Topic 9: Asset investment & financing Decisions

Risk and Decision Making

Risk: in finance is defined as measurable variation in outcomes

Uncertainty: on the hand is the unmeasurable variation of outcomes

The process of Decision Making

1. Identify all current available investment alternatives

2. Select a decision – support tool and set the decision rule
3. Collect the data necessary to make the decision
4. Analyse the data
5. Interpret the results in relation to the decision rule
6. Make the decision

Investment decision tools

- Accounting rate of return

- Payback period
- Net present value
- Internal rate of return

Practice Issues Making Investment Decision

1. Collecting data
- Cost and revenue may not be easy to determine
2. Taxation Effects
- Company tax rate is 30%
3. Finance
- Same investments look good on paper but may have trouble attracting finance from banks or
venture capitalist
4. Human resources
- Will there be employees or consultants available with required skills
5. Goodwill and future opportunity
6. Social responsibility and care of the natural environment

Note: Net working capital: current assets minus current liabilities

Managing Net Working Capital

Effective Management of net working capital involves

1. Maintaining liquidity
2. The need to earn the required rate of return
3. The cost and risk of short term funding (current liabilities)

Permanent assets: must be financed with permanent and spontaneous source of funding
Temporary assets: must be financed with temporary source of funding

Managing Cash

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- Entities manage cash in relation to the following issues:

- The need to have sufficient cash to meet financial obligations
- The timing of cash flows
- The cost of cash
- The cost of not having enough cash

Topic 10: Budgeting

Strategic planning: concerns long term planning (typically 3-5 years)

Budgeting is a process that focuses on the short term
Budgets operationalize strategic plans and allow operational areas to understand how their area
contributes to the entity’s strategic objectives

Budgets

- Performance management involve setting targets in other than just financial terms. E.g improving
customer service and corporate governance
- A budget is the quantities expression of an entities plan
Budgeting can assist in decision-making
- Setting targets for managers
- Identifying resources constraints in budget period
- Identify periods of expected cash shortages and excess holdings
- Determine the ability of the entity to meet financial commitments

The budgeting process

1. Consideration of past performance

2. Assessment of expected trading and operating conditions
3. Preparation of initial budget estimates
4. Adjustment to estimates based on communication with, and feedback from mangers
5. Preparation of budgeted reports and sub-budgets
6. Monitoring of actual performance against the budget over the budget period
7. Making any necessary adjustments to the budget during the budgeting period

Master Budget

- A master budget is a set of interrelated budgets for a future period which provides a framework for
viewing relevant budgets of an entity
- To enable the budget to be used s a control tool to monitor the entity’s achievement of its plans,
classification of items included in the master budget need to mirror the chart of accounts
- Because budgets are based on forecast about the future, complete accuracy is impossible and
variances will occur

Cash Budgets

Note: Budgets form part of management accounting because it is not bound by regulatory requirements.
- A cash budget is a statement of expected future cash receipts and payments
- Best prepared on a month by month basis to enable closer monitoring of cash position
It assist in decision making by:
- Documenting timing of all cash receipts and payments
- Helping to identify periods of expected cash shortages and surpluses
- Identify suitable times for purchase of non-current assets
 Budgets: Planning and control

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- The preparation of the cash budget is an important part of the planning process
- It can be used for monitoring cash performance, also known as the control process

Improving cash flow

Cash inflow may be increase by:

- Improving the collections of cash from debtors
- Seeking ways to improve sales to fees
- Reducing unnecessary stock levels

Cash outflow may be reduced by:

- Cutting expenses by identifying areas of waste, duplication or inefficiency
- Making use of creditors terms
- Keeping inventory levels to only what is required

Behavioural Aspects of Budgeting

- The behavioural aspects of budgeting relate to human involvement in decision-making

Topic 11 – Cost Volume Profit Analysis

Introduction to the concept of CVP

- CVP analysis is concerned with the change in profits in response to changes in sales volumes, costs
and prices
Help answer the following questions:
- How many units need to be sold, or services performed, to break even (earn zero profit)
- What is the impact on profit of a change in the mix between fixed and variable costs
- How many units need to be sold, or services performed to achieve a particular level of profit

Cost Behaviour

Costs behaviour enables:

- The way in which costs change, and
- The main factors that influence those changes
Costs can be classified as fixed, variable or mixed
- The nature of fixed and variable costs, relate to whether such costs are likely to alter in total with
changes in activity

Fixed, Variable and mixed costs

Fixed costs are those costs which remain the same in total (with a given range of activity and timeframe)
irrespective of the level of activity. E.g. lease costs, depreciation charges When we consider levels of activity
in terms of units of output
- Total fixed costs – remain the same, but
- Fixed costs per unit – will decrease as the number of units produced increased

Variable costs: change in total as the level of activity changes. e.g. costs of bricks to build a house, or
aviation fuel for Qantas

Mixed costs: occur when some costs have both fixed and variable components
 Break-even analysis

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Break even analysis – relates to the calculation of the necessary levels of activity required in order to break
even in a given period
Break even occurs when total revenue and total costs are equal, resulting in zero profit
Break even analysis involves the contribution margin concept
- Contribution margin per unit can be calculated by deducting variable costs per unit

Contribution margin Ratio

CM per unit total CM

×100= x %∨ ×100= x %
SP per unit Total sales

Unit Break even Data

- Identify the number of products or services required to be sold to break even or reach profit analysis
- Planning products and allocating resources by focusing on those products that contribute more to
profitability
- Pricing products

Operating Leverage

- Refers to the mix between fixed and variable costs

- Can help understand the impact of changes in sales profit
- Entities with a higher proportion of fixed costs to variables costs are classified as having a higher
operating leverage
- Entities with a higher operating leverage are more risky because more sales are needed to cover the
fixed costs

Topic 12: Accounting and business sustainability

Sustainable business

- Ensuring business is continuously profitable

- The ability of the entity to continue or maintain business as a going concern i.e. to be able to
continues operating into the future
- The developed world is highly industrialised we produce goods using raw materials whose by-
products & consumption impact on natural resources
- Sustainable development is development that meets the needs of the present without compromising
the ability of future generations to meet their own needs.

Business Sustainability: Key drivers

Competition for resources

- Growing population – leading to increasing demands on natural resources, causing some to become
finite because they cannot be replenished quickly enough
- Depletion of resources is also impacting on ecosystems and our environment

Climate Change
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- Industrialisation & fossil fuel based economy has led to global warning and climate change
- More extreme weather conditions, cycles of drought and flood which is impacting on primary
producers
- Implementing climate policy to minimise carbon emissions & create solutions to global warming

Economic Globalisation
- Business operate national and expanding to operate at a global level
- Disparities exist between countries in relation to their enforced environment and social standards

Connectivity and Communication

- Advances in digital communication and technology enable people to track a company’s
sustainability and disseminate their perspectives on its using social media

Business Sustainability: Principles

- The need for sustainability has led to the development of guidelines and principles to help shape the
business to help shape the business sustainability movement
1. Ethics
2. Governance
3. Transparency
4. Business relationships
5. Financial return
6. Community involvement/economic development
7. Value of products and services
8. Employment practices
9. Protection of the environment

Business Sustainability Theories:

Corporate social responsibility (CSR): refers to the responsibility an entity has to all stakeholders, including
society in general and the physical environment in which it operates.

Shareholder value

Corporations Act and company constitution give powers to company board of directors to act on behalf of
the owner, shareholders.

Separation of ownership and control has led to agency theory, which describes the relationship where
managers act on behalf of shareholders.

Stakeholder theory:

Holds that the purpose of the entity is to work for the good of all stakeholder groups, not just to maximise
shareholder wealth

Stewardship theory:

Directors act in the interest of group of stakeholders and not just shareholder wealth

Contributes to the rise of independent non-executive directors servicing on companies boards.

Legitimacy theory

- Entities must operate within the bound and norms of society

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- Deemed the social contract represents explicit and implicit about how the organisation should
conduct its operations.

Business Sustainability: Reporting and Disclosure

One approach to sustainability reporting is the GRI reporting framework, which is comprised of:
- Sustainability Reporting Guidelines
- Technical Protocol
- Sector Supplements
Standard disclosures include:
- Strategy and profile – overview of risks and opportunities
- Management approach – management of sustainability
- Performance indicators – economic, environment and social

Triple Bottom Line Reporting

3 pillars of sustainability known as “Triple Bottom Line” people

Role of Accountants in Sustainability

- Use of skills to aggregate data to generate information for decision making for environmental &
sustainability decisions for reporting purposes
- Performing costs analysis for competing investments
- Audit & assurance services used to develop internal control procedures to ensure the collections and
integrity of information gathers is safeguarded

Ethical Behaviour and Codes of Ethics

- The professional accounting bodies in Australia have a joint code of ethics that is mandatory for all
members and disciplinary action can take place for non-compliance
- It communicates a minimum standard that members must fulfil
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