This first section explains basic bank services. We include the bank account, bank deposits, and cheques. Each of these services contributes to either or both the con­trol or safeguarding of cash.

Bank Account

A bank account is a record set up by a bank for a customer, permitting this customer to deposit money for safeguarding and cheque withdrawals. To control access to a bank account, all persons authorized to use a bank account must sign a signature card, A signature card includes the signatures of each person authorized to sign cheques from the account.

Bank employees use signature cards to verify signatures on cheques. This lowers the risk of loss from forgery for both banks and customers. Many companies have more than one bank account. This is for various reasons including serving local needs and for special transactions such as payroll.

Bank Deposit

Each bank deposit is supported by a deposit slip. A deposit slip lists the items such as currency, coins, and cheques deposited along with each of their dollar amounts. The bank gives the customer a copy of the deposit slip or a deposit receipt as proof of the deposit.

Bank Cheque

To withdraw money from an account, a customer uses a cheque. A cheque is a document signed by the depositor instructing the bank to pay a specified amount of money to a designated recipient. A cheque involves three parties: a maker who signs the cheque, a payee who is the recipient, and a bank on which the cheque is drawn. The bank provides a depositor with cheques that are serially-numbered and imprinted with the name and address of both the depositor and bank.

Banks are used by most companies for many different services. One of their most important services is helping companies control cash and cash transactions. Banks safeguard cash, provide detailed and independent records of cash transac­tions, and are a source of cash financing. This section describes services and doc­uments provided by banking activities that increase managers’ control over cash.

You are an internal auditor for a company. You are currently making surprise counts of three $200 petty cash funds. You arrive at the office of one of the petty cashiers while she is on the telephone. You explain the purpose of your visit, and the petty cashier asks politely that you come back after lunch so that she can finish the business she’s conducting by long distance. You agree and return after lunch. The petty cashier opens the petty cashbox and shows you nine new $20 bills with consecutive serial numbers plus receipts totalling $20. Do you take further action or comment on these events in your report to management?

Recall that under a perpetual system, the Merchandise Inventory account is updated after each purchase and each sale. The Cost of Goods Sold account is also updated after each sale so that during the period the account balance reflects the periods total cost of goods sold to date.Under a periodic inventory system, the Merchandise Inventory account is updated only once each accounting period. This update occurs at the end of the period. During the next period, the Merchandise Inventory balance remains unchanged. It reflects the beginning inventory balance until it is updated again at the end of the period. Similarly, in a periodic inventory system, cost of goods sold is not recorded as each sale occurs. Instead, the total cost of goods sold during the period is computed at the end of the period.

A periodic inventory system requires updating the inventory account only at the end of a period to reflect the quantity and cost of both goods on hand and goods sold. It does not require continual updating of the inventory account. The com­pany records the cost of new merchandise in a temporary expense account called Purchases. When merchandise is soldi revenue is recorded but the cost of the merchandise sold is not yet recorded as a cost. When financial statements are prepared, the company takes a physical count of inventory by counting the quantities of merchandise on hand. Cost of merchandise on hand is determined by relating the quantities on hand to records showing each item’s original cost. This cost of merchandise on hand is used to compute cost of goods sold. The inventory account is then adjusted to reflect the amount computed from the physical count of inventory.

Periodic systems were historically used by companies such as hardware, drug, and department stores that sold large quantities of low-value items. Without today’s computers and scanners, it was not feasible for accounting systems to track such small items as pencils, toothpaste, paper clips, socks, and toothpicks through inventory and into customers’ hands.

We explained that prepaid expenses are assets when they are purchased and are recorded with debits to asset accounts. Adjusting entries transfer the costs that expire to expense accounts at the end of an accounting period.There is an acceptable alternative practice of recording all prepaid expenses with debits to expense accounts. If any prepaids remain unused or unexpired at the end of an accounting period, then adjusting entries must transfer the cost of the unused portions from expense accounts to prepaid expense (asset) accounts. The financial statements are identical under either procedure, but the adjusting entries are different.

To illustrate the accounting differences between these two practices, let’s look at Finlay Interiors’ cash payment for 24 months of insurance coverage beginning on January 1. Finlay Interiors recorded that payment with a debit to an asset account, but it could have been recorded as a debit to an expense account. 

We explained that prepaid expenses are assets when they are purchased and are recorded with debits to asset accounts. Adjusting entries transfer the costs that expire to expense accounts at the end of an accounting period.

There is an acceptable alternative practice of recording all prepaid expenses with debits to expense accounts. If any prepaids remain unused or unexpired at the end of an accounting period, then adjusting entries must transfer the cost of the unused portions from expense accounts to prepaid expense (asset) accounts. The financial statements are identical under either procedure, but the adjusting entries are different.

To illustrate the accounting differences between these two practices, let’s look at Finlay Interiors’ cash payment for 24 months of insurance coverage beginning on January 1. Finlay Interiors recorded that payment with a debit to an asset account, but it could have been recorded as a debit to an expense account.

If errors are discovered in either the journal or the ledger, they must be corrected. Our approach to correcting errors depends on the kind of error and when it is discovered.

If an error in a journal entry is discovered before the error is posted, it can be corrected in a manual system by drawing a line through the incorrect informa­tion. The correct information is written above it to create a record of change for the auditor. Many computerized systems allow the operator to replace the incor­rect information directly. If a correct amount in the journal is posted incorrectly to the ledger, we can correct it the same way.

Another case is when an error in a journal entry is not discovered until after it is posted. We usually do not erase incorrect entries in the journal and ledger. Instead, the usual practice is to correct the error in the original journal entry by creating another journal entry. This correcting entry removes the amount from the wrong account and records it to the correct account.

The second report in Exhibit 2.11 is the statement of owner’s equity for Finlay Interiors. Its heading lists the month as January 2001 because this statement describes events that happened during that month. The beginning balance of equity is measured as of the start of business on January Lit is zero because Finlay Interiors did not exist before then. An existing business reports the beginning balance as of the end of the prior reporting period (such as December 31 fora continuing business). Pinlay Interiors’ statement shows that $30,000 of equity is created by Finlay’s initial investment. It also shows the $2,400 of net income earned during the month. This item links the income statement to the statement of owner’s equity. The statement also reports Finlay s $600 withdrawal and Finlay Interiors’$31,800 equity balance at the end of the month.

The white flag is just a nose away…toward the Million dollar prize in cash savings for your business…

So far, in Inventory and Accounts Receivable, we’ve found $250,000 each in cash savings. Then we found another 250K in Sales and Marketing. And so, now, Accounts Payable is the final process within the Cash to Cash Cycle – and also the final $250,000.The cash cycle is undoubtedly the single most important process to optimize for any business – from when you spend money to when you get money.

Circling the Cash to Cash Cycle.

So let’s tie this back to accounts payable – the event that pays for the liability incurred by purchasing, which is for inventory required by manufacturing to meet demand. Sales generate this demand that creates the accounts receivables, which is turned into cash. And now we have come full circle and completed the discussion on the cash to cash cycle.

Increasing the Velocity of Accounts Payable Processes

Your accounts payable is a bit different than the other processes we have examined so far. The first three processes we looked at represented processes where the focus was on reducing the size of assets (inventory or accounts receivable) or expenses (marketing) and increasing the velocity or cycle time. But in accounts payable our focus is on increasing the size of the asset, while maintaining a solid credit rating – and increasing the velocity of the process.

Now let’s look at how to find $250,000 in accounts payable savings. If your organization has $500,000 in accounts payable each month, then STOP! We can find $250,000 in savings right here. Where, you ask? Increasing payables by 25% will produce $125,000 in cash plus $125,000 from automating tasks, taking more discounts, and managing the process better.

Service Business Procedures Case Study

An organization with $600,000 in monthly payables needed assistance. We examined their payables process to understand and quantify workflow, paper processing and credit issues. Then we designed and implemented a process to increase their use of payables and discounts, improve their payables cycle efficiency, and tie it to their purchasing and receivable cycles. We then reinvested $50,000 back into an Enterprise Resource Planning (ERP) program to automate some of the processes that weren’t automated already.

The metrics we developed reduced their purchasing & payables expenses by 25% and increased their efficiency from 50% to 75% within 2 months of implementing the new procedures. With these new processes and reports, the company now tracks payables cycle efficiency and average days payables, rather than just bills paid on time or outstanding balance, as the measure of their payables effectiveness. The result: an extra $300,000 in cash plus a 50% increase in process capability (capacity).

But how?

Methods to Design Your News Accounts Payable and Accounting Procedures

• Eliminate Paper. The single biggest cost for any purchasing and payables department is paper, including: purchase orders, purchase order follow-up, small-dollar purchases, delivery tracking & receipts, and vendor payments. Utilizing paperless invoices, Web-based supplier self-servicing, centralized vendor files, automated workflows for electronic or imaged invoices (see ERP below), and payment methods, such as business credit cards, Electronic Data Interchange (EDI) and Electronic Funds Transfer (EFT), can reduce paper handling costs by as much as 90%.

• Integrate ERP Systems. Enterprise Resource Planning (ERP) automates the purchasing and payables functions, which allows a company to get more work done with fewer personnel. Also, electronic invoice matching applications save time in retrieving paperwork. It is estimated that an ERP system can annually save an organization $300 per million in sales.

• Increase Payment Terms. Negotiate payment terms based on receipt of goods or the invoice. This can add one week or more to your terms, which can be 25% of 30 day terms. Use EFT for just-in-time payments to maximize your payables terms and minimizing the impact to your credit.

• Take Payment Discounts. If you are getting 2%/10 net 30 terms, then consider taking it. This means you are offered a 2% discount if you pay within 10 days, instead of the normal 30 day terms. This translates into an 18% return on your capital, and for many organizations this is a good return on your investment.

• Review Purchases. Purchasing is a continuous process that requires continuous review. Consider: transportation charges, expedited fees, odd lot penalties, new pricing, new products, consolidating vendors, new vendors or buying groups, payment terms, and more. Communicate with your suppliers to improve the process. And review and monitor everything to account for changes in your environment.

• Communicate with Suppliers. Communicate with your suppliers to improve the process. Ask suppliers to submit their invoices electronically. This will save you time, resources and losses due to waste.

• Eliminate Disputes. Disputes with your suppliers are typically the result of a problem with your purchasing/receiving process. When disputes occur, review your purchasing procedures to ensure that they are producing the correct metrics and that you are not forced to pay for your mistakes.

• Reduce Errors. Overpayments, payments made to the wrong vendors, fake invoices, or even late payments represent a common problem for payables. Increasing your focus on error control, along with written procedures and audits, can reduce these errors considerably.

• Train personnel. Provide your accounts payable staff with regular formal training. This will arm them with better knowledge of frauds, negotiating skills, and an understanding of the economics of payables – which will result in improved effectiveness.

Accounting Policies and Procedures for Cash in the Bank

In the past few weeks, we have showed you four parts of your financial statements that will each contribute $250,000 in cash savings. The last hurdle was Accounts Payable, and we sailed through it. And now we have crossed our final goal: $1,000,000!

Time was – and is – the key. All you have to do is own it. And, remember, next week we will put together each of the four elements of the cash to cash cycle, and look at how it affects the working capital of your business.