Page 106 - Accounting Best Practices

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5–9 Link to Performance Measurements and Rewards
5–8 INCLUDE A WORKING CAPITAL ANALYSIS 95
All too many companies have found that their budgets are entirely unworkable
because they have not accounted for the added cash required for working capital.
This is a particular problem for those organizations forecasting extremely high
rates of growth. They do not realize that they must have funds in advance to pay
for the staff and materials required to produce products, as well as to fund the
considerable increases in accounts receivable that will occur. Because of this, a
company finds that its sales take off, as per the budget, while cash reserves
rapidly dry up, resulting in a cash-starved organization that must scramble to find
more cash to keep it growing. More times than not, a promising start is ham-
strung because of lack of anticipation of working capital needs.
Clearly, the budget must account for working capital. There should be an
extra page devoted to it in the budget, or it can be included in the cash flow page.
In either case, the budget should make an assumption regarding the amount of
inventory, accounts payable, and accounts receivable that will occur as sales go
up; for example, there may be inventory turns of 12 per year, accounts receivable
turns of 9, and accounts payable turns of 10. These turnover figures must then be
built into the working capital formulas to determine how much extra cash will be
needed as sales increase. An alternative approach is to assume that all working
capital changes will be cleared in one month; for example, accounts payable will
be paid in precisely one month, and accounts receivable paid by customers in the
same period. This simpler approach is the one most commonly found in budgets,
though it is not quite as accurate as the first method. The importance of accurate
working capital forecasting cannot be overstated, especially for a cash-strapped
company.
Cost: Installation time:

5–9 LINK TO PERFORMANCE MEASUREMENTS AND REWARDS

A continuing frustration for senior managers is to see an immense amount of
time being put into the formation of the annual budget, only to have employees
completely ignore it over the ensuring year. Some wonder why they bother with
the budget at all. A common result is little or no management support for the
annual budgeting process.
The best practice that resolves this problem is to tightly link the budget and
employee reward systems. By doing so, employees are forced to peruse the budget
continually to ensure that their actual performance matches the standard laid down
by senior management at the start of the year—if not, then their next pay raise
and bonus may not arrive, or be much smaller than expected. At worst, they may
find themselves looking for employment elsewhere. To make this best practice
work, the human resources staff should be brought in at the end of the budgeting