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GEB4111 Section Two Cashflow Management Small Business Accounting: Projecting and Evaluating Performance Objectives Review the basic concepts of accounting Understand the requirements for a small business accounting system

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GEB4111 Section Two

Cashflow Management


Small Business Accounting:

Projecting and

Evaluating Performance

  • Review the basic concepts of accounting
  • Understand the requirements for a small business accounting system
  • Be comfortable with the content and format of common financial statements
  • Understand how accounting information can help you manage your business effectively
  • Learn how to craft budgets for your business
  • Gain understanding of how people make decisions


Why Accounting Matters
  • Proves what your business did financially
  • Shows how much your business is worth
  • Banks, creditors, development agencies, and investors require it
  • Provides easy-to-understand plans for business operations
  • You can’t know how your business is doing without it




All of the following are types of accounting except:

a) Financial accounting

b) Tax accounting

c) Expense accounting

d) Managerial accounting


Three types of accounting:
    • Managerial accounting: used by managers for planning and control
    • Tax accounting: used for calculating and reporting taxes
    • Financial accounting: used by banks and outside investors


Basic Concepts
  • Business entity concept: a business has an existence separate from that of its owners
  • Going concern: business is expected to continue in existence for the foreseeable future
  • Accounting equation: assets = liabilities + owner’s equity


What is a cost? What is an expense?
    • Costs: real changes in what you own
    • Expenses: entries made in your accounting system to record your use of goods and services
    • Managerial accounting is focused on predicting the future, so it uses expenses only for budgeting and planning purpose


Information usefulness: must be accurate and relevant
    • Only two reasons to do accounting:
      • To produce information that is useful to you for managing your business
      • To meet legal or contractual requirements


Computerized accounting: most commonly used (QuickBooks, Peachtree)
    • Systems should easily accomplish:
      • Easy-to-understand user interface
      • Context-sensitive help function
      • Income statements
      • Classified balance sheet
      • Development of a cash budget
      • Produce financial statements




Which Accounting Software is Best for You?

  • Two main types of accounting software:
    • industry specific and generic
  • Consider the following for choosing a package:
    • The size of your business
    • The industry you're in
    • The components you need
    • Available support
    • Financial resources
    • Professional recommendations
    • Ease of use


Setting Up an Accounting System
  • Accounting functions:
    • Accounts payable
  • Payroll
    • Fixed asset
    • Inventory
    • Credit card sales
  • Accounts receivable
  • Insurance register
  • Investments
  • Leasehold records


Financial Reports
  • Five common financial statements:
    • Income statement
    • Statement of retained earnings
    • Statement of owner’s equity
    • Balance sheet
    • Cash flow statement
      • Important thing is that the information flows all the way from the income statement to the balance sheet


Income statement: primary source of information about a business’ profitability
    • Revenues – Expenses = Net income
    • Difficulties in understanding the income statement
      • Disagreements about what exactly should be reported as revenue
      • Disputes over when to recognize revenues
    • Most small business do not have problems with these; sales are cash, or the same as cash


Balance sheet: “Statement of Financial Position”
    • Snapshot of financial holdings and liabilities at the close of business on a specified date
    • Minimum detail is to report assets and liabilities in two categories: Current and Long-term
    • Used to determine the liquidity, financial flexibility, and financial strength of the business


Balance sheet: cont.
    • Limitations:
      • All values listed are historical values
        • Value recorded in the accounting records can be widely different from the asset’s current value
      • Balance sheet might not completely reflect the business
      • Certain assets and liabilities are omitted from the balance sheet


Cash flow statement: sources and uses of cash by the business
    • Cash flows from operating activities
    • Cash flows from investing activities
    • Cash flows from financing activities
      • Net effect of foreign exchange rates
      • Net change in cash balance during the period
      • Non-cash investing and financing activities




Building a Financial Budget

  • Business budgeting is one of the most powerful financial tools available
  • Most effective financial budget includes both a short-range month-to-month plan for at least a calendar year and a quarter-to-quarter long-range plan you use for financial statement reporting
  • It is important to budget both the income statement and balance sheet


Financing activities: actions taken by management to finance the operations of the business
    • Net effect of foreign exchange rates: rates often vary rapidly
    • Net change in cash balance: reconciles the net increase and decrease with the beginning balance
    • Non-cash investing and financing: exchange of value other than cash takes place


Financial accounting can be a highly valuable aid in decision making
  • Reporting to outsiders
  • Record keeping
  • Taxation
  • Control of receivables
  • Analysis of business operations


Managerial accounting techniques will make you a better small business manager
  • More accurate at forecasting profits, planning operations, and conserving scarce resources
  • Managerial functions:
    • Planning, organizing, staffing, directing, and controlling


Cost-Volume-Profit analysis: technique which looks at the fixed and variable costs of a business to arrive at a number of unit sales (volume) to maximize profits
  • Variable Costs: costs that change with each unit produced
    • Raw materials
  • Fixed Costs: costs that remain constant regardless of quantity of output
    • rent




The point at which total costs equal total sales is called the …

a) Breakeven Point

b) Equalization Point

c) Neutral Point

d) Variable Point


Business Plan and the Budget
  • Business plan: specifies the amounts and types of inputs required to achieve a set of desired outcomes
  • Based on assumptions:
    • How risks can be controlled
    • What opportunities can be taken
  • Budgets have the advantage of being comprised of a series of small schedules


Planning / budgeting: process through which strategy is mapped into a series of tactical and operational actions
    • Budget becomes a standard against which performance can be measured
    • Basis for controlling activities and the use of resources
    • Few small business owners consistently budget


Sales budget: projected future level of sales in units multiplied by the sales price per unit
  • Purchases budget: number of units that are expected to be acquired during the budget period
  • Cost of Goods Sold Budget: predicted cost of product actually sold during accounting period
  • Labor budget: amount and cost of labor needed to meet required production
    • Assume that labor can easily be increased or decreased
    • Can easily be modeled as a fixed cost


Manufacturing overhead budget: usually treated as fixed costs
    • Becoming more common for managers to use activity-based cost estimates for overhead
  • Selling, general, and administrative budget: SG&A, contains both costs that change with production and costs that do not
    • Advertising and freight are variable costs in respect to sales


Budgeted income statement: budgets that have been completed to this point are combined into pro forma financial statements
    • Common to create the statement in only a fiscal year format


Completing a comprehensive budget:
    • Final processes to be accomplished to produce a complete master budget
      • Budgeted cash receipts
      • Budgeted cash payments
      • Cash budget
      • From these statements, prepare:
        • Pro Forma projected balance sheet
        • Pro Forma projected cash flow statement


    • Managerial accounting provides information that allows managers to determine how well the business is doing in attaining its goals
    • Variances should be evaluated to determine the significance; they occur due to one of these events
      • Prices are different from what was estimated
      • Quantities are different from what was estimated


Decision Making
  • To make good decisions, you need:
    • Good information
    • Efficient ways to condense information
    • Methods to help compare alternatives




A source of information and a methodology to reduce the complexity of information is…

a) Financial accounting

b) Cost accounting

c) Tax accounting

d) Managerial accounting


Managerial accounting is both a source of information and a methodology to reduce the complexity of the information
  • Accounting is useful for:
    • Managers of small businesses
    • Record keeping
    • Reporting to absentee owners
    • Substantiating assertions made to regulators and taxing agencies


  • Know the importance of managing your business’s money
  • Understand the concepts of money, cash, and cash equivalents
  • Understand the basics of managing cash flow
  • Be able to reconcile bank and company book balances
  • Be prepared to develop a cash budget
  • Have strategies for preventing and coping with cash flow problems
  • Learn strategies for coping with cash shortages


Importance of Money
  • What is money, and why is it so important?
  • Money: cash, cash equivalents, profits, and banking
  • Differences are important
    • Represents the lifeblood of the business, and knowing how to use it can make the difference between boom and bankruptcy


Money In / Money Out
  • Almost 2/3 of all small businesses experience money problems
    • 1/5 of small business managers reported that cash flow is a continuing problem
  • Three primary causes of cash flow problems:
    • Difficulty collecting money due
    • Seasonal variation in sales
    • Unexpected decreases in sales


The cash-to-cash cycle of a pushcart vendor is only a few hours; construction projects may take years to complete
  • Many small businesses experience difficulty because:
    • The mismatch in time between receiving and spending cash
    • Mismatch in time between size of payments received and size of payments to be made


What is money: U.S. Dallas Federal Reserve
    • “Money is a medium of exchange accepted by the community, meaning it’s what people buy things with and sell things for. Money provides a standard for measuring value, so that the worth of different goods and services can be compared. And lastly, money is a store of value that can be saved for later purchases.”



Money is all of the following except:

a) Medium of exchange

b) Measure of wealth

c) Certificates of ownership in a company

d) Store of value


Two purposes of money:
    • To make exchanges
    • To keep track of wealth
  • Remember, a profit on your accounting spreadsheet or in your account book is not money in your hand
  • Money is a medium of exchange, store of value, and measure of wealth


Cash and Cash Equivalents
  • Cash: cash is money immediately available to be spent
    • Cash equivalents: assets that may be quickly converted to cash
    • Currency: bills and coins printed by governments to represent money
    • Demand deposits: money held in checking and savings accounts
    • Commercial paper: notes issued by credit-worthy corporations


Managing Cash Flow
  • Cash can come from only three sources:
    • Cash can be obtained by selling products and services
    • Cash can be obtained from investments the business has made
    • Cash through financing



How to Better Manage Your Cash Flow

  • Measuring cash flow
    • Prepare cash flow projections for next year, next quarter and, if you're on shaky ground, next week
    • accurate cash flow projection can alert you to trouble well before it strikes
  • Improving receivables
  • Managing Payables
  • Surviving shortfalls


Company and bank cash balances: most cash is held as bank deposits
    • First step in managing cash flows is understanding how yours and the bank’s views of cash flow differ
    • Company book balance: sum of company’s internal accounting record of all transactions that affect cash


Company book balance includes:
    • Records of all inflows of cash
    • Cash from sales
    • Receipts on receivables
    • Checks received from customers
    • Deposits made directly to the bank through electronic transfers
    • Records of all outflows of cash
    • Checks written to pay for wages, salaries, inventory, services, taxes, and so on


Bank ledger balance: bank’s accounting system for all recognized transactions that affect the account
    • Balance may vary because of delays in collecting deposits and delays in making cash transfers
  • Bank available balance: actual cash value of the account



A negative balance in a depositor’s bank account is called…

a) Overdraft

b) Float

c) Service charge

d) Surcharge


Overdraft: a negative balance in a depositor’s bank account
  • Float: describes the delay in movement of money among depositors and banks
    • Two primary causes:
      • Delays in transferring money due to internal procedures (availability float)
      • Delays in delivering checks (processing float)


Reconciling bank balances with company book balances
    • key is knowing how much cash is available to you at the moment
  • Process of reconciling bank balance and book balances is quite simple


Two reasons why balances differ:
    • Bank knows information about your account that you cannot know until the bank tells you
    • You know information about your account that the bank cannot know, because relevant transactions have not yet reached the bank


Two-step reconciliation process:
    • Add (subtract) to the bank balance those things that you know about your account that the bank does not know
    • Add (subtract) to your book balance those things that the bank knows



All of the following are purposes of the reconciliation except:

a) Estimate the bank’s available balance for the purpose of managing your cash flows

b) To gain an advantage over the bank

c) Identify any mistakes that were made by either the bank or by your own bookkeeper

d) Check the accuracy of both the bank and business records


Reconciliation serves four purposes:
    • Estimate the bank’s available balance for the purpose of managing your cash flows
    • Identifies any mistakes that were made by either the bank or by your own bookkeeper
    • Checks the accuracy of both the bank and business records
    • Lets you know about items on the bank statement that would not otherwise be included in the business’s accounting records


Forecasting sales receipts: sales forecast is the cash receipts forecast
  • Businesses whose customers make heavy use of their credit cards can face serious cash drains
  • Many businesses have either relatively few large sales events or highly seasonal sales that complicate forecasting


If you provide credit to your customers, you will always wait some period of time for some of your money
    • You will also have some customers who never pay
    • You never know exactly when you will collect cash
    • Reasonable estimate of their amount and timing can be made


Forecasting cash disbursements:
    • Estimates of expenses
    • Knowledge of your business’s payment patterns
    • Predict how much and when cash should be paid out
    • Need to know how much money we will have on the first day of the year to put together a cash budget for the first quarter


Pro forma balance sheet:
    • Final step is to put everything together to create a complete set of pro forma financial statements that you can use for raising money, for evaluating your operations, and for managing your business
    • Comprehensive budgets: referred to as master budgets



Managing Your Cash Flow

  • Cash-flow forecast will help you predict the amount of money that will be coming into and flowing out of your business
  • Take these steps to ensure your new business will maintain its positive cash flow
    • Know what to expect
    • Predict and plan for the slow times
    • Make projections for the future


Preventing Cash Flow Problems
  • Best prevention is attention and understandingyour business’s operations
    • Maintain an accurate forecast of cash needs
  • Techniques to increase cash flows
    • Taking deposits and progress payments
    • Offering discounts for prompt payments
    • Asking for your money
    • Taking on noncore paying projects
    • Factoring receivables


Techniques to decrease cash outflows:
    • Two factors of cash outflows that must be controlled:
      • The amount of cash being paid out
      • The timing of cash being paid out
    • Waste also affects cash outflow


Several strategies that will provide savings in cash outflows:
    • Trade discounts
    • Non-cash employee incentives
    • Use of temporary agencies
    • Consignment
    • Barter
    • Control of the timing of paying out cash
    • Timing of purchases
    • Negotiation of terms with suppliers


cash flow forecasting
Cash Flow Forecasting
  • Allows the entrepreneur to:
    • Determine the business’ financing needs
    • Determine the exact amount of cash needed
    • Determine when cash is needed
determining financing needs
Determining Financing Needs
  • Two choices:
    • Staged Financing
    • Up-Front Financing
  • Each has pros and cons
  • Both choices are based on a fixed time horizon (usually 3-5 years)
staged financing
Staged Financing
  • Pros:
    • Keeps entrepreneur disciplined and minimizes wasting money
    • Only paying for current expenses
    • New series of capital comes in at higher valuation, allowing less equity to be surrendered
  • Cons:
    • No certainty that more capital will be available in the future
    • Required to allocate resources to secure additional funding
up front financing
Up Front Financing
  • Pros:
    • Does not need to allocate resources to raise future funding
    • Avoids risk of capital not being available in the future
    • Avoids potential increase in the cost of capital if it is available in the future
  • Cons:
    • Forecasting in out years may be wrong
    • May give up too much equity/over-leverage a young company
    • Too much capital may spoil an inexperienced business owner
    • Invested capital comes in at a lower valuation
sources and uses of cash
Sources and Uses of Cash
  • Sources of Cash or Cash Inflows
    • Accounts receivable (A/R)
    • Cash payments
    • Other income (I.e. investments)
    • Borrowing
  • Uses of Cash or Cash Outflows
    • Payroll
    • Utilities
    • Loan Payments (Interest plus Principal)
    • Rent
    • Insurance
    • Taxes
accounts receivable
  • There are two ways to approach the management of accounts receivable:
    • 1) See how the “Parameters“ interface with the “Variables”, and
    • 2) The development of a credit granting decision rule.
accounts receivable75


  • Cash Discount - A discount from the face amount of invoice for paying before end of discount period
  • Cash Discount Period - Period in which you can take the Cash Discount, e.g....., 10 days
  • Credit Period - e.g...., 30 days; customer is expected to pay before this date.
  • Collection Effort - The effort that goes into collecting the account; may not be a matter of $’s, rather “effort” in collection.
accounts receivable76


  • Sales
  • Net Income
  • Rate of Return on Sales and ROA
  • Volume of Accounts Receivable
  • NOCF (Net Operating Cash Flow)
  • Bad Debt Expense
accounts receivable77
  • If you reduce the Cash Discount this will have a tendency to increaseBad Debt Expense.
  • The Cash Discountis, in effect, an “early warning system” because if a customer suddenly stops taking a cash discount when it was taking it previously, this may signal that customer is having liquidity problems.
accounts receivable78
  • With respect to the Cash Discount Period, there is little that can be done to shorten it,
  • However, instead of using traditional printed invoice forms, have your invoices computer-generated in real-time (and shipped with the product), so you can specify that a Cash Discount of so much can be taken if the check is post marked by a specified date.
cash management
  • Why should a firm worry about having

too much cash?

  • Because cash is about the most unproductive assetof all!
cash management80
  • Suppose you run out of money, or you call the bank and find that your balance is lower than your Daily Opening Cash Balance? Where do you get the money to replenish your cash account?
  • There are two sources:
  • The first is a pool of Money Market securities backing up your Cash Account.
  • The second is a Line Of Creditfrom your bank.
money market securities
  • Securities appropriate forservicing the cashaccount:
    • Treasury Bills
    • Money Market Funds
  • Or similar securities that provide you with “same day” delivery of funds.
money market securities82

Securities appropriate for “controllables” account:

  • Commercial Paper- Corp. IOU’s - up to 270 days; you name amount and maturity; automatically transferred.
  • CDs AND BANK DEPOSIT NOTES- CDs have practically disappeared. Bank Deposit notes run from 18 months to 5 years.
  • Banker’s Acceptances - discounted drafts against LC’s; comes packaged in various amounts.
  • Repurchase Agreements; RP’s, technically not a security; agreement to buy back sec’s., overnight money
  • Short Term Municipals- Tax exempt. And, maybe,
  • Money Market Preferreds.
money market securities83
  • Securities appropriate for theSurplus Money Market Securitiesaccount:
    • Preferred stock
    • Convertible bonds
    • Tax exempt Municipal Bonds
  • Here, quick liquidity is not a prime determinant. Remember that liquidity and yieldare in juxtapositionto each other.
accounts payable
Accounts Payable
  • In order to determine whether the company’s accounts payable (A/P) are what they should be, you need to analyze the accounts payable turnover and compare it with the industry averages
  • A/P turnover ratio
    • COGS/365 Days = average daily costs
    • Accounts Payable/average daily costs = number of days it takes to pay
management of accounts payable
Management of Accounts Payable
  • To improve A/P,
    • Negotiate better payment terms
    • Time payments according to their due dates
    • Plan cashflow realities
    • Avoid interest penalty charges
    • Communicate with your suppliers
    • Set scheduling goals
    • Be organized
    • Look for warning signs, including low cash levels
    • Prioritize payables
mind the cash gap
Mind the Cash Gap
  • The spread of days between payment of cash and the receipt of cash is called the cash gap or cash conversion cycle
    • Inventory days + days receivable – days payable = cash gap
  • Reducing the Cash Gap
    • Increase Days Payable
    • Decrease Days Receivable
    • Increase Inventory Turnover