Four Main Accounting Cycles

Accounting transactions in the form of sales invoices, receipts, purchase invoices, checks, and payroll entries are posted to the appropriate journals. Simultaneously — as a form of internal control — these postings are recorded in the general ledger, or “GL”. The GL accumulates all transaction activity, where it is organized by account class.

Various reports, including financial statements, can be prepared from the data collected in the GL.  Corrections or necessary adjustments can be made to the general ledger by creating adjusting journal entries, posted to the general journal.

1. Revenue Cycle

Order Entry. Invoices entered through direct entry, sales orders, or a point-of-sale (POS) system, such as a cash register, are posted to the sales journal.  These entries also accumulate on the accounts receivable ledger, organized by customer.  If the business maintains an inventory, the posting of sales also affects the inventory ledger. Finally, all sales journal activity is also posted to the GL.  A discussion of your revenue cycle should be covered in your revenue procedures.

Cash Receipts / Deposits. Receipts on sales and other bank deposits are posted to the cash receipts journal.  Sales receipt information also accumulates on the accounts receivable ledger, organized by customer.  These postings are also entered on the bank account ledger.  Finally, all cash receipts journal activity is also posted to the GL.

Accounts Receivable. Accounts Receivable is a separate journal that records both sales and cash receipt data by customer.  The data comes from the postings to the cash receipts journal and the sales invoice journal.

2. Purchase Cycle

Purchase Orders / Purchasing. Invoices entered through direct entry, or through purchase orders, are posted to the purchase journal.  These entries also accumulate on the accounts payable ledger, organized by vendor.  If the business maintains an inventory, the posting of purchases also affects the inventory ledger.  Finally, all purchase journal activity is posted to the general ledger.

Cash Disbursements / Checks. Payments on account or for expenses are posted to the cash disbursement journal.  Payment on account information also accumulates on the accounts payable ledger, organized by vendor; these postings are also entered on the bank account ledger.   Finally, all cash disbursement journal activity is posted to the general ledger.

Accounts Payable. Accounts Payable is a separate journal that records both sales and cash receipt data by vendor.  The data comes from the postings to the cash disbursement journal and the purchase journal.

3. Payroll Cycle

Payroll data by employees are entered into the payroll journal.  These postings are also entered in the cash disbursements journal and the payroll ledger.  Finally, all payroll journal activity is also posted to the GL.

4. General Journal Cycle

Corrections or adjustments to the above major transaction cycles can be made through adjusting journal entries, posted directly to the general ledger. These are also compiled in a separate journal, known as the “general journal”.

How Does “Posting” Work?

The specific postings, as outlined in the cycles above, do not necessarily take place as separate steps, especially in computerized environments.  There are only two basic posting methods in computerized accounting systems: real-time and batch posting.

In real-time posting, the source transaction (check, bill, payment, receipt, etc.) is posted to the specific journal and any related subsidiary ledger (e.g., accounts receivable, accounts payable, inventory) and is simultaneously posted to the general ledger.

In batch posting, the journals and subsidiary ledgers are posted, but entries are not yet posted to the general ledger.  Posting these journals to the general ledger is done separately.  Typically, a group of transactions (often a full day’s worth) is entered.  Later, after the journals are reviewed for accuracy, this entire day’s group, or “batch”, is posted to the general ledger.

To understand this posting process better, it would be helpful to follow specific transactions through a sample company.  First, however, we need to define various accounting terms and concepts.

Accounting Terms and Concepts

Double-Entry Accounting

We can thank the 14^th and 15^th century Italian merchants for developing the double-entry system of accounting that we still use today.  It is widely believed that Benedetto Cotrugli (aka, Benedikt Kotruljevic) was the first to document this concept of double-entry accounting (in his accounting policies and procedures, perhaps?).  In 1458, he wrote Delia Mercatura et del Mercante Perfetto (Of Trading and the Perfect Trader), which included a brief chapter describing many of the features of double-entry accounting.

In 1494, Luca Pacioli, from San Sepulcro in medieval Tuscany, published the Summa de Arithmetica‘s 36 short chapters on bookkeeping (entitled De Computis et Scripturis, or “Of Reckonings and Writings”) so the subjects of the Duke of Urbino could learn how to conduct business and provide the trader with a fast, accurate method to determine his assets and liabilities.

For many centuries before this, commercial transactions had been recorded — journalized — on paper, papyrus, or clay tablets.  However, these journals provided only totals of transaction groupings. It was the Italians who first recognized that it is impossible for a business transaction to occur without affecting at least TWO accounts. There can never be only one effect from a transaction — there has to be balance.

An Italian farmer sells wood to a shipbuilder for 400 ducats. To account for this transaction, he would record, “wood sale – 400 ducats”. His “sales” account has increased by 400 ducats. But, what else has happened?  What other account was affected? His “cash” account also increased by 400 ducats.

What if he sells his wood to the shipbuilder on credit and receives no cash? In this case, it’s his “accounts receivable” account that increases by 400 ducats.

There Are Always Two Sides – at Least – to Every Transaction

Later, when the shipbuilder pays his debt to the farmer, the farmer records an increase in his cash account and a decrease in his accounts receivable by 400 ducats each.  You can see that an integral feature of the double-entry method is that transactions must equal. At the time, this new method was heralded as an astounding discovery and was described as “a magic mirror, in which the adept sees both himself and others.”

Today, double-entry bookkeeping is used for recording a transaction in two or more different places, or ledger accounts.  This practice simplifies finding errors since the totals of both ledger accounts should agree.

Debits = Credits

Bookkeeping entries are divided into debits and credits. The debit side is typically the left side of the ledger page and credits are on the right.  The origin of the words “debit” and “credit” come from the simple concept: “who owes you” and “to whom you owe”.

Debits are transactions relating to purchases, expenses, or increases in an organization’s assets. Credits are transactions related to revenues, or an increase in the firm’s equity and liabilities. Recording a transaction requires a debit and a credit entry.  If the entries are correctly recorded, the totals on both sides of the ledger agree.

The double-entry bookkeeping method — listing debits in one column and credits in the other — requires that the debit and credit columns add up to zero. The double-entry bookkeeping method is still the basis for tracking financial affairs, almost six centuries .   The following list illustrates the effect of posting a debit or credit entry on each major account type:

These account types are the general account classifications used in all accounting systems.  They are also used to organize the general ledger, from which financial statements are developed.  Your accounting policies and procedures should take into account the main accounting cycles, accounting methods, and accounting terms to guide the operation of your accounting system.

Required Policies Procedures

Only company policies and procedures required by standards, regulations or company strategy must be developed.  ISO 9001 requires only six procedures, so why do many companies feel they need to write 40 or more procedures to achieve control?  Occasional users need procedures as a reminder of procedure steps that they do not perform very often.  Frequent or regular users do not need, and often times do not use, the procedure.  So how are those other 34-plus procedures used?  Most procedures are used to train infrequent users.  For training purposes you may only need a process map.  Are you using your procedures to make up for a weak training program?

Your Policies Procedures Template Design

When you do write procedures you will need to standardize on a procedure template design.  Start your policies and procedures template design by thinking through your document and record control procedures.  Your procedure template design should make room for a header block to ensure your procedure communicates your purpose and scope.

Add a Title, Policy, Purpose, Scope, Responsibility, and Definitions section to help people understand your procedure. Clear department responsibilities identify who does what and helps to declare which positions are mentioned in your procedure with a synopsis of what is expected for each position. Key term definitions reduce confusion; industry jargon should be explained in the definitions section of your procedure to help new procedure users.

Writing Policies Procedures

Before you start writing procedures from scratch, look around for examples, or templates, that you can copy.  Pre-written procedures will speed up your development, reduce your research time, and turn writing procedures into editing procedures.  I’ve found it’s a lot easier to edit a procedure than to write one from scratch, depending on the procedure.  Many procedures are really common using business best practices, so why reinvent the wheel?

If you have to write a procedure from scratch, start writing procedures using active voice construction to reduce task confusion. Subject, verb, object provides clear active voice construction for your procedure.  For example, “Accounts Receivable invoices customers” is clearer and contains fewer words than “customers are invoiced by Accounts Receivable.”  The extra “are” and “by” make the sentence longer, put the subject last, and force the reader to stop and reread the action.  Be direct and to the point — use the active voice.

Add references to related documents to improve your procedures’ usability.  Clearly note when your procedure refers to other procedures or forms.  There’s nothing worse than following a procedure and coming to a passage that refers to a company form and…that’s it. You don’t know what the form looks like, where you might find it, or what version of the form you need.  Putting an example of the form, with an explanation, in the procedure will save you and your users time during procedure training and implementation.

List applicable laws or regulations: clearly communicate your company’s need for compliance.  If you’re implementing a records retention procedure, references to IRS or equal employment opportunity (EEO) passages, for example, provide a brief synopsis and help you implement your procedures.

How to Write Policies and Procedures

Policies Procedures Overhead

Large organizations have a large number of procedures.  They have a lot of staff, business operations, and economy of scale to make their procedures work.  Smaller businesses should remember — the more business procedures you write, the more business procedures you have to edit, implement, train, audit, and review.  More procedures may also produce more audit findings in addition to more updates, more documents to control, and more administration overhead.

Many companies fail to plan for this administration and procedure overhead, so it should come as no surprise that their procedures don’t work as well as expected.  Every procedure becomes outdated, eventually.  Also, due to infrequent maintenance and use, some procedures are overlooked when it’s time to update them.  This can result in repeated procedure audit findings or, worse, repeated waste, fraud, and abuse which the procedures were intended to reduce.

The lean thinking solution is (a) to write only procedures that you absolutely have to write to conform to requirements and (b) to improve your training program to build competent and skilled employees instead of writing procedures you don’t have the time or budget to maintain.

Next week, we’ll cover policies and procedures implementation and training.  It’s much easier to comply with standards and train employees when you’re working with written procedures.  If you’re interested in learning more about your procedures, call or e-mail us for a procedure review of your written procedures.  We’re happy to provide feedback on what you’re using and tell you how you can improve your processes.

How can you use the individual steps of your process procedures journey to focus your business on:

• Adapting your core business processes to process change?
• Building repeatable business processes?
• Adhering to process standards or regulations?
• Managing your business processes more effectively?

Each step of your process procedures project results in an important milestone being reached.  Your entire process procedures project will move along better and quicker, with better results, if you achieve each milestone.

Figure 1 depicts the business process procedures journey work flow.  The journey starts with project management.  The extent of a business process change can be large or small — they may or may not require written procedures — but even small process changes require basic project management to avoid having the law of unintended consequences catch up with them.

1. Process Procedures Project Management

To get the buy-in of your employees, start your process procedures project with a project charter that focuses your team on clear project goals and objectives.  For example, if you’re working on an accounts receivable process, be sure receivables clerks consistently follow the process.

Your process procedures project plan should allow time for the six steps in your process procedures journey: allow about 12% for project planning, 13% for process design, 25% for procedure writing, and 50% for process procedure implementation, training, process auditing, and a management review at the end of the project (Figure 2).

Figure 2 – Process Procedures Project Time

Process procedures project management key milestone: completion of your project charter and project plan.

2. Process Mapping and Process Design

Your procedures process map should include the sequence of process steps with clearly defined inputs, documents, and records.  Make a special note of the process flow metrics, responsibilities, and goals.  For example, an accounts receivable process should note the invoices per hour processed, who is responsible for cash, write-off, or discount approvals, and how close the process is to the goal of collecting within thirty days.  This information will help with later procedure writing, process training, and process auditing.

For many business processes, a process map may be the only documentation needed.  Not all processes require procedures, work instructions, or anything more than a process map.  In fact, a form may be all you need.  It is really a matter of scale: the more employees you have involved in a given function — the more complex it is — the more formal process documentation you’ll need.

Process procedures process mapping and design key milestone: complete “current state” process map with process data.

Next week, we’ll cover writing policies and procedures.  Procedure writing is a result of formal, required compliance and training.  It is often much easier to comply with standards - and train employees – when you work with a written procedure.

If you’re interested in learning more about your procedures, e-mail us at info@bizmanualz.com or call us at 314-863-5079 for a procedure review.  We’re happy to provide feedback on what you’re currently using and show you how we can help you improve your processes.

High-Level Process Map

A High-Level Process Map describes all of the core processes within an organization.  For example, ISO 9001 requires that the sequence and interaction of the Quality Management System processes are determined.  One way to demonstrate that processes are “determined” is through a high-level process map.

Figure 1 shows nine core processes that make up the Order-To-Cash Cycle, their sequence and interaction, thus fulfilling the basic ISO 9001 requirement.  The color coded boxes show the three main process flows or cycles in your business:

• Red is your Order Cycle (Purchasing + Production < Sales);
• Blue is your Just-In-Time (JIT) Production Cycle (Shipping = Receiving + Production); and
• Green is your Cash Cycle (Inventory + A/R – Payables > 0); which taken together make up your Order to Cash Cycle.

Inputs/outputs are labeled, information flows are indicated with a dotted line, and the material flow is a solid line (black for inventory and red indicating the primary material flow).  If you need more detail, then each of the nine processes can further be explained separately in a lower-level process map.  The term “process map” does not refer to the scope of a process being high-level, low-level, or very detailed.  A process map is focused on the activity flow, order, or sequence and interaction.

Figure 1: High-level process maps show all core processes within an organization

Low-Level Process Map

The main difference between a high-level and low-level process map is one of scope.  The process flow has not changed, just the scope of what we are looking at.  The Order-To-Cash Cycle has nine processes identified but each process can be further subdivided into sub-processes.  Each sub-process makes up a low-level process map or process flow chart.  A low-level process map is an area of a high-level process map that we have zoomed into for more detail.

For example: the Accounts Receivable (A/R) Cycle is comprised of customer billing, credit, and collections.  If we take a look at just the credit approval portion (Figure 2) of the whole A/R cycle we see that there are five main steps: sales call, order entry, credit check, review A/R balance, and calculate credit terms. There are three UML symbols used: square for process steps, diamond for decisions and an odd looking square with a curved bottom representing data.  Decision diamonds produce an alternative flow that here represents either an “OK” or “Bad Credit” decision, which requires a new sales call to resolve.

Figure 2: Credit Approval Process Flow Chart

Low-level process maps can provide a lot of detail for analysis and can be used in place of textual procedures for simple processes.  If you want to “lean out” your documentation for ISO 9001 then flowcharts can simplify your procedures and reduce unnecessary paperwork.  Organizations with highly trained employees can benefit by using simple process maps.

One problem with low-level process maps is that sometimes it is hard to determine who is responsible for which activity.  Another is that they may not conform very well to the SIPOC format we prefer.  In this case a Cross Functional or “Swim Lanes” Map can be used to convey individual responsibilities or departmental roles within an organization.

Cross Functional or “Swim Lanes” Map

Cross Functional process maps have the same UML flowchart symbols used in the low-level process map example.  Only now, four cross functional swim lanes have been used to identify who is responsible for each element, decision or data.  You can have any number of swim lanes in your map, although as a practical limit you may want to make it fewer than ten for clarity.

In Figure 3, the first band, the customer is clearly responsible for making a “buying” decision and must complete the credit form.  The sales department is the second band and must respond to sales calls, receive the credit information (form), enter the order, and produce an order form.  The order form is sent to the credit department, which compares the data to the credit criteria issued by management.  If everything looks “OK” then credit reviews the customer’s existing A/R balances for credit capacity, and then calculates the credit terms.  Management is responsible for preparing a “credit issued” report and overseeing the credit approval process.

Figure 3: Credit Approval Swim Lanes Map

Swim lanes are really good at depicting responsibilities and with no loss in the low-level process flowchart information.  Suppliers and customers are obvious and it does conform to our SIPOC format.  Although, we still see alternative backflow present in the “bad credit” decision.  The problem with alternative flow is they can make it hard to follow the process.  A better method would be to use “single-piece” flow (the path a single product takes without alternative flows) and eliminate alternative flows such as in a Document Map.  We will present Document and Value Stream maps next week.

Continued in part II.

When you deliver goods or services and you extend a business customer credit by accepting a promise to pay later through an invoice, then in a sense you are loaning your customers cash.  What steps can you take to make sure you get your cash back?  If you use good cash management practices to protect yourself from your employees and co-workers, then shouldn’t you be taking the same precautions with those outside your business?

Your Credit Policies Are a Part of Proper Cash Management

Of course, we are talking about a proper credit policy for clearly establishing the process of determining who can receive credit (can “promise” to pay later) and how much credit they are allowed.  Since determining credit may not always be a straightforward matter, a credit manual that includes credit policies and credit procedures, as well as clear explanations of the strategy or intent behind the policy, can be very useful.  Communicating the purpose behind credit policies can be a great help to those making the credit decisions.

Clearly communicating information about the how the company wants to extend credit is one important goal of your credit manual, credit policy and procedures.  Another important goal is to create consistency in how you handle and extend your business customer credit, both internally and externally.  But most importantly, your credit policy is about risk reduction.  It should be created in advance and take into account such things as its effect on sales, the impact on the company’s cash flow, and legal liability.

A Credit Manual Communicates Credit Policy and Intent

Internally, the credit manual can be an instrument to get various departments on the same page when it comes to customer credit.  For example, the accounts receivable department and the sales department are frequently at odds regarding what the credit policy should be.  Accounts receivable wants tight credit so they can collect within the proper period and not deal with delinquent accounts.  Sales, obviously, wants to book sales and they are not prone to turning away customers.  It is management’s job to establish clear credit policies and clear credit procedures, as well as explain the reasoning, in order to minimize the inherent conflict created by varied interests of these two departments.

Although it is frequently overlooked, part of the credit process should be regular communication between the various departments involved with using the credit policy manual.  Imagine the synergy created when accounts receivable, collections, sales and marketing, and even design and production all agree and cooperate in managing business customer credit.   The sales department knows and agrees not to waste its efforts on customers who don’t pay, and those making credit decisions know and agree when exceptions need to be made.

A Clear Credit Policy Helps Extend Credit Wisely

Besides establishing consistency internally, the credit manual can also ensure consistent and fair treatment for external customers.  The ability to extend short term credit is an important business tool, and if customers feel they are being treated unfairly or without a modicum of trust or respect – it can mean lost business.  When it comes to completing credit applications, references and credit checks, a certain level of consistency is expected, and this is especially true for making credit decisions.  The name or size of the company should not be a major factor in deciding who gets credit.

For example, I recently worked with training at a large construction company, and one of their regular customers was somewhat of a celebrity businessman.  Apparently, as a matter of practice, this well-known businessman delayed payment of owed invoices until they fell into collections, and then he would attempt to negotiate to a lesser settlement amount.  Eventually, however, the construction company had to tell their customer “you’re fired.”  By the time they considered the delay, the collection efforts, and the reduced payment, they were lucky to break even.

Apparently, this person relied on people wanting to do business with him because of his celebrity status.  You can’t, however, put a customer’s well-known name or brand in the bank to cover your payroll and your own accounts payable.  Your company is better off finding lesser known customers who pay their bills.  Consistent and fair company credit policies can help make sure that happens.

Cash Controls Include Company Credit Policy

Your credit manual and credit policies and procedures are directly related to protecting your cash, and you should understand that component as you develop and update them.  But just as critical as development of the credit manual is how clearly you communicate your policies and procedures clearly to all affected parties in your organization.  Poor credit practice is tantamount to leaving you cash drawer open… maybe no one will take advantage of your carelessness, but why take that chance?

The articles in February revolved around financial issues such as financial controls, working capital, return on investment and cash flows.

Discussions of improving processes are too commonly relegated to the production floor. Is it any less important for your office processes to function effectively and efficiently? How well does you company manage financial aspects like working capital, debt and investments, and leasing? These are just as vital to success as how efficiently production operates. Yet, few companies attempt to understand and improve finance processes to the same degree.

Meaningful Financial Controls For Positive Results

Do you know if you are making money on the cash you borrow? Or how about the assets you deploy like accounts receivable, inventory, or cash? What about the asset acquisitions you make? These are hard questions to ask for some but when it comes to business finance, these are the questions you should be asking – before you raise debt or equity capital.

Read more about financial controls and positive results;

Do You Have Enough Capital ?

Your capital needs are based on your revenue growth and your cash flow situation. Revenue growth comes from increasing the sales of your products or services, which in turn requires increases in expenses, assets, and working capital to fulfill those sales. This may seem obvious, but what is not so obvious is that there is a ceiling to this growth. Your growth is limited to your growth in equity.

Read more about capital needs and cash flows;

What Is Your Business’ Return On Investment ?

Returns are a function of risk; typically the higher the return the greater the risk. Thirty-year government bonds are low risk with returns in the 3-5% range. The overall stock market is more risky but produces an 8-13% return. Small or new businesses are considered the most risky, which is one reason why venture capitalists require average returns of 25-30%.

Read more about your business’ return on investment;

Putting Your Financial Resources To Work

Working capital is the money it takes to run your business on a daily, weekly, and monthly basis. It is the money used to pay your suppliers for materials and the money needed to pay for the goods and services (i.e. inventory and payroll) you have used while you wait for your customers to pay you.

Read more about working capital and financial resources;

Taking control of your financial processes increases the chances of your business’ success. Later this month, Bizmanualz will be releasing the Finance Policies, Procedures & Forms manual, introducing the concept of well-defined and controlled processes to Finance. It can be the first step in understanding your financial processes, and ensuring you receive maximum benefit from your financial resources.

On That Note

Answer to this month’s question:

Treating important company activities like finance from a process point of view is one method to realizing improved performance. When it comes to managing processes, finance is not that different than producing products and services. Productively using financial resources avoids undesirable results like big receivable/payable balances, low returns or unhealthy debt-equity ratios. Improved financial processes can result in effective financial controls and contribute to the company’s success.

Please feel free to contact us with any questions or comments. Our policies, procedures and processes articles site has tons of useful information. Also, please let us know if you’d like any specific topic addressed in our future articles.

Regards,
Chris
Bizmanualz

Our final topic on finance processes is about working capital. Working capital is the money it takes to run your business on a daily, weekly, and monthly basis. It is the money used to pay your suppliers for materials and the money needed to pay for the goods and services (i.e. inventory and payroll) you have used while you wait for your customers to pay you.

There are three important areas that companies should actively manage in order to get the most from their working capital. Here’s how they are related:

working capital = accounts receivable + inventory – accounts payable

Accounts Payable

Accounts payable is perhaps the easiest process to control because it simply involves paying the bills. But paying bills shouldn’t just be left to chance; there should be clear policies and goals that direct these activities. But generally, when it comes to paying bills, The Golden Rule should apply. Treat others’ invoices as you wish others would treat your invoice. Basically, that means pay it on time according to the terms. There may be no advantage in paying early, but purposely paying late as a working capital management tool is unprofessional and can negatively impact your business.

You may think you are getting away with paying your bills late, but in reality, if the organization you’re paying late has their act together, then your delayed payment may eventually result in increased prices or reduced service levels. While you may be the customer, do you really want to run you business in a way that elicits frowns and curses when your name is mentioned? Building such a negative reputation can have long term detrimental repercussions.

Ensure you policy states that payment will be made according to terms, with a goal of mailing payment five business days prior to the due date or having funds transferred on the due date for electronic payments (and a supporting measurement that clearly indicates performance in relationship to the goal). The accounts payable policy should also clearly state when invoices should be paid early.

Accounts Receivable

The cash flowing into your business as a result of customers paying invoices is crucial in managing your business’ working capital. Your organization should be actively measuring Days Sales Outstanding (DSO). DSO is the average number of days it takes to collect payment after the sale was made. Typically calculated as [(Accounts Receivable / Sales) X (Days)]. Days would be determined by the period for which you are calculating DSO; for example 30 if you calculate it monthly and 90 if you calculate it quarterly.

One key to managing Account Receivable is to remove delay in invoicing customers after shipment of an order or delivery of a service. These delays consume cash available as working capital. Set a goal to invoice customers immediately after fulfillment. If it currently takes 10 days to invoice a customer, then the goal should be to do it in 5. If it currently takes 5 then the goal should be 2 days. Finding ways to reduce the DSO frees cash formally tied up in receivables so it can be used in ways that provides return and fuels growth.

Prompt invoicing is the most important method to reduce DSO. It is something you have direct control over, plus, why should customers be conscientious about paying your invoice in a timely way if your make little effort to send invoices promptly?

Inventory Management

Including inventory as a finance function sometimes causes confusion and skepticism. There is no doubt, however, that inventory consumes financial resources; whether in the form of purchased materials/parts, work-in-process, or finished goods. Those responsible for managing the company’s financial resources and performance should also have the ability to oversee and monitor all three types of inventory.

The purchasing representative might believe they are getting a good deal by buying one years worth of parts, and perhaps they are. But making such decisions impacts the overall financial resources consumed by inventory, especially when you include the cost of ownership.

The responsible financial authority should stay informed of inventory performance, and in response set clear policies and goals for reducing and managing inventory levels through metrics such as Inventory Turns (the number of times that a company’s inventory cycles or turns over per year), Days Inventory (the average number of days of inventory on hand per accounting period), Average Inventory (the starting inventory number at the start of a period minus the ending period inventory number divided by 2), and Cost of Ownership (the total cost of maintaining inventory such as warehouse space including utilities and maintenance, finance costs, personnel, equipment, shrinkage, obsolescence, and insurance).

The overarching goal should be to find ways to reduce all types of inventory while ensuring operational needs are being met. This, as with accounts receivable, releases cash tied up in non-productive means so it can be used to gain return or grow the business.

Managing the working capital processes is just as vital to business success as producing products and services that customers want and that fulfills their expectations. Businesses not actively managing their working capital may find an exorbitant amount of financial resources being consumed in unproductive ways such as growing accounts receivable amounts and hefty inventories.

Taking control of your financial processes increases the chances of your business’ success. In the coming weeks Bizmanualz will be releasing the Finance Policies, Procedures & Forms manual, introducing the concept of well-defined and controlled processes to Finance. It can be the first step in understanding your financial processes, and ensuring you receive maximum benefit from your financial resources.

To learn more about changing your paradigm and using process improvement programs for your organization then attend the next How to Align a System of People and Processes for Results class. If you are eager to learn more about creating more order out of the chaos you are feeling at work then the How to Create Well-Defined Processes class is right for you.

ISO 9000 Internal Auditor classes are forming now. Call for information on having your own private in-house classes today.

What Is the Point of an Internal Control System?

It is interesting to note, however, that in many cases the internal control system at public companies consists of a volume of instruction-like procedures that document activities. If a company is taking the time and effort to develop a procedure based, financial control system, then it seems worth the small amount of additional of effort it would take to:

• understand major financial processes
• establish key finance polices and goals (including performance goals as well as producing accurate financial statements)
• determine which processes provide a level of risk or materiality in reaching financial goals
• prioritize development of the control system according to materiality, risk, and other important goals
• incorporate best practices and a continual improvement philosophy to build effective processes and nurture a culture of improvement

Is there a better indicator of an effective control system than clear goals and key performance metrics that are consistently measured and regularly improving?

So the question that applies to companies of all sizes, shapes, and types: Are you taking advantage of the financial control system to improve process results and drive your financial performance upward?

Improving Processes in the Production and Office Space

Discussions of improving processes are too commonly relegated to the production floor. Is it any less important for your office processes to function effectively and efficiently? How well does you company manage financial aspects like working capital, debt and investments, and leasing? These are just as vital to success as how efficiently production operates. Yet, few companies attempt to understand and improve finance processes to the same degree.

In fact, a lack of focus on finance is common, especially among privately owned SMBs. Research shows that a majority of SMBs do not create capital plans, do not actively manage working capital, nor do they conduct analysis of financial statements.

It can even seem a bit humorous to consider the controls and checks businesses put in place, for example, to prevent minor pilferage from the cash drawer, while having no processes in place to, say, conduct basic ratio analysis of financial statements in order to understand the meaning behind the numbers.

Do you know if you are making money on the cash you borrow? Or how about the assets you deploy like accounts receivable, inventory, or cash. What about the asset acquisitions you make? These are hard questions to ask for some but when it comes to business finance, these are the questions you should be asking – before you raise debt or equity capital.

What really represents the biggest threat to the success of your business; Mary Lou borrowing a fin from the till when she is caught short at lunchtime on Friday, or having no thought-out and consistent methods for managing high level financial processes that can represent millions in losses when they go bad? The answer should be obvious.

A Financial Control System that Focuses on Improvement and Success

Of course, we are not saying that businesses should ignore prudent controls over their cash drawer. The point is that focusing on small components while not knowing how much cash is tied up in receivables does not represent a control system that recognizes priorities and risk. Focusing solely on the rote and mundane does little to improve your overall financial performance. Financial control systems shouldn’t just be about compliance, they should be about continually improving key aspects of the financial operation such as:

• Regularly reviewing and improving the overall capital structure.
• Using a capital plan to minimize the cost of capital while strengthening the Debt/Equity position.
• Managing working capital so excessive inventories and receivables do not sap financial resources.
• Ensuring proper calculations and scenarios are explored while making debt/investment or leasing decisions.
• Maximizing returns while minimizing costs for cash and merchant accounts.

A control system of well-defined processes is not only about control or compliance, it is also about consistently striving to do a little better. Control systems that are designed only to achieve compliance are doing the bare minimum, and they represent a missed opportunity to gain improvement and a competitive edge. And that should be enough reason for any size and type of company to think about using a continual improving process approach to creating a financial internal control system. Sox is nice; but continual improvement is better for everyone.

Bizmanualz Procedure Templates Incorporate the Continually Improving Process Philosophy

Last spring we introduced the Bizmanualz Sales & Marketing Policies, Procedures & Forms manual. Our Sales & Marketing manual applied the well-defined, continually improving process approach to a vital business segment. In early March we will be releasing our next manual product – the Bizmanualz Finance Policies, Procedures & Forms. Our goal with the Finance manual is to help businesses of all kinds to take control of their financial processes by consistently implementing best practices, then measuring and reflecting on the results to identify and implement improvements.

There is no reason to start from scratch. All of Bizmanualz policies, procedures & forms products are thoroughly researched to implement best practices while employing a continual improving process approach, and they are reviewed by subject matter experts who work in the field. Plus, every manual includes a CD with all the procedures and forms in Microsoft Word format, so you can easily customize them to meet your needs.

In the coming weeks, we will continue to explore how a process approach can improve your financial performance in areas such as creating capital plans and managing working capital.

In manufacturing and cash flows our goal is to work towards zero defects and doing it right the first time. Both are laudable goals for replication processes that are already designed but how do we do that for iterative processes like the design phase? The answer; You don’t.

Replication Processes

When dealing with the cash or manufacturing cycles you are basically replicating a master process. In manufacturing, you make the same product over and over. Think of it as making copies of a master design. Your cash cycle is the same. You want accounts receivable collected in a timely and consistent manner. Each receivable is collected the same way according to a master process.

In replication you want each copy to be as close to the master as possible, hence your goal is zero defects from the master, while, at the same time, you want it done right the first time to maximize your productivity and reduce waste.

Iteration Processes

Design is about iteration not replication. In design we do not expect to have zero defects the first time. In other words, we expect that a new design will not be right the first time. So we produce an idea and then refine it again and again until we are satisfied that the new idea meets the requirements. Design is an iterative process of refinements. It is the nature of the design process itself.

Your paradigm limits your thinking by literally creating barriers to new ideas. In the design cycle we try out new concepts which expand our paradigm barriers. From these new vantage points we see more new ideas, which then move our paradigm barriers farther out.

Brainstorming

Is your organization designed for change? You see innovation and design come from brainstorming new ideas, seeing the same things a different way, and thinking outside the box. The more new ideas we try the more we refine the concepts we are focusing on and the better the product design becomes.

Law of Diminishing Returns

Iterations come from new ideas but there is a limit to the refinements we can make. As we approach this limit the design is considered “good enough” and we move on until new information, perspectives or old constraints are removed. This is the law of diminishing returns at work.

Thinking Outside the Box

Design flows differ from manufacturing or cash flows because they are based on the principle of iteration versus replication. But how do you continuously innovate to keep the design cycle moving? Next week we will look at thinking outside the box and the keys to innovation, the cornerstone to the design phase.

To learn more about implementing continuous process improvement within your organization, attend the next improvement class How to Align a System of People and Processes for Results . Or, learn How to Create Well-Defined Processes and to document processes.

ISO 9000 Quality Auditor classes are forming now for Internal Auditor or Lead Auditor. Call for information on having your own private in-house classes today.

A lot has been written about lean manufacturing and the importance of balancing your manufacturing flow. But for many, the critical path involves design as in design to order, engineer to order, or build to order. So how do you apply lean in a design to order organization?

There are three core process flows within your company: your cash cycle, your manufacturing (or fulfillment) cycle, and some have a design cycle. What is the difference between these important cycles? Let’s see;

1. Cash Flows

Core Process Flows

Your cash cycle reflects how cash is coming into your organization. It is depicted in the green lines in the core process flows diagram and is comprised of your accounts receivable, inventory and accounts payable processes. Your cash cycle determines the health of your business.

A healthy business has a strong and positive cash cycle, which means that you are collecting money from accounts receivable faster than you are disbursing it through account payable and accumulating inventory. Your cash cycle also determines your working capital needs.

If your cash cycle is negative then you will need to finance your operations with debt or equity capital. How do you know how much your operations need? Just calculate your working capital.

If you add the number of days of inventory to the number of days of receivables outstanding, and then subtract the number of days of payables outstanding then the result is the number of days of working capital your organization has tied up in managing your supply chain.

Your working capital is the investment you are making in the inefficiencies of your processes and procedures plus your investment in your suppliers’ and your customers’ inefficiencies too. The idea is to balance your cash process flows and drive down inventory to reduce your working capital needs. The closer you can get to zero working capital days the more efficient your processes are. Next, there is your manufacturing cycle.

2. Manufacturing Flows

Your manufacturing cycle is found in the blue lines in the process flow diagram and should include your purchasing, production and sales process, which are your three inventory related processes.

The link between your supplier and purchasing determines your raw materials inventory needs. The link between sales and your customers determine your finished goods inventory. Your production process determines your work-in-process (WIP) inventory needs.

In traditional manufacturing organizations, the elements of the production process are separated into functional areas, each with individual goals to maximize their own functional output. Subassemblies or finished goods are built and held in inventory awaiting the next order.

Lean thinking is used to create a demand-based manufacturing flow. Demand-based flow is a form of build to order manufacturing that results in reductions of 50% to 80% in inventory, production cycle time and order lead time. How is this possible?

Balancing the purchasing, production and sales processes results in reduced inventory and its resulting waste. With cash flows, an unbalanced cash cycle produces negative cash flow and the need for increased financing. It is the same with the manufacturing flows. Unbalanced manufacturing flows require more inventory to compensate for all of the variation and unknowns, which increases your inventory, and in turn, your working capital needs.

Do you see how closely the manufacturing cycle is tied to your cash cycle. And yet some people believe more time, money, equipment or people is the answer. But I will let you in on a secret; You don’t need more resources. If you carry inventory then you already have plenty of capacity. Think about it, inventory comes from too much capacity not too little capacity.

Where else do you think it comes from? Raw materials: you bought too much. Work-in-process: your process batches are too big. And finished goods: your sales cycle is too long (probably because you don’t know your customers very well).

In manufacturing, it is all about replication. Increasing your cycle time and making your products faster will reduce inventory, increase quality and bring you closer to your customer. Just eliminate the delays in your processes.

3. Design Flows

Design flows are a little different than manufacturing flows. Design is about iteration, not replication. The dynamics are not the same. That is what we will discuss next week and compare it to the first two important cycles: cash and manufacturing. We have seen how similar they are yet so different. Next week we will also look at design to order, which is where service firms differ from manufacturing firms.

To learn more about implementing continuous process improvement within your organization, attend the next improvement class How to Align a System of People and Processes for Results . Learn How to Create Well-Defined Processes and to document processes.

ISO 9000 Quality Auditor classes are forming now for Internal Auditor or Lead Auditor. Call for information on having your own private in-house classes today.