The financial control of the business
Financial control means the directing and monitoring of the financial resources within the business.
In order to make financial control possible it is first nec¬essary to set objectives and targets within which each depart¬ment is expected to work. The process is known as budgeting and is central to financial management.
Essentially a budget is a financial expression of intentions or expectations. Budgeting occurs at several levels within the business and over different time scales. However, common to all budgets is that they relate to the future and that they are therefore based upon forecasts rather than facts. This is in contrast to the balance sheet and the profit and loss account, which relate to the businesses past performance.
The preparation of a budget consists of a number of stages, which can be expressed as the following sequence.
1.Information. A department will start its budgetary process by looking at the information relating to its present situation. For example, in the case of the Sales Department this means analyzing the current sales figures, identifying trends and taking care to interpret any figures, which may be result of unusual circumstances.
2.Forecasts. The next stage is to look forward to the peri¬od under consideration and try to estimate as accurately as
possible the situation, which will prevail in the future, e.g.
estimate the amount of business is likely to sell over the com¬ing year. Experience will be of great help here but other tech¬niques may also be employed, e.g. market research and statis-tical analysis. Where accurate predictions are difficult to make it is common to prepare more than one set of forecasts, e.g. an optimistic forecast and a more pessimistic one.
Objectives. Once a business has framed its various fore¬casts, e.g. production, sales, marketing and so on, then it is possible to set realistic performance objectives. These will normally take the form of a series of targets that each depart¬ment is expected to meet, e.g. how much is to be produced, the increase in sales the business is aiming for, etc.
The budget. The final stage of the process is to budget to meet the business's performance targets. This means set¬ting out the level of expenditure within which each depart¬ment or sub-department (usually known as cost centres) will have to work. The materials budget will be agreed on the basis of the production targets, the marketing budget on the basis of the sales target and so on. It is very important that all the various parts of the budget are carefully coordinated. It obvi¬ously makes no sense to budget to sell 100,000 units if a pro¬duction target of only 80,000 has been set. Therefore, at each stage of the budgetary process close interdepartmental con¬sultation will be necessary.
Once the budget has been set up there must be sufficient funds flowing into the business to meet the necessary expen¬ditures incurred during its day-to-day trading activities. This process is called a continual flow of money through the business.
The sale of business's goods (or services) generates finance which is used to purchase more materials, pay wages and so on in order to generate more production, more sales and .hence more income. Provided income from sales is suffi¬cient to meet this necessary immediate expenditures then the business can continue to trade.
The business is said to be solvent. If the business is suc¬cessful then the amount received from sales will be greater
than the costs of production and therefore a profit will be made. The profit then can be used to reward the owner(s) and possibly improve or expand the business in order to generate higher profits in the future.
The items which change continually during the normal trading activities of the business are known collectively as the business's working capital. Working capital can be defined as the current assets available to the business minus any current liabilities on these assets.
Current liabilities are the short-term debts of the business which will have to be paid in the near future from current assets. The items making up current liabilities are the vari¬ous sums owed to the business's creditors.
To ensure the efficient operation of the business, working capital needs to be carefully managed. This involves a system of stock control, a debtor policy and cash flow forecasting.
Businesses require finance for a wide variety of reasons and most businesses can obtain finance from a number of dif¬ferent sources. Therefore, decisions have to be made regard¬ing the most appropriate source of finance. The provision of advice concerning the best method of financing different aspects of business activity is one of the key responsibilities of the Finance Department. When considering which method of finance is most suitable for any type of business activity, a number of factors must be taken into account:
1. The purpose for which finance is required. The reason a business requires finance - the application of funds - is often the most important factor in determining how the finance will be obtained - the source of funds. This means that funds required to bridge a temporary cash flow problem are likely to be sought from a different source than funds for
2. The cost of the finance. Certain types of finance are expen¬sive to raise, e.g. an issue of new shares. Other forms of finance can be expensive to service, e.g. interest charges on borrowed funds. The various costs must be carefully considered to ensure the business is obtaining its finance as cheaply as possible.
3.The availability of finance. Some sources of finance are not available to all businesses and this restricts the choice of funding.
4.The present financial structure of the business. It is important to take account of the existing liabilities of the business when considering further finance. The capital gear¬ing of the business is particularly important in this respect.
5.How quickly the finance is required. If the funds are needed immediately, e.g. to supplement cash flow, then the choice is likely to be restricted to a small number of sources, e.g. a bank overdraft. The more time the business has to plan for its financial needs, the wider the choice will be.
Finally, it should be noted that the larger the business, the greater the number of possible sources of funds available. Small firms face particular difficulties in raising the finance they need. This is one of the major reasons preventing the growth and development of such businesses.