / Deficits A Page from an Accounting Ledger Is the balance good news or bad news? Why are there rules to accounting? There are many users of a set of accounts Who would use Loughborough University’s Financial Statements Accounting and Financial Reporting Standards About consistency across organisations UK GAAP Companies Act 2006 Statement of Recommended Practise Financial Reporting Standards All change - New rules from 15/16 GO CO GIN CO N ER NC NS IS TE NC Y Accounting Principles C AC S AL RU PR UD EN CE ACCOUNTING POLICIES Accounting Principles - Consistency Depreciation – use of the straight line method each year, rather than reducing balance one year and straight line the next. When deciding on the treatment of any item, looking at what has been done before is justifiable as it provides consistency Potential Flaw – Could be consistently bad! Accounting Principles - Accruals Recognition of income on research grants Recognition of income from endowments Accounting for goods or services received Depreciation Deferred Grants Accounting Principles - Prudence Accounting of Retirements Recognition of losses on a contract Where a range of potential costs are possible, selecting the “worst case scenario” if no reliable estimation exists. Accounting Principles – Going Concern The assumption that a business will continue in existence for an indefinite period. Impairment of assets Giving up economic benefit – UPP Halls Depreciation Most fixed assets reduce in value over their lifespan – think of your own ‘assets’ Deducted from the fixed assets annually in the Balance Sheet Charged as an expense in the Profit and Loss Account 2 methods: 1. Straight line method 2. Reducing balance method Depreciation – Straight Line The Straight Line Method: takes the original cost of the asset and deducts the same fixed amount each year, eg. A machine costs £10,000 There is no expected residual value at the end of its forecast 5 year lifespan. (Residual Value means how much the asset will be worth and for how much it is expected to be sold at the end of its useful life within the business.) Depreciation will be £2,000 per year leaving a residual value of £0. Depreciation - Example Year Cost £ 1 2 3 4 5 10,000 10,000 10,000 10,000 10,000 Accumulated Depreciation Book Value £ 2,000 4,000 6,000 8,000 10,000 £ 8,000 6,000 4,000 2,000 0 Depreciation – The Reducing Balance The Reducing Balance Method: takes the original cost of the asset and reduces it by a fixed % each year This method is used where the asset is expected to depreciate more heavily in the earlier years of its use. Activity: (complete the table below) A new vehicle costs £12,000 It is decided that it will depreciate at a rate of 25% per year Depreciation - Example Year Cost £ 1 12,000 Accumulated Depreciation £ 3,000 2 12,000 5,250 3 12,000 4 12,000 5 12,000 Book Value £ 9,000 6,750 2,847 Depreciation Question The Finance Office purchase a super duper photocopier costing £24,000 on the 1st August. The University accounts for depreciation on a straight line basis with an expected life of 4 years. After three years, on the 1st August, the Finance Office sells the photocopier to the College for £5,000. Required - Calculate the accounting entries resulting from this transaction. Depreciation Question Year £ Cost £ Accumulated Depreciation £ Book Value £ Depreciation Answer Year Cost £ 1 Accumulated Book Value Depreciation £ £ 24,000 6,000 18,000 2 24,000 6,000 12,000 3 24,000 6,000 6,000 • In Year 4, the book value of £6,000 would be written back to the I&E Account and show as expenditure. However, this would be matched by the receipt of £5,000 from the college. These two amounts would be netted against each other to produce a “loss on disposal” of £1k. • If the proceeds had been more than the £6k net book value then a “profit on disposal” would have been generated. Repair or Fixed Asset Broken Window? Broken Window on the top floor of the Towers? Additional Teaching Room on the side of Edward Herbert? Roof Repair to Schofield? Financial Objectives maximisation of return on capital employed survival maximisation of profit long-term stability growth security What are the Financial objectives for LU? ? The Business Cycle – Where can a business get funds Your Own – Share Capital Someone Else’s – Debt or Loans From the profits of the business – Retained Profits / Reserves The Business Cycle – How can it use those funds Fixed Assets Working Capital Investments Sources of Funds Ordinary Shares Rights Issue Preference Shares Debentures Debt Sources of Money for LU We have no share capital We borrow from banks We have retained reserves We use third party funders e.g. UPP What makes up a set of financial statements? Statement of principle accounting policies 3 main statements Income and Expenditure account Balance sheet Cash flow incl STRGL Notes to the accounts What makes up a set of financial statements? List of officers and staff Providers of financial services Operating and financial review Statement of corporate governance Responsibilities of Council Auditors report to Council Income and Expenditure account – what does it tell us? Designed to answer the sustainability question Brings together all the income and expenditure related to routine operations including subsidiary companies It excludes capital items like new buildings, equipment and grants It reports the total of income and expenditure for a financial year Income and Expenditure account – what does it tell us? It is based on costs committed not cash paid and income earned not just cash received It includes depreciation – spreads the cost of a capital investment over its useful life Exceptional items If income exceeds expenditure a surplus results What surplus is enough? Income and Expenditure Account Why does Loughborough University need to make a surplus? Income and Expenditure account To invest in new capital assets Because our income is volatile Because our income is more volatile than our expenditure To be able to capitalise on opportunities Income and Expenditure Account Exercise in your workbooks Balance sheet – what does it tell us? Picture at a point in time of what the institution is worth Report of what we own What we owe What we are owed Indicator of ability to withstand a difficult period or capacity for development Total recognised Gains and Losses Catches changes in the valuation of assets or liabilities which have not gone through the Income & Expenditure account Balance Sheet Exercise in your work books Cash Flow – Why is this so important The lifeblood of the organisation The cashflow forecast shows the cashflow of the business on a month-by-month basis Shows the real money situation: actual timing of cash outflows (cash and creditors) actual timing of cash inflows (cash and debtors) Variance Analysis Key Points: Cash is not Profit Profit is not Cash Depreciation is not cash For the period ended ….. No cash – no business! Cash Flow – Why is this so important No business goes bust through a lack of profits All businesses go bust through a LACK OF CASH! Cash flow statement– what does it show? Cash flow statement explains how your cash has been managed during the financial year Takes out the non cash items - Net cash inflow from operating activities Shows affect of interest both payable and receivable Returns on investments and the servicing of finance Separates out new investments - Capital expenditure and financial investment Discloses movement on loans - Financing Net increase/decrease in cash Cash/Net liquidity Short term deposits Cash at bank Loans <1 year Loans >1year Total 2012/13 £’000 24,505 51,801 (2,016) (70,953) 2011/12 £’000 22,505 24,012 (1,541) (53,072) 3,337 (8,096) Analysis of Income Funding Council Grants Academic Fees Research Grants Other income Investment Income Total Income 2012/13 £’000 2011/12 £’000 56,967 88,633 39,147 58,880 1,313 66,624 70,726 38,670 60,330 1,407 244,940 237,757 Academic fees and support grants 2012/13 £’000 2011/12 £’000 Home and EU Students 57,944 (65%) 41,067 International Students 30,689 (35%) 29,659 Total 88,633 70,726 (60%) (40%) Analysis of Expenditure Staff Costs Depreciation Other Operating Expenses Interest Payable Total Expenditure 2012/13 £’000 2011/12 £’000 124,303 17,700 91,412 3,416 236,831 122,777 15,221 91,719 2,235 231,952 Staff costs 2012/13 £’000 2011/12 £’000 101,345 100,713 Social Security 7,898 7,831 Pension costs 14,958 14,093 102 140 Wages & Salaries Restructuring costs Total 124,303 122,777 Surplus retained within reserves Surplus on continuing operations Tax Specific Endowments Retained within reserves 2012/13 £’000 2011/12 £’000 8,109 5,805 12 183 12 40 8,309 5,857 Financial Statements 2012/13 Successful year £8.3m surplus after exceptional items £ 8.1m operating surplus Liquidity good though moved to net debt Cash used to finance assets Balance sheet: Assets Tangible assets Benefit re College of Art & Design Investments Long Term Loans Endowments Stocks & Debtors Cash Total 2012/13 £’000 2011/12 £’000 302,723 (2,364) 214 145 2,803 18,376 76,306 300,380 (2,497) 242 173 2,687 18,241 46,517 398,203 365,743 Balance sheet: Liabilities Creditors < 1 Year * Creditors > 1 Year Provisions Pension Liability Total 2012/13 £’000 2011/12 £’000 (73,902) (70,953) (1,922) (47,187) (69,761) (53,072) (1,964) (47,618) (193,964) (172,415) * Includes unapplied deferred capital grants and research payments received on account Balance sheet: Assets and liabilities represented by: 2012/13 £’000 Deferred Capital Grants Endowments Reserves Total 101,932 2,803 101,504 206,239 2011/12 £’000 102,134 2,687 88,507 193,328 Movement in Pension Reserve 2012/13 £’000 Opening Reserve Movement for year Closing Reserve (47,618) 2,431 (45,187) 2011/12 £’000 (28,902) (18,716) (47,618) Review of the Day Any Questions? Please bring calculators tomorrow Ratio Analysis Financial ratios enable you to compare: the current performance of the organisation or operation with past performance the performance of one organisation with that of another organisation (preferably in the same industry) the size of the organisation doesn’t matter too much because ratios cancel out size differences Ratio Analysis Ratios can be split into three areas Liquidity Ratios Profitability Ratios Efficiency Ratios Liquidity Ratios Liquidity (indicates how well equipped the business is to pay its short-term debts) Ratios: Current ratio Liquidity ratio Liquidity Ratios Calculation Current Ratio Current Assets Current Liabilities eg. 2 :1 = £50,000 / 25,000 = 2:1 The recommended current ratio is 2.1 Liquid Ratio Current Assets (excluding stock) Current Liabilities eg. 1:1 Current assets (excluding Stock) / Current liabilities eg. 30,000 / 25,000 = 1.2:1 The recommended liquid ratio is 1:1. Profitability Ratios Profitability (shows the degree of success with which the business is trading) Ratios: Gross profit/sales Net profit/sales ROCE Profitability Ratios Calculation Gross Profit Ratio: Gross Profit x 100 Sales Revenue eg. 10% Means that gross profit is 10% of the total value of sales Net Profit Ratio: Net Profit x 100 Sales Revenue eg. 6% Means that net profit is 6% of the total value of sales. Return on Capital Employed (ROCE): Net Profit x 100 eg. 20% Total Assets less Current Liabilities •Compares inputs (capital invested) with outputs (profits) •Shows the return on funds employed within the business and the effectiveness with which they have been employed Efficiency Ratios Use of Assets (shows how effectively the assets are being utilised) Ratios: Sales/fixed assets Debtor Payment Time Creditor Payment Time Efficiency Ratios Calculation Sales to Fixed Assets: Sales eg. 3 times Fixed Assets Debtor Payment Time: Debtors / credit sales for the year (multiplied by) the time period (eg. 365 days) = debtor collection time in days Creditor Payment Time: Creditors / Credit Purchases (multipled by) the time period (eg. 365 days) = creditor payment time in days Ratio Analysis Please do the exercise in your workbook Ratio Analysis We have prepared another example Financial Accounting Vs Management Accounting Issue Governed by Financial Company law, SSAPs Management Managers’ needs Users Time External Past and present Emphasis Accuracy Data Money Internal Present and future Decisionmaking Money or units of performance Budgeting Budgeting is used in organisations of all types to assist in the development and co-ordination of plans, to communicate these plans to those who are responsible for carrying them out, to secure co-operation of managers at all levels, and as a standard against which results can be compared. The Budget Setting Process Budgeting is part of the short-term planning process. A painstaking process, involving the co-operation and flexibility of all the budget holders who may well have to modify their budgets in the light of both external and internal factors. Many drafts may have to be prepared before the final set of budgets is established. The outcome of the budgeting process is a master budget comprising: Projected balance sheet Projected profit and loss account Projected cashflow The Budget Setting ProcessThe Budget Setting Process These will be supported by a series of operating budgets for each cost area, eg. labour budget, materials budget, sales expense budget. It is vital to apportion responsibility for each budget, in the form of a cost centre, which is responsible for the monitoring and control of costs. What Stops us achieving our budgets Important to analyse the limiting factors, ie. those factors which may put barriers in the way of the organisation achieving its objectives. These are the: External limiting factors (over which the organisation has no direct control) Internal limiting factors (over which the business has considerable control) Group Exercise Working in groups, consider possible examples of limiting factors within the higher education sector and make a list under the following headings. Please split these between annual and longer term External Limiting Factors: Internal Limiting Factors: Flexed Budgets These are used where forecast demand and actual demand are different. By ‘flexing’ the budget, it is possible to get a much more realistic analysis of budgetary performance. The purpose of a flexed budget, therefore, is to account for changes in the budget variables and, consequently, to assess real budgetary performance. For example, the training budget in your workbook, for January, was forecast for 5,000 delegates. If you look at the following slide how would you evaluate budgetary performance? Non flexed budget Forecast 5,000 delegates £ Actual: 4,000 delegates £ Variance £ Support Staff 10,000 8,300 1,700 FAV T. Workbooks 1,000 840 160 FAV Training Staff 15,000 13,200 1,800 FAV D. Workbooks 2,000 1,900 100 FAV Venues 4,400 3,500 900 FAV Catering 1,600 1,600 0 Hotel Expenses 2,400 2,400 0 Other Materials 1,800 1,400 400 FAV 700 720 20 ADV 38,900 33,860 5,040 FAV Services Total Flexed Budgets As you can see the actual expenditure in all but 3 items, was less than forecast expenditure. The net variance is actually just over £5,000 less than forecast. We need to investigate why it is so much less. On investigation, we find that the forecast was based upon 5,000 staff going through training. In reality, however, there were only 4,000 delegates. In order to get a real picture of budgetary performance we can use a technique called ‘flexing’, so that we can create a flexed budget. Flexed Budgets Activity: Complete the flexed budget on page 38 of your workbook by using the formula below. The flexed budget for ‘support staff’ has been done for you. Step 1: Step 2: Find the flexed % = 4,000/5,000 x 100 = 80% Calculate the flexed figures: (example – ‘Support Staff’): 10,000/100 x 80 = 8,000 Step 3: Compare the actual figures with the flexed figures to find the variation from the flexed budget: (example – ‘Support Staff’) 8,300 – 8,000 = +300 = £300 adverse oversp Flexed Budgets (these are the 3 cols you should select) Actual: 4,000 delegates £ £ Support Staff 8,300 T. Workbooks 840 Training Staff 13,200 D. Workbooks 1,900 Venues 3,500 Catering 1,600 Hotel Expenses 2,400 Other Materials 1,400 Services Total Flexed Budget: 4,000 delegates 720 33,860 Variation from Flexed Budget £ 8,000 300 Variance Analysis – Training Budget Forecast Actual: £ Support Staff Variance £ £ 10,000 8,300 1,700 fav 1,000 840 160 fav 15,000 13,200 1,800 fav Workbooks 2,000 1,900 100 fav Venues 4,400 3,500 900 fav Catering 1,600 1,600 0 Hotel Expenses 2,400 2,400 0 Other Materials 1,800 1,400 400 fav 700 720 20 adv 38,900 33,860 5,040 fav Workbooks Training Staff Services Total Flexed Budgets Discuss in Groups that advantages and disadvantages of flexed budgets How else can you flex budgets? Budgetary Control This is concerned with: Monitoring budgeted against actual figures Analysing and investigating variances both positive and negative Re-budgeting where necessary Now a word from our sponsor Economic Challenges What do you think are the major economic challenges facing Loughborough University ? What has changed in the last few years? RASCAL Resource Allocation System and Cost Apportionment at Loughborough It how we fund the academic Schools RASCAL Principles It is an income streamed model All income is distributed All costs are distributed The budgeted Surplus is distributed as a cost Therefore it adds up to zero RASCAL – Indirect Charges Replace COMA Include the Community Charge Now one driver People People = Staff + Students RASCAL – Cross Subsidy It is an income streamed model All home undergraduates are charged £9,000 We wish to remain a mixed University We cross subsidise home undergraduate teaching based on national TRAC T data The Budget Process at Loughborough The process begins with the five year plan Discussions on the overall budget take place at Operations and ALT before business plans are produced These are informed by the Development Plans Areas for investment are highlighted The Budget Process at Loughborough Detailed plans are assessed with Schools to ensure that they are deliverable Result is assessed by operations Committee and new investments are approved Budget for the year is agreed by Council and Finance Committee Budgetary control at Loughborough Performance against budget is assessed quarterly Meetings take place between the Dean and the DVC All areas of expenditure and grant or consultancy income are assessed New forecasts for the year end are agreed The overall University budget is updated to reflect changes Budgetary control at Loughborough LU has a history of performing better than budget Is this good or bad? The Balanced Scorecard A methodology for producing a comprehensive set of measures to assess the success of an organisation Makes use of non financial measures Also known as KPI’s Performance indicators Need to ensure financial security but how? Look at KPI’s for your institution Banking covenants Total funds to exceed £50m Total borrowing costs not to exceed 5% of total consolidate income HEFCE Financial Memorandum Maximum 4% annualised servicing costs No deficits Are you inline with other institutions? Sustainability Reporting We have been asked by HEFCE to produce a report on Financial Sustainability for 2012/13 We were one of the pilot institutions producing this report Here is the example we gave to Council Financial Governance at Loughborough HEFCE – Financial Memorandum Audit Committee Finance Committee Operations Committee External Audit Internal Audit Sources of financial information HEI websites Funding Council websites – summary of financial forecasts from all HEI’s, summary of grant allocations to each HEI, various areas of guidance for each institution Pension fund websites Within institutions themselves HEIDI Thank you and goodnight!