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

Debitso Assetso Expenseso Profits / Surpluses

Creditso Liabilitieso Incomeo 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

Accounting Principles

CONSISTENCY

ACCRUALS

GOING-CONCERN

PRUDENCE

ACCOUNTINGPOLICIES

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 method2. 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 £

Accumulated Depreciation

£

Book Value

£ 1 10,000 2,000 8,000 2 10,000 4,000 6,000 3 10,000 6,000 4,000 4 10,000 8,000 2,000 5 10,000 10,000 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£

Accumulated Depreciation

£

Book Value£

1 12,000 3,000 9,000

2 12,000 5,250 6,750

3 12,000

4 12,000

5 12,000 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£

Accumulated Depreciation

£

Book Value£

1 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 profit

maximisation of return on

capital employed

survival

securitylong-term stability

growth

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

2012/13 2011/12 £’000

£’000 Short term deposits 24,505 22,505 Cash at bank 51,801 24,012 Loans <1 year (2,016) (1,541) Loans >1year (70,953) (53,072)

Total 3,337 (8,096)

Analysis of Income

2012/13 2011/12

£’000 £’000

Funding Council Grants 56,967 66,624 Academic Fees 88,633 70,726 Research Grants 39,147 38,670 Other income 58,880 60,330 Investment Income 1,313 1,407

Total Income 244,940 237,757

Academic fees and support grants

2012/13 2011/12 £’000 £’000

Home and EU Students 57,944 (65%) 41,067 (60%)

International Students 30,689 (35%) 29,659 (40%)

Total 88,633 70,726

Analysis of Expenditure 2012/13 2011/12

£’000 £’000

Staff Costs 124,303 122,777

Depreciation 17,700 15,221

Other Operating Expenses 91,412 91,719

Interest Payable 3,416 2,235

Total Expenditure 236,831 231,952

Staff costs

2012/13 2011/12 £’000 £’000

Wages & Salaries 101,345 100,713

Social Security 7,898 7,831

Pension costs 14,958 14,093

Restructuring costs 102 140

Total 124,303 122,777

Surplus retained within reserves

2012/13 2011/12 £’000 £’000

Surplus on continuing operations 8,109 5,805

Tax 12

12 Specific Endowments 183 40

Retained within reserves 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

2012/13 2011/12 £’000 £’000

Tangible assets 302,723 300,380 Benefit re College of Art & Design (2,364) (2,497) Investments 214 242 Long Term Loans 145 173 Endowments 2,803 2,687 Stocks & Debtors 18,376 18,241 Cash 76,306 46,517

Total 398,203 365,743

Balance sheet: Liabilities

2012/13 2011/12 £’000 £’000

Creditors < 1 Year * (73,902)(69,761)

Creditors > 1 Year (70,953)(53,072)

Provisions (1,922) (1,964)

Pension Liability (47,187)(47,618)

Total (193,964) (172,415)

* Includes unapplied deferred capital grants and research payments received on account

Balance sheet: Assets and liabilities represented by:

2012/13 2011/12 £’000 £’000

Deferred Capital Grants 101,932 102,134 Endowments 2,803 2,687 Reserves 101,504 88,507

Total 206,239 193,328

Movement in Pension Reserve

2012/13 2011/12 £’000 £’000

Opening Reserve (47,618) (28,902)Movement for year 2,431 (18,716)Closing Reserve (45,187) (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 eg. 2 :1Current Liabilities

= £50,000 / 25,000= 2:1

The recommended current ratio is 2.1Liquid Ratio

Current Assets (excluding stock) eg. 1:1Current Liabilities

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 eg. 10%Sales Revenue

Means that gross profit is 10% of the total value of sales

Net Profit Ratio:Net Profit x 100 eg. 6%Sales Revenue

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 timesFixed 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 Financial ManagementGoverned by Company law,

SSAPsManagers’ needs

Users External InternalTime Past and present Present and

futureEmphasis Accuracy Decision-

makingData Money 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

Services 700 720 20 ADV

Total 38,900 33,860 5,040 FAV

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: Find the flexed % = 4,000/5,000 x 100 = 80% Step 2: 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

Flexed Budget:4,000 delegates

Variation from Flexed Budget

£ £ £

Support Staff 8,300 8,000 300

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 720

Total 33,860

Variance Analysis – Training Budget

Forecast Actual: Variance

£ £ £Support Staff 10,000 8,300 1,700 fav

Workbooks 1,000 840 160 fav

Training Staff 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

Services 700 720 20 adv

Total 38,900 33,860 5,040 fav

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!