Tag Archives: Income Statement

The Dreaded Statement of Cash Flows

How you can automatically generate an actual Statement of Cash Flows regardless of what ERP software you use

Those who have experienced the manual preparation of a Statement of Cash Flows using beginning and period end Balance Sheets plus a periodic Income Statement know that this can be a chore and can cause a little confusion along the way with figuring out how to place the different numbers in the designated sections of this statement.

Fundamentally, the preparation of a Statement of Cash Flows is not that complicated and you would expect all accounting and ERP software vendors to provide a working template with each installation. Many of the software solutions targeted at the small to medium size companies not only do not provide such a template but are not capable of programing this statement and as such, a Statement of Cash Flows is not available to users of these software packages. The result is that a Statement of Cash Flows is not produced in many small and even medium size organizations.

Many companies that are required to submit a periodic Statement of Cash Flows, either because they are SEC filers or their lender asks for it, must produce this statement manually for each required period.

I’ve talked to several ERP software vendors and their typical response was that their GL software was not designed to automatically produce a Statement of Cash Flows because there is no way to tag each GL account with the proper treatment for this statement (i.e., how to use each specific GL account activity or changing balance in the compilation of this statement). This confirms that users of these vendors’ software have to perform this chore manually; that is, if they care to do it at all.

I’ve devised a way to automatically produce an accurate and complete Statement of Cash Flows, in each required period, regardless of what ERP software is used and whether or not its GL can accommodate this statement. To do that I use Budget Maestro from Centage Corporation which is a planning, budgeting and analysis software, primarily designed for small and medium companies in a variety of industries, where actual and budgeted financial statements and various reports can be generated in almost real time from available actual accounting and operations data and existing budget and forecasting data.

Budget Maestro was designed to produce all three major financial statements: An Income Statement, a Balance Sheet and a Statement of Cash Flows for every period included in every version of the budget implemented at the company and consolidated across all business entities that make up the organization.

As such, these financial statements are also available in a special version of the data known as Actual Plan. Here, actual accounting data (e.g., period-end Trial Balance) populate this Actual Plan through an export from the ERP GL or via a direct link available for several of the more popular SMB ERP software.

If you transfer your closed period (e.g., month) GL account balances into the Actual Plan in Budget Maestro (something you really need to do to be able to perform analysis of Budget vs. Actual), you will automatically gain access to all three financial statements (plus many other reports you can set up in the system). The actual Statement of Cash Flows will automatically be generated and available to publish. It will be complete and accurate and you will have the choice between using the Direct Method or the Indirect Method.

The secret to accomplishing this in Budget Maestro is careful planning of the chart of accounts and reporting format. This should closely match the setup of your actual GL and its reporting hierarchy. From that point on it is only a matter of periodically performing the data transfer and updating Budget Maestro with any changes to the chart of accounts as they occur in the ERP GL.

Existing and new users of Budget Maestro now have a viable and practical option to generate an actual period Statement of  Cash Flows. This should no longer be a mystery to many accounting and finance managers and depriving company executives of vital information about the financial performance of their organizations should no longer exist.  Furthermore, by using Budget Maestro as an all-encompassing budget solution, The Benefits of an All-Encompassing Budget, company managements can finally gain real insight into the future financial health of their organizations.

Don’t Deprive your Company Management of Meaningful Financial Information

Why you must make sure financial information is periodically, timely and properly communicated to those who really need it 

There are many blog posts here that focus on how important accurate and complete data is in assessing the financial health of any organization, past, present and future. I’ve also written on more than several occasions on how critical it is to employ the right tools in analyzing financial data spanning historical periods, the current fiscal year and all future periods presented through a plan and budget.

All these data, when correctly used, can provide insight into the company’s performance and even project the financial direction it is headed in and influence the decisions that management must make along the way, such as:

  • Will the company be able to continue and sustain its growth (given that marketing and sales opportunities are executed according to plan)? Are specific changes needed to achieve that?
  • Will it have the cash required for this growth? Will it require additional financing? When? In what amount?
  • What additional employees are going to be needed? In what departments? When?

Or conversely:

  • Will the company have to restructure its operations anticipating a downturn in the economy? Will the workforce have to be reduced? How? When?
  • Will new financing be required in order to be able to weather this economic downturn?
  • Will selling of certain assets be required? When?
  • Is the company facing new competition? Will it need to change its strategic and operational plans?

There is little doubt that such important decisions must be supported by reliable facts; this is true both personally and in business. Simply relying just on experience, intuition or speculation usually does not work. We all see how even large organizations make poor choices and decisions (this is usually discovered months and sometimes years later). We witness badly executed acquisitions (or acquisitions that should not have been made in the first place) and expansions into new product lines and new territories without proper research and analysis of existing data and business intelligence. We observe decisions that were not based on facts or reliable data, or due to inability to properly read and understand that data because of lack of a structured analytics process or poorly chosen tools for this job.

Yet finance executives and professionals are tasked with providing management with this needed information, delivering presentations that are both complete and accurate and also easy to understand.

I’ve seen organizations that had the need and opportunity to set up financial tools that would achieve analysis and reporting excellence, but decided not to. They were simply too wrapped up in their daily work, period end closes and delivery of internal and external reporting. Added to that was tradition and taking the path of least resistance which was often doing the same thing they have always done and were comfortable doing.

This is when finance leadership, driven by a progressive CFO, Why CFOs Need to Adopt Financial Analytics) can make a tremendous difference. They must break the old pattern of doing what they have always done, usually limited to collecting and compiling budget data only pertaining to revenue and expense items, while frequently not even comparing it to actual results and certainly not in a timely manner. A much more progressive approach, which surprisingly does not take more time or resources to complete, yet affords management the right information they need: Why you Must Forecast your Balance Sheet Part 1 and Part 2, every accounting period and in concert with actual accounting results for each closed period and immediately after each close.

When company CEO’s are measured by their organizations’ results and often are replaced when expectations are not met, it is vital that those who lead the organization are given the best possible view of their organizations’ performance, through meaningful reports and presentations obtained from a comprehensive data delivery system, Analysis of Everything that draws from past, present and future (forecasted) data. With a proper system setup, there is no reason why company managements should be deprived of critical information needed for them to successfully lead their organizations.

Head in the clouds

Get Your Head in the Cloud

An easier approach to budgeting, planning, and forecasting

I recently started using Microsoft Office 365 with both on-premises and web based versions and cloud storage of data, accessible from any computer, anywhere as if the data were stored locally. I must say that after a few days and as my skepticism subsided I began to really like this approach (I have been exposed to web-based software solutions for several years now but only in large corporate environments). My experience with certain web based software applications was far from pleasant and with the not very intuitive user interface where hundreds or even thousands of menu items and options were scattered across many web pages I constantly ran into a serious navigation challenge each time I was logged into these applications.

When I found out that Centage Corporation was offering a Cloud version of Budget Maestro I decided to try it. I was assured that the user interface was identical to the desktop version, and all I needed was an Internet connection. I was sent an e-mail with the download link of the VMWare Client which I had to install on my desktop computer, or any device I wanted to be able to access Budget Maestro from. I downloaded the file and installed the VMWare client and within minutes I had access to the latest version of Budget Maestro that looked very familiar and ready to go.

Then, with a simple copy and paste function I moved all my plan files to the directory I chose on the network and from there I was able to restore each plan into Budget Maestro (Cloud Version). This whole process was easy as all I had to do was copy files in a familiar environment.

Then I installed the VMWare client on an additional computer, my MacBook Pro. Same great experience as before. This time I didn’t have to copy any plan files since everything was already there. Within minutes I was up and running.

Today, when I started Budget Maestro (Cloud Version) I had a pleasant surprise. I was prompted that my plan version was older than the application and whether I wanted the program to upgrade my plan file in order to make it compatible with the latest maintenance release of Budget Maestro. I replied with a yes and within a few seconds my plan was upgraded and I was able to enter it. I confirmed that the cloud version was higher than my desktop one and realized how great it is to always work with the latest release and have my data files always compatible with this release. Now I have to download the latest version to my desktop computer and reinstall the software, a slight inconvenience.

My next endeavor will be installing the client application on a tablet and maybe on my phone, although I can only imagine that using a phone to access Budget Maestro is mainly meant for viewing data and not for serious data entry and editing.

It’s been over a month now and I can’t speak highly enough of this software solution’s delivery method. Now I have the latest version of Budget Maestro always there and one set of data files – always the most recent versions. The user interface is identical to the desktop version – nothing new to learn. There are no IT issues to be concerned with and access is available globally, anywhere there is an Internet connection. I also verified that the software works great with slower Internet connections (lower bandwidth) which is occasionally the case when I travel.

Forecast and Monitor your Loan Covenants Compliance

How loan covenant compliance can be forecasted with Budget Maestro and Displayed by Analytics Maestro
There has been a recent series of blog posts on this site of why companies must regularly forecast their balance sheets Why you Must Forecast your Balance Sheet Part 2. There is also an older blog post on one of the benefits of doing that: Knowing whether or not the company will be able to meet its loan covenants imposed by their lender Will you breach your loan covenants?. In this post I would like to present a simple example demonstrating how Budget Maestro with Analytics (www.centage.com) can monitor both actual and budgeted loan covenants using Analytics Maestro with actual data collected by Budget Maestro from the ERP or accounting software and budget data provided by Budget Maestro from the budget plan(s).
The easiest way to explain this is by looking at a very common loan covenant that the majority of lenders use with lines of credit and other types of asset based lending. The typical language found in the loan agreement reads as follows:
“Borrower to maintain a Debt Service Coverage ratio of no less than 1.35 to 1 (this ratio can vary), evaluated quarterly. It is defined as the ratio of Cash Flow to Debt Service, where Cash Flow is defined as: The sum of net profit, income tax expense, depreciation, depletion, amortization and interest expense minus distributions, withdrawals and dividends. Debt Service is defined as: The current portion of long term debt plus interest expense.”
Using the above definition as expressed in the loan agreement we construct the following table using actual results from a fiscal year-end quarter ending on 3/31/2015 plus four budgeted quarters of the 2016 fiscal year: 
blog chart 7-27
The actual and four quarterly forecasted sets of numbers are derived from the Budget Maestro plan and presented by Analytics Maestro. Notice that the Current Portion of Long-Term Debt is derived directly from the forecasted Balance Sheet. Depreciation, Amortization and Interest are derived from the forecasted Income Statement but are dependent on activities occurring within the forecasted Balance Sheet that depend on asset acquisitions, sales and disposals, and changes in borrowings that affect the Interest Expense. These are part of the budget model and are entered through the Capital Assets and Financing modules in Budget Maestro.  As you can see, Budget Maestro handles all this automatically and all forecasted financial statements are seamlessly interlinked, just like in an actual accounting system.
Using Analytics Maestro, both actual and forecasted numbers can be represented in a template, similar to our example template, formatted any way you like, with charts, graphs and other custom formatting. Then, when an accounting period is closed, your actual data will display within this Budget Analytics template, along with all forecasted data. The table shown above is an example of data available in Budget Maestro and used by Analytics Maestro to display the actual and forecasted Debt Service Coverage ratio defining this loan covenant.
In our example, you can clearly detect a deterioration of the Debt Service Coverage ratio.  In the last forecasted fiscal quarter, ending on 3/31/2016 the ratio drops to 1.53, not much higher than the minimum required 1.35 ratio.  This is a concern since additional deterioration of this ratio can cause the company to breech its loan covenants and may result in the lender calling the loan or in other adverse consequences to the company.
However, with Analytics Maestro you see this well in advance.  Note that in this example you’ll be able to display this ratio monthly if that’s how you set up your plan in Budget Maestro (although in this example the lender only requires a quarter-end analysis of this ratio).  Now you can revisit your plan objectives, goals, assumptions and drivers, as well as all data supplied by business unit managers and other data used in building the budget. You can contemplate changes, rethink some of the initiatives and implement changes in the business that will result in maintaining a healthy ratio.  For example:  Maybe declaring a cash dividend for the next fiscal year (2016) is not such a good idea.  Removing the dividend will improve the ratio and create a higher safety margin. 
This approach is true for any changes that must be made in response to forecasted results of not just the P&L but the entire chart of accounts. As we have seen in many of the posts in this blog, real visibility into the future financial health of the company is greatly dependent on the ability to budget all balance sheet accounts and have a way (e.g., via Analytics Maestro) to properly display this forecasted data.
Another idea would be to use the what-if analysis feature available in Budget Maestro.  You can also have multiple plans created as part of the budget model, and applying each version can further assist you in analyzing how this loan covenant ratio behaves with each version of the plan.
The benefits gained through using Budget Maestro’s integrated financial statements, including a complete and accurate forecasted balance sheet cannot be over-emphasized.  Seeing and understanding your company’s future financial health in Analytics Maestro should be one of the most compelling reasons for implementing this software solution. The example in this blog post illustrates only one of the many uses of this software and how important it is to have the right tools at your disposal.
 
 
 
 
 
 

Why you Must Forecast your Balance Sheet – Part 2

It is not as hard as you think and the results will greatly justify the effort

In the first part of this series we saw why we need to be able to forecast our company’s balance sheet.  In this installment we will see examples of how a forecasted balance sheet is constructed and a software solution that allows its users to produce a forecasted Balance Sheet and a Statement of Cash Flows automatically from their budget data.

Here are a few examples:

Your sales on credit generate accounts receivable in the period products were shipped or services were provided.  The forecasted balance sheet (A/R balances, and Retained Earning – Current) needs to reflect that, taking into account all of your credit sales to all of your customers, at the right prices and the right terms.  Then forecasted cash and A/R must automatically reflect collections from these customers, according to forecasted payment terms, which may differ from customer to customer.

At the same time, your forecasted expenses on the P&L will require cash.  This cash will have to be disbursed according to forecasted purchases and their specific payment terms as dictated by suppliers. Your other cash disbursements to employees, taxes, purchases of assets and other expenses shown on your forecasted P&L will also need to be considered and shown on the forecasted balance sheet (and Statement of Cash Flows).

Only then, when you have your forecasted cash receipts and cash requirements (represented by the ending cash balance in each forecasted balance sheet period, as well as the output from a forecasted Statement of Cash Flows), will you know whether or not your plan and budget are feasible and what you need to do in order to prepare for execution of the plan.

Another example is projecting in advance whether or not you will be able to meet your loan covenants Make a Covenant to Properly Plan your Company’s Financial Future or being able to forecast any financial ratio during the planning and budgeting period Why Financial Ratios Should be part of Your Budget and Forecasts.  That alone is worth the effort of having a forecasted balance sheet.

The above example can be carried through to all other sections and elements of the balance sheet.  As in actual accounting, every forecasted activity that appears on the budgeted income statement, must automatically find its way to the forecasted balance sheet and from there, automatically contribute to the creation of a forecasted Statement of Cash Flows.

We saw how hard it is (actually impossible to do it right) to create and maintain a budgeted balance sheet in a set of spreadsheets. Similarly, it is as hard to create and maintain a meaningful balance sheet in most dedicated planning and budgeting applications that rely on user supplied formulas, functions, links or any other user programming.

For these reasons I am a great believer and supporter of Budget Maestro from Centage Corporation which is the only planning, budgeting and analysis solution I have seen so far where the balance sheet is automatically derived from the budget and is automatically maintained; it actually evolves in real time as the budget is built. The secret to this remarkable ability lies in the unique design of the software to behave like an actual accounting system for all future periods. This concept is described here Those Debit and Credits.

Not forecasting a complete balance sheet is a dangerous and risky proposition. I seriously question the validity of the entire process when the future financial health of the company cannot be forecasted.  Every organization that engages in building and maintaining a budget should have visibility into its future balance sheet. This balance sheet must be accurate and complete and above all, must automatically follow all budget input and pre-set business rules.  Not being able to do that due to lack of technology tools is no longer a valid excuse why this should not be done.

Why you Must Forecast your Balance Sheet – Part 1

It is not as hard as you think and the results will greatly justify the effort

I have written several times on this blog about forecasting a company’s balance sheet and the many benefits one gets from it. If this is so beneficial, then why is this so hard if not impossible to do using conventional methods and tools? 

Firstly, if you are still working with a spreadsheet to create your budget and periodic re-forecast, then arriving at a reasonably accurate and complete balance sheet is an unrealistic expectation; there are just too many details that have to be passed to the balance sheet from the income statement forecasting activities, plus keeping track of activities that naturally occur only within balance sheet accounts.

To that you must program your various assumptions, that even for a small organization there are not enough rows in the spreadsheet to properly do it and the number of formulas, functions and links required to maintain it are just too numerous. And did I say “maintain”? It is the maintenance of these large spreadsheets that usually renders the whole exercise futile.

I’ve written here on spreadsheet use for planning and budgeting activities and why it is such a bad idea to use them (Forecasting a Balance Sheet in a Spreadsheet World, and Think you can rely on spreadsheets for financial applications?). Many compelling reasons exist against this practice as more and more finance managers and professionals have come to realize.

It is also a fact that many companies that use dedicated planning and budgeting software solutions do not budget their Balance Sheet or their Statement of Cash Flows, since the majority of these applications, despite being in a more robust, database environment, still behave like a collection of spreadsheets with required formulas and links, exposing their users to the many risks and challenges that spreadsheet users encounter.

Why is the balance sheet so important to forecast?  Isn’t the P&L (income statement) sufficient?  My answer is a definite no. Without a budgeted balance sheet company management cannot forecast the future financial health of the organization. The budgeted income statement allows the company to forecast most of its operations, such as sales with its associated costs, operating expenses, including payroll and its related expenses and anything one would normally see on an income statement.

However, unless there is a forecasted balance sheet, closely integrated to the budgeted income statement (think of your own ERP or accounting software where the balance sheet is seamlessly produced and follows the activities in the P&L, as well as directly receives entries into its own GL accounts) there is little value in just getting a complete and accurate forecast of your P&L.

Can you say with confidence that you’ll be able to execute the forecasted P&L? Will you have sufficient cash to purchase inventory for the projected growth or that new product line you are so eager to launch mid-year of your forecast? What about the additional workforce in your forecast? Will you have the cash to support these new hires? What about the three new positions in marketing and the five more inside sales representatives you determined are needed to achieve the sales targets?

Will you be able to finance this expansion? Will you have to sell additional equity in the business? Issue more debt? Sell assets? Will you have to use one, two or more of these methods and when, during the forecasted period?

As is clear here, none of these questions can be accurately and honestly answered without having visibility into a forecasted balance sheet. For this forecasted balance sheet to work well and be meaningful it must be tightly linked to your plan and budget in a way that every budget line affecting the forecasted income statement and all existing business rules must seamlessly affect the forecasted balance sheet.

In our next installment we will see a few examples and learn how this is all possible.

Why CFOs Need to Adopt Financial Analytics

And why they can’t continue to do their daily work without it

RK Paleru, Executive Director of the Systems, Analytics and & Insights Group at George Washington University recently authored the article “How can CFOs adopt Financial Analytics?”.  He touched on the reality facing the finance departments of so many organizations that are not adopting new technologies and therefore still relying on spreadsheets to deliver the results that support decision making.  While these departments know that these tools are flawed, they still continue to rely upon them.

In response to Paleru’s article, a great discussion ensued on Proformative’s website.  One member commented that accounting and finance departments are so wrapped up in the close process, financial statement consolidations, financial reporting generation and compliance activities, that there is hardly enough time to devote to analytics, especially with the inadequate tools many of these organizations possess.  I tried to reinforce the notion that upper management (the CEO, CFO and certain other management team members) must have timely, accurate and complete data in order to be able to make reasonably informed business decisions.  In addition, major changes have to be made in order for management teams to be able to see and understand their company data immediately, as actual data becomes available and in conjunction with existing and updated planning, budgeting and forecasting data.

My general observation is that many existing planning and analytics software solutions do not provide CFOs the data they need.  This is due to the fact that the majority of the software solutions today cannot produce accurate and complete future period financial statements, and especially the Balance Sheet and Statement of Cash Flows.

This is why I am excited by a new generation of Planning, Budgeting and Analytics software which I call:  “SmartBudget Driven Future Period Financial Statements and Analytics”.  I’m sure this definition will be refined as this software category matures but for right now the essence of it is:

Generating future period financial statements and other reports, driven by a smart budget, prepared using built-in drivers and system pre-defined business rules, automatically consolidated across the enterprise that provides the CFO (and the CEO) with the insight into the future financial health of their organization.

Using this type of software, all the traditional potential errors and omissions are completely eliminated or greatly reduced due to the fact that no spreadsheets are employed in this process and users are never asked to provide formulas, functions, links, macros or any other programming.

The software should also perform analytics in particular areas of interest such as sales and expenditures and respond to any other custom requirements the organization might have.

Another desirable feature is the ability to “drill back” into the source GL containing the actual accounting period results.  By pulling in any required detail data from the GL (as detailed as actual transactions, if the ERP software GL is set up to post into in detail), the analyst can examine specific variances and anomalies, not visible on the summary level.  The root cause of these variances or anomalies can be investigated and any found issues can be quickly remediated.  The CFO, equipped with this information will have the opportunity to make process changes, or make timely and informed decisions.

Analytics Maestro, used in conjunction with Budget Maestro can provide:

  • Sales analytics, using both actual and budgeted data
  • Expenditure analytics
  • Future period Balance Sheet for each budget period
  • Future period Income Statement for each budget period
  • Future period Statement of Cash Flows for each budget period
  • Many other specific reports, tailored to the company’s needs

The future period financial statements can be consolidated or filtered by any entity or level in the enterprise entity hierarchy.

With this data, CFOs can have a pretty good idea of what the financial health of the company is going to look like.  They can see the predicted cash balance, receivables, inventory, payables and other liabilities.  They can easily obtain forecasted future financial ratios determine whether the company will comply with loan covenants whether or not it will be able to utilize its credit lines, whether or not it will be able to retire debt and other obligations in future periods and more.

By using a software like Budget Maestro, CFOs can have a pretty good idea of what the financial health of the company is going to look like.  A CFO can perform his or her job with peak performance when relying on intelligent data in real time.  Not relying on analytics can be a costly mistake. Luckily, there is a new technology available that can change all that.