11.

4 – Monitoring and controlling

Monitoring and controlling is essential for maintaining business viability and thus requires
management to monitor internal and external factors that will impact financially on the business’
operations. This may include changes to economic outlook, internal production methods and
changes to workplace laws.

The main financial controls used for monitoring include:

- Cash flow statements

- Balance sheets
- Income statements

Cash flow statements

- The cash flow statement provides a link between the income statement and the balance
sheet

- It provides information about a firm’s ability to pay its debt on time.

- Creditors, lenders, owners and shareholders all use a cash flow statement to assess the
ability of the business to manage its cash and identify trends in cash flow over time.

Cash flows show whether a firm can:

A cash flow statement is a
 Generate a favourable cash flow
financial statement that
 Pays its financial commitments as they fall due
indicates the movement of
 Have sufficient funds for future expansion
cash receipts and cash
 Obtain finance from external sources, if needed.
payments resulting from
 Pay drawings to owners or dividends to shareholders.
transactions overtime.
Cash flow statements are split into three categories:

1. Operating activities

- Are the cash inflows and outflows, relating to the main activity of the business – that is the
provision of goods and services
- Income from sales cash and credit) make up the main operating inflow, whilst dividends
and interest received make up the outflow.
- Outflows consist of payments to employees and suppliers

2. Investing activities

- Cash inflows and cash outflows relating to the purchase and sale of non current assets and
investments.
- These assets and investments are used to generate income for the business
- Examples: selling of a motor vehicle; purchasing new equipment or property

3. Financing activities

- Cash inflows and outflows relating to the borrowing activities of the business
 - Borrowing inflows can relate to equity (capital contribution by owner) or debt (loans from
financial institutions)
- Cash outflows relate to the repayment of debt and cash drawings of the owner or the
payment of the dividends to shareholders

Income statements (statement of financial performance)

- The income statement shows the operating efficiency – that is, the income earned and
expenses incurred over the accounting period with the resultant profit or loss.

It shows:

 Operating income earned from the main function of the business, such as sales of
inventories.
 Operating expenses, such as purchase of inventories An income statement shows
 Analysis of the income statement can indicate whether the operating results for a
expenses are increasing, decreasing or remaining constant and period of time. It shows the
why profits have increased or decreased. revenue earned and
expenses incurred over the
accounting period with the
resultant profit or loss
Expenses are split into 3 categories:

1. Selling: These relate to the process of selling the good or service and can be directly
traced to the need for sales. They include: commission, salaries, wages, advertising,
delivery expenses, electricity and depreciation of shop fittings.
2. Administrative: Costs directly related to the general running of the business. They
include: Stationery, Office salaries, rent, rates, telephone, depreciation of buildings,
audit fees, accountant’s fee and insurances.
3. Financial: These costs are associated with borrowing money from outside people or
organisations and to minimising business risk. They include: interest payments, lease
payments, dividends and insurance payments.

Extraordinary Expenses: The one-off expenses or revenue a business pays or earns. For example:
More stock, after lost in a natural disaster.

Calculations/Formulas:
- Gross profit = (Operating income – COGS)
- Operating profit before tax (gross profit – expenses)
- Retained/net profit = gross profit – expenses
 A balance sheet represents
Balance sheet (statement of financial position) a business’s assets and
liabilities at a particular
- Balance sheet shows the financial stability of the business point in time, expressed in
money terms, and
- It shows the level of current and non-current assets, current represents the net worth of
and non-current liabilities, including investment and owners the business.
equity.

Analysis of the balance sheet can indicate whether:

- The business has enough assets to cover its debts

- The interest and money borrowed can be paid
- The assets of the business are being used to maximise profits
- The owners are making a good ROI
- Shows the ROI, sources and extent of borrowing, level of inventories

Figures show whether the business has sufficient assets to continue to make profits in the longer
term, how much of the assets are financed from outside borrowings, whether the business can
expect to meet its financial obligations in the short and longer term, and how the year’s figures
compare to the previous.

- Three main components include: assets; liabilities; owner equity

Assets are items of value
owned by the business.
Current assets can be turned
into cash within 12 months,
whereas non current assets
cannot be turned into cash
within 12 months
Liabilities are claims by people other than
the owner against the assets (items of
debt), and represent what is owed by the
business. Current liabilities must be repaid
within 12 months where as non-current
liabilities must be met sometime after
that period.
Owners’ equity represents
the owners’ financial interest
in the business or net worth of
the business. Also referred to
as ‘capital’.

Balance sheet – the accounting equation and

relationships

The accounting equation, which forms the basis

of the accounting process, shows the
relationship between assets, liabilities and
owners equity.

Assets = Liabilities +
Owners Equity
Owners’ equity = Assets –
Liabilities
Assets are what are owned by the business;
Liabilities
liabilities and =owners
Assets – is what is owed by
equity
the business.
Owners Equity
PROFIT = Revenue - Expenses