Chapter 6 - The Finance Function and Finance Information

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CHAPTER 6

THE FINANCE FUNCTION


&
FINANCIAL
INFORMATION

201053_Chapter 6: The finance Function and Financial Information 1


TOPIC LIST

1. What does the finance function do? 9 Measuring performance


2 The structure of the finance 10 Measuring climate change,
function sustainability management &
natural capital
3 Managing the finance function
4 Uses and types of financial 11 Establishing financial control
information processes and internal controls

5 Users of financial information and


their information needs
6 Limitations of financial information
in meeting users’ needs
7 Information processing and
management
8 Information security
201053_Chapter 6: The finance Function and Financial Information 2
1. What does the finance function do?
Tasks of finance function

The Finance function is involved in 4 specific, but often interrelated, tasks.

Recording financial • Ensuring accurate records of revenue,


expenses, assets, liabilities and
transactions capital

Management • Information assisting decision-


accounting & making, performance measurement,
planning and control activities
control activities
• Provide information about business to
Financial reporting external users for decisions-making.
• Assessing management’s stewardship

Treasury • Managing funds, including: cash,


working capital items, long-term
management
3

investments, debt and equity finance


201053_Chapter 6: The finance Function and Financial Information
1. What does the finance function do?

Recording financial Management


transactions accounting
• Recording financial • Internal reporting for planning
transactions (payroll, credit and control
sales, credit purchase, etc) in • Determine the unit cost of the
the accounting records goods or services provided by the
business.
• Entering transaction • Forecasts and budgets
summaries in permanent
• Decision making information (e.g.
records (nominal, receivable for investment decisions – CVP,
and payable legers) breakeven, limiting factor
• Proper control of resources analysis)
(Stewardship) • Prepare performance measures
• Cloud accounting, machine • Analyze capital investment
learning, ledger automation, decisions
etc • Determine sales and transfer
4

price
1. What does the finance function do?

Financial reporting Treasury management


• Cash budget preparing and
• Financial statements for monitoring
external users
• Manage cash balances
• Tax reporting (surplus/deficit)
• Regulatory reporting • Manage working capital on daily
basis to optimize cash flow,
including inventory, receivables, and
payables
• Analyze short-term and long-term
financing decisions
• Manage investments
• Manage foreign exchange
• Manage financial risk
• Raise long-term finance

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1. What does the finance function do?
Business partnering
Involves the finance function working alongside other business
functions rather than being a separate function on their own.
 The finance function forms close relationship with the other
business functions →It’s often used as the source of financial
expertise for specific business areas:
 Marketing: insights into drivers of revenue, analysis of sale
volumes, etc.
 Operations/production: analysis of increase/decrease of
cost per unit
 IT: KPIs for IT performance: system downtime, IT
equipment’s age for new investments.
 HR: employees’ productivity
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 Procurement: suppliers’ performance against service


1. What does the finance function do?
Factors relating to effective business partnering

There is a risk that a finance business partner may get


too close to the business function managers, this thus
leads to a compromise of objectivity and
independence.

Insufficient time is allocated to business partnering


because:
✓ Lack of necessary knowledge, skills, and attitudes to
perform business partnering
✓ Resistance by operational managers

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2. The structure of finance function

Centralised finance function:


 Advantages
✓ Better cash management
✓ Easier external reporting
 Disadvantages
✓ Problem in providing local managers with information (internal
reporting)
✓ Global organizations may have difficulties dealing with
exchange rates and different time zones

201053_Ch7_The business's Financial Function. 8


2. The structure of finance function

9
3. Managing the finance function

Factors
influencin
g
structure

Managing
the
finance
function
Organising Planning
and and
leading control

201053_Ch7_The business's Financial Function. 10


3. Managing the finance function

Factors Planning and Organizing and


influencing control leading
finance function • Forecast what is • Defining
• The business’s needed processes,
structure • What are available technology,
resources people
• Organizational • Develop objectives,
structure plans, targets • Allocating and co-
• Markets ordinating work
• Implement plans and
• Technology performance • Generating effort
measuring and commitment
• History and in finance staff
• Making amendments
Ownership when necessary (Leading)
• Culture
201053_Ch7_The business's Financial Function. 11
4. Uses & types of financial information
The need for financial information
 Financial information: about an entity’s activities
expressed in monetary terms. Or according to IFRS,
financial information is contained in an entity’s
financial report, including income, expenses, assets,
liabilities, and equity.
 Businesses and managers require financial information
for:
✓ Planning
✓ Controlling
✓ Recording transactions
✓ Performance measurement
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✓ Decision making
4. Uses & types of financial information
The need for financial information
• Available resources
• Time-scales for implementation
Planning
• Possible outcomes under alternative
scenarios
• Assess whether implementation is
Controlling proceeding as planned for corrective
actions if needed

• Documentation of transactions or events as


evidence in case of dispute
Recording transactions • Legal requirement to record transactions, for
example for accounting or auditing purposes
• Better assessment of profitability

Performance • Comparisons of actual outcome with the


measurement plan

• Information is required as a basis to make


Decision making informed decisions 13

201053_Ch6_Introduction to Financial Information


4. Uses & types of financial information
Types of information

Planning • Planning
information

Operational • Day-to-day activities


information e.g. how many operatives are needed on 1 shift

Tactical • Short-term issues and


opportunities (monthly
information reports for factory)

Strategic • Major long-term decision


information making
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201053_Ch6_Introduction to Financial Information


5. Users and their needs of financial
information

What is financial information used for?

Generally, financial information is used to make


decisions, such as:
- Buy, hold, or sell an equity investment or a debt
instrument
- Provide or settle loans, or other forms of credit
- Influence management decisions

201053_Ch6_Introduction to Financial Information 15


5. Users and their needs of financial
information

Who uses financial information?


Sharehoders
Primary
Lenders and other
payables

Employees
Users

Customers

Suppliers and other


Others
partners

Governments

The public and


community
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201053_Ch6_Introduction to Financial Information


5. Users and their needs of financial
information
When is financial information useful?
 Financial information is useful when:
• Helps make decisions
• Show management’s stewardship (use of
resources)

 Basis for preparation (underlying assumptions):


• Accrual basis of accounting
• Going concern
201053_Ch6_Introduction to Financial Information 17
5. Users and their needs of financial
information
Information for making decisions and making managers
accountable
When making decisions, users need financial info to evaluate:
• The ability of a business to generate cash to pay wages, suppliers,
loan interests, and dividends.
• The timing and certainty of cash flows
The info helps users evaluate how efficiently and effectively the
entity’s management and board discharge their stewardship
responsibilities to use the entity’s resources. The users must
need info on the business’s:
• Financial position (assets & liabilities)
• Financial performance (profit & loss)
• Changes in financial position (cash flow)
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5. Users and their needs of financial
information
Information for making decisions and making managers accountable
Information on the financial position (assets & liabilities)
Factors affecting the business’s This is useful for predicting
financial position
Its economic resources Its ability to generate cash
Liabilities What the business owns to other
parties
Financial structure Future financing needs? Distributed
profit and cash among stakeholders?
Raising new equity and borrowing?
Liquidity Cash will be available in near future?
Solvency Availability of cash in long term to
meet financial commitments
Adaptability
201053_Ch6_Introduction to Financial Information Its capacity to adapt to changes
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5. Users and their needs of financial
information
Information for making decisions and making managers accountable
Information on the financial performance
The Info on a business’s profitability over time helps users
predict or assess:
- Potential changes in economic resources
- The business’s capacity to generate cash flows
- How effectively the business might employ additional
resources
Information on changes in financial position
The Info on a business’s past cash flow helps users predict or
assess its investing, financing, and operating activities:
- How able the business is generating cash
- How well the business uses cash that it has generated?
201053_Ch6_Introduction to Financial Information 20
5. Users and their needs of financial
information

Qualitative characteristics of financial statements

Relevance
Fundamental
Faithful
representation
Qualitative
Understandability
characteristics
Comparability
Enhancing
Verifiability

Timeliness
201053_Ch6_Introduction to Financial Information 21
5. Users and their needs of financial
information
Fundamental qualitative characteristics
A) The financial information is relevant if it has:
• Predictive value: can be used as input to processes employed by
users to predict future outcomes.
• Confirmatory value: correct or confirm past evaluation.
Relevance is affected by:
• Nature of items
• Materiality (importance)
B) The financial information has faithful representation
when it is:
• Complete: include all necessary descriptions and explanations
• Neutral: without bias in the selection of certain info 22

• Error free: no errors in the description or in the process used to


5. Users and their needs of financial information

Enhancing qualitative characteristics


 Understandability:
• Clear and concise
• Users are assumed to have reasonable knowledge
 Comparability
• Throughout the business
• Over time
• Across different business
 Verifiability
• Knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement
 Timeliness
• Provide information in time for decision making. 23
6. Limitations of financial information
• Standard format and presentation though
businesses are very diverse
Standardized and
• Many transactions are combined into few
aggregated figures only ➔ difficult to evaluate some
business’s components

• Covering historical period while most


Backward-looking users of financial info base their
decisions on future expectations.

• Contain financial, not non-financial info:


✓No narrative description of major operations
Omission of non- ✓No discussion of risks and opportunities
financial information ✓No business performance and prospects
✓No management policies of how the business
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is governed and controlled
201053_Ch6_Introduction to Financial Information
6. Limitations of financial information
Other sources of information
• Info on the internet and social media
• Internal management information
• Banks gain business info under the terms of loan
agreements
• Potential investors
• Suppliers get reports on the business’s credit
standing
• Some info such as brochures, publicity materials
• Brokers’ reports 25

201053_Ch6_Introduction to Financial Information


7. Information processing & management

How is data/information processed?

Information processing: Data, once collected, is


converted into information for communicating
more widely within the business.

201053_Ch6_Introduction to Financial Information 26


7. Information processing & management
How is data/information processed?
To be effective, information processing must meet CATIVA
- Completeness: includes everything needed to be processed
- Accuracy: data remains true, information contains no
errors
- Timeliness: should occur in line with data availability,
which means real time (instantaneously)
- Inalterability (unchangeability): no intervention, no
alteration
- Verifiability: capable of being followed through
- Assessability: quality can be judged since the effectiveness
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of processing should be open to scrutiny


7. Information processing & management
Information systems
Data are processed into information by the
business’s information systems
- System: a set of interacting components that operate together to
accomplish a purpose.
- Business system: people, machines, and methods are organized to
accomplish a set of specific functions.
- Information system (IS): systems, and procedures involved in: the
collection, storage, production, and distribution of information
- Information technology (IT): equipment used to capture, store,
transmit, or present info – IT provides a large part of the information
system infrastructure
- Information management: an approach towards the management 28 of
a business’s information.
201053_Ch6_Introduction to Financial Information
7. Information processing & management
Information systems

29

201053_Ch6_Introduction to Financial Information


7. Information processing & management
The transaction processing system (TPS)

 Transaction processing system (TPS): a system


that performs, records, and process routine
transactions
- TPS is used for routine tasks in which data
items and transactions must be processed so
that operations can continue.
- A TPS supports most business functions (see TPS
table in ebook)

201053_Ch6_Introduction to Financial Information 30


7. Information processing & management
Management information system (MIS)
 Management information system (MIS): a system
which converts data from internal sources into
information (usually in forms of reports), which
enables managers to make timely and effective
decisions.
 Management information system (MIS):
• Supports structured decisions
• Reports on existing operations
• Has little analytical capability
• Is relatively inflexible
• Has internal focus
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8. Information security
Why is information security important?

- Information is valuable and deserves care


- Security (in information management): the
protection of data from accidental or
deliberate threats, and the protection of the
information system from degradation or non-
availability of services

201053_Ch6_Introduction to Financial Information 32


8. Information security
Risks to data

- Human error - Natural disasters


- Entering incorrect - Deliberate action
transactions - Commercial espionage
- Failing to correct errors - Malicious damage
- Processing wrong files - Industrial action
- Technical error - Cyber risks like data
corruption, hacking, etc

201053_Ch6_Introduction to Financial Information 33


8. Information security
Ensuring the security of information

• Stop threats from happening,


Prevention prevention is better than cure

Detection • Notice or discover anything strange

• Deter people from doing something


Deterrence (make them less enthusiastic)

Recovery • Fixing the consequences of


procedures materialized threats

Correction • Deal with the vulnerability (build


procedures stricter controls)

Threat avoidance • Change the design of the system


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201053_Ch6_Introduction to Financial Information


8. Information security
Qualities of a secure information system - ACIANA
• Availability: info can be always available to be accessed
by authorized people
• Confidentiality: Info can not be accessed by anyone who
does not have the right to see it
• Integrity: data is as same as its sources, and has not been
accidentally or deliberately reduced, altered, destroyed,
or disclosed.
• Authenticity: being taken from bona fide sources
• Non-repudiation: not being rejected by intended users
because of faults in the system
• Authorisation: changes only by accountable persons
201053_Ch6_Introduction to Financial Information 35
8. Information security
PHYSICAL ACCESS CONTROL

- Personnel
- Door locks
- Intruder alarms
- Devices to be kept secure
- Staff to be allocated PIN (personal
identification number)

201053_Ch6_Introduction to Financial Information 36


8. Information security
Security controls in the systems
Helps to prevent:
➢ Human error
✓ Entering incorrect transactions
✓ Failing to correct errors
✓ Processing the wrong files
➢ Technical error such as malfunctioning hardware or software
➢ Deliberate actions such as fraud
➢ Commercial espionage
➢ Malicious damage

201053_Ch6_Introduction to Financial Information 37


8. Information security
Integrity controls in the system
Data will maintain its integrity if it is complete and not corrupted
- Input controls should ensure the accuracy, completeness, and validity of input.
- Data verification involves ensuring data entered matches source documents
- Data validation involves ensuring that data entered is not incomplete or
unreasonable.
- Processing control should ensure accuracy and completeness of processing.
- Output controls should include: error reports, exception reports, batch control, etc
- Back-up and archive: regular back-up, archive plans, disaster recovery plan
- Logical access system using passwords
- Personnel selection: key people should be carefully recruited.
- Segregation of duties: divisions of responsibilities into separate roles.
201053_Ch6_Introduction to Financial Information 38
9. Measuring performance
9.1. Types of performance measures

Performance
measures

Qualitative measures
Quantitative measures
(not expressed in
(expressed in numerical terms)
numerical terms)

Financial measures
(sales, profits, etc)

Non-financial measures
(number of items
produced, phone calls,
201053_Chapter 6: The finance Function and
etc) 39

Financial Information
9.1. Types of performance measures

Qualitative measures vs. Quantitative measures

✓ Quantitative measures: not just measuring numbers, but expressed in


numerical terms
✓ Qualitative measures: not expressed in numerical terms

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201053_Chapter 6: The finance Function and


Financial Information
9.2 Measuring profitability, activity,
productivity

Cost centers Number of Quantity of


(incurring cost) orders- a outputs in
Profit centers measure of relations to
(incurring cost marketing inputs
and revenue)
Profitability (Cost

Activity

Productivity
and revenue) effectiveness (efficiency of
Machine the use of
breakdowns- resources)
repair and
maintenance
function

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201053_Chapter 6: The finance Function and


Financial Information
Measuring profitability

Profit = Revenue - Costs

Relative terms (profit


Absolute terms: relative to revenue or
$10,000 capital):
Net margin on revenue (%),
Return On Equity (%)

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201053_Chapter 6: The finance Function and


Financial Information
9.3 Measuring resource use
 Resources include:
• Physical assets (buildings, machinery, etc)
• Competencies (what the business is good at
doing?)
• Intangible assets (license, corporate image,
brand, digital assets, etc)
• The way in which the business is structured
• Available knowledge

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201053_Chapter 6: The finance Function and


Financial Information
9.3 Measuring resource use
 Economy, effectiveness and efficiency:

• Reduction or containment of cost


Economy (measured against targets)

• Measure of achievement
Effectiveness referenced to objectives

• ‘being effective at minimum cost’


Efficiency => Efficiency is a combination of
effectiveness and economy
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201053_Chapter 6: The finance Function and


Financial Information
9.3 Measuring resource use
Assessment of whether objectives are being met

• What is output relative to


Productively input?

• How far are targets and


Effectively objectives achieved?

• What is the gain that the


Efficiently business has achieved?
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201053_Chapter 6: The finance Function and


Financial Information
9.4 Measuring critical success factors (CSFs)

Critical success factors (CFSs):


 Product features that are particularly valued by customers,
therefore, where the organization must excel to outperform the
competition. CSF differs from one area to another, such as:
- Price level
- Product quality
- Quality of delivery
 ➔ CSFs concern not only internal resources but also the
competitive environment

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201053_Chapter 6: The finance Function and


Financial Information
9.5 Identifying key performance indicator (KPI)

 Key Performance Indicator (KPI)


Once, CSFs have been identified, the business then must
identify its KPI in relation to them.
KPI: A measure of the level of performance in an area where
a target level (quantified target) must be achieved in order
for the business to outperform rivals and achieve
competitive advantages (examples)
 Benchmarking:
The establishment, through data gathering, of targets and
comparators, through whose use relative levels of
performance (and particularly areas of underperformance)
can be identified. By the adoption of identified best
practices it is hoped that performance will improve. (CIMA)
201053_Chapter 6: The finance Function and
47

Financial Information
9.6 Limitations of financial measures

Comparison Comparison
Information
problem: problem: different
problem businesses
trends
• Out-of-date • Effects of price • Selection of
information leads changes industry norms
to interpretation • Technology • Different financial
problems changes affect and business risk
• Historical cost asset values profiles
may not be • Changing • Different
appropriate environment accounting
• External users: no • Changes in policies
access to detailed accounting • Impacts of size of
information policies the business
• Only symptoms, • Problems in • Impact of
not causes establishing a different
‘normal base environments
year’ 48

201053_Chapter 6: The finance Function and


Financial Information
9.7 The balanced scorecard

Balanced scorecard: An integrated set of


performance measures linked to the achievement of
strategic objectives.

49

201053_Chapter 6: The finance Function and


Financial Information
9.7 The balanced scorecard

Answering the
Perspective Examples of measures
questions
Satisfaction ratings,
Customer retention rates, returns How do customers see us?
rates
Internal
Product quality, failure
business What must we excel at?
rates
processes
Employee retention rates,
Innovation and How can we continue to
time to market for new
learning improve and create value?
products
Gross margin, net margin,
return on capital employed How do we look to our
Financial
(ROCE), gearing, interest shareholders?
cover 50

201053_Chapter 6: The finance Function and


Financial Information
10. Measuring climate change, sustainability
management and natural capital

The triple bottom line (SEE) measures of a business


sustainability management:
- Social: health and safety, workers’ rights, pay and
benefits, diversity of quality, impacts of product use
(on society), etc
- Environmental: climate change, pollution, emissions
levels, waste, use of natural resources, impacts of
product use (on the environment), etc
- Economic: economic stability and growth, job
provision, local economic development, etc
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201053_Chapter 6: The finance Function and


Financial Information
10. Measuring climate change, sustainability
management and natural capital

Climate change: the main cause of climate change is an increase


in the volume of greenhouse gasses in the earth’s atmosphere
and this is caused by industrial activities.
A task force on Climate-related Financial Disclosure (TCFD) was
set up by the Financial Stability Board to develop
recommendations for more effective climate-related disclosures.
Disclosures are information that a company must provide in its
financial statements and other public information to ensure
users are given high-quality and reliable info needed about the
impacts the company have on climate change, the effect of
climate change on company, and the company’s response to it.
52

201053_Chapter 6: The finance Function and


Financial Information
10. Measuring climate change, sustainability
management and natural capital

4 core areas of the disclosure are recommended by TCFD as


follows:
✓ Governance: disclosures relating to the organization’s
governance around climate-related risks and opportunities
✓ Strategy: the impact of climate-related risks and
opportunities on the organization’s business strategy and
financial planning
✓ Risk management: how the organization identifies,
assesses, and manages climate-related risks
✓ Metrics and targets: to assess and manage relevant climate
relevant risks and opportunities
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201053_Chapter 6: The finance Function and


Financial Information
10. Measuring climate change, sustainability
management and natural capital

Sustainability management
IFAC ( the International Federation of Accountants)
states that the accountants’ involvement in
sustainability management is about improving
business decisions making in:
- Responding to uncertainty and risk
- Developing existing and new markets
- Innovating processes, products, and services
- Improving operational efficiency by way of
sustainable operations
- Engaging employees, customers, and suppliers
toward sustainability
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201053_Chapter 6: The finance Function and


Financial Information
GRI Sustainability Reporting Standards

Sustainability Reporting Standards issued by Global


Reporting Initiative (GRI) are about global, voluntary code
for corporate responsibility and sustainability reporting

A GRI-based report typically includes economic, social,


and environmental performance information, and sets
out the organization’s direct and direct impacts.

There are 03 “universal” standards (GR1, GR2 and GR3)


(check Ebook for more info)

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201053_Chapter 6: The finance Function and


Financial Information
Natural capital and Climate Disclosure
Standards Board
Natural Capital: Businesses can take into account how far they depend on natural
capital and how much they impact it so they can include natural capital in their
decision-making.

Climate Disclosure Standards Board (CDSB): publishes the CDSB framework for
reporting environmental and climate change information. Its aim is to ensure that
info about natural capital is given the same prominence as financial capital in a
company’s report. This enables the report’s users to not only appreciate financial
consideration, but also the impact of business on climate change and natural
capital.

International Sustainability Standards Board (ISSB) was set up by IFRS in 2021. Its
objective is to “deliver comprehensive global baseline of sustainability-related
disclosure standards that provide investors and other capital market participants
with info about company’s sustainability-related risks and opportunities.
201053_Chapter 6: The finance Function and Financial Information 56
11. Establishing financial control processes and
internal controls

 Internal control: A process, effected by an entity’s


board of directors, management and other personnel,
designed to provide reasonable assurance regarding
the achievement of objectives relating to operations,
reporting and compliance
 (COSO Internal Control – integrated Framework 2013)

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201053_Chapter 6: The finance Function and


Financial Information
Effective internal control (COSO)
Effective internal control consists of 5 integrated components to
provide an effective framework:

Control • Sets the tone of the business and the control


awareness of people.
environment
• Risk management via assessment,
Risk assessment measurement and control activities

• Actions established through policies and


Control activities procedures that help to mitigate risks

Information and • Information systems: produce reports


• Communication: ensures information flow
communication
• Detect deficiencies
Monitoring activities 58
• Take corrective action to improve the system
201053_Chapter 6: The finance Function and
Financial Information
Risk management and internal control (FRC)

 Risk management and internal control system: encompasses the


policies, culture, organization, behaviors, processes, systems, and
other aspects of the company.
 It helps:
✓ Assess and respond to risks and significant control failures; safeguard
assets (effective and efficient operation)
✓ Reduce the likelihood and impact of risks and errors
✓ Ensure quality of internal and external reporting
✓ Ensure compliance with applicable laws and regulations, and internal
policies
 Guidance on risk management, internal control and related financial
and business reporting
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201053_Chapter 6: The finance Function and


Financial Information
Who is responsible for internal control?

Board of directors Managers


• Policy-making: on an • Implementing the internal
effective system of internal control system
control • Day-to-day monitoring
• Reviewing: how effectively
the internal control system
address risks
• Reporting: on internal
control to shareholders

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201053_Chapter 6: The finance Function and


Financial Information
What constitutes a sound system of internal control?

 A sound internal control system includes:


- Nature and extent of risks
- Likelihood of the risks concerned materializing
- Ability to reduce the likelihood and impact of risks
- Exposure to risk before and after risks being managed
- Operation of the relevant controls and control processes
- Effectiveness of particular controls
- Impact of values and culture of the company

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201053_Chapter 6: The finance
Function and Financial Information
What constitutes a sound system of internal control?

 The system of internal control should:


- Be embedded in the operations and form part of the
culture
- Be capable of responding to evolving risks and changes in
the environment
- Include procedures for reporting any significant control
failings or weaknesses and details of correction actions

62

201053_Chapter 6: The finance Function and


Financial Information
 END OF CHAPTER 6

THANK YOU FOR YOUR


ATTENTION!

201053_Chapter 6: The finance Function and Financial Information 63

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