Questions:
1. An assessment of the traditional roles of the finance function?
2. An evaluation of the financial and non-financial challenges that have directly affected the finance function as a result of globalisation?
3. How the finance function has tried to adapt to the challenges in order to serve management better?
4. Working capital calculations and explanation for an organisation of your choice to illustrate how the finance function can support management?
Answers:
1. Traditional Roles of finance function-
The traditional role of the Finance Function was to maintain a proper track of all the money used in the financial operations. The financial operations include payment of salaries to the employees, maintaining the bills receivable from the debtors and bills payable to the creditors and the control of the capital structure. The finance function is used by the management to get more and detailed information in less time to exercise better control and consistency. The role of finance function to provide more and better information helps in better decision making (Atrill and McLaney, 2011). Better decision making is dependent on the financial performance of the institution for a certain period of time. The traditional role of finance function was to measure the cost function using traditional costing process using marginal costing and activity based costing. This helped the organization understand its cost incurred on various factors. But now the approach of finance function is dealing not just with cost measurement but also including value evaluation and ensures efficiency and control. The value evaluation approach includes focusing emphasis on products which yield more value, using those investments which gives more value and cancelling those which will not yield any additional values (Cochrane, 2013).
2. Evaluation of financial and non financial challenges that directly affected the finance function as a result of globalization-
- The financial challenges that affect the finance function are-
- A challenge in real estate market- The real estate market breakdown was the reason of the global economic crisis. The rise in the number of housing estate more than the number of probable buyers led to this crisis which eventually resulted in foreclosure of securities. So, just because real estate market is good in a particular region does not mean it will be the same everywhere (Gordon, 2015).
- The credit crunch challenge- Another challenge faced is the amount of debt taken by the consumers and corporate. Consumers who use credit card shopping may end up with huge debt; this may stop them from making any future purchase of goods. Small and medium sized industries often have huge loan taken from the bank which has a chance of default due to its size, whereas the corporate which are making good sales can also face financial crunch due to large amount of debt ridden on them (Hamilton and Wood, 2009).
- The risk of exploring new markets- Foreign banks entering new markets in the developing countries face the risk of maintaining low rates of interest due to the probability of price rise due to inflation (Hampton, 2011).
- The non-financial challenges that affect the finance function are-
- Environmental and social challenges- When a company enters a new market they face several problems due to various cultural and political difference. Also, the diversity of environment, issues of poverty and sustainability caused a threat to global market.
- Variability of exchange rates- In the global economy, the exchange rate of one country varies from another. Thus, organization trading in other countries may face slow business at higher interest rates due to frequent change in the exchange rate (Kimmel, Weygandt and Kieso, 2007).
3. Finance function adaptability to the challenges-
Finance function is known as the process of acquiring and using the funds to operate the financial operation of the business. It consists of managing the fund and carry out the financial and investment decisions. The financial decision is used to acquire and utilize the funds acquired from various areas. The investment decision uses the capital budgeting process and working capital management to determine the investment to be made in those assets which will incur more return. The finance function is directly affected by the financial and non financial challenges due to globalization. Globalization led to huge change in the global financial system. Countries are trading in the global market and entering new markets of the developing countries. But they face a multiple challenges while entering a new market (Merino, 2010).
They enter the real estate market with expectations with the increase in the price of the housing market, but after the global financial crisis which occurred due to fall in price of the real estate and defaulted mortgages, the investor should be cautious and maintain proper financial analysis regarding the local real estate market they are thinking to enter. Another problem that banks face is the large amount of debit taken by the consumers and their inability to repay that debit. This limits the purchasing power of the consumers which results in drop in revenue (Stittle and Wearing, 2008). So, it is necessary on the part of the company to have detailed information about their consumers before entering the market. Also, corporate with good sales structure has huge debt riding on their shoulder, this may slowdown the business process. So, the finance managers should check the financial reports and statements to measure the debt and control it for long term sustainability. The foreign banks exploring developing countries try to maintain stability in the new market. But the price of the products is likely to rise due to inflation, which makes it difficult for the bank to maintain a lower rate of interest. So, before entering an emerging economy it is better to analyze the economic condition of the country and it’s advisable to avoid those high risk markets (Powell and Ghauri, 2008).
The difference in financial environment like difference in beliefs, social practices and culture are some of the non financial challenges the financial function face which can be dealt with better analysis and adjusting to the local environment to ensure continuous growth of the business. The constant change of the foreign exchange rate may affect the companies investing in foreign lands, so it is necessary to study the foreign exchange condition (Small Business – Chron.com, 2015). It can be further understand with the use of planning, control, performance management and decision making. Planning is the setting up a plan to make use of the available resources and use it efficiently to reach its desired financial goals set for better financial operation. Once the goals are set and plans are made it is important to control the objectives and plans to see whether things are going as per the plan with making any changes if necessary (Preve and Sarria-Allende, 2010). Once the financial plans are controlled it is necessary to measure the performance of various financial operations like proper allocation of fund and utilizing the funds as per the various financial needs. Performance measurement is done using analysis of financial statements like balance sheet, income statement and cash flow statement. It is necessary to measure and understand the financial condition of the organization (Sagner, 2011). The various kind of decision made on the planning, control and performance management of finance functions are-
- Dividend decision- It helps the organization decide on its profit distribution process, i.e. how to distribute the profit in the form of dividend to shareholder and retain a part to increase market value.
- Investment decision- It helps the organization in deciding on its investment structure, i.e. to how to make new investment in assets which will garner more return and control the old and existing investments.
- Financial decision- It helps the organization in deciding hoe the organization will acquire capital from various sources to carry out its business. It can acquire capital from equity capital and debt capital.
The planning, controlling, performance management and decision making structure helps in better financial function (Sinnett and Ferling, 2007).
4. Working capital calculation and explanation of TESCO-
Current asset of TESCO PLC for the year 2014 is £ 13636 million and current liabilities of TESCO PLC for the year 2014 is £ 10720 million. So, the working capital for the year 2014 is-
Net Working Capital = Current asset – Current Liability
= £ 13636 – £ 10720 = £ 2916 million.
Current asset of TESCO PLC for the year 2013 is £ 12662 million and current liabilities of TESCO PLC for the year 2013 is £ 8547 million. So, the working capital for the year 2013 is-
Net Working Capital = £ 12662 – £ 8547 = £ 4115 million.
The net working capital of accompany is the difference between the current assets and current liabilities. The current asset is the type of asset which is liquid enough to be converted into cash within a short duration of time (one year). It includes cash, inventory, debtors and bills receivable (Thompson, 2009).
The current liability is obligations made to the supplier and the debt to be paid to the creditors within a short period of time (one year).
The higher the NWC higher is the availability of liquid assets with the organization. But, sometimes more working capital results to less availability of equity. This can be understood with the help of current ratio or working capital ratio (Bragg, 2007).
Current Ratio = Current Asset/ Current liability
The ideal ratio for current ratio is 2. So, more than 2 results in excess of liquid asset and more of unused inventory. But a low current ratio of 1 or less shows the firm’s poor liquidity structure. This shows that the firm may face problems in repaying its creditors and carrying out its day to day business.
Current Ratio of TESCO for 2014 = 13636 / 10720
= 1.07
Current Ratio of TESCO for 2013 = 12662 / 8547
= 1.48
The organization we have taken i.e. TESCO PLC, the net working capital for 2013 is £ 4115 million and for 2014 is £ $ 2916 million. The current ratio of TESCO PLC for 2014 was 1.27 and for 2013 was 1.48.
While making investment decisions in current assets the working capital management is required. It helps in understanding the liquidity structure of an organization. TESCO PLC, a multinational grocery and general goods selling industry which is based in England, UK. As per revenue it is the world’s third largest grocery outlet and as per profit, the second largest grocery outlet. So, from the annual report of 2014 of TESCO PLC we have calculated the net working capital and current ratio, both of which have declined from 2013. The NWC of £ 4115 million of 2013 decreased to NWC of £ 2916 million in 2014. This shows the fall in liquid assets which can be readily converted into cash in short span of time. The current ratio in 2013 is 1.48 which is much nearer to ideal ratio as compared to 1.27 in 2014. This shows that the availability of liquid funds has decreased. But, the cash and cash equivalent in 2013 was £ 4.98 million which has increased rapidly to £ 105.58 million which shows that despite a fall in NWC and current ratio, the cash structure of TESCO PLC has shown a good growth. Thus, the finance function helps in deciding the investment decisions in current assets effectively (Anon, 2015).
References
Anon, (2015). [online] Available at: http://www.tescoplc.com/files/pdf/reports/ar14/download_annual_report.pdf [Accessed 3 Apr. 2015].
Atrill, P. and McLaney, E. (2011). Financial accounting for decision makers. Harlow, England: Financial Times.
Bragg, S. (2007). Business ratios and formulas. Hoboken, N.J.: Wiley.
Cochrane, J. (2013). Finance. Cambridge, Mass.: National Bureau of Economic Research.
Gordon, J. (2015). Main Challenges of Global Financial Management. [online] Business & Entrepreneurship – azcentral.com. Available at: http://yourbusiness.azcentral.com/main-challenges-global-financial-management-28692.html# [Accessed 3 Apr. 2015].
Hamilton, S. and Wood, B. (2009). Globalization. Edina, Minn.: ABDO Pub. Co.
Hampton, J. (2011). The AMA handbook of financial risk management. New York: American Management Association.
Kimmel, P., Weygandt, J. and Kieso, D. (2007). Financial accounting. Hoboken, NJ: John Wiley.
Merino, N. (2010). Globalization. Detroit: Greenhaven Press.
Powell, S. and Ghauri, P. (2008). Globalization. London: Dorling Kindersley.
Preve, L. and Sarria-Allende, V. (2010). Working capital management. New York: Oxford University Press.
Sagner, J. (2011). Essentials of working capital management. Hoboken, N.J.: Wiley.
Sinnett, W. and Ferling, R. (2007). Building an agile finance function. Florham Park, N.J.: Financial Executives Research Foundation.
Small Business – Chron.com, (2015). Main Challenges of Global Financial Management. [online] Available at: http://smallbusiness.chron.com/main-challenges-global-financial-management-68317.html [Accessed 3 Apr. 2015].
Stittle, J. and Wearing, B. (2008). Financial accounting. Los Angeles: SAGE Publications.
Thompson, T. (2009). Benchmarking the finance function. Florham Park, NJ: Financial Executives Research Foundation.
