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1 Student Workbook BSBFIM501 Manage budgets and financial plans 1 st Edition 2015 Part of a suite of support materials for the BSB Business Services Training Package

2 Copyright and Trade Mark statement 2015 Innovation and Business Industry Skills Council Ltd All rights reserved. Apart from any use permitted under the Copyright Act 1968, no part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, or otherwise, without written permission from the publisher, Innovation and Business Industry Skills Council Ltd ( IBSA ). Use of this work for purposes other than those indicated above requires the prior written permission of IBSA. Requests should be addressed to Product Development Manager, IBSA, Level 11, 176 Wellington Pde, East Melbourne VIC 3002 or Innovation and Business Skills Australia, IBSA and the IBSA logo are trademarks of IBSA. Disclaimer Care has been taken in the preparation of the material in this document; however, to the extent permitted by law, IBSA and the original developer do not warrant that any licensing or registration requirements specified in this document are either complete or up to date for your State or Territory or that the information contained in this document is error free or fit for any particular purpose. To the extent permitted by law, IBSA and the original developer do not accept any liability for any damage or loss (including loss of profits, loss of revenue, indirect and consequential loss) incurred by any person as a result of relying on the information contained in this document. The information is provided on the basis that all persons accessing the information contained in this document undertake responsibility for assessing the relevance and accuracy of its content. If this information appears online, no responsibility is taken for any information or services which may appear on any linked websites, or other linked information sources, that are not controlled by IBSA. Use of versions of this document made available online or in other electronic formats is subject to the applicable terms of use. To the extent permitted by law, all implied terms are excluded from the arrangement under which this document is purchased from IBSA, and, if any term or condition that cannot lawfully be excluded is implied by law into, or deemed to apply to, that arrangement, then the liability of IBSA, and the purchaser s sole remedy, for a breach of the term or condition is limited, at IBSA s option, to any one of the following, as applicable: (a) if the breach relates to goods: (i) repairing; (ii) replacing; or (iii) paying the cost of repairing or replacing, the goods; or (b) if the breach relates to services: (i) resupplying; or (ii) paying the cost of resupplying, the services. Published by: Innovation and Business Industry 1 st edition published: April 2015 Skills Council Ltd 1 Level 11 st edition version: Wellington Pde Release date: April 2015 East Melbourne VIC 3002 Phone: Fax: ISBN: Stock code: BSBFIM5011W

3 Table of Contents Introduction...1 Features of the training program...1 Structure of the training program...1 Recommended reading...1 Section 1 Review Concepts of Financial Management...3 What skills will you need?...3 Standard accounting practices...4 Cash and accrual accounting methods...5 Management accounting...7 Cost accounting: Overview...9 Cost accounting: Cost classifications Cost accounting: Concepts and models Budget classifications Cost centre allocations Section summary Further reading Section checklist Section 2 Plan Financial Management Approaches What skills will you need? Ensure access to budgets and financial plans Clarify the budgets and financial plans Negotiate budgets and financial plans Risk management Contingency planning Section summary Further reading Section checklist Section 3 Implement Financial Management Approaches What skills will you need? The management cycle: Budgeting and leadership Communicate to team Identify and set accountabilities Budget management and human behaviour Support team to achieve goals Organise resources and systems... 72

4 Use electronic spreadsheets to manage budgets Section summary Further reading Section checklist Section 4 Monitor and Control Finances What skills will you need? Budgetary control Monitor expenditure and variance Implement contingency plans Reporting requirements Government reporting requirements Section summary Further reading Section checklist Section 5 Review and Evaluate Financial Management Processes What skills will you need? Financial management data Analyse variance Analyse cash flow Analyse profit Implement corrections and improvements Section summary Further reading Section checklist Glossary Appendices Appendix 1 Cash flow 2011/12: Dolly s Delight Appendix 2 Master budget template: Dolly s Delight Appendix 3 Strategic goals and operational plans: Dolly s Delight Appendix 4 Dolly s Delight profit and loss Appendix 5 Dolly s Delight policies and procedures BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd

5 Student Workbook Introduction Introduction Features of the training program The key features of this program are: Student Workbook Self-paced learning activities to help you to develop an understanding of key concepts and terms. The Student Workbook is broken down into several sections. Facilitator-led sessions Challenging and interesting learning activities that can be completed in the classroom or by distance learning that will help you consolidate and apply what you have learned in the Student Workbook. Assessment Tasks Summative assessments where you can apply your new skills and knowledge to solve authentic workplace tasks and problems. Structure of the training program This training program introduces you to managing budgets and financial plans. Specifically, you will develop the skills and knowledge in the following topic areas: 1. Review concepts of financial management 2. Plan financial management approaches 3. Implement financial management approaches 4. Monitor and control finances 5. Review and evaluate financial management processes. Your facilitator may choose to combine or split sessions. For example, in some cases, this training program may be delivered in two or three sessions, or in others, as many as eight sessions. Recommended reading Some recommended reading for this unit includes: Bear, C., Blythe, P. and Flanders, D., 2005, Introduction to budgeting, 4 th edn, Thomson, Melbourne. Daft, R. and Samson, D., 2009, Fundamentals of management, 3 rd edn, Cengage Learning, Melbourne. Hilton, R., 2008, Managerial accounting, 8 th edn, McGraw-Hill, Boston. Langfield-Smith, K., Thorne, H., Hilton, R., 2006, Management accounting: information for managing and creating value, 4 th edn, McGraw-Hill, Sydney. Swann, M., and McEachern, W., 2001, Microeconomics: a contemporary introduction, Nelson Thomson Learning, Melbourne. Wrice, M., 2004, First steps in retail management, 2 nd edn, Macmillan Publishers Australia Pty Ltd, South Yarra. BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 1 of 136

6 Introduction Student Workbook Please note that any URLs contained in the recommended reading, learning content and learning activities of this publication were checked for currency during the production process. Note, however, that IBSA cannot vouch for the ongoing currency of URLs. Every endeavour has been made to provide a full reference for all web links. Where URLs are not current we recommend using the reference information provided dto search for the course in your chosen search engine. 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 2 of Innovation and Business Industry Skills Council Ltd

7 Student Workbook Section 1 Review Concepts of Financial Management Section 1 Review Concepts of Financial Management The focus of this unit is on the skills and knowledge required by managers to manage budgets and financial plans. Section 1 provides an overview of fundamental principles and techniques of budgeting and financial planning. This section also provides an overview of types of budgets applicable to this unit as well as an introduction to cost centre allocations. Scenario: Dolly s Delight Doll house manufacturer Dolly s Delight Pty Ltd Manufacturing Company builds and sells dolls houses to retailers. The company employs 70 people in the manufacturing side of the business and 16 people in the administration side of the business. The company was formed ten years ago, initially funded by Eden Black, the present CEO. The company had been struggling financially for the past four years. After a recent reshuffle of staff and a few changes in management, the business has now become stable again and is beginning to make a profit. The company has decided to outsource what it can and has moved some of the aspects of the business to contractors and outside organisations. This has included sections of the business such as the basic bookkeeping and payroll, the distribution of its goods to outside businesses, website design and updates. The company made a net profit last year of $320,000 (before income tax) and aims to increase this by 20% in this financial year. The company intends to make a small profit compared to revenue but build its reputation in the market for quality and customer service with a view to increasing profits much more over coming financial years. What skills will you need? In order to work effectively with budgets and financial plans, you must be able to: identify and apply management accounting principles and techniques to financial planning: standard accounting practices, cash and accrual accounting, management accounting and cost accounting identify types of budgets identify cost centre allocations. BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 3 of 136

8 Section 1 Review Concepts of Financial Management Student Workbook Standard accounting practices Although this unit does not require you to apply accounting practices and techniques to produce, for example, financial statements or make entries into journals or ledgers, this Student Workbook assumes some knowledge of standard accounting practices. The standard accounting practices assumed by this Student Workbook include the following: the application of the accounting cycle the use of journals and ledgers the use of double-entry bookkeeping the use of the account groups: assets (including receivables and inventories), liabilities, capital (owner s equity), revenue and expenses the practice of making year-end closing entries for the preparation of financial statements. The above accounting practices underpin the financial reporting system of a firm dealing with past business transactions. Although financial planning focuses on future projections of organisational performance to facilitate planning, the assumption of standard accounting practices is important because managers engaged in financial planning derive much of their information from the output of standard accounting practices, namely, the financial statements and various account balances such as cost of goods sold (COGS), for example. Basic accounting principles Five fundamental principles of accounting, relating to the generally accepted accounting principles (GAAP), are revenue, expense, matching, cost and objectivity. Learning activity: Basic accounting principles Go to a website to find a list of basic principles of accounting and record the terms and their definitions below: Compare sources of information. Are there any differences in terms and/or definitions? How do you explain the differences? 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 4 of Innovation and Business Industry Skills Council Ltd

9 Student Workbook Section 1 Review Concepts of Financial Management Cash and accrual accounting methods There are two approaches that a business in Australia can adopt when recording transactions, producing financial reports and reporting to the Australian Tax Office (ATO). These methods are called cash and accrual accounting. Cash accounting only recognises, records and processes a financial transaction when cash is actually received or paid. Accrual accounting recognises, records, and processes a financial transaction when the transaction actually occurs regardless of when it is to be paid. A simple example of this difference would be a plumber doing work on a project that finishes in the last week of July. The plumber issues the client with the invoice for $1,000 in July but does not receive payment until August. Under the cash accounting system, the money becomes income for the plumber in August, whereas under the accrual accounting system the income was really earned in July because that is when the client became legally responsible for payment for the work. The matching principle of accrual accounting sets out to ensure that in a given accounting period, the income and the expenses incurred in earning that income are accurately matched and reflected in the accounts and the reports. Benefits of accrual accounting Accrual accounting is an accounting process designed to more accurately reflect the true nature of a business financial position and performance. After centuries of accounting practice, accrual accounting has become the standard for reporting. Adopting the accrual accounting method aligns with AASB (Australian Accounting Standards Board) standards and with the practice of larger corporations. Other benefits for adopting the accrual accounting method include: more accurately reporting the profit of a business for a given period providing a better method for planning expenses, as well as preparing monthly and yearly budgets provides the true value of a business being suited to tracking large volumes of transactions giving a more accurate picture of the organisation's overall financial performance and financial position allowing external stakeholders like banks and creditors to be better informed about the business prospects being more comprehensive and focusing on total resources, not just cash accrual accounting methods allowing for a seamless transition from small to large as the business grows and expands the focus on total resources providing a better and more comprehensive measure of financial performance and facilitating resource allocation. BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 5 of 136

10 Section 1 Review Concepts of Financial Management Student Workbook Budget projections derived from financial reports based on the accrual accounting method are more likely to be accurate and fair representations of the future financial position of the business. In addition, as we shall see later with regard to the principles of cost accounting, keeping track of costs associated with business operations, as they are incurred, is far more useful to budgeting and financial planning than merely tracking the initial outlay of cash, for example, for raw materials. The level of detail and point-in-time accuracy provided through accrual accounting can lead to more detailed, reliable and meaningful budgeting. Learning activity: Accrual accounting and budgets Consider your own organisation or an organisation you are already familiar with or wish to research. Which method of accounting, cash or accrual, does the organisation use? How is information from the accounting system used to inform budgets? How reliable is the information? How does (or would) the use of the accrual method improve the accuracy and reliability of budgets produce by or for the organisation? 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 6 of Innovation and Business Industry Skills Council Ltd

11 Student Workbook Section 1 Review Concepts of Financial Management Management accounting Accounting may be divided into two branches: financial accounting and management accounting. As illustrated in the diagram below, each branch has its own area of concern, methods and key stakeholders. Accounting Financial Accounting External Users Set Reports Government Agencies Investors Creditors Loan Funders Trade Associations Management Accounting Internal Users Custom Reports Directors and CEO Line Managers Unit. Store. Employees Financial accounting is focused on producing a limited set of specific prescribed financial statements in accordance with generally accepted accounting principles. The central outputs from financial accounting are audited financial statements such as the balance sheet and income statement that provides a scorecard by which a company's overall past performance can be judged by outsiders. Managerial accounting, on the other hand, deals with information that is not made public and is used for internal decision-making only. Reports are far more detailed than financial accounting and can cover performances and activities by departments, products, customers and employees. It is an accounting system that helps management achieve the goals and objectives of the organisation with an emphasis on the measurement, analysis, communication and the control of financial and non-financial information. This branch of accounting is primarily interested in assisting the organisation s department heads, division managers, and supervisors to make better decisions about the day-to-day operations of the business and in particular, those relating to the planning and control decisions BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 7 of 136

12 Section 1 Review Concepts of Financial Management Student Workbook The essential data is conveyed in a wide variety of reports and is specifically targeted at those who direct and control the organisation. These reports help to promote more efficient and effective planning, resource organisation, personnel management, performance evaluation, and operations control. Unlike financial accounting, there are no external rules governing management accounting. The emphasis in this branch is on making decisions that affect the future with actual results being compared to, for example, budgets, activity-based costing, financial planning, or to industry benchmarks. These reports are delivered frequently and in a timely way according to the requirements of management. Most reports are analytical in nature with a heavy emphasis on variances in the key indicators that monitor the financial performance of the business. A more specialised area of management accounting is cost accounting, which will be examined in more detail below. Management accounting: planning and control Planning and control are two key and related components of management accounting. Planning involves formulating the firm s objectives and includes the detailed description of the steps needed to meet these objectives. Planning involves custom reports derived from information in financial statements and activities such as: cash flow projections long term budgets and plans operational plans short term budgets and plans financial projections setting targets and key performance indicators for aspects of business performance such as production, sales, income and expenditure, etc; targets may be set for organisational performance as well as for team performance. Control involves the continuous assessment of actual performance against a budget or standard/target. Importantly, it also involves taking corrective action through following or forming contingency plans to keep financial plans on track. Control may also include revising plans or targets. In other words, planning and control may influence each other in a process of continuous and reciprocal improvement. Planning Control 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 8 of Innovation and Business Industry Skills Council Ltd

13 Student Workbook Section 1 Review Concepts of Financial Management Learning activity: Planning and control Planning and control are two key elements in financial management. From your experience, identify and describe at least one activity that you have done or witnessed for each element. Cost accounting: Overview Cost accounting is an approach to evaluating the overall costs that are associated with conducting business. Managers use cost accounting to support decision-making. Cost accounting is recognised as a form of management accounting, because its primary use is for internal managers rather than outside users. Typically, you will need to use data from the most recent year ended, or reporting period, since that is the only way to have accurate numbers to accompany a budget. It is important to note that past year expenditures can be affected by unusual circumstances and any variances like this must be carefully accounted for. Apart from financial statements, data can come from a range of sources, but typically these are: inventory, materials and finished product records consumables records records of purchases and associated costs sales information labour utilisation records materials used payroll records manufacturing and general overhead costs. When looking at a manufacturing company like Dolly s Delight, it is useful to allocate costs to a business activity. If we look at the total production process in a flow chart, we can visualise where the costs are in the process and how they flow down through the production process. BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 9 of 136

14 Section 1 Review Concepts of Financial Management Student Workbook Research and development Planning Processes Design and processes Supply of product Production and Manufacture Manufacturing Production Selling and Admin Marketing Distribution Customer service From the diagram above we can identify the costs involved in production and how they flow from the one stage in the process to the next. It is important to assign the costs to activities so that we can work on identifying where the costs have come from and anticipate future costs. Planning and process costs: These costs identify the initial stages of the production process and include things such as the development of a new product and its design, as well as working on the processes that will be involved with the manufacture. Production and manufacture costs: The direct costs involved with the manufacture of the product for sale. It involves everything from the assembly, to the equipment used and the direct materials involved with the production. Selling and administration costs: The costs in this area involve all the final costs involved with getting the product into the market and the distribution of the final item. It involves all the office and administration costs as well. As well as helping to plan operations for maximum benefit and produce accurate budgets, cost accounting helps to provide the tools to analyse how well company resources are being used to generate revenue and achieve strategic goals. By identifying production costs and further defining the cost of production, it is possible, for example, to note any long term or short term trends that indicate a rise in production costs with respect to budgeted output. In such cases, management may either apply the necessary controls to correct budget variances or adapt budgets and financial plans to reflect new business realities. 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 10 of Innovation and Business Industry Skills Council Ltd

15 Student Workbook Section 1 Review Concepts of Financial Management Principles of cost accounting An important principle in cost accounting is the practice of accounting for costs rather than outlays. As discussed previously, the method of accrual accounting helps to provide the detail necessary for operational budgeting. For example, accrual accounting records the value of raw materials purchased for future production as an asset, not merely as an outlay of cash, as would be the case using a purely cash accounting method. Each unit produced, then, would be seen to incur a cost with regard to the value of the raw materials held by the business. Cost accounting allows these costs to be analysed and provides the basis for both anticipating future costs and making sound strategic decisions relating to, as an example, what to produce and how much to produce within a given time-frame. Other important principles of cost accounting include the following: accounting for hidden costs and externalities accounting for direct overheads/indirect costs accounting for past and future outlays accounting for costs according to the lifecycle of the product. In order to gain a broad understanding of cost accounting this section provides a summary of the terminology referred to above and then progresses to discuss important cost accounting concepts and models which can be usefully applied to financial planning. Cost accounting: Cost classifications There are a number of different ways that costs can be classified. For example, they may be classified by nature, function, traceability, variability, controllability, normality or abnormality, etc. Costs may be classified and recorded on a cost sheet. Two classifications of cost accounting of key importance for this unit are variability and traceability (direct or indirect costs). Variable and fixed costs Fixed costs per are those costs you need to spend to maintain your business or product sales but which do not change in line with changes in your sales volume or business activity. Rent is a good illustration of a fixed cost. Regardless of how much you sell, the rent is still going to be the same. Other fixed costs could include equipment rental or lease arrangements, insurance, interest on debt, plant and equipment expenses, utilities, business licenses and salaries of permanent, full-time workers. As the charts below show, total fixed costs do not change with increased volume of production, yet the fixed cost per unit reduces the more volume is produced. BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 11 of 136

16 Section 1 Review Concepts of Financial Management Student Workbook Learning activity: Why fixed? Give an explanation as to why the following are considered fixed costs. Cost A license to operate a food business. The interest costs on the loan taken out to establish a business. Answer Variable costs are those costs that do vary in line with and usually in direct proportion to changes in sales volume or business activity. Usually the largest and most common variable cost is the cost of buying or manufacturing the goods that are sold. This cost is often referred to as cost of goods sold (COGS). Other variable costs might include packaging, and labour directly involved in a company's manufacturing or sales process, vehicle fuel and salesperson s telephone calls. As the chart below shows, variable costs will increase in line with volume yet the variable cost per unit will remain the same. TOTAL VARIABLE COST VARIABLE COST PER UNIT 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 12 of Innovation and Business Industry Skills Council Ltd

17 Student Workbook Section 1 Review Concepts of Financial Management Semi-variable costs are those costs that are a blend of the two. For example, electricity to run the machinery that makes products is included on the same bill for the electricity that lights the office, whether there is production happening or not. Staffing is another area that could break up the costs between both concepts. Often staffing costs may increase during a busy period if management makes a decision to employ temporary staff to handle increased sales. Learning activity: Variable or semi-variable? Look at the following costs and determine if they are variable or semi-variable. If semivariable, then explain which part of the costs is fixed and which part is variable. Cost Telephone costs for the office sales team. Salaries and wages to operate a retail store over Christmas. Contributions under the Superannuation Guarantee (Administration) Act 1992 Advertising costs used for corporate branding and branding specific product promotions. Sales team members paid on commission only. Fuel costs to operate a machine used in the production of goods. Answer Direct costs and indirect costs Indirect costs are also referred to as overheads. Overheads are the costs incurred by the firm but which cannot be attributed directly to a unit of production. One example of an overhead is rent, which is a necessary cost of business but is not directly related to the production of a specific product. Direct costs are those costs incurred by a firm which can be directly attributed to units of production. One example of a direct cost is raw material without which a final product would not exist. Raw material is a direct cost because it can be directly attributed proportionally to a unit of production. BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 13 of 136

18 Section 1 Review Concepts of Financial Management Student Workbook Learning activity: Name that cost Look at the cost on the left and decide whether it is more fixed than variable and whether it is more direct than indirect. Cost Fixed Variable Direct Indirect Rent Casual production wages CEO salary Head office building insurance Raw materials Electricity to run the plant Cost accounting: Concepts and models Several concepts and models are important for cost accounting. These depend on the cost classifications discussed above. This section will discuss manufacturing cost concepts and several models for budgeting costs. Manufacturing cost concepts The prime cost is composed of direct material costs and direct labour costs: Direct Materials Direct Labour Prime Cost 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 14 of Innovation and Business Industry Skills Council Ltd

19 Student Workbook Section 1 Review Concepts of Financial Management The production cost is composed of prime costs and indirect costs: Direct Materials Direct Labour Factory Overheads Product Costs The conversion cost, the cost required to convert a product from raw material to a product, is composed of indirect costs and direct labour costs. All three cost concepts, particularly the production cost, may factor into the cost accounting models discussed below. Learning activity: Calculate the costs Given the information below, calculate the prime cost, the product cost and the conversion costs. Cost Prime cost Factory Overheads Factory overheads $100,000 Direct materials $50,000 Direct labour $20,000. Production cost Conversion cost Answer Direct Labour Conversion Cost Marginal costing model Marginal costing, also known as cost-volume-profit (CVP) costing, involves the analysis of the relationship between production costs, sales volume and profit. Using CVP analysis you can calculate the break-even point and the volume of sales required to earn a particular profit. Consider the following formula. BSBFIM501 Manage budgets and financial plans 1 st edition version: Innovation and Business Industry Skills Council Ltd Page 15 of 136

20 Section 1 Review Concepts of Financial Management Student Workbook $SSSSSSSSSS = $VVVVVVVVVVVVVVVV CCCCCCtttt + $FFFFFFFFFF CCCCCCCCCC + $PPPPPPPPPPPP or PP XX = (VV XX) + FFFF + PPVVCCPPPPPP P X V FC Price per unit Number of units Variable cost per unit, or unit cost Fixed costs An important concept for CVP costing is unit contribution margin : Price per unit The unit contribution margin is related to profit. The unit contribution margin is the marginal profit per unit of sale (or gross profit per unit). Example: Dolly s Delight Sales of dolls $3,000,000 (60,000 units * $50 ) Variable costs Price per unit $1,780,000 (60,000 units * $29.66 per unit) $50 (ex GST) Variable cost per unit $29.66 Total contribution margin $1,220,000 Unit contribution margin $20.34 Fixed Costs $900,000 Profit $320,000 The contribution margin may also be expressed as a ratio: Using unit figures: CCCCCCttVVVVVVCCttVVCCCC mmmmmmmmmmmm VVSSttVVCC = Using total figures: Variable cost per unit CCCCCCttVVVVVVCCttVVCCCC mmmmmmmmmmmm VVSSttVVCC = Unit contribution margin PPVVVVPPPP ppssvv CCCCVVtt VVVVVVVVVVVVSSSS PPCCSStt ppssvv CCCCVVtt PPVVVVPPPP ppssvv CCCCVVtt SSSSSSSSSS TTCCttSSSS vvvvvvvvssvvssss PPCCSSttSS SSSSSSSSSS 1 st edition version: 1 BSBFIM501 Manage budgets and financial plans Page 16 of Innovation and Business Industry Skills Council Ltd

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