134 135
how finance works
Management accounting
80%
of small business
start-ups across
the world fail
because of
poor cash-flow
management
Factoring Transaction in which a
business passes its invoices a third
party (factor), which collects payment
from the customer for a commission
Accounts payable Payments a
business has to make to others
Accounts receivable Payments
a business is due to receive
Aging schedule A table charting
accounts payable and accounts
receivable according to their dates
Cash-flow gap Interval between
payments made and received
Cash conversion
Successful businesses convert their
product or service into cash inflows
before their bills are due. To make the
conversion process more efficient, a
business may speed up:
Customer purchase ordering
Order fulfillment and shipping
Customer invoicing
Accounts receivable collection
period
Payment and deposit
NEED TO KNOW
CASH DRIES UP
CASH IN HAND DECREASES
Managing a surplus
Move excess cash into a bank
account where it will earn interest,
or make profitable investments.
Use cash to upgrade equipment
to improve production efficiency.
Expand the business by taking
on new staff, developing products,
or buying other companies.
Pay creditors early to improve
credit credentials, or pay down
debt before it is due.
Managing a shortage
Increase sales by lowering prices,
or profit margins by raising them.
Issue invoices promptly and
pursue overdue payments.
Ask suppliers to extend credit.
Offer discounts on sales invoices
in return for faster payment.
Use an overdraft or short-term
loan to pay off pressing expenses.
Continue to forecast cash flow
and plan to avert future problems.
HANDLING THE FLOW
CASH
IN
CASH
OUT
Negative cash flow
Less cash is flowing into the
business than is flowing out. Over
time, the stock of cash will decrease
and the business will face difficulties.
Bankruptcy
If cash flowing out continues
to exceed cash flowing in, cash
stock levels will drop so low that
the business becomes insolvent—it
has no assets left to continue trading.
$
NO CASH
IN/OUT
NO CASH
IN/OUT
US_132-135_Cash_Flow.indd 135 15/12/2014 12:57
How it works
Every business needs to budget for anticipated
revenue and operating costs within the financial year.
Unlike capital budgeting, in which senior management
allocates what will be spent on specific projects or
assets, revenue budgeting focuses on the overall
projections for money coming in and money going out
for each month of the coming financial, or accounting,
year. Accountants compile operating budgets from
each manager in the business, along with expected
cash-flow projections for the business, to create a
master budget. The master budget can also include
figures for any financing that the company is expected
to need over the coming year. As the year progresses,
the projected budget and the actual money coming in
and going out are monitored on a daily, weekly, or
monthly basis, so that any deviations from the original
budget can be identified, and, if necessary, remedied.
Budgets
1%
of companies
worldwide made
accurate budget
forecasts, from
2004 to 2007
Setting and
controlling budgets
Budget-setting is a process that
takes place between the department
managers, senior management, and
finance department in a company to
establish and control the cost of each
department or project.
Setting the budget for a business involves planning the income and
expenditure for the accounting year. This is usually broken down into
months so that planned budget and actual figures can be compared.
Consultation
Senior management sets out
the company’s objectives to the
departmental managers. Each
manager is then responsible for
working out the budget required
by their individual department,
in order to meet those objectives
for the coming year.
Prepare the budget
The budget is usually based on the
accounting year, but broken down
into shorter periods. Departmental
managers submit their budgets to
senior management for approval.
These may cover areas such as
operating costs (salaries and supplies)
and administration (office expenses).
$
US_136-137_Budgets.indd 136 21/11/2014 16:38
136 137
How finance works
Management accounting
Planning, Programming, and Budgeting
Systems (PPBS) A budgeting system used
in public service organizations such as city
councils and hospitals
Virement An amount saved under one cost
heading in a budget is transferred to another
cost heading to compensate for overspend
Budget slack Deliberately underestimating
sales or overestimating expenses in a budget
There are two main approaches to setting budgets:
INCREMENTAL AND ZERO-BASED
NEED TO KNOW
Master budget
Once approved, the budgets from
each department are combined into
a master budget for the year, which
includes: a budgeted profit-and-loss
account, a projected balance sheet,
and a budgeted cash-flow statement
that typically shows a month-by-
month breakdown.
Measure performance
After each month (or equivalent time
period set in the budget), the actual
figures realized by the company are
compared with the original budget
projections. Variations are examined
closely to work out whether they are
significantly different from the figure
in the original budget.
Take action
If necessary, the budget is revised
to take into account any unforeseen
and continued expenditure, or any
savings that were not anticipated. If
income is less than expected, action
may be taken to alter departmental
processes or campaigns in order to
reach the targets set in the budget.
Incremental budget The
budget for the year ahead is
based on the previous year’s
budget. This budget takes
into account any changes,
such as inflation, which could
have an impact on the new
calculations. The downside
is that previous inaccuracies
may be carried forward.
Zero-base budget The coming
year’s budget starts afresh, with
no reference to previous years.
This means that each item
entered into the budget is
carefully scrutinized and has to
be justified by the department
managers. This method makes
it easier to see the full cost of all
planned changes.
$
$
$
US_136-137_Budgets.indd 137 21/11/2014 16:38
136 137
How finance works
Management accounting
Planning, Programming, and Budgeting
Systems (PPBS) A budgeting system used
in public service organizations such as city
councils and hospitals
Virement An amount saved under one cost
heading in a budget is transferred to another
cost heading to compensate for overspend
Budget slack Deliberately underestimating
sales or overestimating expenses in a budget
There are two main approaches to setting budgets:
INCREMENTAL AND ZERO-BASED
NEED TO KNOW
Master budget
Once approved, the budgets from
each department are combined into
a master budget for the year, which
includes: a budgeted profit-and-loss
account, a projected balance sheet,
and a budgeted cash-flow statement
that typically shows a month-by-
month breakdown.
Measure performance
After each month (or equivalent time
period set in the budget), the actual
figures realized by the company are
compared with the original budget
projections. Variations are examined
closely to work out whether they are
significantly different from the figure
in the original budget.
Take action
If necessary, the budget is revised
to take into account any unforeseen
and continued expenditure, or any
savings that were not anticipated. If
income is less than expected, action
may be taken to alter departmental
processes or campaigns in order to
reach the targets set in the budget.
Incremental budget The
budget for the year ahead is
based on the previous year’s
budget. This budget takes
into account any changes,
such as inflation, which could
have an impact on the new
calculations. The downside
is that previous inaccuracies
may be carried forward.
Zero-base budget The coming
year’s budget starts afresh, with
no reference to previous years.
This means that each item
entered into the budget is
carefully scrutinized and has to
be justified by the department
managers. This method makes
it easier to see the full cost of all
planned changes.
$
$
$
US_136-137_Budgets.indd 137 21/11/2014 16:38
How it works
Fixed assets are items that enable
a business to operate. They tend
to be long-term holdings and
cannot be easily converted
into cash. Fixed assets can be
categorized as either tangible or
intangible: tangible assets are
material objects, while intangible
assets have no physical form.
Current assets are held for the
short term and used mainly for
trading. The most important
category in terms of generating
revenue is current assets. The key
component of these is inventory.
Inventory can be finished goods
ready for sale, but it can also be
the raw materials that will be
used for producing the goods.
Assets and inventory
Assets and inventory in practice
The partial balance sheets below show the current assets of a branch of Super Sports Inc.,
a sportswear and sports accessories company. These assets include cash in the bank and
inventory held by the company. The inventory in this case consists of all the items in the
shop that are ready for sale.
A company’s possessions, or assets, are divided into two categories:
fixed (or long-term) assets and current (or short-term) assets. Current
assets consist of cash in the bank and inventory.
Assets
Cash at bank
Inventories
Total assets
$
12,000
22,000
34,000
Assets
Cash at bank
Inventories
Total assets
$
54,000
0
54,000
Super Sports Inc.
May 31
Super Sports Inc.
June 15
Balance sheet as of May 31
The “Assets” section of the balance sheet shows that the
company holds $22,000 worth of inventory (or goods) at
this point in time, as well as $12,000 cash in the bank.
Balance sheet as of June 15
Two weeks later, the company sells all of its inventory for
$42,000 and receives payment for this sale on the same day.
This means that total assets have risen by $20,000—the
profit made on the sale of the inventory—and increases
the amount of cash in the bank by $42,000.
Asset valuation A method of
assessing the value of a company’s
holdings. Asset valuations may
take place prior to a merger or
the sale of the business, or for
insurance purposes
NEED TO KNOW
US_138-139_Assets_And_Inventory.indd 138 21/11/2014 14:25
138 139
how finance works
Management accounting
Inventory can include three types of stock, depending on the kind of business being
carried out: raw materials, unfinished goods, and finished goods. See pp.316–317.
TYPES OF INVENTORY
Raw materials
Materials and components scheduled
for use in making a product. For
example, a chocolate factory will have:
Ingredients in the form of sugar,
cocoa mass, cocoa butter, additives,
flavorings, and perhaps milk or nuts.
Foil, plastic, and paper for the
wrappers and packaging
Work in progress
Materials and components that have
begun their transformation into
finished goods; these may be referred
to as “unfinished goods.” For instance,
a graphic designer will have:
Layouts and designs that are
being developed and are awaiting
client approval
Finished goods
The stock of completed products, or
goods ready for sale to customers.
A bookstore, for example, will have:
Hardback and paperback books
of various genres and formats
supplied by publishing houses
Gift items such as greeting cards
and notebooks
V
E
H
I
C
L
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S
L
A
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H
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D
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A
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T
I
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S
Brands and designs,
creative innovation
Legally protected words
and symbols
Own brands, including
value and luxury ranges
Internet portal for
online sales
Licensing revenue
streams
Trucks and branded
company cars
Retail outlets plus
company he adquar ters
Store displays and
back office furniture
Computers for
administrative work
Warehouse and
distribution equipment
Intangible fixed assets
Tangible fixed assets
Types of fixed assets
Super Sports Inc. owns a range of tangible and intangible fixed
assets. Compared to tangible fixed assets, the worth of
intangible fixed assets can sometimes be harder to evaluate.
©
US_138-139_Assets_And_Inventory.indd 139 21/11/2014 14:25
138 139
how finance works
Management accounting
Inventory can include three types of stock, depending on the kind of business being
carried out: raw materials, unfinished goods, and finished goods. See pp.316–317.
TYPES OF INVENTORY
Raw materials
Materials and components scheduled
for use in making a product. For
example, a chocolate factory will have:
Ingredients in the form of sugar,
cocoa mass, cocoa butter, additives,
flavorings, and perhaps milk or nuts.
Foil, plastic, and paper for the
wrappers and packaging
Work in progress
Materials and components that have
begun their transformation into
finished goods; these may be referred
to as “unfinished goods.” For instance,
a graphic designer will have:
Layouts and designs that are
being developed and are awaiting
client approval
Finished goods
The stock of completed products, or
goods ready for sale to customers.
A bookstore, for example, will have:
Hardback and paperback books
of various genres and formats
supplied by publishing houses
Gift items such as greeting cards
and notebooks
V
E
H
I
C
L
E
S
L
A
N
D
A
N
D
P
R
O
P
E
R
T
Y
F
U
R
N
I
T
U
R
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C
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M
P
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Q
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P
M
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T
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A
N
D
M
A
C
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I
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I
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T
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L
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C
T
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A
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P
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P
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T
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A
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K
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B
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C
O
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P
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T
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R
S
O
F
T
W
A
R
E
C
O
P
Y
R
I
G
H
T
A
N
D
R
O
Y
A
L
T
I
E
S
Brands and designs,
creative innovation
Legally protected words
and symbols
Own brands, including
value and luxury ranges
Internet portal for
online sales
Licensing revenue
streams
Trucks and branded
company cars
Retail outlets plus
company he adquar ters
Store displays and
back office furniture
Computers for
administrative work
Warehouse and
distribution equipment
Intangible fixed assets
Tangible fixed assets
Types of fixed assets
Super Sports Inc. owns a range of tangible and intangible fixed
assets. Compared to tangible fixed assets, the worth of
intangible fixed assets can sometimes be harder to evaluate.
©
US_138-139_Assets_And_Inventory.indd 139 21/11/2014 14:25
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