Qualification - Higher National Diploma in Business
Unit Name - Financial Management
Unit Number - Unit 15
Assignment Title - Financial Management
Learning Outcome 1: Apply different approaches used to support effective decision-making
Learning Outcome 2: Analyse financial management principles which are used to support effective financial strategies
Learning Outcome 3: Evaluate the role of management accountants and accounting control systems
Learning Outcome 4: Evaluate ways in which financial decision-making supports sustainable performance
Assignment Brief
Case Scenario
Task 1
You have recently established your own management accounting practice and have been invited to make a ‘pitch' to a potential client. In your presentation, your aim is to persuade the client of the value of management accounting and management accounting techniques in informing decisions, maximising performance and helping to ensure long-term sustainable growth.
Your presentation will cover:
1. An evaluation of a range of approaches, techniques and factors which contribute to effective decision making in an organisation.
2. Stakeholder management and the management of conflicting objectives of different stakeholder groups.
3. The value of management accounting techniques in cost control and maximising shareholder value.
4. Techniques for fraud detection and prevention and the approach to ethical decision making.
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Solution:
Approaches and considerations to make successful decisions:
Managers use a number of different strategies to pick among the options and make a decision. In certain cases, it might be a combination of a variety of different approaches that will help them to produce the best results. All the important decisions of the company are taken by the managers at the top-level who completely relies on the middle level management. Therefore, all the tactical decisions are handled by the middle level managers and all the operational activities are handled by the lower level managers. Some of the most common decision-making methods and techniques are.
• Market Research: Before making any decision gathering of information relating to market plays a very vital role which will include about the customers, competition in the market which will help to take effective decision. (Camuffo,2020)
• Marginal Analysis: The marginal analysis compares costs against the advantages of a product or operation. This method of research allows business executives to assess whether and when the optimal return on investment (ROI) is generated by action or input. Marginal analysis takes into consideration accounting preferences, information and resources constraints which helps the managers to take optimal decisions. (Dincer,2019) In order to perform a marginal analysis, variable needs to be adjusted such as the sum of an input that is used, or the volume of output that isgenerated.After deciding thevariable, it helps to determine what the net benefit increase will be if another unit of the control variable is added. That is perceived to be the added unit's marginal gain.
• SWOT Analysis: To make a big change in the company, SWOT diagramshelp to divide the situation into four different section -Strength, Weakness, Opportunities and Threats.A SWOT Analysis helps toidentify certain forces that affect a plan and decision. Decisions of all other members and stakeholders should also be taken into consideration as it will help to find different opportunities and threats which is not possible by an individual.(Camuffo,2020)
• Decision Matrix: It is a list which contains pros and cons which help to weigh various options more accurately against each other. It is a table with all the choices in the first column, and all the variables influencing the decision in the first row, by using the matrix.
• Pareto analysis: When lot of decisions are to be taken at a time then this strategy is used. This strategy helps to identify which decisions will have a overall greater impact and thus helps to prioritize which decision should be taken first.
• Feasibility Study: Entrepreneurs must determine the probability of developing a particular project and whether it will bring benefit or not. When a new product or any service is launched proper study is required which will help to decide whether the strategy is feasible for the enterprise or not.(Dincer,2019)
For effective decision making the organisation can use any of the above-mentioned instrument and also can make the combination of any approaches inorder to obtain the best for the organisation.
Stakeholders conflicting objectives:
Several businesses are beginning to concentrate on the needs of other stakeholders.Any person with an interest in a business, and can influence or be influenced by the business is known as stakeholdersclassifying employees and managers as internal stakeholders and shareholders, customers as external shareholders. .A common issue that emerges with having multiple stakeholders in an organization is the direct conflict among each other, as they cannot all agree with their respective self-interests. Board members or the management of the company must take care about the interest of the stakeholder's. Certain potential conflicts among different stakeholders is in the field of decision making which is supported by some stakeholders and opposed by some like the business decision to reduce the cost is to cut jobs which are likely supported by shareholders, bank but opposed by employees and the local community .(Bahadorestani,2020) Similarly to increase the factory capacity business decision is to add extra shifts which is likely supported by management, suppliers and as well as its customers but opposed by the local community, business decision to replace manual work with the introduction of new machinery is supported by customers and shareholders but opposed by the employees, business decision to improve profit margins by significantly increasing the selling price are supported by management and as well as its shareholders but completely opposed by the customers. Therefore, it is very important to balance the interest of different stakeholders in a business as all the stakeholders have their own different priorities like the shareholders expect a high return on investment, where as employees expect a good working condition and environment, customers expect quality as well as reliable products.And thus it becomes veryimportant to maintain the balance as most of the conflict arises when the needs of one stakeholder compromise the expectation of the other stakeholder.(Erhardt,2019)
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Internal Stakeholder conflicts
• Employees since the personal interest of an employee is to have a job security as well as the security of income and in case business takes a decision of reducing salaries and wages then the decision taken would be a conflicting decision.
• Owners:Conflict between shareholders always occurs because corporate strategy is typically based on the strategy based on long-term decisions, which can result in reinvestment and eventual deferment of payments of dividends.
External shareholders conflicts
• The primary interest of this stakeholder is goods and services that satisfy their needs and wants. If the goods dissatisfied the customers and because of this disappointment, there is a conflict of interest.
• Suppliers:Often they contribute to project execution with goods and services, so that the business continues to buy its products. So if the delivery is on time and the prices are fair then relationship is sustainable otherwise it would lead to conflict.
However, the objective of an organisation is to find the differences and solve the conflict in a constructive manner rather than avoiding the conflicts. Thus, the stakeholders with different conflicting views should involve themselves in the resolution process so that they can deal the differences in an effective manner.
Value of Management Accounting Technique in Cost Control and Maximization of Shareholder Wealth
Managerial accounting is an accounting method that identifies, measures, analyses and interprets accounting information which helps the management to take efficient decisions and manage the activities within the organization efficiently. It is focused on the internal decision making of the company and thus are effective tool for internal managers. It is a very useful technique for cost control and minimization because it comprise of various tools which helps in measurement of costs, analysis of those costs and taking corrective actions.(Youssef,2020) The mangers can use tools like cost- volume analysis, stock control models, budgeting etc. for making short term decisions and for long term decisions tools like payback period, net present value method, internal rate of return can be used for achievement of goals and selection of appropriate projects. Thus, the technique of management accounting helps in measuring and monitoring performance in real-time decision taking by executive management. It helps to measure performance against forecasts and budgets due to which company can avoid costly affairs and reduce their costs. The various tools for cost control provided by management accounting are as follows:
• Standard Costing - It is technique where standards are at a level of production. The standard set are then compared with actual performance and the reasons behind deviation between them is found it. Later corrective measures are undertaken to control these costs.
• Budgetary Control - Budgets are prepared for future expenses, production etc. on the basis of past performance. It helps in constant monitoring of actual costs with the budgeted costs and gets triggered whenever there is a deviation. Thus, it helps in keeping a track of expenses.
• Capital Expenditure planning - Through effective tools like NPV, Internal Rate of return etc. company evaluates the cash inflows and profitability of the project to be invested.
• Controlling of overheads, labour expenses and material expenses during the manufacturing process.
Thus, it can be seen that management accounting is focussed towards internal management of the company and aims to keep a track of the costs incurred and controlling them.A company's shareholders are the owners of the company. These are the ones who worry most about a firm's financial wellbeing. (Ostaev,2019) Stakeholders are all individuals or groups of people linked in some way or other to the business.The basic mission behind a company is to meet the needs of its stakeholders and maximization of their wealth. To facilitate the functions of the company and to earn good profits it is very important for a company to have a strongdecision-making process and investing projects. The management accounting technique helps in proper cost control due to which revenue of an organization increase thereby adding to the maximization of wealth of shareholders.
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Detection of fraud and its Prevention:
In the field of fraud, the two terms, which auditors know and understand well, is the principles of risk and materiality. How seriously the business takes fraud prevention and detection is based on the assessment of the value of these variables. So it is necessary for all auditors to take due account of the risk and material of fraud in their company as it will also impact the audit resources allocated to fraud related activities .Thus, for the prevention and detection of fraud both the management as well as audit plays a very important role.As the authority of the whole system,people as well as records are in the hand of the management and for the evaluation as well as designing of controls audit is expertise. In all the organisation whether it is private or government frauds happens everywhere. Thus, fraud losses are significant.Management, staff and internal and external auditors may be required to work together to deal with the fraud.(Saia,2018)
Approaches to ethical decision making:
Justice approach: The approach to justice implies that people should be treated fairly irrespective of their life-station, that is, they should not be discriminated against. It portrays all community members are benefitted from ethical acts.The disadvantage of this approach is that the decision taken may be bias for a particular group which may not even be realised by the decision makers.(Wittmer,2019)
Utilitarian Approach:The Utilitarian Approach analyses an intervention in terms of its effects to all individual stakeholders. It aims to accomplish the greater good while causing the least damage or avoiding the suffering.This ensures that the needs of each individual should be weighed fairly while taking the decision. The main disadvantage of this approach is that measuring the values of costs as well benefits is quiet impossible.
Virtue approach: The virtue approach to ethics suggests the certain values that people will aim for. Meaning that a person who has established virtues will automatically behave in a manner compatible with moral principles. The main disadvantage of this approach is that it does not provide guide.(Wittmer,2019)
Common Good Approach: This strategy is based on a view of society as a group whose members work together in order to obtain a shared set of values and objectives.The main complication that arises with this approach is that This approach is complicated by the fact the people have different opinions of what constitutes the common good. Furthermore, preserving the common good also demands that certain groups bear higher costs than others.(Noothigattu,2018)
They do this for very different reasons based on the above ethical approaches, and it is important to consider the nuances of different strategies that are used in the various contexts in which they work. Finally, all decisions have an ethical aspect, and one of the most critical management considerations is whether the decisions that they make as workers or managers are ethical.
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Task 2
You are to work in a group to evaluate an annual report of a listed company in Hong Kong and use the annual report to calculate appropriate ratios using Excel. You are to present your analysis of the company performance in a 2,000-word report. The report should include the following:
1. Identify how the data obtained might help to inform operational and strategic decisions for the company.
2. Compare and contrast three investment appraisal techniques and evaluate their effectiveness in helping to maximise return on investment (ROI).
3. Demonstrate the value of techniques (e.g. cash flow statements, break-even analysis) in helping to inform financial decision making.
4. Analyse how financial decision making supports long-term sustainability.
5. Make recommendations for how management accounting can be used to improve financial sustainability.
Solution:
Introduction of the Chosen Company
The chosen company is AIA Group Limited. AIA Group Limited is a company that is provides insurance products and other services alongside its auxiliaries. It came into existence in the year 1919 with the headquarters in Central, Honk Kong. The business is listed on the Hong Kong stock exchange (code 1299) in October 2010 with the third-largest IPO in the world of HK $ 159.08 and has become part of the Hang Sang Index. The company has branches all around the world in countries like China, Thailand, India, Indonesia, Australia and others.The company's coverage covers life insurance, liability insurance, health and serious condition insurance, and insurance policies for the protection of income from disability. It has seen tremendous growth over a period of years due to its allied financial services. The report focuses on the various financial aspects and other non - financial aspects of the company.
Relevance of the data obtained from annual report in operational and strategic decisions of the company.
The information obtained from the financial reports helps to analyze the financial health of any company. The data obtained from these reports can be used to compute the ratios of the company, which provide an in-depth analysis of the financial position and the activities of the business enterprise. It helps in understanding the operations of an enterprise and enriches the knowledge to take strategic decisions. (Linares-Mustarós,2018)
Evaluation of performance of the company in the last few years.
Profitability level:The company's sales as of November 30, 2014 were US$ 25,169 billion, which decreased in 2015 to US$ 22,486 billion. Again, revenue increased to $27,797billion in 2016. Revenue has risen exponentially to $32billion for 2017. A drastic decline in 2018 saw sales fall to $33 billion, while 2019 was a milestone year of $48 billion in revenue. The net profit margin in the year 2018 was 21.85%.
Liquidity position - The company has a good liquidity position which is evident from the cash flow statement. The cash flows from the operating activities are very high due to which the company has surplus cash position.
Debt - Equity Ratio - Over the past 5 years, AIA's debt capital has shown a steady decline. This can be demonstrated by the growing earnings and cash flows from operations. In 2015, the debt was 6.5billion percent and $31.42 billion equity for a debt equity ratio of 20 percent. The ratio fell in 2016 to 15 per cent. It also declined to 14 percent in 2017.The company had a 13.4 percent debt ration of $7.7 billion and equipped for 2019.
AIA is currently thriving. EBIT, profits, growth rate, cash flows and the raising debt ration demonstrate how well the business has done over the years, with increasing revenues. The Asian region's largest insurance firm has shown the world its strengths and financial achievements, and why it is so respected.
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Investment Appraisal Techniques
Investment decisions are significant and vitally important decisions for any company. Investing is the way to increase, and optimize the return on the capital of the shareholder. The biggest problem that management faces is about making the right investment decisions. Risk and uncertainty are always associated with investment decisions. The fundamental objective of the investment assessment, therefore, is to check whether the initial outlay will add future cash inflows to the company. To achieve that aim, companies need certain inputs. To achieve the result, these inputs are put through the investment assessment process.
The three most important investment appraisal techniques used by the companies are as follows:
• Net Present Value - Net Present Value is the method of calculation of net cash inflows from an investment project. It is calculated by subtracting the discounted cash flows from initial cash outflows. The most important aspect about this technique is that it considers time value of money i.e. it is based on the concept that value of money declines with time due to factors like inflation etc. In addition, it uses reinvestment rate that is considered to be close to its cost of capital, which is more realistic than other techniques. A project is considered good if it has positive NPV.( Wambua,2018)
• Internal Rate of return - It helps to determine the profitability of any investment. At this point, the Net Present Value of the project is 0. It provides a benchmark for acceptance or non-acceptance of any project. If the actual cost of capital i.e. discount rate of the company is higher than internal rate of return it depicts that the Net Present value is likely to decline and it should not be accepted. The major drawback of IRR technique is that it is difficult to compute IRR and the technique is based on assumption that cash inflows are always reinvested which may not always hold correct.
• Pay-back Period - It is the technique which focuses on the time frame within which the initial investments made on the project are recovered. The companies tend to accept an investment project if the amount invested is recovered within the life of the project. This technique is usually accepted when the company intends to maintain liquidity and has to choose among many projects. Thus, the project with a lower payback period is accepted. The major drawback with this technique is that it does not consider time value of money.( Häcker,2017)
Thus, the investment appraisal techniques help in the evaluation of the project and selection of the best investment project that will increase the return on investment and overall profitability of the company.
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Use of techniques by AIA Group
The company uses all the above-mentioned techniques while evaluating the investment decisions. While calculating Net Present Value of any project it tends to consider time value of money and thus takes into consideration the inflation rates and foreign exchange fluctuations. The company uses IRR technique also and tends to choose investments with IRR higher than its weighted average cost of capital of 4.64%. Thus, an investment appraisal technique helps in evaluating the effectiveness of projects.
Value of techniques and its importance in decision-making process
• Cash Flow Statements - It records the cash inflows and outflows of a company, and represents the liquidity position of the company. The company has to schedule its profits and expenditure for the cash flow statement and it is significant to foresee the balance for the period and based on that future cash flows can be estimated.It tests how well a corporation is handling its cash position and its ability to manage cash to pay its debt obligations and cover its operating expenses. (Özcan,2020)
Recommendation on AIA Group financial performance
AIA Group prepares cash flow statement. From the annual report of year 2018 it can be seen that the company has 2146 cash and cash equivalents at the end of the year. The cash flows have increased in the year 2018 as compared to year 2017. Though investing and financing activities have increased in year 2018 there is an increase in cash flows it is due to increase in cash flows from operating activities. Thus, cash flows provide a complete picture of availability of cash with the company.
• Budgeting - The aim of budgeting is to provide a picture of how the company will work, if such policies, activities, plans are implemented. It helps company owners to focus on cash flow, cut costs, boost profitability and increase returns on investment. It forms the basis of success of any business. It helps in the preparation and management of the company's finances. The main aspect of budgeting is that it helps in forecasting income and expenditure and plays a key role in preparation of business plan. It helps in decision making process.( Malenko,2019)
Recommendation on AIA Group financial performance
It seems that the expenses of the company have declined in the year 2018 as compared to year 2017. It can be possible through budgeting and budgetary control technqiues employed by the company.
• Break Even Analysis - The break-even point is the point where the sales level is enough to recover all business expenses. It is a no profit no loss situation. A business enjoys profit above this level until and unless there is a hike in expenses. It helps in decision making as to whether the product should be manufactured or not. It helps in budgetary preparation and setting up targets. Also, it helps in determination of minimum number of units to be sold and helps in controlling of costs and monitoring.
Recommendation on AIA Group financial performance
The company has increasing trend of profits since the year 2015.In 2015, the company posted profits of $2.75 billion that nearly doubled in 2016 to $4 billion. Again, there has been a regular $2billion rise bringing earnings to $6billion in 2017. 2018 was a tough year in terms of both sales and profits down to $3billion. In 2019, earnings reached $6.6 billion with a 14 percent profit margin. This shows that the company is above its Break even point level.
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Financial Decision Making in Long term Sustainability
Financial decision making refers to the process whereby decisions related to various sources of finance, stakeholder's equity, debts, business operations etc. are undertaken in order to maintain long term sustainability and growth of business enterprise. Financial decisions are the main decisions for any organization and thus success or failure of an organization entirely depends on these decisions. Long term sustainability is an approach to long-term value development, taking into account the manner in which an enterprise works in an ecological, social and economic climate. (Ozili,2018) Sustainability is based on the assumption that the development of such strategies promotes the longevity of companies. Financial decision making plays a very important role in ensuring long term sustainability of any business organization. These are as follows:
• Deciding on the sources of funds - A business requires funds to conduct its business activities. A company that aims to exist for a longer period of time has to arrange sources of funding from long term sources like equity, debt, long term financial institutions etc. (Ozili,2018)
• Managing Profitability - The company has to manage its profits in order to maintain long term sustainability. High profits depict cost cutting and low profits shows inefficiency of business operations. For a continued survival and growth, a business needs to maintain continued good profitability.
• Proper Planning and Reporting - Financial planning should be sufficiently versatile to allow for market shifts and unforeseen opportunities, but robust enough to prevent you from moving into risky, unsustainable areas. This helps business to secure a good and sustainable position in the market.
It is true that financial as well as non- financial decision making are important for maintaining long term sustainability of any business enterprise. The non-financial factors include corporate social responsibility activities, corporate governance measures and other environmentally friendly activities that robust the process of growth, expansion and continued existence.(Hacker,2019)
Financial Decision making in AIA Group
ESG (Environmental, Social, and Governance) is an important part of business model in AIA. The investment strategy is based on the basis of the ESG. Thus, AIA is also aware of their more extensive impact in driving improvements in disclosure and understanding of ESG over the region. For maintaining long term sustainability and growth the company makes investments that will ensure steady return and income. Also, their commitment towards ESG measures helps in avoidance of government intervention and adds life to the business.
Recommendations as to how management accounting can be used to improve financial sustainability.
Managerial accounting provides both quantitative and qualitative information on operations and finances of company. It is used internally by management, owners and employees to make decisions. It is a tool of continuous improvement through enhanced measurement and improvements techniques. It comprises of various tools like cost management and quality management which continually focuses on controlling the costs and managing the quality of goods and services provided by the company. Thus, it will ensure expansion and growth of business that will help to improve financial sustainability.