Finance & Funding in Travel and Tourism - management accounting info

The International Travel College of New Zealand 1

Finance & Funding in the Travel and Tourism Sector

Unit #2 – Learning Outcome 2The use of management accounting information as a decision-making tool

in travel and tourism businesses


What is Management Accounting?

• Concerned with providing managers with the information they require for the day-to-day running of the business.

• Reports produced are for specific purposes, designed for a particular manager or use, and contain a lot of detail to help with decision making.

• These reports are for internal use only and have no restrictions in the way are presented or produced.

• Management accounts are produced as frequently as required by managers, which may be weekly or monthly, allowing them to keep a close check on business performance.

• Reports include past performance as well as future performance projections or forecasts.

• Reports include information quantified in monetary terms in addition to non-financial information such as measures of physical quantities of inventory/stock.


Types of Management Accounting Information

• Managers and business owners use a wide range of information to help them not only run their business on a day-to-day basis but to plan ahead, form business strategies and provide them with the information they will need to make sound business decisions.

• The amount of information and complexity of it will depend on the size of the business.


Financial Statements

• A financial statement is a formal record of the financial activities of a business, person, or other entity.

• Relevant financial information is presented in a structured manner and in a form easy to understand.

• They typically include basic financial statements, accompanied by a management discussion and analysis. The financial statements typically are:

Statement of financial position: also referred to as a balance sheet, reports on a company's assets, liabilities, and ownership equity at a given point in time.

Statement of comprehensive income: reports on a company's income, expenses, and profits over a period of time. A profit and loss statement provides information on the operation of the enterprise. These include sales and the various expenses incurred during the processing state.

Statement of cash flows: reports on a company's cash flow activities, particularly its operating, investing and financing activities.


Budgets

• Budgets are financial plans for the short term, typically one year, and likely to be expressed mainly in financial terms.

• Businesses use budgets to plan for future activities and to set various goals and objectives within the company.

• They help the organization set specific expectations which aid in evaluating performance throughout the company.

• Budgeting helps organizations implement specific strategies to meet goals and objectives.

• A budget is an estimate and may need to be adjusted over time.


Variance Analysis

• Variance analysis is most often used when comparing your actual results of business operations against the budget to identify areas for further investigation.


Forecasts

• A financial forecast is an estimate of future financial outcomes for a company.

• Forecasts are prepared using historical sales data and previous actual costs, in addition to considering external market and economic indicators.

• Forecasting is used in the preparation of budgets and similar financial statements.


Management Information Systems (MIS)

• Businesses use information systems at all levels of operation to collect, process and store data.

• Everyone who works in business, from someone who pays the bills to the person who makes employment decisions, uses information systems.

• Management aggregates and disseminates data in the form of information needed to carry out the daily operations of business.

• Examples include a computer database holding customer and product information, systems holding details of all financial transactions, scheduling and diary systems, computer systems monitoring productivity, call monitoring systems.

• There's hardly any large business that does not rely extensively on their MIS systems to better understand the effects of their strategies, and help enable effective decision-making.


Budgets


Budgets in Business

• Budgets are plans for the short term – typically one year.• They are expressed mainly in financial terms. • Their role is to convert the long-term plans into actionable

‘blueprints’ for the immediate future. • Budgets usually define precise targets such as:

- Cash receipts and payments- Sales- Detailed inventory/stock requirements- Detailed labor requirements- Specific production requirements.

• Budgeting is not the role of accountants – it is the role of the managers of the business.

• Accountants can give advice based on their knowledge, expertise and skills.


Consider Options

Identify Objectives

Evaluate options and make a selection

Prepare Budgets

Perform and collect information on actual performance

Respond to divergencies between plans and actuals and exercise control

Revise plans (budgets) if necessary

Budgeting is used in decision-making, planning and control processes within a business


Budgets in Planning

• All businesses have an objective to make money (otherwise they wouldn’t be in business!), but this goal must be defined and expanded in order to make it happen.

• In order to achieve the objective businesses will make a long-term plan, typically a five year plan, and will also have a short term plan looking forward to the next 12 months.

Business Objectives

Long Term Plan

Budget

(Short Term Plan)


Budgets in Planning cont..Long Term Plan defines the general direction of the business:• The market for the business• Production/service rendering methods (online, retail etc)• What the business will offer to its customers• Level of profit sought• Financial requirements and financing methods• Personnel requirements• Bought-in goods and service requirements and sources

The budget (short term plan) goes into more detail:• Sales and expenses• Cash flows• Short-term credit to be given or taken• Inventory/stock requirements


Relationship between objectives, long-term plans and budgets:

• The objective is likely to last for quite a long term, often for the entire life of the business.

• A series of long-term plans identifies how the objective is to be pursued.

• Budgets/short-term plans identify how the long-term plan is to be fulfilled


The Source of Plans and Budgets (who does them!)

• It is the function of management of a business to set long-term plans and budgets.

• It is up to the management to determine the budget cycle and when, if ever, to revisit and adjust budgets that have been set.

• Annual budgets set targets for a year for all levels of the business.

• Budgets are usually broken down into monthly budgets.• Budgets are set for different areas and activities of a

business, such as departmental budgets, regional budgets, revenue budgets, expense budgets.


Types of Budgets• Sales Budget - The sales budget is an estimate of future sales, often broken down

into both ‘units’ and dollars. It is used to create company sales goals.

• Production Budget - An estimate of the number of units that must be manufactured in order to meet the sales goals, estimates the various costs involved with manufacturing those units.

• Cash Flow Budget - A prediction of future cash receipts and expenditures for a particular time period.

• Marketing Budget - An estimate of the funds needed for promotion, advertising, and public relations in order to market the product or service.

• Project Budget - A prediction of the costs associated with a particular company project, including labor, materials, and other related expenses.

• Capital Budget - A prediction of company needs in regard to fixed assets, such as buildings, vehicles, machinery, and other equipment, the cost of upgrading present assets, the cost of acquiring new assets, costs associated with maintenance of the assets, and fees associated with the assets.

• Master Budget - A summary of the plans created for the sub-units of the company, used to create projected financial statements, also referred to as a budgeted income statement and a budgeted balance sheet.


Budget-Setting Process

1. Who will take responsibility for the budget-setting process

2. Communicate budget guidelines to relevant managers3. Identify the key or limiting factor 4. Prepare the budget for the area of the limiting factor5. Prepare draft budgets for all other areas6. Review and co-ordinate the budgets7. Prepare the master budget8. Communicate the budgets to all interested parties9. Monitor performance relative to the budgets


Limiting Factors

• In any business there is always some aspect which will stop it from achieving its objectives to the maximum extent.

• Such a factor is called the ‘limiting factor’, ‘key factor’ or ‘principal budget factor’. Some examples of limiting factors are:

– capacity of production– skilled labor shortage– material’s shortage– shortage of space– low demand for product or service– shortage of funds


Approaches to setting budgets

Top Down• Senior management of each budget originate the budget targets,

consulting with lower levels of management, refining them and producing final version.

Bottom Up• Targets are ‘fed up’ from junior managers or front line staff whose

input is incorporated into the budgets of middle managers who in turn feed their recommendations to senior management.

• This approach is increasingly used in practice in order to achieve ‘buy in’ and full agreement with staff on the goals and targets.

• Once budgets are agreed they are circulated to managers who are tasked with implementing their particular budget.

• Managers monitor their team’s performance relative to the budget, and remedial action taken where things are going wrong.


Uses of Budgets

1. Promotes forward thinking and identification of short-term problems

2. Used to help co-ordinate between different areas of the business

3. Motivates managers to better performance

4. Provides a basis for a system of control (monitoring actual performance against planned performance)


Using budgets for control

Flexible budgets• Budgets can provide a useful basis for exercising control over a business.

• This is because control is usually seen as making events conform to a plan.

• Since the budget represents the plan, making events conform to it is the obvious way to try to control the business.

• Taking steps to exercise control means finding out where and why things did not go according to plan and seeking ways to put things right for the future.

• This may include revising the budgets for future periods as original targets may have been unrealistic, or the business environment may have dramatically changed since the budgets were prepared.

• Conventionally, budgetary control is handled by operational managers, but control and authority for revising the budget remains with senior management.


Standard quantities and costs

• A budget is a financial plan for a future period of time.

• It is build up from standards.

• Standards are planned quantities and costs (or revenues) for individual units of input or output.

• The standards are the building blocks that are used to build the budget.


Variances• A variance is the difference in what was budgeted/planned compared to the

actual results• Variance can be calculated for both costs and revenues. • Variance analysis in managerial accounting is associated with the

outcome of the planned and actual results and the effects of their differences.

• Useful in management and accounts and also in calculating labour and materials costs.

• Variances are ‘uncovered’ when monitoring the budgeted and actual profit levels produced in management accounting control processes.

• When the actual results are better than the expected results, the variance is described as favourable. ie achieving higher sales volumes than planned, or reducing expenditure.

• Variances can also be ‘adverse’ – ie producing lower sales volumes than budgeted, or incurring higher levels of expenditure.

• Businesses will often experience both favourable and adverse variances in their actual performance.


Types of variances

• Sales volume variance: lower or higher sales achieved

• Direct materials usage variance – more or less materials used in the production of the unit or service

• Direct materials price variance – a change in price of the materials used in production of the unit or service

• Direct labour variance (labour efficiency and labour rate) – changes in the cost of labour or the amount of human resource time taken to produce the unit or service

• Fixed overhead spending variance – a change in the fixed overhead price


Financial Projections

A ‘forecast’ of future revenues and expenses for a business


Using Financial Projections

• Projected financial statements are valuable to a business manager or owner when developing long-term strategic plans.

• When making such plans managers need to consider the financial consequences to the business as a whole of pursuing a particular course of action.

• Managers may be confronted with a number of possible options. It is necessary to decide which gives the best return in relation to the risks involved.

• Projected financial statements (also known as financial projections) can be prepared for each option and used to assess the likely future returns.

• On the basis of these statements an informed decision can be made.


Consider Options

Identify Objectives

Evaluate options and make a selection

Prepare Budgets

Perform and collect information on actual performance

Respond to divergencies between plans and actuals and exercise control

Revise plans (budgets) if necessary

Budgeting is used in decision-making, planning and control processes within a business

Third step in planning is where

financial projections are used


Projected statements may be prepared on the basis of:

• An optimistic view of likely future events

• A pessimistic view of likely future events

• A ‘most likely’ view of future events


Evaluation of Projected Statements

• How reliable are the projections?

• What underlying assumptions have been made and are they valid?

• Are the cash flows satisfactory? Can they be improved by changing policies or plans

• Is there a need for additional financing? Is it feasible to obtain the amount required?

• Can any surplus funds be profitably invested?

• Is the level of projected profit satisfactory in relation to the risks involved? If not, what could be done to improve matters?

• Are the levels of sales and individual expense items satisfactory?

• Have all relevant expenses been included?

• Is the financial position at the end of the period acceptable?

• Is the level of gearing acceptable?


Sensitivity Analysis

“What if….?”


What is Sensitivity Analysis?• Asks and answers the question ‘what if…?’

• What if sales were up 5%? What if we spent 10% more on equipment? What if we increase the selling price by 4%?

• Useful when evaluating projected financial statements.

• Take a single variable (eg volume of sales) and examine the effect of changes in the chosen variable in the likely financial performance and position of the business.

• An assessment can then be made of the sensitivity of financial performance and position to changes in that variable.

• Only one variable is examined at a time, but a number of variables considered to be important to the performance of the business may be examined consecutively.


Capital Investment Decisions


The Nature of Investment Decisions

• Key feature of investment decisions is the time factor.

• Investment involves making an outlay of something of economic value, usually cash, at one point in time which is expected to yield economic benefits to the investor at some other point in time.

• Typically, the outlay precedes the benefits!

• The outlay is typically one large amount and the benefits arrive in a stream over a fairly long period.

• Investment decisions are of crucial importance to the investor:

• Large amounts of resources are often involved – could be an costly mistake if you get it wrong.

• It is often difficult and/or expensive to ‘bail out’ of an investment once it has been undertaken.


Methods of Investment Appraisal

1. Accounting rate of return (ARR)The accounting rate of return method takes the average accounting profit which the investment will generate and expresses it as a percentage of the average investment in the project as measured in accounting terms.

2. Payback period (PP)The payback period is the length of time it takes for the initial investment to be repaid out of the net cash inflows from the project.

3. Net present value (NPV)The net present value method compares the sum of the present value of all expected cash inflows with the present value of the expected cash outflows related to a given project or investment opportunity.

4. Internal rate of return (IRR)This method is closely related to the NPV method in that, like NPV, the internal rate of return involves discounting (building in a percentage opportunity cost for not having the investment money available) future cash flows.


Other considerations when evaluating an investment proposal:

• Relevant costs – only consider costs relevant to the decision

• Opportunity costs – arising from benefits forgone must be taken into account

• Taxation – profits will be taxed, the investment may attract tax relief

• Cash flows, not profit flows – focus on the cash, not the profit

• Interest payments – be careful not to double count these in financial calculations

• Other factors – non financial issues, such as investing in a complementary service or product, being first to market etc.


Avoiding insolvency

Insolvency is the inability of a debtor to pay their debt


Insolvency

• A business becomes insolvent when it is unable to pay its debts on time, or if it doesn’t have sufficient assets to cover its debts.

• But business insolvency doesn’t happen overnight.

• Keeping a close eye on your business’ performance and cash flow gives an early warning of any impending problems, and time to take action to avoid insolvency.


Improving cash flow

• Invoice customers - on time and regularly• Chasing debts - don’t let late payments go unchallenged.• Avoiding overtrading - don’t try to fulfill more orders than

the business has the resources and cash to cope with.• Reducing any unnecessary stock.• Renegotiating with suppliers - see if the business’s main

suppliers will agree to adjust credit limits and payment dates.

• Looking at arrangements - such as Factoring and Invoice Discounting - these pay a percentage of any outstanding invoice in advance.

• Selling assets – business owners can sell under-used assets and lease them instead.


Negotiate with creditors

• Never ignore creditors — if the debt is above a certain level (can often be less than $2000) they can petition a court to order a company into liquidation.

• If business owners are worried about the risk of business insolvency they should talk to their creditors before becoming insolvent, and try to renegotiate a payment plan that they can realistically meet.

• Creditors who stand to lose their money if a business folded are likely to be more willing to negotiate.


Reduce overheads

• If a business is having financial problems, a review of the overheads to see where savings can be made is essential, but don’t make such big cuts that the business has trouble operating. Possible cuts include:

Advertising costs and research/development costs can be reduced very quickly.

Staff costs — reducing overtime or staff hours (but be aware that making redundancies will cost more in the short term and have serious consequences on morale, so should be considered carefully).

Investment costs — a short term measure; in the long term the business owners are likely to need to invest in the growth of the business. However, leasing rather than buying new equipment is an option.

Premises costs — consider relocating to smaller premises or sub-leasing part of the business premises.


Get professional advice

• When directors take timely advice on saving a failing business, bankruptcy becomes a less likely option and the chances of a successful business turnaround are improved.

• Directors should not wait until the problems get out of control and insolvency is inevitable.

• Directors should seek professional advice immediately if:

They cannot cover company debts

They cannot pay company staff

They have a serious lack of working capital

They receive a Court Order

Finance & Funding in Travel and Tourism - management accounting info

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