Executive Finance and Strategy: How to Understand and Use Financial Information to Set Strategic Goals

345 Pages·2014·4.272 MB·English

by  Ralph Tiffin

i
Executive
Finance and
Strategy
How to understand
and use financial
information to set
strategic goals
Ralph Tiffin
ii
To Professor Jeff McLachlan – a good friend
Publisher’s note
Every possible effort has been made to ensure that the information contained in this book
is accurate at the time of going to press, and the publishers and author cannot accept
responsibility for any errors or omissions, however caused. No responsibility for loss or
damage occasioned to any person acting, or refraining from action, as a result of the ma­
terial in this publication can be accepted by the editor, the publisher or the author.
First published in Great Britain and the United States in 2014 by Kogan Page Limited
Apart from any fair dealing for the purposes of research or private study, or criticism or review,
as permitted under the Copyright, Designs and Patents Act 1988, this publication may only be
reproduced, stored or transmitted, in any form or by any means, with the prior permission in
writing of the publishers, or in the case of reprographic reproduction in accordance with the terms
and licences issued by the CLA. Enquiries concerning reproduction outside these terms should
be sent to the publishers at the undermentioned addresses:
2nd Floor, 45 Gee Street 1518 Walnut Street, Suite 1100 4737/23 Ansari Road
London EC1V 3RS Philadelphia PA 19102 Daryaganj
United Kingdom USA New Delhi 110002
www.koganpage.com India
© Ralph Tiffin, 2014
The right of Ralph Tiffin to be identified as the author of this work has been asserted by him in
accordance with the Copyright, Designs and Patents Act 1988.
ISBN 978 0 7494 7150 7
E­ISBN 978 0 7494 7151 4
British Library Cataloguing-in-Publication Data
A CIP record for this book is available from the British Library.
Library of Congress Cataloging-in-Publication Data
Tiffin, Ralph.
Executive finance and strategy : how to understand and use financial information to set strategic
goals / Ralph Tiffin.
pages cm
ISBN 978­0­7494­7150­7 (paperback) – ISBN 978­0­7494­7151­4 (ebk) 1. Business enterprises­­
Finance. 2. Financial statements. 3. Managerial accounting. 4. Strategic planning. I. Title.
HG4026.T54 2014
658.4’012–dc23
2014023624
Typeset by Graphicraft Limited, Hong Kong
Printed and bound by CPI Group (UK) Ltd, Croydon, CR0 4YY
Contents
Contents iii
Introduction 1
Order of the chapters 3
Terminology used in this book 3
Structure of the chapters 5
How you might use this book 5
01 6
What is strategy? 6
Content, order and logic of this chapter 6
Definitions of ‘financial’, ‘strategy’ and ‘strategic’ 7
Further strategy-related definitions 8
What is business strategy? 11
What is the objective of financial strategy? 12
Why be in business? 13
Conclusion 14
02 15
Financial strategy 15
Content, order and logic of this chapter 15
What do successful companies say? 16
iii HWohwat dsouecsc emssafkuiln cgo ma rpeatnuirens osany i nvestment 1li8nk with strategy? 17
Making a good return is the objective, but what exactly is ROI? 20
Strategic drivers of ROI 22
Conclusion 25
Revision and learning pointers 26
ContEntS 0B3as ic financial report2s 7and concepts 27
Content, order and logic of this chapter 29
The importance of cash records and reports 30
Bedrock concepts 33
Income statement – the P&L account 33
Statement of financial position – the balance sheet 41
Conclusion 50
Revision and learning pointers 50
04 51
What underpins financial statements? 51
Content, order and logic of this chapter 52
Company law and directors’ responsibilities 53
Record keeping/bookkeeping 57
Internal controls – accounting systems and procedures – prevention of error and fraud 69
External and internal audit – prevention of error and fraud 71
Corporate governance 79
Conclusion 81
Introduction 1 Revision and learning pointers 81
05 83
Accounting ‘rules’ 83
Content, order and logic of this chapter 84
Background to accounting standards 85
What do GAAP, FASB, IASB and IFRS mean? 87
Principal accounting concepts – going concern and accruals 91
01 What is strategy? What does financial strategy mean? 6 How the concepts impact on the figures (and restrain some behaviour) 96
GAAP, which may cause issues with strategies 99
Conclusion 99
Revision and learning pointers 99
Content, order and logic of this chapter 6 Appendix to chapter 5 100
1 FRS 102, Section 2 100
Definitions of ‘financial’, ‘strategy’ and ‘strategic’ 7 2 Principal extant international accounting standards 100
06 105
Further strategy-related definitions 8 PCuobnltiesnhte,d o ordr esrt aatnudto lroyg aicc coof utnhtiss chapter 110055
What extant accounting standards require 106
What is business strategy? 11 Balance sheets – statements of financial position 121
Notes to financial statements 135
What is the objective of financial strategy? 12 UDKev feulollp fimneanntcsi ainl sfitnaatenmcieanl trse porting 114560
The strategic report 151
Why be in business? 13 Future developments 154
Conclusion 156
Conclusion 14 Revision and learning pointers 156
07 157
Interpreting financial statements 157
Content, order and logic of this chapter 158
Techniques for interpreting financial statements 159
Ratio analysis 162
02 Financial strategy: why be in business? 15 Working capital ratios 171
Analytical review 173
External ratios 174
Why we have to disclose ratios 180
Content, order and logic of this chapter 15 Conclusion 182
Revision and learning pointers 182
What do successful companies say? 16 08 183
Cash: the vital element 183
How does making a return on investment link with strategy? 17 CWohnetreen ct,a oshrd aeprp aenadrs l oing ificn oafn tchiaisl cshtaatpetmere nt1s 84 184
Cash flows for trading – working capital 185
What successful companies say 18 Insolvency – going concern – overtrading 190
Capital cash flows 192
Making a good return is the objective, but what exactly Statement of cash flows 193
Cash-flow-focused strategies 208
Conclusion 214
is ROI? 20 Revision and learning pointers 214
09 215
Strategic drivers of ROI 22 Management accounting 215
Content, order and logic of this chapter 217
Conclusion 25 TChaeu twioindae rsyc owpoer dosf mona nmaogdemelleinntg accountin2g1 8 217
Management reports – to assist with understanding strategy and its delivery 219
Revision and learning pointers 26 Sales and costing definitions and models 225
KPIs, dashboards and detailed analysis 234
Analytics – can there be too much analysis? 239
Conclusion 240
Revision and learning pointers 240
10 241
03 Basic financial reports and concepts 27 Budgeting 241
Content, order and logic of this chapter 241
What does budgeting mean? 242
Content, order and logic of this chapter 29 FWohreyc basutdingge tm? ethods 224532
Methods of budgeting 256
The importance of cash records and reports 30 Budget culture 261
Conclusion 266
Bedrock concepts 33 R11e vision and learning2 6p7ointers 266
Investment appraisal 267
Income statement – the P&L account 33 Content, order and logic of this chapter 268
The need for investment appraisal 269
Statement of financial position – the balance sheet 41 The time value of money and required rates 274
Cash flow models 277
Conclusion 50 CRoismk midoenn taifipcpartaioisna la mnde amsuarneasg ement 227883
How much analysis should be carried out? 288
Revision and learning pointers 50 The need for a consistent and robust process 289
The many uses of appraisal models 291
Conclusion 295
Revision and learning pointers 296
12 297
Structural or pure financial strategies 297
04 What underpins financial statements? 51 Content, order and logic of this chapter 297
Basic definitions 298
Gearing or leverage and the ‘magic’ of gearing 300
Content, order and logic of this chapter 52 LGeraosuinpg s tarnudc toufrfe-sb alan3c0e9 sheet finance 304
Special purpose vehicles or entities – off-balance sheet activities 314
Company law and directors’ responsibilities 53 Foreign currency issues 318
Hedging strategies 319
Record keeping/bookkeeping 57 CRoevnicsliuosni oann d learning3 1p9ointers 319
13 320
Summary 320
What are your company objectives – where do you fit in? 320
Strategies both financial and physical to support objectives 321
Links between the book’s chapters and strategies 322
Are your strategies co-coordinated and aligned? 324
Aphorisms 324
Glossary 325
Accounting institutions and terms 325
iv Contents
Internal controls – accounting systems and procedures –
prevention of error and fraud 69
External and internal audit – prevention of error and fraud 71
Corporate governance 79
Conclusion 81
Revision and learning pointers 81
05 Accounting ‘rules’: how accounting theory and rules
affect the strategic numbers 83
Content, order and logic of this chapter 84
Background to accounting standards 85
What do GAAP, FASB, IASB and IFRS mean? 87
Principal accounting concepts – going concern and accruals 91
How the concepts impact on the figures (and restrain
some behaviour) 96
GAAP, which may cause issues with strategies 99
Conclusion 99
Revision and learning pointers 99
Appendix 100
06 Published or statutory accounts 105
Content, order and logic of this chapter 105
What extant accounting standards require 106
Balance sheets – statements of financial position 121
Notes to financial statements 135
UK full financial statements 146
Developments in financial reporting 150
The strategic report 151
Future developments 154
Conclusion 156
Revision and learning pointers 156
07 Interpreting financial statements 157
Content, order and logic of this chapter 158
Techniques for interpreting financial statements 159
Ratio analysis 162
Working capital ratios 171
Analytical review 173
External ratios 174
Why we have to disclose ratios 180
Conclusion 182
Revision and learning pointers 182
Contents v
08 Cash: the vital element 183
Content, order and logic of this chapter 184
Where cash appears in financial statements 184
Cash flows for trading – working capital 185
Insolvency – going concern – overtrading 190
Capital cash flows 192
Statement of cash flows 193
Cash-flow-focused strategies 208
Conclusion 214
Revision and learning pointers 214
09 Management accounting: internal reports and business
models 215
Content, order and logic of this chapter 217
The wide scope of management accounting 217
Cautionary words on modelling 218
Management reports – to assist with understanding strategy and its
delivery 219
Sales and costing definitions and models 225
KPIs, dashboards and detailed analysis 234
Analytics – can there be too much analysis? 239
Conclusion 240
Revision and learning pointers 240
10 Budgeting 241
Content, order and logic of this chapter 241
What does budgeting mean? 242
Forecasting methods 243
Why budget? 252
Methods of budgeting 256
Budget culture 261
Conclusion 266
Revision and learning pointers 266
11 Investment appraisal: investment strategy 267
Content, order and logic of this chapter 268
The need for investment appraisal 269
The time value of money and required rates 274
Cash flow models 277
Common appraisal measures 278
Risk identification and management 283
How much analysis should be carried out? 288
The need for a consistent and robust process 289
vi Contents
The many uses of appraisal models 291
Conclusion 295
Revision and learning pointers 296
12 Structural or pure financial strategies 297
Content, order and logic of this chapter 297
Basic definitions 298
Gearing or leverage and the ‘magic’ of gearing 300
Leasing and off-balance sheet finance 304
Group structures 309
Special purpose vehicles or entities – off balance sheet
activities 314
Foreign currency issues 318
Hedging strategies 319
Conclusion 319
Revision and learning pointers 319
13 Summary 320
What are your company objectives – where do you fit in? 320
Strategies both financial and physical to support objectives 321
Links between the book’s chapters and strategies 322
Are your strategies coordinated and aligned? 324
Aphorisms 324
Glossary 325
References 330
Index 331
1
Introduction
t
his book explains (as no other) finance and accounting from a strategic
perspective and not from the sources of transaction data – the important
but often downplayed bookkeeping; not from trying to understand the
disparate aspects of the accounting and reporting process in some ad hoc
manner but from the stance of the prime use of accounting, which is to plan,
implement and track strategies through modelling and financial reporting
both internal and external. This book thus gives a coherent and focused
understanding of finance and financial statements anchored on the premise
that finance, accounting and accountants are there to serve businesses – to
be the core tool for identifying, modelling and delivering strategy and there-
fore business success and sustainability.
There are many purposes of financial reporting. Historically, the purpose
of bookkeeping and preparing balance sheets was to control, the need for
control being a key driver to create and set out the rules for single- and then
double-entry bookkeeping, a system designed among other things to prevent
the excesses of rogue traders (does anything ever change?) but also to assist
owners in knowing where their expanding businesses were heading.
As industry blossomed in the 19th century and management and owner-
ship of capital (invested money) grew apart, stewardship of assets under
management became a prime reason for reliable (audited) accounts, and
this remains true today. The latest thinking on the purpose of finance and
accounting, particularly financial reporting, is to be found in a term coined by
the IASB (International Accounting Standards Board) Framework – ‘decision
useful’, a clear but inelegant term. The economist mindset which pervades
accounting standard setters and accounting academics pushes the idea of what
‘decision useful’ might mean beyond sensible limits, and could even be
blamed for causing moral hazard, for example when valuing assets and
liabilities. Examples are to be found where ‘fair values’ have to be adopted:
Should not a liability have a single fair value, being the amount you have to
repay in full to settle the debt? Possibly, but a fair value may be a lower amount
of liability where the ‘market’ indicates so.
or
Should the fair value measurement of a non-financial asset take into account
a market participant’s ability to generate economic benefits by using the asset
in its highest and best use?
These examples indicate that accounting today is more sophisticated (in
a complex and complicated manner) than many would suppose. Strategies
may be hidden or prevented by accounting practice.
2 Executive Finance and Strategy
But you may well be wondering what the history of bookkeeping and
accounting theory has to do with strategy. It is the author’s view, supported
by years of observing the best (and worst) companies both large and small,
that successful companies have a very clear understanding of the prime reason
for the finance function and its outputs, namely to quantify, implement and
track delivery of strategies with the clear aim of achieving the company’s
objectives.
Accounting and financial statements may be the domain of the accountant
but they do not belong to the accountant. The purpose of accountants and
much of the responsibility of the finance director or chief financial officer is
to be the servant of the business – to keep the records, ensure the safe custody
of assets and limitation of liabilities, and then to report your activity and
business to you – the managing director, chief executive officer, production,
sales or other board member or senior manager; responsibility for under-
standing the figures and tracking your strategy then passes to you!
This book therefore aims to explain what you can expect to get out of
the reports, the figures, the models for your business. Accountants produce
reports and form the business models, but these are not their figures but
yours – you must understand them.
This book leads you to the quantification of your strategy or supports
your questioning of others’ strategies. If you are going to win the battle,
any strategy ought to be quantifiable. The book explains how your strategy
can be revealed and then measured with numbers – currency values – in
monetary terms.
Many companies’ strategies are explained as actions that will achieve the
desired goals or often vaguer ‘visions’ – but business strategies will be manifest
in financial statements – greater or less income, higher or lower costs, thus
higher or lower profits – with resultant increases/decreases in net assets
and cash flows. Numbers will reveal the success or failure of strategy. More
importantly, financial models can clearly demonstrate where a particular
strategy might lead.
All the chapters of this book are focused on finance as record keeper and
predictor of business strategies – clear figures allow no hiding place.
The majority of books on finance for non-accountants focus of clarifying
jargon, myth busting, explaining terminology, explaining why accountants
have their rituals; they do not explain that finance is the revealer (or illumi-
nator?) of strategy.
Strategically, why is anyone in business? Successful and long-lived
(sustained) companies understand the reasons. When directors (maybe
under the influence of their short-termist shareholders) lose sight of why
they are in business, ego, indolence or incompetence leads to value if not
company destruction.
Companies will cease to exist without sales or revenue streams, but also
costs – both operating and capital – have to be managed. Finance is at the
heart of any business – businesses would not exist without the pumping of
cash through the business and the consequent recording of the flows.
Introduction 3
order of the chapters
The order is to address firstly what the words ‘strategy’ and ‘financial strategy’
mean, why we need clear objectives and what these might be. This also starts
to put in place the relevance of the balance sheet and income statement with
respect to managing business strategies. Chapters 1 and 2 deal with these issues.
A thorough understanding of the three principal financial statements, the
balance sheet, statement of financial position and income statement, how
they are compiled and what rules pertain is vital if financial strategy is to be
reported and the effects of strategic decisions understood – Chapters 3 and 6.
As well as understanding the purpose, the meaning and how to interpret
the principal financial statements, it is essential to know what the law
requires, ‘law’ being company law, governance rules and GAAP (Generally
Accepted Accounting Principles) – these topics are covered in Chapters 4
and 5. For many executives the ability to interpret figures is their prime aim
and Chapter 7 focuses on how strategies may be revealed by interpretation
of financial statements.
For some executives, cash generation and use are the only financial strategies
they understand or need, but whatever your strategies, cash flows will be
involved – Chapter 8.
Management accounting, internal reports and business models outline
the modelling and internal reporting that can be done to understand the effect
that strategies might have and monitor the chosen strategies – Chapter 9.
Budgeting of operations, that is, budgeting revenues and costs, is a
universally adopted process by which both revenue and costs are planned
and controlled. Revenue maximization and cost reduction will inevitably
be continuing strategies in any sustainable business – Chapter 10.
Investing money is a strategy by itself, the aim being to make a return on
investment; thus, understanding the techniques of capital budgeting or
investment appraisal is essential for any executive – Chapter 11.
The structure of the balance sheet, how much borrowing or leverage you
have, will affect returns to investors but also increase or decrease risk. This
is pure financial strategic decision-making and for some, the only strategy
they are interested in – Chapter 12.
Chapter 13 aims to summarize the many strategies and techniques for
identifying, planning, tracking and hopefully delivering your chosen strategies.
It aims to answer the question: ‘What are the paths to sustainable success?’
terminology used in this book
A principal barrier to understanding finance, never mind strategy, is the ter-
minology used by finance folk. Not only does terminology change between
countries but it also develops over time. New and updated standards with
new terminology are being continually developed and issued, converging
between countries and jurisdictions wherever possible.