Financial Decision Making

FINANCIAL DECISION
MAKING

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................4
Role Of Accounting And Finance Department
..........................................................................................................................................................3
Ratio Analysis……………………………………………………………………………………..7
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................13
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Executive Summary
The aim of the report is to bring an understanding of accounting and finance importance in an
organisation. Importance of concepts have been discussed relating to the type of company
chosen. Financial ratios to grasp a better understanding used in company’s valuation and
performance comparison with previous year help in getting a clear picture of company’s
financial strengths and weaknesses.
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INTRODUCTION
The study revolves around importance of accounts and finance department and its techniques to
help an organisation respond well to financial matters. Skanska Plc is a UK Construction
company which is operating since 1887 and started by manufacturing concrete products. Skanska
since then has diversified in an international construction company and has played a pivotal role
for the infrastructure growth in Sweden. The study will also evaluate financial ratios to have a
better understanding of company’s performance since previous year and areas to work on.
Role Of Accounting And Finance Department
Accounts as the name suggests keeps the record of money going in and out of the business. It
prepares financial statements such as general ledgers, Balance sheet, Profit and loss statement
etc. to book the entries of financial transactions occurring within a fixed period say annually or
quarterly. These statements can be used for internal analysis of the company by the management
and also by shareholders who want to invest in the company (Brooks and Oikonomou,2018).
Finance department is responsible for management of cash through means of employing
capital, acquiring funds, managing funds within organisation’s other departments and planning
for asset acquisition for company as per future requirements. It has to manage the balance of
equity and debt for the company so as to maintain solvency of the company. It uses a number of
techniques to evaluate cash flows and calculating rate of return for better investment on projects.
Importance of Accounting Department
Accounting within an organization is necessary to keep a track of money spent on
production, overhead expenses, promotional expenses etc. Some advantages of
accounting are:
a) It helps in knowing how well the business is performing, who are the major source of
funding for business and who are its debtors.
b) Company abides by rules and regulations and follows statutory compliance and thus
avoids penalties by following rules of accounting.
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c) It helps in budgeting and financial ratios depict the state which has to be given more
attention to. The underperforming segment in the organisation is found out and
accordingly budget is allocated to bring improvement.
d) Accounting helps in filing financial statements at Registrar Office, at stock exchanges
where they are listed and for filing of taxes.
There are varied types of industries operating in commerce and thus accounting may differ in
some cases for them. Skanska being a construction company has its own way of evaluating
accounting techniques which suits its requirements for the type of industry it operates in
(Cockcroft and Russell, 2018).
There are although some common parameters in every organisation to assess and which are also
of importance to shareholders in financial accounting function which are:
a) Income statement: It lists all the gains on cost of goods sold and also expenses whether
variable or fixed with overheads counted in. The net profit or loss displays the
performance in profitability for the term, quarterly or annually.
b) Balance Sheet: It comprises of company’s assets and liabilities. Further it details into
current assets and current liabilities which help see the investors company’s current
liquidity and solvency in the market. Net working Capital can also be calculated with its
help which is necessary for company’s operations (Brooks and Oikonomou,2018).
c) Ledgers: Also called general ledgers, it records transactions in debit and credit for the
company. Debit records all the transactions coming in and credit all the transactions
going out for the company.
Management accounting covers cash flows and rate of return on investment projects. It
also prepares budget to be allocated to various departments.
d) Cash flow statement: Cash inflow and outflow are two aspects involved in accounting
which helps to know the source of funds, the expenditures and costs involved, company’s
payables and account receivables are known. It thus helps in knowing net cash available
for company’s operations.
e) Budget: It is prepared using previous year financials and ratios to judge the amount
allocation to each department and make provisions for the underperforming department.
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Audit Function
A company has to abide by rules and regulations while performing its operations. Audit in
Skanska sees to it that compliance is being followed with statutory rules to avoid penalties.
Companies have their internal auditors who judge the operational reports and find out any errors
which may have crept in. The executives are informed to rectify the errors before the external
audit takes place. They also check for accuracy in financial statements and also have a look at the
company’s goals whether any change in policies is required to help company achieve its
objectives (Fischer-Pauzenberger and Schwaiger, 2017).
As discussed above, there are some aspects related to construction accounting which differ in
calculation of financials listed below:
Job Costing
Skanska being a construction company has contracts which employs a variety of projects or jobs.
It can become a complex process to account them in one go as all are having different set of
costs and expenses. Job Costing helps to account all the direct, indirect expenses along with
revenue of each job separately thus eliminating confusion. This has helped the company to cover
up all overhead expenses while determining profitability for each project. This organised way
helps company’s internal accountants to easily review the financial statements and make tax
filing easier (Cockcroft and Russell, 2018).
Cash basis
Cash basis accounting has benefitted Skanska to record revenue and expenses as and when they
come in a contract which has simplified the process of keeping records although the expenses
have to be distributed evenly throughout the years if it is a multi-year contract.
Percentage of Completion
A contract has varying length and as such matching final revenues and expenses is a bit difficult
task. Here arrives the tool of Percentage of Completion used in Skanska which helps the business
come over this hurdle. There is an estimation of expenses made on a particular job in the project
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and then the actual expenses incurred in completion of the job is taken which is divided by the
former to get the profit or loss occurred. This helps to see whether a project is on the right track
or not. If there is a profit it is multiplied by percentage of completion of project till yet to get the
estimated gross profit. This has shown good results with not much deviation.
Tax function
Tax Strategies
Construction companies like Skanska have a difference in tax reporting as per approaches. For
completed contracts, income and expenses are recorded after the job is completed which allows
to defer taxes until project completion. However, Percentage of Completion is a better approach
to combat tax fluctuations which records income and expenses as per year received. Companies
get to defer taxes too with permission from Internal Revenue Service (Floyd and List, 2016).
Importance of Finance
Finance in any business plays prominent role in acquiring, managing and allocating funds to
various departments in the organisation. Financial planning requires methods and techniques
which are duly followed to get results for the organisation. The functions within finance are as
follows:
a) Investment function
Managers decide how to raise capital for company’s operations in Skanska. Company can launch
its IPOs, issue bonds and debentures in market to raise capital for company’s operations.
Skanska managers see to it that there is a balance of equity and debt as relying more on debt can
raise solvency issues in future (Loughran and McDonald, 2016). Debt can be in a form of bank
loan from company’s bank, a group giving credit etc.
b) Financing function
As business is generating revenues per day, it is necessary to rightly put money in areas like
pending payments, bills, finance for equipment and raw materials, for machinery, paying the
labour, suppliers along with delegating funds to various sections within the organisation.
Skanska with a good operating finance software is able to delegate funds in the right sections and
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able to maintain daily records. Previous financials are also used to match the funds delegated in
increase or decrease mode.
c) Dividend function
Skanska has to pay its investors certain amount of profits it generates on an annual basis. The
managers decide the amount to be given through calculations as per the stake of the shareholder.
This is dividend money which is taken out of gross profit generated. As the number of investors
are large in number, financial calculations are done with help of technology to allocate the funds
correctly.
d) Working Capital function
Skanska manages its working capital in a way that neither there is excess funds reported nor
there is a shortage of cash. Excess funds will mean the resources are not being optimally utilized
which is required for conducting day to day operations. Resources optimally utilised will
generate profits. Lower funds will mean company is not able to manage money for daily
operations and liquidity of the company is low (Floyd and List, 2016).
Ratio Analysis
Ratios 2018 2019
ROCE=Operating Profit/Total
Assets-Current Liabilities*100
750/(2955-645)*100= 32.46 975/(6000-2220)*100=25.79
Net Profit Margin=Net
Profit/Sales*100
600/4800*100=16.66 675/6000*100= 11.25
Current Ratio=Current
Assets/Current Liabilities
1515/645=2.34 2070/2220=0.93
Debtors Collection
Period=Receivables/Sales*365
900/4800*365=68.43 1200/6000*365=73
Creditors Payment
Period=Payables/Purchases*365
570/2700*365=77.05 2100/4800*365=159.68
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Return On Capital Employed
This ratio depicts a company’s profitability as to how well the capital has been employed to
generate earnings. Operating Profit is taken as numerator which is got by deducting operating
expenses from gross profit. It is also known as Earnings before Interest and tax on the company
depicting the amount company earns from its operations (Loughran and McDonald, 2016). EBIT
is calculated as revenue minus cost of sales plus the operating expenses. The capital employed is
taken out as current liabilities minus from total assets as the liabilities have to be paid off and
thus cannot be counted as capital.
Some analysts consider taking the average capital employed which is the average of opening and
closing capital employed for a period or term. As ROCE takes into consideration shareholder’s
equity with long term debt as capital employed it helps in better financial comparison of
companies having a prominent debt. It talks of revenue generated per $1 of capital employed.
Companies who have a stable or rising ROCE are generally preferred by investors rather
than the ones whose ROCE is lower.
Speaking of Skanska its ROCE has lowered in 2019 form 2018 which means less
profitability for the investors. Although Operating profit has risen with sales going up, but a
significant increase has been seen in total assets and current liabilities. With increase in a/c
payables, the current liabilities have increased. An increase in assets is a good sign but it could
also contain long term debt for the company. Secondly, the optimum utilisation of assets is
required here to generate a significant increase in operating profits or EBIT. Then it will help
company to generate a better ROCE.
Investors who are looking forward to invest will be concerned more in the increase in
operating profits than assets as higher the operating profit, higher will be the ROCE.
Net profit margin
The ratio shows the net profit or income generated from revenue shown in percentage terms and
sometimes in decimal. It is calculated by taking net profit as gross profit minus the operating
expenses and again minus the interest and taxes. This is also known as net earnings or revenue
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which has transformed itself into profits. The denominator is sales or revenue and reflects on per
dollar value of revenue which has become profit for the company. This margin shows how well
the company has covered up its operational costs and generated income. Net profit shows
whether a company’s operations are going in right direction or not. It signifies if a company
needs to decrease its operational expenses (Mburayi and Wall, 2018).
Investors see from the financials if the profit has been increasing and company being able
to generate returns from revenue and able to cover up operational and overhead expenses. Net
profit being expressed in percentage helps to compare company with different operational sizes
as well.
Speaking of Skanska it can be seen that net profit has declined in 2019 from the previous
year which is not a good sign as this reflects company’s earnings going down. From the balance
sheet it can be seen that overhead expenses like purchases have gone up significantly with a
slight increase in operational expenses. Company will have to boost up sales and try to reduce
operational expenses while seeing to it that purchases are controlled by cutting down on items
not coming useful in the process.
Although there is a decline in net profits an increase in gross profit is seen in 2019 which
means if the company takes right measures it will be able to cover up its overhead expenses in
next year assessment.
Current ratio
It falls under the heading of liquidity ratios and depicts company’s current assets and current
liabilities. It shows whether a company is able to pay its short-term obligations within a year and
also to maximize company’s current assets to balance its current liabilities and debts which will
also help increase its net working capital (McLaney and Atrill, 2016). Current assets are those
which have to be used or sold within a year to suit ongoing operations. They include cash, cash
equivalent, account receivables, stock inventory, marketable securities etc. Current liabilities are
those which have to be paid off within a year such as short-term debt, accounts payables, notes
payable etc. Current ratio in ideal situation would be one stating that company can cover its
current liabilities fully with its current assets. A higher current ratio than 1 is also acceptable
showing company’s current liquidity but a much higher ratio will mean company is not able to
manage its utilisation of assets effectively.
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Skanska has a decline in current ratio since 2018 which is not a good sign for the
company’s liquidity position as the ratio has gone below 1. It means company’s current assets
are less than current liabilities. Earlier the ratio was below 3 meaning good for company’s
liquidity as well as optimum utilisation of company’s assets.
It can be seen despite growth achieved in current assets cash in hand has declined and trade
payables have increased significantly adding up to the current liabilities. Company will have to
generate methods to increase cash to help pay off the payables.
Investors generally prefer current ratio higher than 1. Skanska will have to work on
increasing current assets to increase current ratio and hence attract investment.
Debtors Collection Period
The amount of time taken to collect receivables from debtors is known as debtors collection
period (Mburayi and Wall, 2018). The less time taken for debt recovery better it is for the
company to increase its cash segment and utilise it for company’s operations or maybe paying
the company’s credit. The denominator taken to calculate the ratio is sales as on the sales
generated how fast is the recovery rate of receivables. As sales is taken on an annual basis the
resultant of numerator and sales is multiplied by 365.It is thus denoted in days. A company when
doing an order of goods in advance or issuing debt knows the time line in which to recover debt.
If the receivables are collected in the time period it will show the efficiency of the company.
Speaking of Skanska it can be seen that a slight increase in debtors collection period has
been since 2018. A higher collection period will mean company having less cash at present
moment than the standard terms. Although not much of an increase is there which will prevent
deterrence of investors. Investors are looking for investment where the company doesn’t have
much pending payments as it can hamper their dividend payments at the right time.
Creditors Payment Period
It can be said as the ratio which depicts the time taken by the business to settle trade credits thus
mentioned also as account payables. The calculation is made on a yearly basis as the
denominator in the ratio is purchases done by the company on a yearly basis (McLaney and
Atrill, 2016). The company has to make use of credit for its operations and also ethically pay its
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dues on time to earn or maintain its reputation with its creditors. If a company is paying its dues
timely that shows the liquidity position of the company to be good.
Speaking of Skanska its payment period has increased more than double in 2019 with a
significant increase in account payables as well as purchases. Also it means company is taking
up longer to pay its dues. Company has to amend changes in a way that payments do not take
more duration and standardly payments can be done.
Investors may see it as a company’s way to use credit for a longer duration but it can
also raise questions whether company is facing a liquidity crunch or not. A lesser current ratio
will increase such doubts. A company’s tie up with its creditors has to be sound as to maintain
cash needs in future.
CONCLUSION
It can be concluded that accounting and finance are two pillars supporting the organisation in
both internal and external means. Internally they help in maintaining records and budget
allocation with supporting the need of better investments among projects. Externally the reports
being used by investors to put their money in safe place with returns thus boosting investment for
the company. It can also be seen with the help of financial ratios companies are able to find out
its own strengths and weaknesses and compare with the previous year performance of where they
need to work. It will help investors also to gauge the financial strength of the company.
Company’s profitability increases in an organised way with help of these functions.
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REFERENCES
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disclosures and performance on firm value: A review of the literature in
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Cockcroft, S. and Russell, M., 2018. Big data opportunities for accounting and finance practice
and research. Australian Accounting Review. 28(3). pp.323-333.
Fischer-Pauzenberger, C. and Schwaiger, W.S., 2017, November. The OntoREA© accounting
and finance model: ontological conceptualization of the accounting and
finance domain. In International Conference on Conceptual Modeling (pp.
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Fischer-Pauzenberger, C. and Schwaiger, W.S., 2018, October. OntoREA© accounting and
finance model: hedge portfolio representation of derivatives. In IFIP
Working Conference on The Practice of Enterprise Modeling (pp. 372-
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Floyd, E. and List, J.A., 2016. Using field experiments in accounting and finance. Journal of
Accounting Research. 54(2). pp.437-475.
Loughran, T. and McDonald, B., 2016. Textual analysis in accounting and finance: A
survey. Journal of Accounting Research. 54(4). pp.1187-1230.
Mburayi, L. and Wall, T., 2018. Sustainability in the professional accounting and finance
curriculum: an exploration. Higher Education, Skills and Work-Based
Learning.
McLaney, E. and Atrill, P., 2016. Accounting and finance an introduction. Pearson Education
Limited.
Seasongood, S., 2016. A case for robotics in accounting and finance. Financial Executive.
Smith, S., 2020. DIY corpora for Accounting & Finance vocabulary learning. English for
Specific Purposes.57. pp.1-12.
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Smith, S.J. and Urquhart, V., 2018. Accounting and finance in UK universities: Academic
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pp.588-601.
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