Accounting For Decision Making Essay Sample

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Accounting is known as the tongue of business. Formalization of data and numbers in such a manner so as to help to arrive at decision making and financial planning is the main object of accounting process. While book keeping is mainly concerned with organizing and keeping records, i.e. books of accounts but accounting is employed to examine the data of information. The main objective of this study is to make opinion or strategies based on trend or movements or assumptions.

Financial reports are generated from financial accounting records of an organisation. Financial accounting includes the arrangement and preparation of a business’s financial statements, chiefly for outside users of the business. Financial reports are utilized by owners, prospective owners of a business and creditors of organisations. Due to application of law, an organisation should have to submit financial statements to governmental agencies that regulate the business and stock markets if the company is a listed company.

Financial reports and statements are prepared in accordance with set of rules , procedure and standards for reporting financial information known as the “ Generally Accepted Accounting principles” (GAAP) , as established by the Financial Accounting Standard Board ( FASB). This standard stipulates that a company “account for all of their assets or economic resources according to their historical cost.” (Horngreen, Stratton & Sundem, p.6)

In addition to it, suppliers, shareholders, financial institutions and banks may also benefit from the financial reports of an organisation. (Horngreen, Stratton & Sundem, p.5)

Managerial reports are prepared from Managerial accounting statements. Managerial accounting assists managers to plan and manage an organization’s operations. Budgets are prepared to convey management’s goals in financial terms by measuring, identifying, analyzing, accumulating, communicating and interpreting accounting and financial information. Over a period, performance reports are prepared to evaluate the actual results with that of budgeted one. With the help of cost accountants, the management keeps watch of how much it costs a company to manufacture a product or to provide the service. (Horngreen, Stratton & Sundem, p.5)

Managerial accounting does not require complying with rules and procedures of the GAPP. An organisation can develop its own internal accounting system that will suit most to the needs of the company.

Managerial report is a devise for using a financial metric (dollars) as a normalizing mechanism for taking decision about different choices and alternatives. For instance, a managerial report helps you to come to a conclusion whether it is better to add 1000 customer account advocates in a call centre in UK, against staffing a user experience and technical writing department in California and investing in billions in intuitive products, Managerial reporting helps to take decisions and to do right thing.

The practice of financial analysis  germinate from the budgeting and accounting reports of an organisation and thus directs to generation of managerial reports that explain into the firm’s overall strategic decision making process. Hence the quality of the report at all level is more significant. The financial statement should reflect the true fiscal position of the organisation and it should not be an obscure. Financial and managerial reports should disclose a factual picture of the organization’s performance, making it to the outsiders and financial analyst to interpret financial results on their own.

  1. LITERATURE REVIEW:

This paper mainly investigates how the internal reports based on the financial performance of a company are useful in arriving at conclusion regarding financial health of a company and to take vital decisions to improve the financial health of an organisation. Further it studies the reasons for the faulty or misleading financial reports being practiced by certain organisation and how to identify such.  firms from their financial reports.

This paper has evaluates various journals and articles published on the subject and has applied the same for this research. This paper also deals with the failure of hospitals as forewarned by their financial ratios. This research also investigated how the business is using various management techniques for measuring its performance. This study also analyzed how financial ratios are helpful to gauge the strength or weakness of a business. The study also discusses the concept of downsizing the employees does not have any significant impact on its financial performance.

  1. MAKING MANAGEMENT DECISIONS THROUGH APPLICATION OF FINANCIAL DECISIONS:

In this chapter, let us view how financial analysis and reporting are processed and is being used as efficient financial tools. For all decisions made in an organisation must be based on prudent financial information and careful analysis. Can we open a new branch? How many hours per week can we afford to operate our factory?

How productive is our employees? How much money is being lost on workers idle time? How cost effective was the training intercession? Can we prolong our services at current costs?  To answer to all the above questions, a manager needs financial and managerial input mainly accounting data’s. ( Wertheim Paul,1993)

A prudent financial analysis may help to diagnose the deficiencies in other management areas like project or program management, human resource management, the availability and use of technology or the organization’s leadership. As a curative measure, a manager may have to review his organization’s management strategies, resources, structures, internal and external information needs and capabilities.

This broad view may help to enlighten manager’s perspective on how financial management contributes to one’s organisation. Thus this will induce the manager to suitably design or change the chart of accounts, reports, improve financial reforms and databases and train staff to efficiently employ financial information on continuous basis.

3.1. Deciding on Labour and Staffing patterns:

Employee cost will disclose the hours worked, cost of staff time and this will help the manager to analyse the labor, compensation issues and staffing matters. One can evaluate good financial data to study how overtime pay and leave pay accrual are influencing labor costs or employee cost of the organisation. This financial analysis can reveal which actions are most labour oriented which may guide you to restructure management processes and control the level of effort of employees of an organisation. (Hake, E. R., 2005).

3.2 Fixing fees for services and other fees:

Cost to provide a particular service can be derived from financial data’s of an organisation as this will help the management to take critical decisions like estimating prices for any products or services , developing budgets , bidding for new projects or business or planning in reduction of costs. If the cost per service of an organisation is arrived at, then it will be easy to take into other factors such so as to come to a decision how to offset these costs.

3.3 Determing the combination of services:

Cost per unit of production, cost per unit sold of different services and their cost effectiveness can be derived from financial data of an organisation and this can be utilized to decide to which services to provide, emphasize, promote or subdize. Further information’s like clientele, catchments’ population, service utilization and service volume are also needed for this purpose. By monitoring the services which are rarely used or often lose money, a manager can conclude how best to apply appropriate changes.

3.4 Estimating future supply costs and inventory:

From the financial data of an organisation we can infer the price fluctuations, consumption patterns, the costs of keeping supplies in stock which includes transportation, logistics, personnel and facilities management. A manager can use this information for taking decisions such as which supplier to select, which supplier has to be renegotiated, to purchase inventory on a seasonal basis so as to reap the benefit of price advantage through out the year. A manager has also to decide whether the costs of spoiled and expired stock need to be controlled or contained.

3.5 Analysis of Variance:

A variance analysis is an exhaustive assessment of disparity between actual and planned results. The main three part of variance analysis are assessment of the actual cost with that of budgeted cost (expenses), assessment of the intended quantity of an activity or procurement with the actual quantity and valuation of the actual output with the planned output. (Kohl beck, M., 2005).

3.6 Budget:

It can be explained as a detailed financial plan revealing expected future income and expenses. As an effective controlling tool, it helps to scrutinize current operating environments of an organisation. Immediate corrective action can be resorted by analyzing     and on reviewing and reacting variances between expected and actual expenses once variance is reported.

3.7 CASH FLOW STATEMENT:

It signifies how cash was engendered and how it was used up for the business purpose. It discloses the incoming  and outgoing of cash in an organisation and it reports various types like cash flow from financial activities, cash flow from operating activities and cash flow from investing activities. It is being deployed by financial managers to assess whether there will be sufficient cash on hand to meet expenditure requirements.

  1. RISK MANAGEMENT:

A prudent manager can manage the risky conditions by constant examining of financial status of his organisation. Certain happenings may bring potential impairment to the organisation.

For instance, a sudden increase in repair costs and sharp decline in sales revenue may leave the organisation without enough funds to provide services and fulfill objectives. A manager must review likely risk and to shun or control perilous situations like failure to meet quality, performance, budget objectives or quality. Financial data’s are the immense source in risk management process which will help to quantify the risks by resources type like inventory, employees, cash, facility or receivables.

Finance managers normally apply two techniques for handling risk mitigation and contingency planning. Risk alleviation guarantee strategies and procedures to control, prevent, or reduction of impact of the risk event if it transpires. For instance, if there is risk of fall in sales revenues, a mitigation technique would be to add more products or diversification of business so that the decline in sales of a particular product may not be detrimental. Like wise, a contingency plan would be to add up a reserve fund that could be used to supplement the fall in sales revenue due to competitors strategy or depression. (Kristy James E., 1994)

  1. PRUDENT MANAGEMENT DECISIONS FROM FINANCIAL DATAS:

One of the critical financial management aspects is to build good financial decisions. Since financial management influences all parts of management, it is better to recognize and realize the sound financial management and discover how to use sound financial information.

One of the best ways to compare the financial performance is to look into the competitor’s performance. For instance, a hospital may look into the hospital wide financial reporting which helps to understand how they have performed and to analyse the reasons for poor performance if any. Comparing the gross and net margin with the other hospitals will help to fix the loophole.

Further comparison of actual with that of budgets will also assist to know whether revenue and expenses are with in the budgeted range and if there is a variance, the reasons for the same. A hospital may keep a strict eye on its margins and various means to measure the level of profitability by having close watch on emergency department visits, inpatients admissions, surgeries, revenues from scan and x-rays and blood testing etc. This information will help a hospital to manage its cost either on monthly or periodical basis. Admission rates, costs and gross revenues may act as best performance indicators.

For example, if the number of outpatient department visits at a particular facility is trailing back, then CEO will talk to physician to know the reasons. Thus managerial report helps to take a decision for the discontinuance of a poorly performing product line.[1]

  1. Hospital Closure can be foretold by key financial Ratios:[2]

Bench Mark Data for hospitals are available with Maryland Health Services Commission for Rate Control (HSCRC), Health Care Investments Analyst (HCIA) and Market Insights, Inc, a data management company in USA. HSCRC supplies departmental operational data and financial data in the state of Maryland in USA.

These data includes labor and non-labor costs for every pediatric unit in the state, number of paid hours per day and in case of obstetrics, relative value of units employed for the procedures to provide relative hours and these data are proved to be very good bench mark and they even figure in the use of agency hours to the appropriate department. HCIA has released a list of top 100 hospitals in the U.S.A and this listing of best-practice hospital is a good place to commence in developing a peer group.

HCIA predicts that if all the hospitals could achieve the best-practice criteria, then $21.6 billion per year would be minimized from national health care cost and the mortality would diminish by 17% and there will be reduction of 14% in complication rate. This study feels that this is the chief advantage derived in achieving the best practice in an industry.

Selecting the benchmark peer hospitals is the primary step that needs the chief insight from the hospital executive team. Best practice hospitals may be chosen by the data management companies and this may be agreed for using the experience of hospital executives. As the medical performance differ by location, regionally nearer hospital should be selected which are identical in reputation, size, city, teaching affiliation and unionization. Local hospitals may be selected for the purpose of comparing the operations and cost of hospitals competing for the same patients.

Certain Ratio’s for liquidity, leverage capital efficiency and capital resource availability can forewarn closure of hospital up to two or three years in advance with an accuracy of nearly 75%.

This is evident from an analysis of various financial ratios from existing and closed hospitals in US.  However, the variables for capital efficiency, asset availability and leverage would still retain a high predictive accuracy though the liquidity measure may be on the decline. Timely discovery of decisive problems could prompt earlier or more aggressive development of tactical, financial and strategic courses of action for improving financial health. It is necessary to compare industry norms if one wants to measure how susceptible a given hospital is moving for a closure. Liquidity ratios may be on the decline continuously as hospitals continue to battle rising cost, fierce competition and declining reimbursement. 

Identifying which hospitals are most vulnerable to closure on the basis of precise financial indicators could be of great use to administrators and others involved in hospital financial performance.

71 hospitals that were closed in U.S between 1986 and 1987 were selected for this study. It was find out that closed hospitals had higher leverage (debt) ratios than the open hospitals and lower capital efficiency, asset availability and lower liquidity ratio. [3]

Standard & Poor has raised credit bench marks for the not-for-profit healthcare facilities seeking funding as the median of key financial indicators for 2005.  The key financial indicators for 2005 are as follows: cash on hand as 151 days for 2005, debt service coverage 34, days in accounts receivable as 57.4 days for 2005, and excess margin for 2005 as 4.1%

Once the peer group has been identified, perfection can be attained in a number of ways. A hospital may aim wide areas for enhancement such as operating cost, clinical utilization or mortality.

  1. CASH FLOW RATIOS CAN BE EMPLOYED TO FIND REASONS FOR BUSINESS FAILURES:

Cash flow information can be utilized to find out the success or failure of the business in advance as it has been evident from the previous empirical studies like Gentry, 1984, Bernard and Stober, 1989, Carslaw and Mills ,1991 , BarNiv 1990. Most of these studies have found that the level of cash inflows and outflows from various activities are highly interconnected and a failure of any part of the system to function may jeopardize or cause the entire firm to fail. (Glover, J. C., 2005)

The key ratios are [4]

Current ratio:                         2 to 1,

Quick ratio                             1 to 1

Liquidity ratio                         0.40 to 1

Equity / debt ratio                  1.65 to 1

Return on Equity                    14%

If you apply the above ratio and can find out the 80% of the financial health of any company.

For instance, if unusual increase in accounts receivable may lead to conclusion that accounts receivable are being managed very badly and may result in high bad debts. But if you have at closer look, you may find out that the company may have introduced a new product or a new market where such receivables are considered to be rational and the new product may elevate the company to soaring heights later or vice-versa.

Financial Ratio’s can foretell warning signs:

Companies in distress offer difficult analytical problems for analyst.

Financial problems like problem in meeting obligations like equity deficiencies, liquidity problems, funds shortage and debt default.

Operation Problems may result in prospective revenues may be doubtful, ability to operate in danger, consistent failure in operational success, inefficient management, poor control over business operations.

Special indicators like incurring operating losses , initiation of liquidity process , a waning allocation of product market , delaying payments to short term creditors , skipping of dividends , bond default and rating changes , Bank account excessively overdrawn , insufficiency of cash flows . (Barker, R., 2004).

The major disadvantages of the financial ratios include the timeliness of the financial statements, location within the trade cycle, the lack of consideration of the business sector and the overlook of accounting policies. The financial ratios are the best indicators for further examination and not to be construed as a means themselves.

  1. FINANCIAL PERFORMANCE AND EMPLOYEE DOWN SIZING:

Whenever there is financial crisis to a corporation, one of the advice given by the management consultant is to down size its employees so that there will considerable reduction in fixed expenses and helps to minimize the loss or maximize the margins. For example, of late international companies were in the news for their decision to down size its employee’s costs. Lucent Technologies , General Electric , Fujitsu , General motors , American Airlines , British Airways , Boeing were on the news as they have announced major lay offs . As per Bureau of Labor Statistics, sliming down activities in USA has crossed 2 million job cuts in both 2001 and 2002. (Mass Lay off Statistics, 2002). One of the major question haunts with the industry watchers is do the downsizing really produce any result?

No. This is the finding what Cascio had in his findings conducted in 1998. Cascio

Scrutinized about 300 companies in S& P 500 that downsized its employee forces between 1880 and 1990. His focus was to the following financial indices. 1) cost of goods sold 2) Return on Assets 3) profit margin 4) expenses to sales ratio 5) stock price. Cascio calculated the averages of financial performance for the 3 years prior to the declaration of layoff and 3 years after the down sizing. Surprisingly, the results revealed that none of those financial variables were noticeably influenced following the layoff. Finally, Cascio found out that “downsizing per se did not appear to lead to improved company financial performance, nor did it have a detrimental effect on company financial performance “(1998:69)

Thus Cascio’s finding clearly negativated the myth that down sizing always helps to improve the financial performance. Contrary to this, Cascio’s was able to expose with the help of financial data’s that no sea change in financial performance was witnessed in those companies that was opted for downsizing its employee force.[i]  [ii]

  1. CONCLUSION:

Thus, management and financial reports are both very key elements of the business world. Most of the companies have some form of each type of accounting knitted into their business operations. By adopting appropriate standards for each, the company will be able to successfully keep track of their financial standing for internal as well as external objectives.

Banks and financial institutions which have vested interest in borrowing firms should ascertain that the borrowers have to adopt policies regarding requiring customer to prepare the financial reports as per the guidance of Generally accepted accounting principles ,auditor rotation , necessary information on off balance sheet items .

Financial analyst should view corporate financial statements and pay special attention to accountant’s opinion letter, management discussion, and the notes to the statements and analysis on public companies and also consider the implications of management’s decisions relative to accounting policies.

A financial analyst should also review the company’s latest form 8-k, which is filed with SEC which records the occurrence of any material events or corporate changes of importance to investors or lenders like any disagreement the firm has had with the auditors, any of late changes in the constituent of audit firm.( Saatci, E,2004)

By diligent financial analysis, one can identify the accounting irregularities from the financial and managerial reports of an organisation and thus avoid doing business with the management of questionable integrity.

Likewise, benchmarking surveys and best practices reviews are beneficial tools for detection of problems, finding out ways to improve and signaling positive changes. Though benchmarking and best practices are modern tools for business improvement but they will not cure everything that is ailing a company.

Benchmarking and best practices initiatives are most triumphant when they are advanced with an open mind and the belief that they symbolize an education process.

HCIA predicts that if all the hospitals could achieve the best-practice criteria, then $21.6 billion per year would be minimized from national health care cost and the mortality would diminish by 17% and there will be reduction of 14% in complication rate. This study feels that this is the chief advantage derived in achieving the best practice in an industry.

71 hospitals that were closed in U.S between 1986 and 1987 were selected for this study. It was find out that closed hospitals had higher leverage (debt) ratios than the open hospitals and lower capital efficiency, asset availability and lower liquidity ratio.

Cash flow information can be utilized to find out the success or failure of the business in advance as it has been evident from the previous empirical studies like Gentry, 1984, Bernard and Stober, 1989, Carslaw and Mills ,1991 , BarNiv 1990

Thus the analysis of financial ratios can be helpful to detect the problem areas in advance. Companies in distress offer difficult analytical problems for analyst. Financial problems like problem in meeting obligations like equity deficiencies, liquidity problems, funds shortage and debt default.

Operation Problems may result in prospective revenues may be doubtful, ability to operate in danger, consistent failure in operational success, inefficient management, poor control over business operations.

Special indicators like incurring operating losses , initiation of liquidity process , a waning allocation of product market , delaying payments to short term creditors , skipping of dividends , bond default and rating changes , Bank account excessively overdrawn , insufficiency of cash flows .

Thus this study proves that the company’s managerial report and internal report are excellent tools for the measurement of efficacy and financial achievement and also a diagnostic tool to detect the perils in advance to undertake correctional measures. A company may overcome its negative factors by undertaking timely correctional methods through its managerial and financial ratios or else it has to remain as an old dog which never learns new tricks.

 

10. BIBILIOGRAPHY

[1] ‘Are you keeping an eye on your organization’s financial pulse? Healthcare financial Management, Dec 2005.

[2] Wertheim Paul, Key financial ratios can foretell hospital closures, Health Care Financial Management, Nov, 1993.

[3] Wertheim Paul, Key Financial Ratios can foretell hospital closures. Health Care Financial Management, November, 1993.

[4] Kristy James E., ‘Conquering financial ratios: the good, the bad and the who cares? –Business Credit, Feb, 1994.

[i] Thomas J. Bergmann, Kenneth P. De Meuse, Catherine E. Roraff,, Paul A. Vanderheiden -, (2004.) New Evidence regarding Organizational Downsizing and a Firm’s Financial Performance: A Long-Term Analysis. Contributors: journal of Managerial Issues. Volume: 16. Issue: 2. Publication Year: Page Number: 155+.

  1. Aier, J. K., Comprix, J., Gunlock, M. T., & Lee, D. (2005). The Financial Expertise of CFOs and Accounting Restatements. Accounting Horizons, 19(3), 123+.

  1. Bedard, J., Chtourou, S. M., & Courteau, L. (2004). The Effect of Audit Committee Expertise, Independence and Activity on Aggressive Earnings Management. Auditing: A Journal of Practice & Theory, 23(2), 13+.

  1. Betsch, T. & Haberstroh, S. (Eds.). (2004). The Routines of Decision Making. Mahwah, NJ: Lawrence Erlbaum Associates.

  1. Chou, R. Y. (2005). Forecasting Financial Volatilities with Extreme Values: The Conditional Autoregressive Range (CARR) Model. Journal of Money, Credit & Banking, 37(3), 561+.

  1. Cocheo, S. (2005). The Efficiency Ratio: How Good a Tool? ABA Banking Journal, 97(6), 10+.

  1. Collins-Dodd, C., Gordon, I. M., & Smart, C. (2004). Further Evidence on the Role of Gender in Financial Performance. Journal of Small Business Management, 42(4), 395+.

  1. Cookingham, V. P. (1989, November). Accounting: The Language of Business. Security Management, 33, 103+.

  1. Coulter, J. M., & Vogel, T. J. (2004). Pets.com, Inc.: Assessing Financial Performance and Risks in the E-Commerce Industry. Issues in Accounting Education, 19(4), 567+.

  1. De Meuse, K. P., Bergmann, T. J., Vanderheiden, P. A., & Roraff, C. E. (2004). New Evidence regarding Organizational Downsizing and a Firm’s Financial Performance: A Long-Term Analysis. Journal of Managerial Issues, 16(2), 155+.

  1. Hake, E. R. (2005). Financial Illusion: Accounting for Profits in an Enron World. Journal of Economic Issues, 39(3), 595+.

  1. Montgomery, H., Lipshitz, R., & Brehmer, B. (Eds.). (2005). How Professionals Make Decisions. Mahwah, NJ: Lawrence Erlbaum Associates

  1. Prowle, M., & Morgan, E. (2005). Financial Management and Control in Higher Education. New York: Routledge.

  1. Saatci, E. (2004). Integrating Financial Analysis into Presentations. Business Communication Quarterly, 67(3), 316+.

15.Horngreen C.T, Straton, W.O & Sundem, G.L, Introduction to Management accounting (12th ed,), Prentice Hall, New Jersey.

  1. Barker, R. (2004). Reporting Financial Performance. Accounting Horizons, 18(2), 157+.
  2. Glover, J. C., Ijiri, Y., Levine, C. B., & Liang, P. J. (2005). Separating Facts from Forecasts in Financial Statements. Accounting Horizons, 19(4), 267+.
  3. Kohl beck, M. (2005). Reporting Earnings at Summer Technology-A Capstone Case Involving Intermediate Accounting Topics. Issues in Accounting Education, 20(2), 195+.

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