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Essay on Financial Discipline

December 24th, 2009 Leave a comment Go to comments

Financial Discipline is being disciplined in financial matters i.e., following the rules and regulations that are framed in business for its operations and instructions. Financial Discipline is being in the grid framed by the business rules.

In the same way finance builds or breaks the business. It is very necessary in every transaction and operations. Even to start or move or contact with other people money or finance is needed in every nook and corner of the business. That is the importance of finance in business.

And now importance of discipline. Discipline in narrow way looks to be the force drawing backwards but actually it is the one, which holds it firm, sustaining and survivable. It is just like a thread holding the kite down. When we see we feel that the thread is making it to be at down but actually it is the one which makes and makes it flying up in the sky with all the great swings. If the thread of the kite is strong then it can tackle all the swings and twists that would happen in the sky that is in the same way Financial Discipline holds the business in various turns and twists in its business run. Without the Financial Discipline business can’t run smoothly.

For ex:- we have made a decision or a rule to spend 1 crore in a business. But if we exceed it to 1.25 crores then it multiplies to a deficit of in crores with in few years which we will not be able to fill up. That is the reason Financial Discipline is very necessary. When we make a decision or rule to spend some money our stipulated expenditure shouldn’t exceed that decided money.

But another point need to be mentioned here is flexibility in Financial Discipline. Financial Discipline doesn’t mean being very rigid in its rules. A little of flexibility in nature is ever welcome because situations environment are not ever controllable and in our hands it so a little of deviations from the rules already fixed for the new situation or circumstances arrived is not harmful.

With the advent of concept of Financial Discipline the new role or position has become very vital in the modern business. That is CFO-chief financial officer. He has to deal with all the financial matters of the company. With regards to what is the need of finance in the business, where it needs more and more capital, how to generate that finances and use that finance in an effective way. In the area of management reporting, what CFO doesn’t want a firm handle on revenue, P&L, and balance sheet impacts and key performance metrics in real-time, not just at quarter end! But few finance groups has it. Then there’s Microsoft, one of the pioneers, which is well on its way to transforming reporting from a static, scheduled event to one of rapid information access. This lively session unveils the key building block, the Finance Dashboard, and demonstrates how it enhances the visibility and responsiveness of the finance organization.

Under increased scrutiny from investors, employees, and business partners, CFOs are now reassessing critical management processes to control costs, increase value, and improve performance. This session provides clear insights into how best practices can be used to effectively manage risk while also preparing the ground for growth. Learn the benefits of aligning management processes with shareowner interests, combining low cost with effective control, recognizing early warnings of potential problems and opportunities, and effectively measuring ROI on technology investments.

In today’s tight market conditions, when the CFO must allocate resources only to the most promising opportunities for growth, it can make sense to invest in technology that digitizes processes so that front-line decision-makers know the profitability of their customers, products, channels, and facilities in real-time. This session will demonstrate how to take action to improve the underlying drivers of profitability and increase earnings even in a quarter when revenue is flat.

For a business there are a lot many areas where Financial Discipline need to be kept under practice as a part and parcel of the business. They are:
1. Investment management
2. Working capital management
3. Budgetary control
4. Cost control
5. Auditing
6. Corporate tax planning
7. Financial ratioes

First let us start with Investment management. There is a saying with regards to investment management. That is “In investing your money, the amount of interest you want should depend on whether you want to eat well or sleep well.”

The investment objectives are like:
1. Safety- the safety of the principal amount is most important concern. It rules out investments in phony companies and their “khazana” schemes.
2. Liquidity- the second objective is to have liquidity at short notice. If you cannot sell the investment or there is no facility for loan or premature withdrawal, it is not liquid.
A bank deposit is an extremely liquid investment. You can
terminate a fixed deposit even prematurely. You can raise a loan on fixed deposit. But, on the other hand, land and buildings are not liquid investment.
3. Regular returns- the third objective is to generate regular returns by way of interest or dividends. If any special tax advantages are available, it is all the more welcome.
4. Capital appreciation- the fourth objective is to ensure that there is adequate capital appreciation, particularly during the times of inflation. Otherwise, the purchasing power of your money is not protected. The real value of your money should not be allowed to go down.
5. Ability to take risk- the investment program should take into account the risk preferences of the investor concerned. The ability and willingness to take risks in turn decide the risk preference.

Over and above all these factors personal and tax factors need to be kept in mind to have a better investment management.

Second and most important is working capital management. First let us study about the factors influencing the working capital needs. They are:

1. The nature of business: some businesses are relatively more working capital-oriented whereas some are not. Examples: units which use expensive raw materials like special steel, high-value chemicals, petro-products, etc. Some businesses have fluctuating needs for working capital due to seasonality of their operations, e.g. agro-based industries like sugar, cotton-gaining, expeller units, solvent extraction units, etc. Thus the nature of business is a major determinant of the quantum of working capital needed.

2. Manufacturing process, technology and facilities: Working capital needs are also influenced by the manufacturing process, technology and the plant facilities available. If the manufacturing process involves a long production cycle- sometimes extending tyo 12 to 18 months or even more- the working capital needed will be quite high. Examples: ship-building industries, construction industry, heavy engineering and machine tools units.

3. Competitive forces: the forces of competion among the suppliers of goods and services, suppliers of stores and spares, packing materials, etc.-will offer favourable terms to you if there is competition among them.

4. Infrastructure: the abysmal economic and physical infrastructure in India also effects the working capital needs adversely by prolonging the operating cycles.
Transport: Poor facilities at ports; Inefficient air cargo service; Thefts and other malpractice, particularly in the railways and the Bombay docks.
Communications: Inefficient postal services; Hot lines are down most of the time; Difficulty in making telephone calls to factories located away from metros.

The very most important aspect of working capital is cash management. Cash is held in business for three major reasons: To meet current needs such as payments of suppliers bills, dividend payment, tax payment, payment of wages, etc. To gain short-term profits by making investments in short-term securities if there is a temporary cash surplus. To seize any opportunities which may unexpectedly come up. Once in a while, for example, the raw material process may suddenly go down, owing to changes in government policies or supply-demand position, etc.

Cash is something with which every manager wants to play safe.

The normal attitude of managers is to act in a very cautious manner when planning their cash needs. In this process they tend to ask for more cash than may require under normal circumstances. All contingencies, such as a strike or major national transport bottlenecks and a severe demand recession, do not generally take place all at the same time. The cash forecasts submitted by the branch managers should be carefully reviewed with a view to eliminating any unnecessary reserves meant for meeting contingencies which may, typically, not happen under ordinary circumstances.

In addition, it is necessary to install and monitor a system of cash forecasting. Past experience is an invaluable guide in understanding certain patterns of cash receipts and cash payments. Wherever possible income and expenditure should be matched, so those peaks in payments do not precede but follow peaks in receipts. The time lag for collection and banking of cheques may be minimized by requesting customers to directly deposit the cheques in various branches of the company’s bankers, if the company’s operations are spread widely. Management should continuously explore opportunities for short-term investments of surplus money since temporary surplus is unavoidable in any business. The call money market can perhaps provide such opportunities.

The suggestions regarding the better working capital management are as follows:
1. Adequate provisions for working capital in the original project cost: without necessary working capital, your entire investment in plant and machinery may come to naught. Do not allow the unit to suffer for want of working capital. Do not over provide or under provide. Provide adequate quantum of working capital to keep the plant running at optimal levels.

2. Negotiating skills: working capital management involves a lot of negotiating skills in order to get the best terms from your bankers, your suppliers and your customers. Negotiating skills can be developed in a systematic manner to enable you to negotiate the best possible price and the most favorable credit terms.

3. Relationships: working capital management has perhaps more to do with relationships than with money. If you have good relationships with all the concerned parties, you can manage your working capital better.
With suppliers:- your creditability with your suppliers is of utmost importance. You have to honour your commitments on time. personal rapport also goes a long way in developing good business relationships.

With buyers:- you must maintain good personal contacts with your buyers. This will help you in getting your money promptly.

Think of filling cases for collection of debts. Instead, persuade, cajole, and coax. Avoid litigation at all costs. Given the Indian legal process you will only make your lawyer rich and your debtor defiant.

4. Monitoring: Working capital management is an area, which requires continuous monitoring. If you shackle your efforts, things can immediately go wrong. Inventories can accumulate, debtors mount up, bank account become irregular and you may run out of cash. You cannot afford to lose your grip. Constant monitoring is the key word. Keep at it. Day in and day out.

Role in the working of the business thus a great care needs to be taken in case of working capital management. So CFO should be very careful in managing the working capital of the org as it has got a direct effect on the administration and working of the day to day in organization.

The important aspect of the Financial Discipline is Budgetary control. Budgetary control is an effective tool with which we can maintain the Financial Discipline in the organization. Budget is financial decision with regards to the expenditure and incomes in the particular year. An organization is supposed to work with the figures that are fixed in the budgets for that particular year. There are some managers who seem to think, “ the budget is an annual game to be carefully played with the accountants, and to be completely forgotten once the figures have been agreed upon”. There are several organizations where “ the budget is conceived as advice strictly for the use by boss in holding people’s feet to the fire”. The purpose of effective budgetary control is not fully served in either of these situations.

Budgetary control is a powerful system, which should be tactfully used to infuse dynamism, not suffocation, into an organization. It can be successfully developed, installed, and implemented only if all the concerned mangers actively participate in the preparation of meaningful budgets.

Need for budgeting:- budgeting is an alternative to groping in the dark, managers who dislike budgets, are those who to loll after they leap. The companies, which do not have budgetary control, may survive by accident, like ships without compass, It is true that companies were making profits before the arrival of all the chartered financial analysts, chartered accountants, M.B.A’s, industrial engineers, and others. But the fact is that times are changing fast; and risks and uncertainties are increasing day by day. Gone are the days when a company in Pune could produce scooters and sell them to the customers on the waiting list. Nowadays, no company, however big or small, can afford to walk blindfolded, if it is genuinely interested in survival and growth.

Budgetary control compels the management to translate its intentions into quantitaive and monetary objectives. In the absence of a sound system of budgeting, the Managing Director may hope to increase the profit after tax by 10% in 1991, whereas it may, in fact, come down by 5% as a result of certain built-in constraints, which could have been easily revealed by a good system of budgetary control. The best way to realize the full potential and sort out the problems is to fit them into a budge. Inherent strengths come out, as hidden problems surface. A sound budget is a bridge to fill the gap between ambition and achievement of the management.

Finally, the budget is today’s commitment for tomorrow’s action. Since every organization exists today to fulfil tomorrow’s commitment, it is necessary to commit its resources- men, material, money, machines, and methods- today, and not at a future date. If there is no budge, there is no systematic commitment of these resources to produce the desired result to fulfil tomorrow’s obligations of the company. It becomes difficult, futile, and too late to assign responsibility for unsatisfactory future performance, if there is no agreed budget today.
Features of budgetary control system: Future oriented: Budgets are prepared for a defined future period. A good budget has to be developed with the help of past, present and future trends in sales, costs and profits. However, it should be remembered that a budget should not become a mere mathematical or statistical exercise. It should essentially be management exercise, wherein business experience must have precedence over financial algebra. Integration with the corporate plan: budgets should be backed by well-defined corporate policies. Budgetary control should become an integral part of the overall corporate plan of company, a budget which is integrated with a corporate plan for five years and then carve out the operational budget from the first year of the corporate plan, this practice should be continued, year after year. Key-factor analysis: a key factor in business is that one important aspect ;which constrains the activity of the company as a whole. The key factor in many businesses tends to be the level of demand and sales.

A budget should evolve around the key factors in a particular business, every business has a set of key factors, which limit the level of activities. These key factors should be correctly identified and diagnosed. Budgets will be meaningful only when the key factors are considered in depth. If sales level is the key factor, first of all the sales budget should be prepared; and then only the other budgets. If, on the other hand, plant capacity is the key factor, the production budget should be prepared first.

Another important aspect of Financial Discipline is Cost control. If we want to increase our profits there are two ways, one is to increase sales and other is reducing the expenses or costs. That is what we are going to study now i.e., effective cost control systems.

Many companies hire the best available consultants to install a scientific system of cost control. In government many committees are appointed to suggest ways and means of cost control. However, we find that in actual practice these cost control programs often fail hopelessly – not because the system of cost control is badly designed. Although the reasons for the failure of such cost control programs may be many, we are identifying the more important ones so that necessary remedial actions can be taken.

Failure to integrate the technical system with the social system: Management tend to perceive cost control schemes merely as technical systems. After all, the success of this technical system depends largely upon the help and co – operation coming from the social system in the organization, namely the people. Effective human participation is essential to implement any cost control program successfully, if the willing cooperation of the people, on whom the cost control system is “imposed”, is not forthcoming, even the best cost control system designed and installed by the best consultant is bound to fail.

Failure to motivate people to reduce costs: real and substantial savings from reduction in costs can come not when people are threatened with punishments, but when they are motivated by incentives, promotions, and increments. Highly motivated people can go on their own, searching for avenues to reduce costs,. Those who are not motivated always offer a hundred and one excuses as to why costs are already at and irreducible level. The best way to tackle such, as situation is not to issue threats, but to motivate them for higher productivity. Threats can yield only temporary results.

Failure to specify cost control objectives clearly and look at the organization as whole: without specific objectives, performance cannot be measure; without clear goals there is nothing to strive for. The objectives and goals should be realistic and flexible to change when conditions change.

Employees should be permitted to participate in setting up the objectives. Display of performance measurement motivates the employees towards greater cost control. You should look at the total organization in any meaningful effort at cost control. Otherwise, there is danger of costs being pushed from one department to another. For example, cost control on purchases may lead to buying inferior quality material that will lead to more manufacturing time and higher wastage in processing.

Failure to overcome employees’ resistance: people always resist change; but they may not resist it if the change is for the better changes work best when employees have a part in planning them. When it is not possible to share the decision making, resistance can be reduced by convincing the employees about the likely benefits arising out of the changes. Full information about the proposed changes can reduce fear and resistance.

Cost control is not just an advanced financial technique, it is a delicate human relations exercise, the success of cost control lies not in calculating detailed variances and preparing upto date reports alone. It lies in developing standards for which the people in the organization will have acceptable to all concerned, the remaining part of the exercise, namely the variance analysis is purely mechanical, the managerial part comes once again at the time of fallow – up action. How many times have you pulled up people for mediocre and poor performance? How many times have you sincerely appreciated it when your subordinate has done a good job? Have you at least cared to pat him on the back? The real key to success is here – not in your techniques alone.

Failure to set priorities for cost control: priorities are not properly recognized. First things should come first. If we are making great efforts to save the cost of pencils when there is soaring too – breakage cost, we are, in fact, fooling ourselves. A Company must make an ABC analysis for implementing cost control programs. Always remember the Pareto’s principle also known as 80/20 rule): 80 percent of the activities contribute to 20 percent of the results. It is the balance of 20 percent of the activities, which contribute to 80 percent of the results. The principle applies well in cost control plans also.

Failure to have a continuous program: efforts to control costs must be continuous. A planned and continuous attack on costs achieves better results than an annual crash program to control costs, annual crash plans can o9nly create an adverse impact on emplyeee morale and yield extremely temporary results.

In the words of Peter Drucker, the annual cost reduction drive is as predictable in most businesses as a head cold in spring . It is about as enjoyable, but six months later costs are back where they were and the business braces itself for the next cost reduction drive.

Failure to focus on quality improvement: several companies have realized that the primary source of cost reduction lies in quality improvement. If your costs will drop dramatically through improved customer satisfaction and reduced after – sales service problems. Absolutely zero defects. 100 percent satisfaction.

The success of Japanese companies in consumer electronics, passenger cars, domestic appliances, office equipment, photo cameras, etc., lies in quality improvement. They produce the best quality, obviously at the lowest cost; the customer is just looking for the “Made in Japan” label. He wouldn’t question the price.

The moral of the Japanese success is focus on quality, better quality and best quality. Your costs will drop and profits will rise.

Another important aspect Financial Discipline is corporate tax planning. It is quite essential activity to be taken up by the corporate society people.

Paying tax is not a natural instinct like eating or sleeping. Unlike the land tax, which has been there since time immemorial, income tax is relatively quite young, less than a hundred years old. Hence if mankind is still not very used to paying income tax, its unfamiliarity is, perhaps, more to be blamed.

Since its inception, the income tax act has been amended thousands of times and rendered one of the most incomprehensible legislation man has to deal with. Totally confusing tax legislation administered by corrupt system provides the ideal breeding ground for tax evaders and tax evaders.

Tax planning is often confused with tax evasion and tax avoidance. At the outset let us be clear about three different methods of saving on taxes:
Tax evasion is illegal. Tax is saved by suppressing the income and by increasing the expenditure and reporting lower profits.
Tax avoidance is a method whereby loopholes in the tax laws are exploited to the advantage of the assesses.
Under section 88 HHC, 100% tax exemption is available of income from exports.
Tax planning is a perfectly legal method, both in spirit and letter. The financial activities of the assesses are so organized that the maximum possible tax incentives and benefits are availed of.
The first method, namely tax evasion, is unquestionably deplorable and deserves to be condemned.

But there is a considerable controversy about the second method; namely, tax avoidance. Even judicial opinion is sharply divided on this issue. However, it is being realized, by and large, that exploiting legal loopholes is not an act of good citizenship.
The third method is quite legitimate and deserves to be studied. There are two basic assumptions of legitimate and honourable tax planning:
All the relevant facts are made known clearly to the tax authorities; no material information is deliberately concealed with an intention to defraud; and
?There are no false transactions or make – believe devices in order to circumvent the legal provisions.

Form of organization: the rate of tax payable depends upon the form of business organization – whether it is a widely – held company or a closely- held company. A widely – held company pays tax at a lower rate. To become a widely – held company, the shares of the company should be offered to the public and listed on a stock exchange.

Capital structure: interest payable on debt is tax deductible expenditure, whereas dividend on equity is not. Hence, the proportion of debt and equity in a given capital structure has an impact on the average cost of capital. A higher debt component results in lower average cost of capital for profit – making and tax – paying company.

New business: when a new business is set up(whether by a new company or by an existing company), several tax – related benefits are available – like additional depreciation on new equipment, investment allowance, partial tax exemption of profits from new business under certain circumstances etc.

Takeover of sick units: when a healthy and profit making unit takes over a sick unit with accumulated losses, the losses of the sick unit can be ser – off against the profits of the profit – making unit. Thus, the profits of the healthy unit get tax – sheltered.
Research and development: the R&D expenditure incurred for in – house facilities, or outside the company are permitted as deduction. There is a prescribed procedure to get in-house R&D centre approved for this purpose.

Investment of surplus funds: incorporate dividends are 100 percent exempt from tax(under certain conditions). If surplus funds are invested in 9 percent tax free bonds issued by public sector undertakings, the effective yield (taking tax exemption into account) goes up tp 15 percent. Many cash – rich companies are using the of UTI as a tax- planning device.

The other important aspect to Financial Discipline is Auditing. Auditing is a process of checking the accounting records for acccuracy of the records. This is compulsory for limited companies whether it is private limited company or public limited company.

These audits which are compulsory for public companies under the Companies Act consist of the annual audit of the accounting records as an assurance to the shareholders that they have been properly prepared and reflect the correct position. In a sense these audits assist the overall controlling by providing a check the accuracy of the records. Thus this control is provided in the form of an independent auditor examining the company’s financial statements, particularly the Profit and loss account and Balance sheet. A good auditor can in the course of his audit work develop useful suggestions on business matters generally as well as with regard to improving the effectiveness of policies, procedures and controls, particularly in the light of his experiences with so many other companies.

Internal auditing is another control tool available to management for Financial Discipline. In the narrow sense, internal auditing refers to the checks provided by the organization’s own people, or a staff of internal auditors, on the accounting policies, procedures and controls adopted by the organization. It is different from the normal outside auditing performed by external auditors who perform post audits. Although the expression is often limited to the auditing of accounts, it is better considered from a managerial angle as a tool for checking and controlling and operations generally. The internal auditors should not only confine themselves to appraising whether the accounts are accurately kept to reflect the facts, but should also appraise policies and procedures of management with regard to the quality of management, the use of managerial authority as well as whether controls are adequate and effective.

The main objective of the internal auditing function is to assist management’s day – to – day follow – up and control made so necessary through decentralization or delegation of authority and responsibility. However, it cannot be substitute for a discharge of managerial responsibilities, as supervisors at all levels cannot abdicate their own responsibilities of follow – up and control. In this sense, internal audit should be viewed as an organized approach for supplementing the day – to – day supervision by line supervisors.

Profit and loss account analysis is quite popular for measuring the overall performance as it indicates the gross income, the deductions and the final net income. As figures of the previous year can also be indicated, the trend in the different items could highlight the deviations. Theses could then be studied for evolving the remedial measures, where necessary. In the same way, comparitive balance sheets can be used for controlling overall performance.

A better technique than comparing absolute figures for gauging the efficiency of the company’s operations over a period of years with regard to its own performance or on an inter – firm comparison basis, would be to convert the accounting information into the form of ratios or percentages. Ratio analysis is a method of presenting and analyzing in arithmetical terms the relationship between figures as the ratio gives the numerical relationship between two numbers. Often it is more useful to convert the ratio into a –percentage by expressing the relationship in hundreds. Ratios “discreminately calculated and wisely interpreted can be useful tools of analysis”.

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