Why Are These Activities Important?

Best Practices in Budgeting, Forecasting, Cash Flow Management, Accounts Receivable and Accounts Payable Management Presented To: Penn State University - Abington Continuing Professional Education for CPAs and Attorneys Presented By: William J. Fink, CPA, CSMC October 8, 2016 Why Are These Activities Important? What are the true costs (e.g., economic and opportunity) of these activities versus the benefits in terms of improved cash flow and opportunities for business growth (e.g., organic growth and acquisitions)? What are the lost opportunity costs from not undertaking these activities on a consistent long-term basis? 2 Bill s Top Five Best Practices In Budgeting & Forecasting Prepare annual operating and capital expenditure budgets in advance of each subsequent fiscal year. These budgets are prepared by each department and division manager and should be reviewed by senior management to ensure they provide the target profit returns sought by a firm s owners. Adopt the zero-based budgeting approach when preparing the annual operating budget. This entails a review of the components of each expense line item and helps prevent unchecked expense growth. 3 Bill s Top Five Best Practices In Budgeting & Forecasting Clearly identify and define all budgeting assumptions, including: Tax rate changes; Depreciation schedules; Inflation percentages; Productivity improvement changes; Impact of quality initiatives; Capacity levels; Improvement or deterioration in gross and net margins; Capital expenditures; 4 1

Bill s Top Five Best Practices In Budgeting & Forecasting Clearly identify and define all budgeting assumptions, including: Impacts of changes in capital structure or additional debt levels; Impact of changes in interest rates; and Impact of changes in workmen s compensation and medical insurance rates. 5 Bill s Top Five Best Practices In Budgeting & Forecasting Prepare the operating budget in the same accounting software that the firm uses for its general ledger system. In this way whenever a new expense item is entered into the system, the employee must include the general ledger account number to which the expense is charged. The general ledger system then compares the total yearto-year or period-to-date expense for a specific item to the budgeted amount and the system either accepts the expense item if the expense category is within budget or issues a warning for an over-budget expenditure. By deploying this practice, a firm can be assured of keeping expenditures in line with budgeted targets. 6 Bill s Top Five Best Practices In Budgeting & Forecasting Compare the actual monthly financial performance and year-to-date financial performance of the business to the monthly budgeted financial performance and year-to-date budgeted financial performance. Identify all material variences (e.g., price, labor, material or expense) to determine short-term and longterm positive and negative trends. Initiate policy changes and correction actions in response to these comparisons promptly. 7 Best Practices in Budgeting and Forecasting Establish a definitive budget procedure, timetable and review process. Store budgeting information and defined assumptions in a central database so that all authorized managers can have access on a continuing basis. Consolidate and eliminate useless or unnecessary general ledger accounts as a part of the budgeting process. Establish and communicate project-ranking criteria (NPA, IRR, payback period, management prerogative, etc). 8 2

Best Practices in Budgeting and Forecasting Prepare a working capital and financing needs analysis as part of the budgeting process. Clearly state, define (or redefine, as necessary) all budgeting assumptions. Clearly define and test all current and forecasted capacity utilization levels. Best Practices in Budgeting and Forecasting Establish the maximum limit of available funding and conduct the budget process (e.g., operating budget and capital budget) within this format. Clearly identify capacity utilization assumptions and step-costing constrains for operating and capital assets as part of the budgeting process. Budget personnel-related expenses by groups of positions rather than by specific departments. Create a summary budget for use by senior and/or executive management. 9 10 Best Practices in Budgeting and Forecasting _ Link performance metrics established in the budgeting process with employee incentive goals and rewards. Use activity-based costing as a part of the budgeting justification and approval process. Automatically link the budget and the general ledger system. Conduct quarterly reviews of all budgeting assumptions and revise the operating budget on a quarterly basis. 11 Why Is Cash Flow Management Important? It is critical to managing payments to vendors, employees, banks and other creditors, and owners and investors. It is essential to managing seasonality and cyclicality. It is critical to planning short-term purchases for inventory and supplies and long-term purchases for equipment. 12 3

Why Is Cash Flow Management Important? It is essential in identifying short-term funding gaps in working capital and longterm financing needs for expansion or acquisition. It is critical to planning the repayment of debt. It is essential to providing short-term and long-term returns to owners and investors. Accounts Receivable Collections Sales Finished Inventory Operating Cycle (Cash-To-Cash Cycle) Cash Production Purchases Materials Inventory Accounts Payable 13 14 Essential Elements of Good Cash Management Know when your cash needs will occur. Know why your cash needs occur. Understand your options for meeting additional cash needs. Plan to meet those cash needs through savings and/or financing. 15 16 4

Best Practices In Cash Management Access bank account information via the Intenet. Use photocopies of customer checks to facilitate check posting and same day deposits. To the fullest extent that it is economically feasible, collect all receivables through lockboxes. Best Practices In Cash Management Consolidate bank accounts to reduce month-end reconcilement and improve the speed of cash investment. Implement controlled disbursements Implement positive pay and/or reverse positive pay systems. Implement rapid deposit systems to reduce bank accounts and improve cash availability. 17 18 Best Practices In Cash Management Establish zero-balance deposit accounts. Make payments using the automated clearinghouse (ACH) network or wire transfers. Prepare a monthly cash budget to determine cash needs or cash available for investment. Establish and utilize an excess cash investment policy What Constitutes A Successful Accounts Receivable Management Program It is essential to have appropriate collection management. This includes use of lock-box, pre-authorized checks, electronic payment and cash concentration account(s). It is critical to utilize timely invoice practices. 19 20 5

What Constitutes A Successful Accounts Receivable Management Program - It is essential to effectively monitor receivable balances not less than monthly. It is critical to establish and maintain appropriate credit terms. It is essential to establish collection policies for problem accounts and consistently utilized them. 21 Best Practices In Accounts Receivable Management Send invoices as soon as possible, preferably on the day a job/project is completed or the earlier of when merchandise is shipped or delivered. (Deliver or include invoices, if possible.) Use electronic invoicing (e-mail or fax) when possible to speed collections and reduce G&A expenses. 22 Best Practices In Accounts Receivable Management - Bill change orders or additional work orders separately in order to avoid collection delays. Use electronic/fax invoicing, if possible. Require progress payments, when and if possible. Deposit all payment checks in the Bank on Best Practices In Accounts Receivable Management - Use electronic deposit/collection of payment checks to the fullest extent possible. Review accounts receivable agings weekly with the firm s Collection Manager or Controller. Have a designated employee handle collections for problem payors. the day of receipt. 23 24 6

Best Practices In Accounts Receivable Management - Clearly define ownership of customer relationships between the sales staff and accounting staff. Implement and utilize collection call segmentation based on invoice amount and/or relationship profitability. Provide trade discounts for early payments to customers/clients. Establish customer payments via credit cards (e.g., Visa, American Express, MasterCard or Discover Card). 25 Best Practices In Accounts Receivable Management - Conduct immediate review of all unapplied cash. Outsource customer billings and accounts receivable collections. Simplify product pricing to the extent possible in order to improve accounts receivable collections. Write-off past due accounts receivable balances with no higher management approval. Maintain a central customer order database that both the sales staff and the accounting staff have access. 26 Best Practices In Accounts Receivable Management - Subscribe to an on-line service for immediate and automatic notification of bankruptcy filings. Set-up automatic e-mail or fax of overdue invoices and letters Establish and utilize a collections call database. Implement a customer order exception tracking system that is utilized by both the sales staff and the accounting staff. 27 Best Practices In Accounts Receivable Management - Install and utilize payment deduction investigation software that is utilized by both the sales staff and the accounting staff. Conduct credit checks on all new customer relationships and pre-approve all customer credit levels based on an established credit policy. Add a receipt signature to invoices or outsource delivery services to FedEx, UPS, etc., where a signature is obtained to ensure delivery. E-mail customer invoices in Acrobat format to the extent possible to speed receivables collection and reduce postage expense. 28 7

Best Practices in Accounts Payable The accounts payable function is the most laborintensive of all accounting functions and is, therefore, an excellent source of labor savings if the correct best practices can be established. The basic process relating to accounts payable in most companies is to receive three types of information from three distinct sources: An invoice from a supplier; A purchase order from the company s purchasing department; and A proof of receipt from the company s receiving department. 29 Best Practices in Accounts Payable The accounts payable staff then matches the invoice, purchase order and proof of receipt to ensure that a requested payment is authorized and that the underlying merchandise has been received or the related services have been performed, and then pays the bill. The above process is extremely labor-intensive because there is such a large amount of matching of paperwork to undertake, but also because the invoice, purchase order and proof of receipt almost never match. Either the purchase order quantities or prices do not match what the supplier(s) is/are charging, or else the amount received does not match the quantities on the invoice or proof of receipt. 30 Best Practices in Accounts Payable The best practices relating to accounts receivable fall into four main categories, most of which are designed to reduce the matching of the invoice, purchase order and proof of receipt. Conceptually, the best practices relating to accounts receivable are as follows: The first category of best practices attempts to consolidate the number of invoices arriving from suppliers, thereby reducing the paperwork from this source. This includes the use of procurement cards and reducing the number of vendors and suppliers to the company. The second category of best practices focuses on reducing or eliminating the number of receiving documents. This includes substituting occasional audits for ongoing matching of the receiving documents and directly entering receipts into the company s computer system. 31 Best Practices in Accounts Payable The third category of best practices targets a reduction in the number of purchase orders that must be matched to the invoice and the proof of receipt. This includes using blanket purchase orders and automating three-way matching of documents via computer. The fourth category of best practices focuses on the accounts payable process, by attempting to reduce and automate the number of steps required before a company issues a payment to a supplier or vendor. This includes using a signature stamp or using an electronic payment method, such a wire transfer or automated clearinghouse ( ACH ) payments. 32 8

Best Practices in Accounts Payable The accounts payable process is one of the most convoluted of all the processes a company can adopt. First, it requires the collection of information from multiple departments (e.g., purchasing orders from the purchasing department, invoices from suppliers, and receiving documents from the receiving department). The process then involves match these documents, which almost always contain exceptions, and then tracking down someone to approve exceptions or sign checks, which then must be mailed to the supplier or vendor. 33 Best Practices in Accounts Payable The key to success is to re-engineer the entire accounts payable process by eliminating the paperwork, the multiple sources of information, and the various levels of approval. The only true best practice that addresses each of these fundamental issues of the accounts payable process is paying based on receipt. To pay based on receipt, one must begin with the concept of eliminating the accounts payable staff that performs the traditional matching process. Instead, the receiving staff determines that there is a purchase order at the time of receipt. If a purchase order exists, the computer automatically pays the supplier or vendor. 34 Part of the problem in the accounts payable process is that many accounting systems require a manager s (or several levels of managers ) approval on a supplier or vendor invoice before it can be paid. Though it is reasonable to have such a requirement if there is no purchase order for the invoice, many systems require the signature even if there is already a purchase order (which is a form of prior approval). Additionally, most accounting systems require a manager s signature on unapproved invoices, no matter how small the invoices may be. The result of these common approval procedures is that the accounts payable staff delivers invoices to managers for signatures and then waits until the documents are returned before proceeding further with the payment process. If the manager is not available to sign an invoice, then it sits; If the manager loses the invoice, the invoice is never paid, often resulting in an unhappy supplier who must send a new copy of the invoice for processing. 35 36 9

A best practice to eliminate this accounts payable dilemma is to limit approvals to a single event of document and, wherever possible, limit this approval to a period prior to the receipt of the supplier invoice. For example, an authorized signature on a purchase order should be sufficient overall approval for payment of an invoice. After all, if the signature was sufficient to authorize the initial purchase of the goods or service, then shouldn t the same signature be the required approval for the payment of the supplier s or vendor s bill? By shifting the approval to the purchase order, we avoid having the accounts payable staff track down someone after the supplier s invoice has been received, which effectively reduces time in the overall accounts payable process. Another variation is to use a signature on the purchase requisition, which comes before the purchase order. As long as either document is signed by an authorized person and sent to the accounts payable staff in advance, it does not matter which document is used as authorization. (The key is to use a single authorization before the supplier sends an invoice.) 37 38 One reason why so many companies require multiple approvals, both at the time of purchasing and at the time of payment, is that they do not have a sufficient degree of control over the purchase authorization process. There may not be any real check of authorization signatures when the purchase requisitions are converted into purchase orders, nor are there any required signature(s) when the purchase orders are issued to suppliers. In addition, the signature stamp used to sign checks may not be properly controlled. In each of the above cases, if there were tight control over the authorization used, there would only be a need for a single authorization. Using tight control over approvals that are give early in the accounts payable process results in a shorter processing cycle and fewer delays. 39 One of the most significant problems for the accounts payable staff is the continuing delay in receiving approvals of supplier and vendor invoices from authorized employees throughout a company. This problem can be avoided through the use of negative assurance for invoice approvals. Under this approval system, invoice copies are sent to authorizing employees, and are automatically paid when due unless the employees tell the accounts payable staff not to issue payment. 40 10

By focusing only on those invoices that may be unauthorized or incorrect, the accounting staff can process the vast majority of all submitted invoices without delay. The process can be further streamlined by digitizing an incoming invoice and e-mailing it to the authorizing employee. By doing so, employees can be reached even when they are off-site, as long as they check their e-mail on a regular basis. By linking the e-mail transmissions to workflow software, the accounting staff can designate how long an invoice can remain pending in a recipient s e-mail before it is automatically routed to another authorized person, thereby assuring that someone will see the invoice and respond if a potential problem exists. 41 Instead of using a purchase order or check to purchase merchandise or services, a company can use a procurement card as a payment option. A procurement card, which is also called a purchase card, is a credit card that has a few additional features. The purchase card is issued to those companies officers or employees who make frequent purchases, with instructions to continue making regular purchases with the card. This practice eliminates the multitude of supplier invoice by consolidating them into a single monthly credit card statement. 42 As there is always a risk of having a user purchase unauthorized items with a credit card (including cash advances or excessively expensive purchases), the purchase card adds a few features to control precisely what is purchased. It can have a limitation on the total daily amount purchased, the total amount purchased per transaction, or the total purchased per month. It may also limit purchases to specific stores or only to stores that fall within a specific category, such as hotels, rental car companies, restaurants or wholesale companies and nothing else. These built-in controls effectively reduce the risk that purchase cards can be misused. 43 Typically, once the company receives the credit card statement, it may be convoluted to determine the expense accounts to which all the charges belong. To facilitate the accounts payable process, a company can specify how the purchase card statement should be sorted by the credit card processing company. The sorting can be done as follows: Location of the purchase; Standard Industrial Classification (SIC) Code; Dollar amount; or Date of purchase. 44 11

The purchasing limitations and expense statement changes are the key differences between a regular credit card and the purchase card. It is even possible to receive an electronic transmission of the purchase card statement so that a company can do its own sorting of expenses. Another feature of the purchase card is Level II data. Level II consists of the following: A supplier s minority supplier status; Incorporation status; and Tax identification number (TIN). 45 46 Another option of a purchase card is the inclusion of Level III data reporting. Level III data reporting includes such line-item details as: Quantities; Product codes; Product descriptions; Freight and duty costs; and Such other information as needed to determine exactly what merchandise or service is being purchased with a company s procurement card. Most major national suppliers of credit cards, including American Express, MasterCard and Visa can supply both Level II and Level III purchase data. When purchase cards are distributed to a large portion of the employee base, there is always a risk that an employee will abuse the privilege purchase unauthorized items or purchase excessively. There are several ways to prevent this misuse and reduce its effects: Provide purchase cards only to employees responsible for the purchasing function, who can use them to pay for items for which they would otherwise issue a purchase order. Given that this step does not address the large quantity of small purchases that employees make, a second approach is a gradual introduction of purchase cards to employees who have responsibly demonstrate an ability to make small purchases. 47 48 12

The characteristics of the purchase card can also be altered, by limiting the dollar amount of purchases per transaction, per time period, per department or even the number of uses per day. An additional method of avoiding employee misuse of purchase cards is to have each employee sign an agreement that describes the policy for use and the sanctions that will be imposed by a company for misuse of the purchase cards. The use of purchase cards can actually interfere with existing internal procedures for the purchase of certain items, rendering those systems less efficient. For example, an automated materials planning and purchasing system for inventory can issue purchase orders to suppliers with no manual intervention; adding inventory items to the purchase card program would counter the integrity of the inventory planning and purchasing system, requiring more manual reconciliation of inventory. Capital asset purchases typically go through a detailed review and approval process before they are acquired. As such, they are not a good choice for capital asset purchases. 49 50 Electronic Data Interchange (EDI) involves the transfer of electronic documents between companies. These documents are sent in strictly defined formats, of which there are over one hundred different formats (one for each type of standard company transaction, including a supplier billing). These formats tend to be extremely large in volume and are complex because they are designed for use by multiple industries. However, most companies only need to full out a small portion of each EDI message. Once completed an EDI message is transmitted to the recipient. This can be done directly, but it usually goes to a third-party provider that maintains a mainframe computer that receives messages from a number of subscribing companies. The recipient then enters each EDI message into its own system for further processing. 51 52 13

Advantages of EDI: If properly installed, EDI allows for a great degree of automation by directly linking the transfer of information into a company s computer system with no manual data entry. EDI allows for the processing of large quantities of transactions without the expense of tracking down and fixing data-entry errors. Disadvantages of EDI: EDI is expensive to implement and only the largest transaction volumes will offset the cost of the initial set-up. 53 For example, if a company wants to receive all of its accounts payable billings by EDI, it must first contact each supplier and persuade it to send EDI transmissions, set-up procedures between the two companies for doing so, and then test the system before going live. In addition, the true labor savings will only be realized if the incoming EDI message are automatically entered into the recipient s computer system, which calls for the customized programming of an automated interface between the EDI system and the recipient s computer system (and this can be an expensive undertaking). Most suppliers will not want to participate in this system unless there are significant transaction volumes between them and their customer. 54 One portion of the accounts payable matching process is to physically match receiving information (usually a packaging slip or bill of lading) to a supplier invoice, thereby proving that the goods being paid for were actually received. The receiving documentation usually moves to the accounts payable staff over a period of several days (provided it is not lost or misplaced on the way). Once it arrives, the information may not match with the quantities being billed by the supplier. Consequently, the matching of the receiving documentation tends to be delayed, missing or cause for extra due diligence by the accounting staff. 55 The alternative approach is to enter receipts directly into the computer system, rather than forwarding receiving documents to the accounting department for manual matching to the supplier/vendor invoice. This approach has the advantage of instant communication of receipts to the accounting staff, since an entry into the company s database at the receiving dock will be instantly transmitted to the accounting staff. The accounting software can then compare the received amounts to the purchase order (which is already entered into the company s computer system). All that remains is for the accounting department staff to enter the purchase order number listed on the supplier s invoice to determine the quantity that was received and how much has yet to be paid. By adopting this approach, the majority of the accounts payable matching process is eliminated. 56 14

A centralized accounts payable department may have difficulty receiving documents from outlying locations or suppliers in to receive early payment discounts. The best way to avoid this problem is to find an alternative method for transmitting documents. A simple and relatively low-cost approach to solving this problem is to fax all documents to the accounts payable department. To do this effectively, there should be a separate fax machine that only processes incoming accounts payable documents. By adopting this procedure, it guarantees that the fax machine will not be occupied by outgoing fax transmissions. To make this system work even better, the accounting department should consider a fax rerouting capability that sends incoming faxes to an electronic mailbox if the fax machine is busy, with transmission occurring as soon as the fax machine is available to receive new income transmissions. 57 58 The major disadvantages of this system are: The cost of an additional telephone line to support the fax machine, the cost of the fax machine and a fax rerouting capability. There is also the risk that some faxes can be lost in transmission. 59 Utilize trade discounts to the fullest extent possible. Use controlled disbursement services and zero balance accounts to track incoming checks and use available cash more efficiently. Use the ACH payment system to the fullest extent possible. Use of ACH is already required for federal and state withholding taxes. 60 15

Questions Thank You For Your Attendance and Participation 61 62 16