Importance of Financial Management Skills to a Company’s Success
Accounting and financial Management skills are crucial aspects for any business to thrive in its operating environment. This is due to the fact that the main financial goals of any business solely depend on solidarity of the financial decisions formulated and adopted by an organization. These goals include profit maximization and shareholder wealth maximization (Bailey, 2010). In order for management to formulate good financial decisions, management must have access to information acquired from an organization’s accounting and financial system (Clark & Fujimoto, 2002). From AIS all information about financial statements is acquired, this information indicates the operating results of an organization. Access to such information leads to effective management since financial responsibility is vested on managers. Therefore, “financial information or data indicates key areas where a company has excelled and identifies also areas that present opportunities for making better decisions and for improvement” (Bailey, 2010). The main objective of this is to create stability and operating efficiency. Financial management knowledge and skills determine “the success, growth and stability of any company during a trading period, for instance, five (5) years as in our case” (Cissell & Flaspholer, 2010). To have an overview of this, I have referred to two financial statements which serve a purpose of indicating current operating conditions and future operating conditions. These indicate whether a company will be stable in terms of its earnings and ability to meet its obligations within a given period of time. These financial statements are the balance sheet and the profit and loss statement (the income statement).
The profit and loss statement is derived from the difference between revenues and expenses with the resultant figure representing profit or loss. This is done within a one-year trading period. With financial statement analysis skills, the DMC will be able to make cash flow and financial projections, and one will be able to project on the efficacy of its operations in the future (five years in this case). The other financial statement that one needs to have is the knowledge and skills to analyze the balance sheet. A balance sheet ascertains the financial position of an organization at the end of the trading period. The book-keeping equation, Assets = Capital + Liabilities, is used to indicate the net worth or owner’s equity in the business. Knowledge on this information is crucial in establishing whether there is growth and stability of any business. Moreover, ratios such as the profitability ratios and the gearing ratio are calculated from the balance sheet. Such ratios enable a company to know how well it will be stable in terms of earnings as well as knowing how it meets its obligations within a given trading period. Financial analysis skills, therefore, are a must for the management of Durango Manufucturing Company.
Use Of financial information by the Company Stakeholders
Financial statements serve to provide key information to the company’s stakeholders to ascertain the financial position, the performance of the enterprise and any deviations of financial position (Bailey, 2010). This information is relevant and useful when making financial decisions such as investment decisions. The information contained in this report centers on three facets that include employees, investors and the lenders. To them, this information is vital for them to make crucial decisions that touch on the effectiveness of the company’s operations.
Ideally, investors need to be informed for them to gauge the risks of engaging in such a venture. This will also help them to predict profits associated with the prospective venture. They will also use ratios such as profitability ratios calculated from the balance sheet to predict future earnings or dividends. Investors will also use this information to determine risks associated with investing in such a company, for instance, if the debt-equity ratio is higher.
Lenders will use financial information to determine the credit worthiness of DMC. They, therefore, use ratios such as quick ratio to determine a company’s liquidity. A higher quick ratio will mean that Durango will be operating efficiently. Ideally the quick ratio should be one-to-one. Lenders would also like to know the assets owned by the Durango to make lending decisions with regard to ability to pay.
Employees will require financial information such as profitability ratio and quick ratio in order to determine the prospects of their remuneration being constant or increased. Moreover, this information will help one to predict job security since if DMC operates on a higher debt, then it means there is no job security.
Capital Budgeting Ratio appropriate for Durango to evaluate its proposals
DMC will conduct capital budgeting to assess worth or viability of future projects are likely to invest in. Capital budgeting involves extensive evaluation of a project expected inflows and outflows within a given period. Capital budgeting “methods are Net Present Value (NPV), Profitability Index (PI), Payback Period and Internal Rate o Return (IRR)” (Choi & Levich, 2009). As a consultant, I propose using profitability index method. This method is simple to use since it evaluates the benefits and costs of proposed projects with similar useful life. It is calculated as a ratio of benefits versus costs, that is:
- PI = NPV benefits/NPV costs.
And, the rule for determining viability of ventures are given below:
- Accept the project if PI>1 or Reject project if PI<1.
The Profitability index method will be most appropriate for the DMC since it will put into perspective capital expenditures accrued when expanding and the capital benefits realized from the expansion of production and operations. NPV method and IRR method have the same decisions as PI (Altman & Inshore, 2006). PI is more appropriate since it incorporates the time value of money, it considers all expected cash flows of a project in its entire life, and it makes or adopts the right investment decisions in case of discrepancies in the project’s cash outlays with the right rate of return.
Improving operational Efficiency in Production Department, by adopting Costing Approach.
Nowadays organizations are improving operational efficacy in order to outdo the competition and gain competitive edge over competitors. This is in production departments which include supply chain, maintenance, quality assurance, operations, stores, technical design and support, production and planning, and distribution. Process costing system “allocates indirect overheads to manufacturing after tracing direct overheads/costs” (Bailey, 2010). These costs are assigned to products produced in bulk quantities/batches. Processing costing is, therefore, most appropriate for production/manufacturing department since Durango will be manufacturing identical/similar products and in large quantities through a continuous process. Ideally, for the purposes of proper accounting method while transferring the cost of finished products to cost of sale of the products, process costing system is preferred mostly in order to create an accurate matching of finished products to generate sales revenue.
Job order costing, “unlike process costing, assigns costs to individual products which are different from each other” (Bailey, 2010). This method creates a special order for each item indicating direct labor and direct materials added to manufacturing overheads. In Durango Manufacturing Company, job order costing will be most appropriate for the supply chain department in order to control how different raw materials are used in the manufacturing process and also for clients’ orders. It can also be adopted in the operations department in order to control and account for labor hours by creating special orders.
Activity-based coasting (ABC) is a very important auditing tool since it quantifies activities and resources, relating them directly to the final product/service. Therefore, ABC assigns indirect overheads into direct overheads. Activity-based costing is most appropriate in quality and assurance department since it will enable Durango’s quality assurance officers to make appropriate decisions to eliminate ineffective production processes, this will in turn support making of strategic decisions and measure improvement of processes. ABC is used to eliminate ineffective use of resources to improve on the production process.
Argument for Outsourcing Manufacturing /Labor to a Foreign Country
The Durango Manufacturing Company may decide to outsource their workforce from foreign countries in order to have a diverse workforce and reduce labor overheads. Outsourcing labor will benefit DMC in a number of ways that are highlighted below.
First, it reduces costs of outsourcing workforce since outsourced labor seems to be cheaper than domestic labor. This is due to the fact that most contracted employees are on contract basis as opposed to being full-time employees. Outsourced labor also attracts low wages, and other costs that are significantly reduced are recruitment, insurance and hiring costs.
Second, it introduces a time zone factor, that is, for instance, when hiring online support staff such as data entry staff. Due to differences in geographical time zones, the outsourced staff will still be working even when it is a holiday in the US. Since most outsourced staff won’t recognize American holidays.
Third, it simplifies hiring and firing, for instance, when online platforms such as ‘Odesk’ are on staff outsourcing. There are no hurdles in managing outsourced staff since ‘Odesk’ has already managed them, and payment is guaranteed through terms and conditions. Inability to work on agreed terms means no hiring and no payments.
Finally, it increases innovativeness and productivity due to tapping of more knowledgeable and diverse work force, and it is assumed that outsourcing creates an expert base due to the access to skilled services. Outsourcing workforce, therefore, will be most appropriate for DMC.
Durango’s five year prospect with regards to business environment
In order to sustain a 10% growth in revenue for the next half a decade, some elements within its business environment would have to change. I predict that the business, regulatory environment will have to change in order to minimize operating risks in the financial industry within the financial sector. This will influence Durango Manufacturing Company in that it will have to comply with tighter regulations. This may mean more investment for the Durango company to fit in the new regulatory environment. This may derail the progress of achieving 10% growth in revenue in the next five years. This is due to the fact that new regulations come with costs such as costs related to overhaul of the organizational structure in some cases and changing of reporting functions. This, therefore, will limit profitability, especially if capital requirements are increased while some production activities are minimized.
Economic environment involving both microeconomic and macroeconomic factors of the country will also affect DMC. Factors such as inflation, unemployment, interest rates, and unemployment are some of macroeconomic factors. If, for instance, this company has had a debt which attracted low interest rates, and all over sudden the interest rates increase due to prevailing economic conditions such as inflation, this company will have to pay higher interest for the debt. This will in turn affect revenue growth since the profitability of earnings will significantly reduce, and therefore, the company might not achieve desired 10% growth in revenue within the next five years. This is a bit tricky since higher interest has a positive impact on tax since interest on debt is a deductible expense, but inhibits growth in revenue. It is a win/lose situation. Also, if the demand of the company’s products reduces, then this automatically derails the progress towards 10% growth in revenue since profits generated will significantly reduce.
Opportunity-based strategic plans vital in attaining its goal (10% growth)
Strategists need to frame a road map vital in enhancing the opportunities available for DMC in order to realize the 10% growth margin in the long-run. A good strategy will be increasing the market share or simply the client base. Therefore, Durango needs to both brand and explore new market niches. This will in turn increase Durango’s client base, since more people will know about Durango’s products. With increased demand for the products, the sales revenue will also increase in the next five years. For marketing purposes, DMC should adopt marketing tools that consummate with the new or changing technology. A good example of this is marketing the products through online platforms such as the social media and the company’s website. With this, prospective buyer will be able to trade online by ordering for products online. E-trading is key towards achieving 10% growth in revenue within the next five years.
Enhancing internal controls to diminish risks for failure.
Fraud is an unethical business practice. Akin to DMC is “Philip Morris, a cigarette manufacturing company, which was deemed to be committing fraud or being unethical due to its marketing strategies” (Amihud et al., 2008). This company targeted children, and made them vulnerable to addictive habitual practices formed from smoking cigarettes. Moreover, it also sold Marlboro cigars to minors. Their marketing slogan was that ‘smokers die younger.’ They also “delivered a statement in the Czech Republic that premature deaths from cigarette smokers impact positively to the government since there are savings accrued” (Amihud et al., 2008). They also marketed cigarettes with defective filters for a period spanning forty years. The internal control that was defective in this company was in quality control, whereby the company marketed defective cigarettes knowingly deceiving their clients that the products met their requirements while in the real sense the products were defective as aforementioned. A corporate cultural environment that contributed to this fraud is the combative nature and defense of self-mechanism adopted by Philip Morris Company’s CEO, defending Philip Morris that cigarettes aren’t illegal products, and individuals should have the right to buy. Improvements of this internal control will help mitigate risks by enabling the company to comply with the regulatory requirements in the business environment. Accurate reporting will also minimize fraud and waste of resources and in the long-run help fulfill management objectives (Chung, & Pruitt, 2008).
DMC risks fraud owing to an absence in internal controls
All businesses and especially manufacturing companies should have internal controls that ensure that the business is operating efficiently and effectively as required. Within DMC, there are great risks for fraud owing to an absence in internal controls. These risks are owed to the fact that the senior management has no accounting and financial management skills, therefore there will be fraud since the management will be unable to implement and comply with accounting controls and regulations in order to ensure accuracy in financial information and financial reporting as well. Accounting controls will ensure that assets of this company are well utilized and that there is accuracy in financial reporting and also that the reconciliation of financial statements and assets accounts are done correctly and accurately. Durango company should, therefore, structure their internal controls in the following ways to ensure that they are effective in detecting fraudulent transactions.
One of these ways is to establish a financial detective internal control such as the use of electronic monitoring systems to detect bad checks written by clients for respective payments. This will minimize the loss of inventory and reduce time needed to recover money from fraudulent purchases.
Another way is through establishing operational internal controls that are the detective. There can be a cross-match of all recorded transactions in various departments through the computer system. For instance, when linking information on supply and chain department to finance department through a computer system in order to rectify unrecorded transactions. This will minimize fraudulent transactions that may result in accounting errors. With this, there will be prompt rectification of any errors identified. It will also minimize loss of revenue generated and loss of crucial business data.
The roles and responsibilities of the audit team and ways to make them effective
DMC’s audit committee has many roles other than oversight and financial reporting. Corporate reporting is also their role. Senior managers, the audit committee, the board of directors and the external auditor all sit in this committee. Their roles include risk management (discussing policies and measures to mitigate risks), handling complaints (they lay down framework to handle aired complaints regarding internal controls), auditing and reporting. Furthermore, they are responsible for disclosure of all financial information to the public after close analysis and extensive review, following the procedures formulated by the management (for disclosure of such information). Essentially, an independent auditor who is answerable to the audit committee can carry out their oversight roles.
The proposed model for improving audit committee effectiveness is assessing the performance of the audit committee, while at the same time preserving their independence, not to interfere with the over sighting role of the audit committee. This will anchor itself to the public accounting and oversight board. Without compromise, there will be effective corporate governance as well.
Conclusion
To sum it up, DMC should incorporate the following in the organizational structure in order to comply with SOX mandates. Introduce a public oversight board, conduct financial disclosures, and preserve the independence of external auditor, corporate responsibility, and corporate fraud accountability to mitigate risks arising from fraudulent transactions.
References
Altman, I., & Inshore, V. (2006). The Default Experience of U.S. Bonds. London: Salomon Center.
Amihud, Y., Christensen, B., & Mendelson, H. (2008). Further Evidence on the Risk-Return Relationship. Chicago, IL: University of Chicago Press.
Bailey, W. (2010). Canada’s Dual Class Shares: Further Evidence On The Market Value Of Cash Dividends. Journal of Finance, 43 (5), 1143-1160.
Choi, S., & Levich, R. (2009). The Capital Market Effects of International Accounting Diversity. New York, NY: Dow Jones Irwin.
Chung, H., & Pruitt, S. (2008). A Simple Approximation of Tobin’s Q. Financial Management Journal, 23 (1), 70-74.
Cissell, R., & Flaspholer, D. (2010). The Mathematics of Finance. New York, NY: Russell Sage Foundation.
Clark, K.B., & Fujimoto, T. (2002). Product Development Performance. New York, NY: Harvard Business School Press.