Finance & Funding in Travel and Tourism - management accounting info

The International Travel College of New Zealand 1
Finance & Funding in the
Travel and Tourism Sector
Unit #2 – Learning Outcome 2
The use of management accounting
information as a decision-making tool
in travel and tourism businesses

What is Management
Accounting?
• Concerned with providing managers with the information they
require for the day-to-day running of the business.
• Reports produced are for specific purposes, designed for a
particular manager or use, and contain a lot of detail to help with
decision making.
• These reports are for internal use only and have no restrictions in
the way are presented or produced.
• Management accounts are produced as frequently as required by
managers, which may be weekly or monthly, allowing them to keep
a close check on business performance.
• Reports include past performance as well as future performance
projections or forecasts.
• Reports include information quantified in monetary terms in addition
to non-financial information such as measures of physical quantities
of inventory/stock.

Types of Management Accounting
Information
• Managers and business owners use a wide
range of information to help them not only run
their business on a day-to-day basis but to plan
ahead, form business strategies and provide
them with the information they will need to make
sound business decisions.
• The amount of information and complexity of it
will depend on the size of the business.

Financial Statements
• A financial statement is a formal record of the financial activities of a
business, person, or other entity.
• Relevant financial information is presented in a structured manner and in a
form easy to understand.
• They typically include basic financial statements, accompanied by a
management discussion and analysis. The financial statements typically
are:
 Statement of financial position: also referred to as a balance sheet,
reports on a company's assets, liabilities, and ownership equity at a given
point in time.
 Statement of comprehensive income: reports on a company's income,
expenses, and profits over a period of time. A profit and loss statement
provides information on the operation of the enterprise. These include sales
and the various expenses incurred during the processing state.
 Statement of cash flows: reports on a company's cash flow activities,
particularly its operating, investing and financing activities.

Budgets
• Budgets are financial plans for the short term, typically
one year, and likely to be expressed mainly in financial
terms.
• Businesses use budgets to plan for future activities and
to set various goals and objectives within the company.
• They help the organization set specific expectations
which aid in evaluating performance throughout the
company.
• Budgeting helps organizations implement specific
strategies to meet goals and objectives.
• A budget is an estimate and may need to be adjusted
over time.

Variance Analysis
• Variance analysis is most often used when
comparing your actual results of business
operations against the budget to identify
areas for further investigation.

Forecasts
• A financial forecast is an estimate of future
financial outcomes for a company.
• Forecasts are prepared using historical
sales data and previous actual costs, in
addition to considering external market
and economic indicators.
• Forecasting is used in the preparation of
budgets and similar financial statements.

Management Information Systems
(MIS)
• Businesses use information systems at all levels of operation to
collect, process and store data.
• Everyone who works in business, from someone who pays the bills
to the person who makes employment decisions, uses information
systems.
• Management aggregates and disseminates data in the form of
information needed to carry out the daily operations of business.
• Examples include a computer database holding customer and
product information, systems holding details of all financial
transactions, scheduling and diary systems, computer systems
monitoring productivity, call monitoring systems.
• There's hardly any large business that does not rely extensively on
their MIS systems to better understand the effects of their strategies,
and help enable effective decision-making.

Budgets

Budgets in Business
• Budgets are plans for the short term – typically one year.
• They are expressed mainly in financial terms.
• Their role is to convert the long-term plans into actionable
‘blueprints’ for the immediate future.
• Budgets usually define precise targets such as:
- Cash receipts and payments
- Sales
- Detailed inventory/stock requirements
- Detailed labor requirements
- Specific production requirements.
• Budgeting is not the role of accountants – it is the role of the
managers of the business.
• Accountants can give advice based on their knowledge, expertise
and skills.

Consider Options
Identify Objectives
Evaluate options and make a selection
Prepare Budgets
Perform and collect information on actual performance
Respond to divergencies between plans and actuals and
exercise control
Revise plans (budgets) if necessary
Budgeting is used in decision-making, planning and control processes within a business

Budgets in Planning
• All businesses have an
objective to make money
(otherwise they wouldn’t
be in business!), but this
goal must be defined and
expanded in order to
make it happen.
• In order to achieve the
objective businesses will
make a long-term plan,
typically a five year plan,
and will also have a short
term plan looking forward
to the next 12 months.
Business Objectives
Long Term Plan
Budget
(Short Term Plan)

Budgets in Planning cont..
Long Term Plan defines the general direction of the business:
• The market for the business
• Production/service rendering methods (online, retail etc)
• What the business will offer to its customers
• Level of profit sought
• Financial requirements and financing methods
• Personnel requirements
• Bought-in goods and service requirements and sources
The budget (short term plan) goes into more detail:
• Sales and expenses
• Cash flows
• Short-term credit to be given or taken
• Inventory/stock requirements

Relationship between objectives,
long-term plans and budgets:
• The objective is likely to last for quite a
long term, often for the entire life of the
business.
• A series of long-term plans identifies how
the objective is to be pursued.
• Budgets/short-term plans identify how the
long-term plan is to be fulfilled

The Source of Plans and Budgets
(who does them!)
• It is the function of management of a business to set
long-term plans and budgets.
• It is up to the management to determine the budget cycle
and when, if ever, to revisit and adjust budgets that have
been set.
• Annual budgets set targets for a year for all levels of the
business.
• Budgets are usually broken down into monthly budgets.
• Budgets are set for different areas and activities of a
business, such as departmental budgets, regional
budgets, revenue budgets, expense budgets.

Types of Budgets
• Sales Budget - The sales budget is an estimate of future sales, often broken
down into both ‘units’ and dollars. It is used to create company sales goals.
• Production Budget - An estimate of the number of units that must be
manufactured in order to meet the sales goals, estimates the various costs
involved with manufacturing those units.
• Cash Flow Budget - A prediction of future cash receipts and expenditures
for a particular time period.
• Marketing Budget - An estimate of the funds needed for promotion,
advertising, and public relations in order to market the product or service.
• Project Budget - A prediction of the costs associated with a particular
company project, including labor, materials, and other related expenses.
• Capital Budget - A prediction of company needs in regard to fixed assets,
such as buildings, vehicles, machinery, and other equipment, the cost of
upgrading present assets, the cost of acquiring new assets, costs associated
with maintenance of the assets, and fees associated with the assets.
• Master Budget - A summary of the plans created for the sub-units of the
company, used to create projected financial statements, also referred to as a
budgeted income statement and a budgeted balance sheet.

Budget-Setting Process
1. Who will take responsibility for the budget-setting
process
2. Communicate budget guidelines to relevant managers
3. Identify the key or limiting factor
4. Prepare the budget for the area of the limiting factor
5. Prepare draft budgets for all other areas
6. Review and co-ordinate the budgets
7. Prepare the master budget
8. Communicate the budgets to all interested parties
9. Monitor performance relative to the budgets

Limiting Factors
• In any business there is always some aspect which will
stop it from achieving its objectives to the maximum
extent.
• Such a factor is called the ‘limiting factor’, ‘key factor’ or
‘principal budget factor’. Some examples of limiting
factors are:
– capacity of production
– skilled labor shortage
– material’s shortage
– shortage of space
– low demand for product or service
– shortage of funds

Approaches to setting budgets
Top Down
• Senior management of each budget originate the budget targets,
consulting with lower levels of management, refining them and
producing final version.
Bottom Up
• Targets are ‘fed up’ from junior managers or front line staff whose
input is incorporated into the budgets of middle managers who in
turn feed their recommendations to senior management.
• This approach is increasingly used in practice in order to achieve
‘buy in’ and full agreement with staff on the goals and targets.
• Once budgets are agreed they are circulated to managers who are
tasked with implementing their particular budget.
• Managers monitor their team’s performance relative to the budget,
and remedial action taken where things are going wrong.

Uses of Budgets
1. Promotes forward thinking and identification of
short-term problems
2. Used to help co-ordinate between different
areas of the business
3. Motivates managers to better performance
4. Provides a basis for a system of control
(monitoring actual performance against
planned performance)

Using budgets for control
Flexible budgets
• Budgets can provide a useful basis for exercising control over a business.
• This is because control is usually seen as making events conform to a plan.
• Since the budget represents the plan, making events conform to it is the
obvious way to try to control the business.
• Taking steps to exercise control means finding out where and why things did
not go according to plan and seeking ways to put things right for the future.
• This may include revising the budgets for future periods as original targets
may have been unrealistic, or the business environment may have
dramatically changed since the budgets were prepared.
• Conventionally, budgetary control is handled by operational managers, but
control and authority for revising the budget remains with senior
management.

Standard quantities and costs
• A budget is a financial plan for a future period of
time.
• It is build up from standards.
• Standards are planned quantities and costs
(or revenues) for individual units of input or
output.
• The standards are the building blocks that are
used to build the budget.

Variances
• A variance is the difference in what was budgeted/planned compared to the
actual results
• Variance can be calculated for both costs and revenues.
• Variance analysis in managerial accounting is associated with the
outcome of the planned and actual results and the effects of their
differences.
• Useful in management and accounts and also in calculating labour and
materials costs.
• Variances are ‘uncovered’ when monitoring the budgeted and actual profit
levels produced in management accounting control processes.
• When the actual results are better than the expected results, the variance is
described as favourable. ie achieving higher sales volumes than planned, or
reducing expenditure.
• Variances can also be ‘adverse’ – ie producing lower sales volumes than
budgeted, or incurring higher levels of expenditure.
• Businesses will often experience both favourable and adverse variances in
their actual performance.

Types of variances
• Sales volume variance: lower or higher sales achieved
• Direct materials usage variance – more or less
materials used in the production of the unit or service
• Direct materials price variance – a change in price of
the materials used in production of the unit or service
• Direct labour variance (labour efficiency and labour
rate) – changes in the cost of labour or the amount of
human resource time taken to produce the unit or
service
• Fixed overhead spending variance – a change in the
fixed overhead price

Financial Projections
A ‘forecast’ of future revenues and
expenses for a business

Using Financial Projections
• Projected financial statements are valuable to a business manager
or owner when developing long-term strategic plans.
• When making such plans managers need to consider the financial
consequences to the business as a whole of pursuing a particular
course of action.
• Managers may be confronted with a number of possible options. It is
necessary to decide which gives the best return in relation to the
risks involved.
• Projected financial statements (also known as financial projections)
can be prepared for each option and used to assess the likely future
returns.
• On the basis of these statements an informed decision can be
made.

Consider Options
Identify Objectives
Evaluate options and make a selection
Prepare Budgets
Perform and collect information on actual performance
Respond to divergencies between plans and actuals and
exercise control
Revise plans (budgets) if necessary
Budgeting is used in decision-making, planning and control processes within a business
Third step in planning
is where
financial projections are used

Projected statements may be
prepared on the basis of:
• An optimistic view of
likely future events
• A pessimistic view of
likely future events
• A ‘most likely’ view of
future events

Evaluation of Projected
Statements
• How reliable are the projections?
• What underlying assumptions have been made and are they valid?
• Are the cash flows satisfactory? Can they be improved by changing policies
or plans
• Is there a need for additional financing? Is it feasible to obtain the amount
required?
• Can any surplus funds be profitably invested?
• Is the level of projected profit satisfactory in relation to the risks involved? If
not, what could be done to improve matters?
• Are the levels of sales and individual expense items satisfactory?
• Have all relevant expenses been included?
• Is the financial position at the end of the period acceptable?
• Is the level of gearing acceptable?

Sensitivity Analysis
“What if….?”

What is Sensitivity Analysis?
• Asks and answers the question ‘what if…?’
• What if sales were up 5%? What if we spent 10% more on
equipment? What if we increase the selling price by 4%?
• Useful when evaluating projected financial statements.
• Take a single variable (eg volume of sales) and examine
the effect of changes in the chosen variable in the likely
financial performance and position of the business.
• An assessment can then be made of the sensitivity of
financial performance and position to changes in that
variable.
• Only one variable is examined at a time, but a number of
variables considered to be important to the performance of
the business may be examined consecutively.

Capital Investment Decisions

The Nature of Investment Decisions
• Key feature of investment decisions is the time factor.
• Investment involves making an outlay of something of economic
value, usually cash, at one point in time which is expected to yield
economic benefits to the investor at some other point in time.
• Typically, the outlay precedes the benefits!
• The outlay is typically one large amount and the benefits arrive in a
stream over a fairly long period.
• Investment decisions are of crucial importance to the investor:
• Large amounts of resources are often involved – could be an costly
mistake if you get it wrong.
• It is often difficult and/or expensive to ‘bail out’ of an investment
once it has been undertaken.

Methods of Investment Appraisal
1. Accounting rate of return (ARR)
The accounting rate of return method takes the average accounting profit which the
investment will generate and expresses it as a percentage of the average investment in
the project as measured in accounting terms.
2. Payback period (PP)
The payback period is the length of time it takes for the initial investment to be repaid out
of the net cash inflows from the project.
3. Net present value (NPV)
The net present value method compares the sum of the present value of all expected
cash inflows with the present value of the expected cash outflows related to a given
project or investment opportunity.
4. Internal rate of return (IRR)
This method is closely related to the NPV method in that, like NPV, the internal rate of
return involves discounting (building in a percentage opportunity cost for not having the
investment money available) future cash flows.

Other considerations when evaluating an
investment proposal:
• Relevant costs – only consider costs relevant to the decision
• Opportunity costs – arising from benefits forgone must be taken
into account
• Taxation – profits will be taxed, the investment may attract tax relief
• Cash flows, not profit flows – focus on the cash, not the profit
• Interest payments – be careful not to double count these in
financial calculations
• Other factors – non financial issues, such as investing in a
complementary service or product, being first to market etc.

Avoiding insolvency
Insolvency is the inability of a
debtor to pay their debt

Insolvency
• A business becomes insolvent when it is unable
to pay its debts on time, or if it doesn’t have
sufficient assets to cover its debts.
• But business insolvency doesn’t happen
overnight.
• Keeping a close eye on your business’
performance and cash flow gives an early
warning of any impending problems, and time to
take action to avoid insolvency.

Improving cash flow
• Invoice customers - on time and regularly
• Chasing debts - don’t let late payments go unchallenged.
• Avoiding overtrading - don’t try to fulfill more orders than
the business has the resources and cash to cope with.
• Reducing any unnecessary stock.
• Renegotiating with suppliers - see if the business’s main
suppliers will agree to adjust credit limits and payment
dates.
• Looking at arrangements - such as Factoring and Invoice
Discounting - these pay a percentage of any
outstanding invoice in advance.
• Selling assets – business owners can sell under-used
assets and lease them instead.

Negotiate with creditors
• Never ignore creditors — if the debt is above a certain
level (can often be less than $2000) they can petition a
court to order a company into liquidation.
• If business owners are worried about the risk of business
insolvency they should talk to their creditors before
becoming insolvent, and try to renegotiate a payment
plan that they can realistically meet.
• Creditors who stand to lose their money if a business
folded are likely to be more willing to negotiate.

Reduce overheads
• If a business is having financial problems, a review of the overheads
to see where savings can be made is essential, but don’t make such
big cuts that the business has trouble operating. Possible cuts
include:
 Advertising costs and research/development costs can be reduced very
quickly.
 Staff costs — reducing overtime or staff hours (but be aware that
making redundancies will cost more in the short term and have serious
consequences on morale, so should be considered carefully).
 Investment costs — a short term measure; in the long term the business
owners are likely to need to invest in the growth of the business.
However, leasing rather than buying new equipment is an option.
 Premises costs — consider relocating to smaller premises or sub-
leasing part of the business premises.

Get professional advice
• When directors take timely advice on saving a failing
business, bankruptcy becomes a less likely option and
the chances of a successful business turnaround are
improved.
• Directors should not wait until the problems get out of
control and insolvency is inevitable.
• Directors should seek professional advice immediately if:
 They cannot cover company debts
 They cannot pay company staff
 They have a serious lack of working capital
 They receive a Court Order

Finance & Funding in Travel and Tourism - management accounting info

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